The questions entrepreneurs ask
themselves when selling their business.
Below you will find frequently asked questions about selling a company. They will help you better understand some of the key concepts in a sell-side transaction.
When is a good time to sell a business?
For businesses in traditional industries, a good time to sell is generally when your company’s revenues and profits are increasing. This signals to buyers that the business is built upon a solid foundation. For firms in emerging fields, crossing to commercialization or important revenue milestones usually dictate whether timing is favourable or not. In either case, the ability to defend your competitive position and to substantiate your growth potential is critical.
There are external factors that can have a major impact on timing: positive macro-economic trends such as the availability of cheap debt for buyers to make acquisitions; and sector-specific dynamics such as frequent, recent and noteworthy M&A activity.
What is adjusting or normalizing EBITDA?
For buyers to make a decision on whether to buy a specific business versus another, they must be able to compare their operational profitability.
A key measure of operational profitability for most businesses is EBITDA (earnings before interest, tax, depreciation and amortization). It is often not possible to compare two businesses’ EBITDA because owners may pay themselves above-market compensation, or the business pays below-market rent because it owns the building in which it operates.
This is why your sell-side advisor will adjust or “normalize” EBITDA, to show how your business would have performed if it were in different hands. Adjusted or normalized EBITDA therefore plays a fundamental role in the vast majority of company sales, since it allows buyers to compare apples to apples, and thus facilitates a sale.
What are EBITDA multiples?
Multiples of normalized EBITDA are one of the most common valuation mechanisms. Buyers will express their offers as a function of normalized EBITDA times a multiple, which is generally between 3x and 8x for companies with revenues of C$5 to $50 million, but can lay outside that range in unusual circumstances.
How are multiples set? Typically, the higher the revenue the bigger the multiple, because larger companies are less common and more stable; therefore, buyers are willing to pay bigger multiples to acquire them. Size is not the only parameter that affects multiples: revenue growth rate, above-average operational margins, whether the management team is of high quality and will stay after the sale, patents and other intellectual property, quality of the information provided to buyers, and whether there is competitive tension between purchasers also affect multiples.
Besides EBITDA multiples, are there other ways to value a business?
For many fast-growing businesses, especially those with recurring revenues (such as software-as-a-service multi-year subscriptions), EBITDA can lag actual cash flows. For that reason, such companies are often valued on a multiple of revenues.
Companies in other stages of their lifecycles (e.g. pre-revenue start-ups, or firms in distressed situations) will be valued using other methodologies.
How can I increase my business valuation and get the highest price?
There are two answers to this question…
(1) Before exposing your company to potential buyers, you need to show strong financial and operational performance in your most recent operating periods – but without compromising future growth prospects. Some companies do this internally, but many opt to bring in an external consultant.
(2) Once your company is in market, your M&A advisor must aggressively yet tactfully introduce your business to multiple relevant buyers, in order to create an auction-like environment. All else being equal, generating multiple bids can increase the actual sale price by 15%-60% over a buyer’s initial offer.
How can I find my potential buyers?
It is normal for you to have a sense of some of the most likely buyers for your business. However, about 75% of our clients sell to buyers that they didn’t consider ahead of engaging with us. On a typical mandate we are able to engage between 40 and 200 relevant acquirers across the world, ranging from private equity firms to strategic buyers. We locate these buyers through our own proprietary database, other restricted-access resources and our partnerships with other advisors. Doing so significantly increases the likelihood of closing the deal at a great price, with a buyer who is a great fit.
Why can a deal fail?
There are many reasons why deals fail, even after the two parties are aligned at a high level and sign a letter of intent.
The top reason for the buyer to walk away is that the seller’s financial performance decreases materially during due diligence. This is why it is critical to carry on business as usual, despite the extra demand on your time that the transaction calls for. Trying to manage the deal on your own is extremely challenging, and is one of the main reasons why entrepreneurs choose to partner with an M&A advisor.
Material discoveries during the due diligence process are the second reason that kills a deal. Whether a seller intentionally or unintentionally withholds information, it puts the deal in serious jeopardy every time: a buyer’s trust can erode very quickly. A good M&A advisor must invest a lot of time to ensure that no stone is left unturned and that mitigating solutions are presented for any challenging aspect of your business.
What is the difference between selling shares and selling assets?
Under an asset purchase, the buyer acquires some or all assets of a company, and the shareholders of that company retain the shares of the legal entity, which may become a non-operating “shell” entity. Purchasing the assets of a company significantly mitigates the buyer’s risk of taking on undisclosed or contingent liabilities. Though a more complex transaction, buyers often prefer an asset purchase, since due diligence is more specific to the assets, and it allows the buyer to peg higher capital cost allowances on the cost of depreciable purchased assets, which reduces its tax burden.
When purchasing shares, the buyer acquires ownership of the seller’s legal entity, which comes with all existing assets, known or unknown liabilities (excluding debt, which is normally paid off from closing proceeds), and the tax history of the seller. From legal and procedural standpoints, a share purchase is simpler than an asset purchase, with no need for extensive legal work to specifically define what assets and liabilities are being purchased.
What are the possible tax consequences of selling a business?
The structure of a deal has a significant impact on tax consequences for the seller. For example, under a share purchase, the seller realizes a capital gain if the shares have increased in value. Tax rates on capital gains are more favourable than regular income rates. Furthermore, in Canada, the seller may further decrease its tax burden if it qualifies for the lifetime capital gains exemption of $824,176 (in 2016).
An asset purchase often leads to double taxation for sellers: once at the corporate level and again at the individual level once proceeds are advanced from the target company to the owners. In some transactions this is unavoidable, and in others it is preferable. There are many tax-related nuances, and it is critical to discuss your specific situation with a tax accountant.
How long will it take to sell my business and how much time will I have to commit?
Typically, it can take anywhere from 6 to 18 months to close a transaction. Here are the typical stages of a sale:
Preparation of marketing materials: This usually takes about two to four months and your typical time commitment is three to four days, spread across interviews, gathering information, and reviewing and approving marketing collateral.
Identification of potential buyers: This usually runs in parallel with the previous stage, and since you need to review and approve the list, you will need to commit about a day of your time.
Go-to-market campaign: Contacting and qualifying buyers usually takes about two to three months, and you would typically need to commit one to three days of your time for conference calls and meetings.
Receiving and negotiating LOIs: For one to two months, we will run the auction and select the preferred offer. This will require two to four days of your time to discuss and review the LOIs.
Due diligence: This stage takes two to three months and is typically the most demanding time, since the buyer is investigating your company in tremendous detail. Be prepared to put in one or two weeks at this stage.
Legals and closing: Finalizing the agreements and closing the deal takes approximately a month, and your legal counsel will demand a significant portion of your bandwidth, as they will need you to review all agreements.
From the archives: October 2018
Buyers' Perspectives in a Competitive M&A Market
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