it’s easier to estimate the value of this part. Beyond that, there are many variables that tend to influence the perceived value. Prof- itability and cash flow are among the most important elements of value. You can chat about buyers and value with a business broker in your area, but remember: They are motivated to complete a sale and thus collect their commission, which is typi- cally 10% of selling price. Far too oſten, business owners convince themselves (even without the aid of mari- juana, opioids or liquor), that their busi- ness is worth some astronomically high value. With that in mind, this is probably a good time to reveal that the Easter Bunny is not real! Go ahead and take a reflective moment before moving on. I’ve played key roles in both large and small company acquisitions, and my ex- perience has been that standard formulas (which can be somewhat useful) are oſten not the driving force in establishing pur- chase price. In the real world, we need to think about who the buyers are and why they are interested in buying the business. Are they planning to merge or absorb your business into their existing compa- ny? Is the buyer a passive investor look- ing to be an absentee owner and expect- ing the business to essentially run itself? Of course, a primary determining factor of price is why the company is “on the block.” Who initiated the discussion and why? How many potential qualified buy- ers are there? There are always at least two prices: cash and terms. If you’re expecting to receive a check with full payment and just walk away, you will no doubt receive a relatively lower price for your business. You will also likely face some tax consequences associ- ated with a sudden and large slug (lump sum) of income for that particular income tax year. Needless to say, requiring a cash deal will also severely narrow your popu- lation of potential buyers. WWW.ALOA.ORG Of course, in a cash sale, you won’t have to strap on the risk associated with get- ting paid in the future, and this risk is very real. Once upon a time, a small business owner asked my opinion regarding the offered price of an unsolicited cash offer for her successful business. Upon con- sidering all of the known elements, my recommendation was to accept the price. The seller did the deal but initially felt they received less than a fair price for the business. However, when the new buyer/ owner subsequently drove the business into the ground in less than one year and had the state chasing them for sales taxes, suddenly that lower cash price didn’t look so bad aſter all! Strange things can happen. Payment terms almost always result in a higher price than an all-cash deal but definitely carry greater risk. But if your buyer company fails or files bankruptcy, your chances of getting paid any balance due could evaporate or greatly dimin- ish. You can possibly negotiate a hybrid model with a substantial down payment and the balance financed over typically three, five or seven years. Other Terms and Conditions Sometimes, transaction terms include the seller remaining available (or actively on the payroll as a consultant) for a transi- tional period. Some types of deals are structured so that the ultimate sale price is somewhat dependent on the performance of the business aſter the sale. This is known as an “earn out.” The idea is to mitigate the possibility of the business falling apart (possibly because of primary customer accounts being lost) shortly aſter the sale. Such arrangements provide a smoother transition while the new ownership takes control. Unless there are binding con- tracts for continued work with customers, what assurances does a buyer really have that these customers will remain loyal? Probably none! Buyer’s Due Diligence Although this article is about exit strate- gies, you might one day find yourself in the role of a buyer. Or, part of your exit strategy could include a merger as an in- terim step or end game. Under such scenarios, you’ll proba- bly have a vested interest in learning as much as possible about your intended seller or partner firm. Indeed, part of your exit strategy may be to look at ac- quisition candidates to hone your skills in this area long before you’re expecting to sell your business. You can expect to sign an NDA (non- disclosure agreement) in which you pledge to protect confidential informa- tion about the seller company that is dis- closed during your due diligence process as prospective buyer. Some companies (more than you might suspect) do this as a guise for competitive market re- search. I leave it to you to sort out the ethical issues! You might not know the Latin phrase caveat emptor, but you are likely to be familiar with the English translation: “buyer beware.” Perhaps nowhere is this concept more important than in a poten- tial buyer’s due diligence process. Due diligence means the research, in- spection and assessment process that a buyer engages in prior to a purchase. Some would call it “kicking the tires,” “looking under the hood” or “doing your homework.” Take the example from one of my past lives where I was asked to help a buy- er structure an offer to acquire a well known, branded, 100-plus-year-old con- sumer products manufacturer. The buyer was an experienced and a savvy business- man but had never been directly involved NOVEMBER 2020 KEYNOTES 21
