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Capital Ideas for Middle Market Businesses

Evaluating the Offer

By Jay Carter, Managing Director
San Diego Office
Corporate Finance Associates

question marks

As an owner, you are likely to have multiple opportunities to sell your business. When you receive an offer, how do decide whether or not to accept it? Should you negotiate for a better deal? Should you find a different buyer altogether? Should you do nothing? Before answering these questions, it helps to put the offer into proper perspective.

First, consider the offer in the context of the market. Second, consider the offer in the context of your goals. A market rate offer that meets your personal and financial goals is one worthy of careful consideration.

Is this a market rate offer? This can only be determined by obtaining multiple offers from qualified buyers and comparing them. Valuing a privately-held company is tricky, and it cannot be done in a vacuum. Rules of thumb and “comparable” valuations provide valuation pointers, but they do not determine the true market value of a business. A well planned sale process produces multiple offers within a short period of time and enables objective evaluation of each. Without multiple offers, it is impossible to know whether the valuation and terms offered are fair for your business.

What are your goals for a sale transaction? Merely receiving a strong offer—and even completion of a sale—does not assure success. Success is achieved when the sale transaction aligns with well-defined seller goals. Your personal and financial goals should provide the framework within which each element of the offer to purchase your business is evaluated. How much income will you need? Do you have family gifting or philanthropic aspirations? How will you spend your time after the sale? What about your employees? Your goals for the transaction are as important as the transaction terms. If you take time now to establish your goals, you’ll be in a much stronger position to evaluate offers when you receive them. (For information about planning for life after business, check out “Halftime” by Bob Buford and “From Success to Significance” by Lloyd Reeb. These books were written to help people find renewed passion and purpose outside of a successful professional career.)

With the contextual framework of the current market conditions and the seller’s personal and financial goals, here are four key considerations when evaluating any offer:

  1. Valuation

  2. Form of Payment

  3. Post-transaction responsibilities in the business

  4. Post-transaction liabilities/risks

Valuation
The business valuation should be clearly stated in the offer. The value offered should be appropriate for the business based on the current market conditions. The value should also be adequate to meet the seller’s financial goals. If both of these conditions are met, take a look at the transaction structure.

Terms of Payment
The method the purchase price is paid to a seller can be as important as valuation when considering an offer. An all-cash offer is the easiest to evaluate and is normally most-desirable to a seller. Other forms of consideration are i) seller notes, ii) earn-outs, iii) retained equity, and iv) consulting or non-compete agreements. Anything other than cash at closing represents risk to the seller. A buyer likes the seller to share in the risk after a transaction is closed; it keeps the seller interested in the future success of the business. Sometimes non-cash forms of consideration are used when bridging a valuation gap between buyer and seller. Similarly-valued offers can have disparate payment terms, necessitating a thorough understating of the payment terms.

Post-transaction Role
Does the offer require the seller to play an active role in the business post-closing? Buyers normally require some period of time (3-12 months) for transition after closing, but they may require longer-term employment after closing. Consider what impact this has on your post-transaction plans. Employment and compensation terms may or may not be included in a written employment agreement. Compensation for post-closing employment should be considered separately from the purchase price.

Post-transaction Liabilities/Risks
What risks does the seller retain after closing? One of the primary benefits of selling a privately-held business is for the owner to reduce risk by diversifying their assets. A seller note is one way that seller retains risk after closing (and limits their ability to diversify). If the business does not perform, the seller note may not be paid. Other post-closing risks for sellers may be in the form of liabilities that are not assumed by the buyer, such as bank loans, accounts payable, taxes, warranty claims, lawsuits, and unreported liabilities. Sellers also take on the risks associated with representations and warranties they make in the sale documentation. Limiting post-transaction risk can be very valuable to a seller.

If, after careful consideration, you have an attractive offer, it is still not time to accept it. The buyer’s first offer is never their best. Consider the acquisition from the buyer’s perspective, check your goals again, and then respond with an informed counter offer. Within this framework, responding properly to an offer on your business can provide a solid basis for the most significant financial event of your life.


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