How Selling A Company Works

How Selling A Company Works

Luke Harris. Partner, Fivecast Financial

Corporate Finance Consultant, Entrepreneur, and Engineer

Luke Harris. Partner, Fivecast Financial

Corporate Finance Consultant, Entrepreneur, and Engineer

Introduction

Deciding to sell a company that you are in control of will likely be one of the most important decisions that you'll make in your life. The goal of this guide is to shed some light on how the process typically goes once you've made that decision, plus provide some pointers on how to achieve a favorable outcome as a seller.



The dynamics of a deal can be very different depending on the motivations of the buyer. The two main categories of buyers are financial buyers, who want to buy the company simply on the basis of its ability to provide them with a financial return on investment, and strategic buyers, who may be able to realize value from acquiring a company beyond just its standalone value. For example, if a company has a B2B software product that they're selling profitably directly to customers, a private equity firm (a financial buyer) might be interested in buying the company because they expect the future profits of the company to provide them with a good return. Alternatively, another B2B software company (a strategic buyer) might want them because their product is very similar to other products that they sell, and this would be a complementary offering for them that they could sell through their existing distribution network. As such, strategic buyers are sometimes able to justify paying higher prices than financial buyers due to the synergies they'll be able to benefit from.



As you might imagine, the best way to get the highest price for a company in a sale is to have an attractive company in the first place - one that's successful, profitable, and growing in an enormous market that no one can compete with. Assuming you're doing the best you can on all of those fronts, there are some additional steps you can take to help achieve the best result in a sale.



Most of the following assumes you've decided to sell the company proactively, rather than reacting to an unsolicited bid. But even if you have received an unsolicited bid, I still recommend going through all of the following steps, and I'll explain more about why as we go.

Process Overview

Preparation Clean up and pull together info on the company to share with potential acquirers

Determine what an acceptable outcome would be

Determine suitable acquirers to reach out to First Round Reach out to potential acquirers to gauge their interest

For those who express interest and sign a "Non-Disclosure Agreement" (NDA), share company overview materials

Meet with (or hold calls with) interested parties to discuss the company and answer questions

Parties interested in participating submit opening bids via a non-binding "Indication of Interest" (IOI) Second Round Serious bidders proceed to the next round and get access to more in depth company information

Comprehensive meetings with management are held

Parties interested in proceeding submit their second round bids via a "Letter of Intent" (LOI)

Final negotiations are held and the best bidder is chosen to move forward Exclusivity, Due Diligence, and Closing The chosen acquirer is granted exclusivity to conduct final due diligence

Final contract is signed, funds are wired, and the Company changes hands A typical sell-side process involves the following steps:

Preparation





In soliciting bids from potential acquirers, there are going to be a lot of things about your company that they're going to need to know in order to decide if they're interested at all. And if they are, there's more they'll need to know to decide what amount to bid. In helping them decide what amount to bid, the more uncertainty you're able to remove for them, the more they'll be willing to pay. People really don't like uncertainty when they're buying things, and companies are no exception. Some uncertainty is uncontrollable (like the possible threat of a new competitor coming out of nowhere), but there's a lot of uncertainty that you can alleviate for them.



The best thing you can do is give them as good of data about your business as possible. Your financials should be accurate, clean, and buttoned-up. If your business is selling widgets, you should be able to tell them exactly how many widgets you sold each month, and how many units every one of your customers bought in each period. You should be able to tell them exactly how much each widget costs you to make, and you should be able to describe in detail how you go about winning new customers. You should have a list of every employee you have, what their role is, and what they get paid. Buyers will often expect to see projected financials as well. All of this type of data is typically compiled into a data room that potential bidders will get access to down the line.



If a potential bidder has uncertainty about any area of your business, that's another possible area of risk to them, and to make up for that increased risk, they're going to have to bid lower than they otherwise would if they had the full picture.



It's worth noting that while emphasizing the bright spots of your business is a good thing to do, hiding things is a very bad thing to do. If you mislead a potential acquirer and they end up buying your company, you're now guilty of fraud. So while you don't need to air all of your dirty laundry in the first meeting, and often declining to provide certain pieces of data until farther along in the process can be a perfectly reasonable thing to do, you cannot mislead them.



The next step of preparation is to determine a reasonable valuation range for your business that is both grounded in reality and is one that you'd be willing to actually sell at.



From a strictly financial perspective, there are a handful of common methodologies that are employed for determining the valuation of a company. The gold standard is the Discounted Cash Flow method. Comparable Companies analysis or Precedent Transaction analysis are also typically used, which both use the known valuations of comparable companies as a proxy for the value of the company in question, typically as a multiple of some metrics like revenue or profit. Another is an affordability analysis, which seeks to calculate how much a buyer would be able to pay such that they achieve a certain target return on investment.



Going into how all of those work is outside of the scope of this article, but it's a good idea to go into a sale process with an idea of what's reasonable and acceptable to you. Reasonable people can disagree on valuation because it ultimately boils down to estimates of what the company's future earnings will be, but it's good to go into those conversations prepared.



If the reason a buyer is interested in your Company is strategic rather than financial in nature, the subject of valuation gets much more hazy, and can often be driven more by emotion than anything else. The most useful lens to use in thinking this through is what value the buyer will be receiving by owning your company. If, for example, they think that you offer a capability that they need to continue surviving, you're the only company for sale that offers that capability, and they don't think they could build it themselves, you will be in a position to receive a premium valuation.



If you expect the sale price of your company to be greater than ~$5mm, I would highly recommend hiring an advisor to help you through the process and help you get the best deal available. (Full disclosure: I'm biased on this point - In some sense, a company is an asset like any other, and is subject to the market forces of supply and demand. As such, the better a job you can do to position your company as a unique and valuable asset (i.e. it's in short supply) and get multiple interested bidders to the table (i.e. it's in high demand), the better your outcome is likely to be.In soliciting bids from potential acquirers, there are going to be a lot of things about your company that they're going to need to know in order to decide if they're interested at all. And if they are, there's more they'll need to know to decide what amount to bid. In helping them decide what amount to bid, the more uncertainty you're able to remove for them, the more they'll be willing to pay. People really don't like uncertainty when they're buying things, and companies are no exception. Some uncertainty is uncontrollable (like the possible threat of a new competitor coming out of nowhere), but there's a lot of uncertainty that you can alleviate for them.The best thing you can do is give them as good of data about your business as possible. Your financials should be accurate, clean, and buttoned-up. If your business is selling widgets, you should be able to tell them exactly how many widgets you sold each month, and how many units every one of your customers bought in each period. You should be able to tell them exactly how much each widget costs you to make, and you should be able to describe in detail how you go about winning new customers. You should have a list of every employee you have, what their role is, and what they get paid. Buyers will often expect to see projected financials as well. All of this type of data is typically compiled into a data room that potential bidders will get access to down the line.If a potential bidder has uncertainty about any area of your business, that's another possible area of risk to them, and to make up for that increased risk, they're going to have to bid lower than they otherwise would if they had the full picture.It's worth noting that while emphasizing the bright spots of your business is a good thing to do, hiding things is a very bad thing to do. If you mislead a potential acquirer and they end up buying your company, you're now guilty of fraud. So while you don't need to air all of your dirty laundry in the first meeting, and often declining to provide certain pieces of data until farther along in the process can be a perfectly reasonable thing to do, you cannot mislead them.The next step of preparation is to determine a reasonable valuation range for your business that is both grounded in reality and is one that you'd be willing to actually sell at.From a strictly financial perspective, there are a handful of common methodologies that are employed for determining the valuation of a company. The gold standard is the Discounted Cash Flow method. Comparable Companies analysis or Precedent Transaction analysis are also typically used, which both use the known valuations of comparable companies as a proxy for the value of the company in question, typically as a multiple of some metrics like revenue or profit. Another is an affordability analysis, which seeks to calculate how much a buyer would be able to pay such that they achieve a certain target return on investment.Going into how all of those work is outside of the scope of this article, but it's a good idea to go into a sale process with an idea of what's reasonable and acceptable to you. Reasonable people can disagree on valuation because it ultimately boils down to estimates of what the company's future earnings will be, but it's good to go into those conversations prepared.If the reason a buyer is interested in your Company is strategic rather than financial in nature, the subject of valuation gets much more hazy, and can often be driven more by emotion than anything else. The most useful lens to use in thinking this through is what value the buyer will be receiving by owning your company. If, for example, they think that you offer a capability that they need to continue surviving, you're the only company for sale that offers that capability, and they don't think they could build it themselves, you will be in a position to receive a premium valuation.If you expect the sale price of your company to be greater than ~$5mm, I would highly recommend hiring an advisor to help you through the process and help you get the best deal available. (Full disclosure: I'm biased on this point - we offer M&A advisory services to people looking to sell their company). There are a lot of pitfalls to avoid, and a good M&A advisor will help you avoid those and help maximize the value you receive. Most M&A advisors will charge a monthly retainer while the deal is going on, as well as a success fee equal to a small percentage of the ultimate transaction price in the event that a sale is successfully closed.

First Round

Once you've prepared the materials on your company, honed your pitch a bit, and given some thought of the value to potential acquirers, the next step is to pull together a list of companies that might be interested in acquiring you, and then beginning the process of reaching out to the appropriate contacts at those companies.



To the extent that you have preexisting relationships or can get warm introductions from your network, you should definitely leverage those. Absent of that, it's time to reach out cold, whether by email, LinkedIn message, phone call, or whatever other channel might make sense for your circumstances.



Reaching out to financial acquirers is pretty straightforward. Their job is to do acquisitions that generate returns for their investors, so they will almost certainly take your call and be eager to engage with you if your company falls within their criteria (industry and size in particular).



Reaching out to strategic buyers is much more complicated. Sometimes your best bet is to get in touch with the company's corporate / business development department (if they have one), as that's often the area of the company that manages acquisitions. Larger companies that routinely do acquisitions will have such a department, but smaller companies often won't. Another approach is to reach out to whatever person in the division that would oversee your company's operations post-acquisition who can become the deal "champion" to sell their colleagues internally and get their buy-in. Getting the attention of the company's C-suite can be a successful approach as well.



This outreach is often done by sharing a 1-2 page "teaser" document that gives a high level run down of what your Company does and provides some key highlights. This is sometimes done on an anonymized basis. If they express interest in learning more, you'll then have them sign an NDA and give them access to the data room that contains the overview materials on your Company.



If they like what they see in the data room and are interested in engaging further, the next step is typically an intro call. This might be between them and your M&A advisor if they just have high level or clarifying questions, and then will be with you directly (the management team of the seller) so the potential acquirer can get to know you and the business better.



After these calls, bidders will be asked to submit an "Indication of Interest", or IOI, which is a non-binding first round bid. This will include a valuation and detail on the structure of the offer. "Structure" basically refers to everything outside of the valuation, like form of consideration (stock vs cash), legal structure of deal (stock acquisition or asset acquisition), timing / contingency of payments (upfront vs deferred, earn-out), employment agreements (or lack thereof) for executives, and so on.



There are other factors to consider in evaluating bids as well, like speed and certainty to close, securing a good outcome for employees and other stakeholders, quality of life and level of autonomy post-close, ability of the acquirer to achieve the Company's vision, and so on.

Second Round

After receiving first round bids from all participating parties, select parties will be invited into the next round. They'll often be granted greater access to information, and management meetings are typically held in person to go into more depth on the business.



After those meetings and the potential acquirers have had a chance to get to know the business better, they'll then be asked to provide revised bids. There will often be multiple rounds of negotiations with all remaining bidders, and it is nearly always in the best interest of the selling company to foster this competitive dynamic between bidders. No bidder is going to be thrilled about participating in an auction, they will often kick and scream about this, and will often try to get you to value other dimensions of the deal beyond just price. Sometimes there is value to you as the seller in such angling, sometimes it's simply a negotiating tactic.



You certainly want to do all you can to not upset the buyer and not make them feel like you don't value them as a partner, particularly if they're going to pay in illiquid stock and want to retain you on the management team, but the message should also be clear that they need to put their best bid on the table if they want to acquire you.

Exclusivity, Due Diligence, and Closing

Once you are through the second round negotiation process, you will then choose the most attractive bidder to move forward with in the next stage. They will draft a "Letter of Intent", or LOI, which lays out in detail the terms on which they expect to close a transaction, their expected timeline to close, and their conditions to close that must be met. This is the stage where the lawyers and accountants from both sides get involved. The LOI is typically a formal contract that has some binding provisions, like granting the buyer an exclusivity period to complete their due diligence, during which time the seller agrees to cease all further communication with other potential acquirers. Occasionally the LOI will contain a "Break-Up Fee" provision, where if the potential buyer fails to close a transaction by the end of the exclusivity period, they owe the seller a penalty fee, which can help keep the buyer from playing games and ensure they're serious. There will also often be an escrow provision, where some percentage of the proceeds at close (typically 10-15%) are put into escrow for some period of time (typically 12 months) that can be clawed back in case you made any material misrepresentations about the business during the sale process (like not disclosing pending lawsuits, not disclosing back-taxes owed, etc).



It is to your great advantage as a seller to make the conditions to close in the LOI to be as minimal as possible. To the extent possible, you should insist that the buyer complete their "business due diligence" before signing an LOI, and that the exclusivity period should be reserved for "confirmatory due diligence". Business due diligence is them getting comfortable with the team, the market, your metrics, your financials, and so on, whereas confirmatory due diligence is them verifying that you actually own the company, verifying that you made the money you say you made, etc. They should be essentially sold on the deal before you sign an LOI, and the exclusivity phase should just be reserved for confirmatory due diligence. The primary reason for this is that you quickly begin losing leverage upon entering exclusivity, and it is to your advantage to get to close from that point as quickly as possible.



Unscrupulous buyers may attempt to get you into exclusivity, have you tell all other potential buyers that they've lost the process and you'll be selling to someone else, you begin losing your leverage, begin getting fatigued by the deal process, and they'll then attempt to renegotiate the deal on you. Unless they identify something legitimate about your business that wasn't disclosed to them previously, or your business has legitimately changed for the worse since you entered negotiations, this is referred to as a "re-trade" of the deal, and is a very shady move. I almost always advise clients not to tolerate this from buyers, and on the flip side I also advise sellers not to do this to a buyer once a deal has been agreed to (assuming the buyer has been acting with integrity along the way).



During the exclusivity period, the lawyers will be working on the "Definitive Agreement", which is the legal document that governs the transaction. Once confirmatory due diligence is complete, both parties will execute the final documents, the funds will be wired and the stock will be legally transferred, and the deal will be complete.

Conclusion