Tuesday , December 11, 2018

Part VI: One More Time—Why Sell to “Insiders” Who Have No Cash?

The last three articles have focused on the 10 important elements of a business owner’s plan to successfully sell or transfer his or her company to “Insiders” (family members, key employees and co-owners).


Some of those business owners who read these articles are probably saying, “I really don’t think I’m interested in a sale of my company to Insiders. I simply don’t want to spend all that time planning and making sure all of those elements are in place. Anyway, I’ll get more money and more cash upfront if I sell my company to an outside third party.” These owners believe there is far less risk and time involved selling to a third party than to Insiders.


Are they correct? As diplomatically as possible, we suggest that they just might be dead wrong!


Third-party sales involve risk. Sales to third parties are less risky than sales to Insiders only if a business can be sold for all cash or if there’s simply no time to implement a carefully designed sale to an Insider.


Investment banker Kevin Short reminds owners that unless a company has more than $1 million (or even $2 million) in EBITDA, is in an attractive market sector, has strong fundamentals, and enjoys a unique competitive advantage, it is unlikely to sell to a third party for substantially all cash. Also, the sale is likely to be structured as a small amount of cash upfront together with an “earnout” which is only paid in full if the company meets its projections going forward over the next several years.


Selling to a third party requires a third party wanting to buy. In a difficult M&A market, being in an attractive market sector is more important than ever. Again, according to Kevin Short, “hot” or “niche” industries include power, alternative energy, health care, medical services and healthy-living products.


Companies engaged in construction, retail, real estate, automotive and consumer products will find it difficult to attract a buyer in today’s marketplace. Most owners who are able to find buyers for these “project-based” businesses discover that valuation multiples are typically low and cash upfront minimized.


Our experience has been that for most companies, today’s M&A market is certainly more active than two years ago, but companies with less than $1 million EBITDA are unlikely to receive a purchase price of more than 4 times EBITDA (cash flow). The most realistic owners quickly realize that there simply are no third parties interested in their companies.


Waiting for third party buyers involves risk. We suspect that some owners hold to the belief that there’s little risk in waiting for a third-party buyer because it provides an excuse to “avoid the hassle” of planning. But, what if a qualified buyer doesn’t show up? What happens if, when you are ready to sell, the M&A market is dormant, or your industry niche has fallen out of favor, or your business and/or the economy is in decline or worse?


Why subject your future financial security to these uncertainties? Why not assume control of your exit—your life, really—by creating an exit strategy that allows you to choose your buyer, name your sale price, control ownership until you are fully paid; and shift the burden of the company’s future performance from you to the buyer?


Insider sales require time to plan. While sales to Insiders require work on the owner’s part, sales to third parties can require just as much work and be just as time-consuming.


Once owners understand third-party sales, they usually agree—especially if their companies are too small to attract qualified third-party buyers—that transferring to Insiders can be a far better course than liquidation.


The objection to Insider transfers: “Insiders do not have money to begin buying your company.” That’s true—today. But they can, and will if your company has a good management team that desires ownership, your company has good cash flow, and you have ample time before leaving to design a tax-sensitive transfer plan and to implement that plan.


Insider sales yield cash. Owners can often get as much cash (with no more risk) in an Insider transfer as they can from a third-party sale if they have time to work with their advisors to design and to implement a plan. For many smaller businesses, a sale to Insiders may be the only alternative to liquidation.


If owners use their time wisely for small businesses, there’s no reason that the Insider transfer cannot yield as much cash as the third-party sale.


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