This morning a client I have been working with for several months to help him sell his company and I were on the phone with a potential buyer, when without warning my client dropped a huge bomb into the conversation. Basically he threw a fact out that significantly reduced the profitability of his company and thus the price he could expect to receive for his business. Ouch.
As his sell-side advisor and investment banker, this is something he should have told me in the very first month of our relationship, while we were working on the valuation and putting together his presentation. Unfortunately this is not the first time this client has failed to disclose pertinent information that would affect the value of his company. I wanted to pull my hair out! I thought, “I wonder if sellers know how critical it is they don’t hide information from their advisors or potential buyers – even if it lowers the value of their company? What other important lessons I have learned over the years I have been valuing and selling companies that would be helpful to a manufacturer as they contemplate their exit strategy?”
I decided that key lessons I’ve learned over the years would be both entertaining and beneficial to my readers, many of whom are likely thinking of selling their companies in the next few years as the demand for pet companies continues to be incredibly strong. If you are one of those companies, here is an insider’s look at WHAT NOT TO DO WHEN PREPARING YOUR COMPANY FOR SALE:
1. HIDE BAD NEWS. As I mentioned above, this client continues to present one piece of bad news after another that we should have known about at the very beginning of our relationship. Had we known then what we know now, we would have had a very different approach to the engagement. Hiding bad news only produces negative feelings and disappointment. The lesson I learned is to ask way more questions in advance of taking a new sell-side client. Questions that would have alerted me to the brain damage I was about to receive.
2. HAVE LOW MARGINS. As a manufacturer, your value is driven by your margins – especially your gross margins. Unless you are a high volume food producer, margins lower then 35-40% are not appealing to a potential buyer unless they can see a clear and immediate path to improving those margins. I made the mistake of taking a client who had 29% gross margins, and then spent the next year trying to find a buyer for what otherwise was a great product. Every potential buyer that declined to pursue said the same thing – the margins are too low.
3. HAVE NON-EXISTENT OR MESSY FINANCIAL STATEMENTS. You can’t expect a buyer to pay you a high multiple of cash flow based on good looks alone.. The importance of having buttoned—down financial reports cannot be overstated. Several years ago I tried to sell a $15 million dog treat company, but it became impossible because the seller wasn’t willing to spend a few thousand dollars to have his financial statements cleaned up and reviewed by a CPA. After nearly two years and 250 hours of my time, I finally had to give up. Recently I have been working with a client on a buy-side engagement, helping them find pet companies to purchase. We looked at dozens of companies, and I was shocked at the number of businesses of decent size that do not have professionally-done financial statements. In several cases, it resulted in us passing on the opportunity to buy the company. Folks, it is worth the investment to hire a professional to keep your books, especially if you are thinking of selling the company anytime soon.
4. HAVE DECREASING REVENUES. I cannot begin to tell you how much harder it is to sell a company whose revenues are in decline. The challenge is that buyers will usually not put a value that is acceptable to the seller if revenues are not growing. The price expectation gap gets wider and wider the more significant this problem is. As you may know, companies are valued on a multiple of their EBITDA (earnings before interest, taxes, depreciation, and amortization). Multiples for pet product companies that are growing and have strong margins are in the 7 to 10X EBITDA range. Multiples for companies that have declining revenues and poor margins are in the 4 to 6X EBITDA range.
5. NOT HAVE INTELLECTUAL PROPERTY. When advising clients on exit strategies, I always emphasize the importance of having patents, trademarks, and copyrights because unfortunately the pet industry is full of companies that don’t think twice about knocking off someone else’s original idea. If that idea is not IP protected, it could mean the difference between poverty and prosperity for an inventor or business. Just being able to advertise having a patent, trademark, or copyright is often enough to keep copycats at bay. And when you go to sell your company, having that IP will significantly increase not only your value, but also your opportunity to appeal to a wider range of buyers. Sophisticated buyers want to know that if they are paying good money for your company, the product will be protected in the market against knockoffs.
So before bringing your company to market for sale, work as long as hard as you need to create year-over-year revenue growth, margins in the 35-50+% range, and as much intellectual property as you can possibly create. If your goal is to build enough wealth to live happily ever after, these strategies will get you there. Just Do It!
Carol Frank of Boulder, CO, is the founder of four companies in the pet industry and a Managing Director with BirdsEye Advisory Group, where she advises pet companies in M&A transactions and Exit Planning. She is a former CPA, has an MBA, is a Certified Mergers and Acquisitions Advisory (CM&AA) and holds Series 79 and 63 licenses. She highly values and incentivizes referrals and can be reached at cfrank@birdseyeadvisory.com.