By: Patrick Ungashick
This short case study tells the real story of a business owner who was sure he was ready to sell his company, only to find out that being “ready” takes more work than it might seem. This true story also shows how even a little proper planning pays big dividends. (Note: The names and some of the details have been changed and marked with an asterisk* to honor this former client’s confidentiality.)
Reggie* was ready and eager to sell his company — now. He explained that he expected to close within the “next 30 days — 60 at most,” during his initial phone call with me.
He explained that he was holding a LOI from an eager buyer who had contacted him and made a great offer. But, before signing the LOI, he thought it would be good to have our team take a look, as he had heard of us and what we do.
“I am ready to sell now, however,” he cautioned me during this call. “I don’t care if it’s not the absolute highest price out there. I know this buyer, and they are making lots of acquisitions. It’s a good price, and they’ll close quickly. I just want you to take a look at this LOI and see if there’s anything that jumps out at you.”
I replied that our team would take a look and get back to him, which we did in a follow-up phone call a few days later.
That follow-up call threw a wrench into Reggie’s plans to sell quickly. The issues we saw in this LOI ultimately delayed his company sale by over a year. That’s the bad news. The good news is Reggie ended up selling for several million dollars more than he expected and avoided a near-certain lawsuit with his business partner along the way.
Gaining a True Earnings Picture
Here’s the quick version of what happened:
The first issue with the LOI was the price. Reggie’s LOI offered him $10 million* for his company, based on paying six times the earnings.
During our follow-up phone call, we asked Reggie how his company’s earnings had been calculated. We learned that Reggie and his controller had not thoroughly reviewed the company EBITDA, and we recast (or adjusted) it to show a true earnings picture.
For example, the company had several non-recurring expenses associated with a recently resolved legal issue. Also, Reggie’s compensation was well above market rates — even more than he had estimated. These two items alone added back almost $500,000 in additional adjusted profits. At a six multiple, this potentially added $3 million to the company sale value, provided the buyer agreed to the revised EBITDA and paid the higher price.
The second issue was ownership and governance. Reggie owned 80% of his company, and his 20% partner was a former employee. Reggie explained to us that he and his partner were not feuding, but they were not on the warmest of terms either.
However, Reggie was confident that there was nothing to worry about pertaining to the sale for two reasons. One, Reggie held a controlling interest and therefore could “negotiate and approve anything.” Second, Reggie was confident that his partner would want to sell too.
Avoiding a Deal-Killing Lawsuit
Reggie’s LOI raised further concerns, however. The ROI allocated a considerable portion of the purchase price to an employment and non-compete provision covering Reggie. Any dollars allocated toward Reggie’s post-sale employment contract and non-compete agreement would not be split 80/20 between the partners but would be paid entirely to Reggie. Reggie had to admit that this might cause tension with his partner.
Furthermore, after our follow-up phone call, we reviewed the buy-sell agreement between Reggie and his partner. Under the legally binding agreement, Reggie actually did need his partner’s permission to sell the entire company, which is common. Majority ownership does not automatically grant a partner the authority to sell the entire company. (Ask us more about this.)
Later, after Reggie hired us to help him address the aforementioned issues, we contacted the minority partner. Interestingly, the minority partner included his attorney in every conversation, which instantly gave us a very clear picture of how little trust existed between these two individuals.
The partner disclosed that he would block any sale that did not split the total deal proceeds 80/20 and even threatened to take legal action against Reggie for pursuing a sale without his knowledge. Had Reggie signed the original LOI without addressing these issues, it seems likely a serious legal fight would have ensued.
Closing the Deal After More Than a Year of Work
As mentioned previously, Reggie ended up hiring us after we pointed out these issues during our follow-up phone call. In spite of these red flags, it was obvious to us that Reggie still expected to close the sale quickly, perhaps with only a delay of one to two months to resolve these matters.
In reality, it took more than a year before the sale was concluded, and not before the deal nearly fell through on several occasions.
Reggie’s buyer did eventually agree to pay the $3 million higher sale price, but not before reviewing all of the company’s financial results in great detail. This review added several months to the due diligence process and ruined any chance of a quick closing.
Reggie’s partner also eventually agreed to a sale, but not before extensive, tense, and contentious discussions between the two partners and their attorneys. At one point, the minority interest insisted on speaking directly with the buyer, which worried Reggie and frustrated the buyer, who did not appreciate being dragged into the middle of the partners’ dispute. These discussions consumed many months too.
Finally, right in the middle of dealing with these other issues, Reggie’s company lost one of its largest customers, one that accounted for about 15% of the company’s revenues and profits. The loss of this customer caused the buyer to further slow its timetable, waiting to see if Reggie’s sales team could replace the lost volume with new customers. Ultimately, his team did manage to do so, but not before the deal looked like it would fall through due to that issue as well.
Reducing Risk and Maximizing Sale Price Requires Time
This case study has a happy ending. Reggie sold his company for 30% more than he had hoped, avoided a deal-killing lawsuit, and walked away happy. However, he experienced more than a year of daily stress and anxiety because his company was not as ready as he believed it to be.
Every client situation and story is unique, yet Reggie’s story is common in one important sense. Many business owners underestimate the effort and time required to prepare their company for exit. Sure, some deals are executed quickly and cleanly. However, more often than not, some issues must be addressed to reduce risk and maximize sale price in a deal. In this way, Reggie’s story is typical.
Waiting until you hold a LOI in your hand is not the time to start preparing for exit. Reggie would have saved himself considerable stress, cut his attorney’s fees, and further increased his company value if he had started preparing for exit much earlier. All business owners must commence formal exit planning once they reach their final five years or run the risk of a significant delay in exit.