An investment banker told me a story of a business owner who killed the sale of his business at the 11th hour over FedEx charges. The termination of the deal resulted in hundreds of thousands of dollars wasted on the part of the seller along with exposing the business to real risk. Most business owners would not make that decision lightly, and certainly not over a thousand dollar FedEx issue.
I fear that the owner and his advisors allowed the following to take place. The owner finds himself sitting in the dark in his family room at 3:00AM staring at a sheet of paper. The owner is desperately trying to figure out how to avoid making the projection come true. He is about half way through a process to sell his company to his closest competitor. He is reviewing a final estimate of the following numbers reducing his total net payout:
- Total taxes
- Total advisor fees
- Other expenses like tail liability insurance
His final “take home” number is half of what he expected. Worse still, based on updated projections and adjusting his expenses for life post transaction, this amount is starting to feel short of what he really needs to ride safely off into the sunset. The question at hand? “How expensive, damaging, and possible is it to kill the deal at this point?”
Once an owner is deep into the process to sell his business, the cost and negative impact of undoing the process can be crippling. And, most business owners would have allocated their time and resources differently had they known these numbers earlier. Clearly, they would not have started the process if the net result was less than what they needed to achieve their financial objectives. No one wants this result – not buyers, not sellers, not advisors.
Don’t let you or your clients fall into this information gap. Any business owner who is likely to exit using a third party sale process, needs to get ready. Getting ready includes two primary components:
- Corporate pre-sale due diligence
- Personal pre-sale due diligence
Corporate pre-sale due diligence is designed to make sure risks are identified and addressed as early as possible. Ideally, corporate pre-sale due diligence is completed with more than 3 years to go before any anticipated sale or transaction.
However, as outlined above, business owners and their advisors must include personal pre-sale due diligence alongside the corporate pre-sale due diligence. Personal pre-sale due diligence is the careful projection of the net value an owner will receive from likely deal structures after taxes, debt, advisor fees and other expenses. This number needs to be honestly compared to the net after tax number the business owner must receive to experience “Happily Ever After”.
Without this careful personal pre-sale due diligence, business owners can get far enough down the path in a sale process to be hit by the perfect negative storm – the amount won’t be sufficient and the cost to back out will be too high.
To project the net after tax result a business owner can expect, they need to be educated on valuation ranges and transaction types that will apply in their industry and specifically to their business. This information needs to be adjusted for taxation specific to their entity and common deal structures. Outstanding debt must be considered. And, the expected cost of advisors and other expenses must be included. Most business owners are not aware that even good transactions can leave them with 50 – 60% of gross proceeds after everyone else gets paid.
The next step in projecting their personal needs can include some hidden land mines. The challenge for many is getting a handle on their personal expenses post transaction.
In my practice, I call this process recasting the business owners “ME-BITDA” or from the business owner’s perspective – what’s in it for me. I coined this term to mirror an accounting calculation and key valuation metric: Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).
Adjusted MEBITDA is calculated using Modified (personal) Expenses Based on Interest, Travel and Dangerous Avocations. This process makes sure to pick up personally any adjustments to EBITDA made to eliminate business owner perquisites, travel, meals and entertainment expense from the corporate Profit and Loss statement. For example, if the business is supporting $5,000 annually of travel that the buyer will not incur, EBITDA could be increased by that $5,000 expense. The result is a small increase in the potential value of the business as expressed as a multiple of EBITDA. However, the business owners MEBITDA needs to also be increased by the same $5,000. It is our experience that business owners tend to desire a similar level of travel post employment.
Thus, with some additional effort, a business owner will be able to re-cast their personal expenses to reflect their likely expense rate in retirement. As a result, they will be better positioned to estimate the net present value required to support that expense flow. From here, the owner will be better armed to compare what they need against what they are likely to obtain during the third party sale process net of taxes, fees and expenses.
As a result of these two steps – projecting actual net results from the sale and comparing this number to the net present value actually required, business owners will have a greater ability to know when deal structures, offers and concessions will jeopardize their financial health. This information will enable business owners to end unhelpful transactions earlier in the process thereby reducing the economic damage created by exiting a sale process at the 11th hour.
About John O’Dea:
John has spent over a decade working to simplify investment, insurance and succession planning concepts so that business owners and their employees can be more confident in the actions they take to improve their financial future. Operating a business requires difficult and very personal trade-offs. John specializes in helping business owners and their employees model these trade-offs to better understand the net personal impact of financial strategies – especially those present during business owner transitions. See more at: Summit Advisors John O’Dea.
Neither Summit Financial Group nor Securian Financial Services, Inc. are affiliated with Rick Randel or the Randel Law, Inc. Securities and investment advisory services offered through Securian Financial Services, Inc. Member FINRA/SPIC. Summit Financial Group, LLC is independently owned and operated. 2000 Crow Canyon Place, Ste 450, San Ramon, 94583. TR#1290740