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Article originally published in Business Vancouver.
The art of completing a successful acquisition or divestiture requires skill, insight and exceptional planning. The first step of the process is to develop a strategic plan that considers your business’ needs and goals. Are you planning to acquire a business or an asset as part of your long-term growth strategy, or has an opportunity suddenly made itself available? Are you selling your business or certain assets as part of a retirement plan or to move on to a new enterprise?
When it comes to buying a business, identifying the appropriate business and then identifying the appropriate value of the business is critical. Paying too much for a business can have serious ramifications, affecting the future profitability and financing capacity of the business. To help understand if the selected business is the right business for you, it is very important to understand whether the amount of earnings the vendor is claiming the business brings in is sustainable – to understand the quality of earnings – before you finalize the deal.
Being aware of the quality of earnings is not just about looking at the numbers, although that is an important indicator. It requires developing a thorough understanding of the target’s overall business operations, growth prospects, tax ramifications and industry outlook. That entails spending one-on-one time with management of the target company before even looking at the detail behind the financial statements. This first step gathers the information you need to determine your risks.
To better understand where your risks lie, you first need to understand how the business operates and do financial, customer and vendor analyses. For example, if you know through a conversation with the management of the target company that one customer makes up 40% of sales, you can focus your work on how quickly that customer pays, calculate the percentage her purchases have increased or decreased, determine how vulnerable the company is to its existing orders, etc.
Every quality-of-earnings investigation identifies at least one issue that the buyer needs to know. If it affects the value of the business, the buyer and vendor are usually able to renegotiate the deal in the buyer’s favour. Even serious issues can be resolved if they are brought to light before the deal is finalized.
While it is possible to have your internal accounting team check the quality of earnings, there are certain instances when it is important to have an independent third party specializing in transaction advisory do the work for you. This is especially important when you are seeking financing. A transaction advisory specialist will also be able to help structure your acquisition in a way that will maximize the capital and tax advantages available to you.
Done properly, due diligence to check the quality of an enterprise’s earnings is like insurance for buyers. Accurate information in hand, you can understand the issues ahead of time, renegotiate the deal based on the earnings that are really there, structure the transaction in a beneficial manner and complete the transaction successfully.
Upon deciding that you would like to divest your business, it is very important to develop a strategic plan identifying your timeline to divest, what you are looking for from a divestiture process (financial return, continued employment for yourself and/or your employees, etc.) and who might be the “right buyer” for your business.
But who exactly is this so-called right buyer? Your choice is between a strategic buyer – a company that operates in the same, or a complementary, space or industry as your company – or a financial buyer, which is an individual investment company seeking acquisitions that provide favourable profit and cash flow. The key to selecting the right buyer is to identify your personal and business goals. Some of the factors to consider before selling your business include timing your exit, employee security, company culture and risk tolerance.
If you want to remain with the business, a financial buyer may be a preferred partner. Strategic buyers may look to introduce their own management into the target business shortly after the transaction closes, giving you a few months to two years to transition out of the company.
Strategic buyers may also want to integrate your company within their existing operations, meaning layoffs as synergies are achieved. If protecting loyal employees is a high priority, look for financial buyers aligned with this goal. A financial buyer entering a new market through acquisition may need to keep all existing personnel.
With a strategic buyer, you are likely to have limited execution or industry risk after the transaction, unless you agree to an earn-out or vendor take-back as part of your deal. As it is more likely that a financial buyer will require continued ownership by a seller post-transaction in a minority form or relatively significant earn-out or vendor take-back provisions, you will likely continue to hold execution, industry, governance and control risks post-transaction. Deals with financial buyers also typically involve recapitalizing the balance sheet, meaning additional risk to ongoing operations of the business due to added leverage on the balance sheet.
The divestiture process is complex and needs to start with an open dialogue around what the owner is looking to achieve. Understanding your goals, it is then possible to develop a strategy and identify prospective buyers that are most likely to maximize the achievement of those objectives. With planning, you can execute a transaction that will be successful in more ways than just financially.
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