What to do with the business – Part II

By Roger Grochmal 

 

Selling your company is one of the most important decisions you will make in your business life. In the May/June 2021 issue of Mechanical Business, I wrote about the things you can and should do to establish the highest value for your company, whether you intend to sell or not. Once you have decided to sell your company, it will take discipline and commitment to make it a reality and to get the full value for the hard work you have invested over the years.

The first question you need to answer is: do you want to walk away when the deal is done or continue working? This is important for two reasons. The first is that most contracting businesses are built around the skills of the owner and when you walk away, much of the value in the business walks away too. This will impact the price someone is willing to pay.

A purchaser will usually want you to stay involved for a period of time, often two to three years. If your business is large enough a second opportunity may present itself. Your business could be of interest to a private equity buyer looking for an anchor company around which to expand from.

 

STEP 1 – Who do you sell to?

There are four classes of buyers. You can sell to family, employees, a financial buyer, or a strategic buyer such as a competitor. Selling to family is complicated for a number of reasons. Family dynamics play a big role, especially if there are children who are not in the business. How do you establish a price that is fair for your legacy to all of your children without saddling the next operator with so much debt that the business is unable to grow? Do you have the resources to be the “Bank of dad”? To sort all of this out estate planning can become quite complicated.

Selling to employees can be equally challenging, as very few have the financial resources and they, like your children, will look to the owner to provide the bulk of the financing.

In either case, will you be able to completely retire from the business when your money is on the line? A good shareholders’ agreement that clearly sets out responsibilities along with dispute resolution mechanisms is essential for all parties.

Most of the activity is occurring in the last two buyer categories. Businesses with good recurring revenue (service agreements) or very sticky customers are attractive to financial players. Competitors look to acquire businesses so that they can become more attractive to financial buyers.

 

STEP 2 – Finding a buyer

The first step in the sales process is to quietly look for a buyer on your own, or advertise your intent to sell to a targeted group of potential buyers using a business broker or investment banker. Make sure you have a clear understanding of their fee structure and what you expect them to do for their money.

Once you have identified potential buyer(s), the work begins. All parties need to sign a Confidentiality or Nondisclosure Agreement. Confidentiality is paramount. Once employees find out the business is for sale, all of their energies become focused on rumours as to what their individual futures hold.

You will want your lawyer or accountant to set up a virtual data room to upload a good range of confidential information such as financial statements and key performance metrics for the business. It is important for you to control this process so you can limit who has access to confidential data.

This is where I put in a plug for lawyers and accountants. Buying and selling businesses is not something our regular lawyers and accountants do every day. Find the best people experienced in mergers and acquisitions that you can afford. If your transaction is large enough, you may also want to avail yourself of tax experts who focus solely on the tax implications of selling businesses.

 

STEP 3 – Coming up with a short list

After potential buyers have looked at the preliminary data you provide, you need to narrow the field down to a short list of serious buyers. Now you can have a series of meetings to negotiate the price and terms for the deal. Key considerations at this point are shares versus assets. Buyers like to buy assets to limit exposure to warranties and other business problems that might arise down the road.

Sellers like to sell shares usually to take advantage of generous capital gains allowances in Canada. If you are in no real hurry, structure your business ownership to take advantage of this opportunity. This legal structure needs to have been in place for at least two years before the transaction takes place to be allowable by the Canada Revenue Agency.

Are you looking for a fixed price or doing a formula? Even a fixed price transaction will have formulas attached, since everything is based upon information you provide at the beginning of the process that may change by the time all the dust settles and the transaction closes. Ensure all formulas are as well defined and detailed as possible.

Once all of these matters have been agreed to, the next step is to sign a nonbinding Letter of Intent (LOI). It is nonbinding because the buyer at this stage still does not know much about your business and if something material is discovered, they may choose to walk away. Among other things it will include future details of purchase and adjustment formulas, your employment, noncompetition if you leave, and holdbacks to be taken.

 

STEP 4 – No pain, no gain

This takes us to the next and most painful step and that is “due diligence.” The buyer will usually request every bit of information possible about your business including everything that could create liability down the road. This includes copies of every contract you have ever signed, information about customers, suppliers, employees, inventory, warranties, service agreement programs, and so on.

You, and they, will know more about your business than you have previously known. It is crucial that you hold nothing back. Failure to disclose something may cost you big time if it comes to light, as you will be required to provide substantial “reps and warranties” against all of these future events.

This is a full-time job. The expectation in the LOI is that you will continue to manage the business in its regular course while all of this is happening in the background. It takes a lot of time. In our case, my son continued to manage the business while I looked after fulfilling the due diligence requirement. Even then, it still took us three months, which I was told was quite quick.

 

STEP 5 – The final lap

The final step is for the lawyers on both sides to draft and agree on a definitive Sale and Purchase Agreement (SPA). This is another place where good legal expertise is required as those of us who operate HVAC/R and plumbing businesses will never understand the many nuances.

The virtual world has actually made this process less onerous. It is a lot easier to maintain confidentiality as no one needs to traipse around the building asking questions of your staff. Secondly, signing electronic documents is easier than physically signing multiple copies of multiple documents. It is a daunting journey, but when you see the money in your bank account at the end, it will definitely be worth it.

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