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The Offering Memorandum

A solid, factual and compelling offering memorandum maximizes the chances of not only selling a business, but obtaining the highest possible price.  An offering memorandum is also referred to as the selling memorandum, a confidential descriptive memorandum, or simply as “the book.” The memorandum, regardless of the terminology used, must be as factual as possible, but the Executive Summary portion of it allows for a bit of “selling the sizzle.”  Most potential buyers want to know the basics of the company and of the deal right at the beginning.  What is the proposed transaction and what are some of the company highlights?  The executive summary should also contain an outline of the ownership and management structure, a description of the business, some financial highlights, a quick review of the company’s products and/or services, its markets, reason for sale and any other major items of importance.

The executive summary, then, is a quick synopsis of the items covered in the offering memorandum that should entice a prospective buyer to study the offering memorandum itself.  Here are some critical elements of the offering memorandum:

• Executive Summary
• The Company
• History of the Company
• The Markets
• The Products
• Distribution
• Customers and/or Clients
• The Competition
• Management
• Real Estate
• Financials
• Growth Strategies
• Competitive Advantages
• Conclusion
• Exhibits

“The offering memorandum should not only be a compelling document in order to capture the reader’s attention, but it should be so thorough that one should expect the potential acquirer to submit a fairly tight price range for his or her initial offer.  In short, the best offering memorandums are complete but not too long, easy to read, believably professional and show that the company has an opportunity for growth.”
    Source: The Best of the M&A Today Newsletter

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Considerations When Selling…Or Buying

Important questions to ask when looking at a business…or preparing to have your business looked at by prospective buyers.

• What’s for sale?  What’s not for sale?  Does it include real estate? Are some of the machines leased instead of owned?

• What assets are not earning money? Perhaps these assets should be sold off.

• What is proprietary? Formulations, patents, software, etc.?

• What is their competitive advantage? A certain niche, superior marketing or better manufacturing.

• What is the barrier of entry? Capital, low labor, tight relationships.

• What about employment agreements/non-competes? Has the seller failed to secure these agreements from key employees?

• How does one grow the business? Maybe it can’t be grown.

• How much working capital does one need to run the business?

• What is the depth of management and how dependent is the business on the owner/manager?

• How is the financial reporting undertaken and recorded and how does management adjust the business accordingly?

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Reasons to Sell / Reasons to Acquire

A January 2004 survey conducted by the DAK Group/Rutgers found the following breakdown of why businesses are for sale:

Reasons To Sell

  • Risk reduction      44%
  • Competition or market changes   41%
  • External pressures     27%
  • Lifestyle factors (age, health, etc.)   14%
  • Lack of capital      9%
  • Ownership/management issues  07%

Note: Multiple responses allowed;  Source: DAK Group/Rutgers

It is interesting to note that the top, by far, three reasons to sell are financial as is the fifth reason. The information furnished by much of the media suggests that the big reason to sell is generational – in other words, all of yesterday’s owners are now ready to retire.  According to the survey above, that motivation (included in “Lifestyle factors”) represents only 14 percent, and it  includes health and other personal issues.  The last reason, at 7 percent, might also include retirement since ownership/management could be involved with retirement issues.  Twenty-one percent of the respondents mentioned either lifestyle or ownership/management issues.  Placing these reasons at the top of the list does not justify the hype of the “baby-boomers” retiring over the next few years.

Shown, below, the reasons for considering an acquisition seem to be more obvious.  Although growth leads the list by a hefty margin, all of the other reasons could also be considered growth issues.

Reasons for Considering an Acquisition

  • Growth   72%
  • Acquire competitor  38%
  • Product diversification 37%
  • Geographic diversification 29%
  • Technology   09%

Note: Multiple responses allowed;   Source: DAK Group/Rutger

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Keys to a Successful Closing

The closing is the formal transfer of a business. It usually also represents the successful culmination of many months of hard work, extensive negotiations, lots of give and take, and ultimately a satisfactory meeting of the minds.  The document governing the closing is the Purchase and Sale Agreement.  It generally covers the following:

• A description of the transaction – Is it a stock or asset sale?

• Terms of the agreement – This covers the price and terms and how it is to be paid.  It should also include the status of any management that will remain with the business.

• Representations and Warranties – These are usually negotiated after the Letter of Intent is agreed upon.  Both buyer and seller want protection from any misrepresentations.  The warranties provide assurances that everything is as represented.

•  Conditions and Covenants – These include non-competes and agreements to do or not to do certain things.

There are four key steps that must be undertaken before the sale of a business can close:

1. The seller must show satisfactory evidence that he or she has the legal right to act on behalf of the selling company and the legal authority to sell the business.

2. The buyer’s representatives must have completed the due diligence process, and claims and representations made by the seller must have been substantiated.

3. The necessary financing must have been secured, and the proper paperwork and appropriate liens must be in place so funds can be released.

4. All representations and warranties must be in place, with remedies made available to the buyer in case of seller’s breech.

There are two major elements of the closing that take place simultaneously:

• Corporate Closing: The actual transfer of the corporate stock or assets based on the provisions of the Purchase and Sale Agreement.  Stockholder approvals are in, litigation and environmental issues satisfied, representations and warranties signed, leases transferred, employee and board member resignations, etc. completed, and necessary covenants and conditions performed.  In other words, all of the paperwork outlined in the Purchase and Sale Agreement has been completed.

• Financial Closing: The paperwork and legal documentation necessary to provide funding has been executed. Once all of the conditions of funding have been met, titles and assets are transferred to the purchaser, and the funds delivered to the seller.

It is best if a pre-closing is held a week or so prior to the actual closing.  Documents can be reviewed and agreed upon, loose ends tied up, and any open matters closed.  By doing a pre-closing, the actual closing becomes a mere formality, rather than requiring more negotiation and discussion.

The closing is not a time to cut costs – or corners.  Since mistakes can be very expensive, both sides require expert advice.  Hopefully, both sides are in complete agreement and any disagreements were resolved at the pre-closing meeting.  A closing should be a time for celebration!

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Seller Financing — How a Broker Can Help

Another important factor relating to the asking price is the amount of cash involved in the sale. There is an old saying that the higher the full-price, the lower the down payment – and vice-versa. The sale of almost any business involves some seller financing. The smaller the down payment, the higher likelihood of a quick sale. No seller wants to take back his or her business because the buyer wasn’t successful. On the other hand, a buyer wants to make sure that the business will not only pay for itself, but also provide sufficient income for his or her family’s needs.

What it all boils down to is that the seller wants the buyer to be successful and the buyer wants to buy a successful business. With the amount of capital required in today’s market to buy a business, sellers should feel optimistic that they are dealing with successful buyers.

A Valuable Service

Screening and qualifying buyer prospects is perhaps the business broker’s most valuable service. Business brokerage industry statistics indicate that over 90 percent of buyer prospects who call on business-for-sale ads are unqualified for some reason. The successful business broker survives by mastering qualifying and screening techniques!

Maintaining Confidentiality

Confidentiality is always a major concern. Sellers feel that maintaining confidentiality is important in safeguarding the current business. They don’t want the word to leak out to customers, suppliers, competitors – and especially the employees. This is an area where a business broker professional can be especially helpful. They use non-specific descriptions, screen and qualify buyers and require buyers to sign confidentiality agreements before showing businesses or providing specific information.

However, even under the best of circumstances, rumors can fly. There are basically two ways sellers can muffle the business-for-sale problem. The first is to explain that over the years there have been people who have inquired about whether the business might be for sale. These inquiries are unavoidable and they do happen.

The other way is to handle the matter directly and to explain that you have been considering retiring and now may be the right time. The employees, especially the key ones, should be told prior to putting the business on the market so they don’t hear the rumors second-hand. They should be told that they are very important to the business’s success and that a new owner would most likely be happy to retain them. When the sale is complete, they can be offered a bonus for helping in the process. Sellers should do whatever it takes to keep the employees from deserting the ship and keep them on deck to maintain business as usual. Once employees have been dealt with openly and fairly, they will understand that discretion will help protect their future.

The Future of the Business

Sellers may feel that they have built the platform for the future growth of the business. It is only natural for them to want to share in any extraordinary profits in what they feel they have helped create. Sometimes, if the price is low enough and it allows a buyer to purchase the business, he or she may be willing to provide some type of earn-out or royalty based on any substantial increase in sales. The professional business broker can offer advice on how to make this work for everyone. However, everyone has to agree that no one can predict the future. As mentioned earlier, the buyer is hoping to buy the future, but is not willing to pay for it.

What Buyers Think

Many buyers think that the business they buy should be able to pay for itself. They are wary of sellers who demand all cash. Is the seller really saying that the business can’t support any debt, or is he or she saying that the business isn’t any good and I want my cash out of it now, just in case?

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Why Seller Financing?

Many business owners would like to receive all-cash for their business when selling. And yet they are often told that this is really not possible. Why? Most people are accustomed to financing just about everything – home, car, vacation home, even college for their children. The first question business brokers are often asked is, “How much money will I have to invest to buy that business?”

Seller financing is usually necessary because of the lack of outside financing available. Certainly, some is available, but less than 90 percent of small business sales receive outside financing when selling. If you are selling, you may be one of the few lucky ones, but the business better be absolutely perfect.

If a seller is not willing to finance the sale, many buyers suspect a problem. After all, a business should be able to pay for itself and provide a reasonable income for a buyer. A buyer then wants to know what is wrong with the business that the seller wants all cash?

Aside from this, even if a buyer has all of the necessary funds, he or she may want to spend their money on improving the business, adding equipment, building inventory, or just keep it for working capital.

Another similar issue that is raised by sellers is that, if they are willing to finance the sale, they want some outside collateral to secure the loan on their business. They want to make sure that they get all of their money – with no risk. Buyers are very sensitive about this issue. Again, they raise the point about the business being able to pay for itself. They may feel that the seller wants additional security because of concerns about the business’s ability to generate a reasonable profit. This is not a reassuring signal to the buyer. Most buyers are already using most of their capital for the down payment, and they generally are very reluctant about using their home or retirement funds for additional collateral.

The services of a business broker professional can usually provide guidance in the overall financing process. And financing is often the key to the successful selling of a business.

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Financing the Business Sale — Some Questions to Answer!

Structuring the purchase of a business is an issue that should be faced early in the selling decision. Ultimately, the final structure of the sale will be determined by actual negotiations between buyer and seller, but the seller must still answer the following questions:

  • What is the lowest amount of cash acceptable from the sale?
  • Has consideration been given to paying off all unsecured creditors and a portion of the closing costs? (Both are, in most cases, the seller’s responsibility.)
  • Is there any long-term or secured debt that can be assumed by the buyer? (This may make more cash available to the seller.)
  • What is an acceptable interest rate for the seller-financed sale?
  • Will the business be able to service the debt and still provide a return acceptable to a buyer in relation to the down payment required? (This is a particularly important question for the seller to address.)
  • What are the tax consequences of the sale?

Recent studies indicate that the more favorable the terms, the higher the price. In fact, one study found that offering favorable terms might increase the total selling price by 30 percent. A business broker professional can advise you on the all-important issue of seller financing.

The professional business broker is a good source for assistance in structuring the sale of a business. Although they are not able to provide legal advice, business brokers are the experts of preference when the arena is the business marketplace. Brokers will use their knowledge of previous sales, current market conditions, and outside financing strategies, if applicable or available.

A business generally represents a seller’s largest financial asset. How the sale is structured may mean the difference between the success or failure of the transaction. The best sale structuring will result in the best deal possible for both buyer and seller. A business broker can be the key player in accomplishing this goal.

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Seller Financing: It Makes Dollars and Sense

When contemplating the sale of a business, an important option to consider is seller financing. Many potential buyers don’t have the necessary capital or lender resources to pay cash. Even if they do, they are often reluctant to put such a hefty sum of cash into what, for them, is a new and untried venture.

Why the hesitation? The typical buyer feels that, if the business is really all that it’s “advertised” to be, it should pay for itself. Buyers often interpret the seller’s insistence on all cash as a lack of confidence–in the business, in the buyer’s chances to succeed, or both.

The buyer’s interpretation has some basis in fact. The primary reason sellers shy away from offering terms is their fear that the buyer will be unsuccessful. If the buyer should cease payments–for any reason–the seller would be forced either to take back the business or forfeit the balance of the note.

The seller who operates under the influence of this fear should take a hard look at the upside of seller financing. Statistics show that sellers receive a significantly higher purchase price if they decide to accept terms. On average, a seller who sells for all cash receives approximately 70 percent of the asking price. This adds up to approximately 16 percent difference on a business listed for $150,000, meaning that the seller who is willing to accept terms will receive approximately $24,000 more than the seller who is asking for all cash.

Even with these compelling reasons to accept terms, sellers may still be reluctant. Selling a business can be perceived as a once-in-a-lifetime opportunity to hit the cash jackpot. Therefore, it is important to note that seller financing has advantages that, in many instances, far outweigh the immediate satisfaction of cash-in-hand.

  •  Seller financing greatly increases the chances that the business will sell.
  • The seller offering terms will command a much higher price.
  • The interest on a seller-financed deal will add significantly to the actual selling price. (For example, a seller carry-back note at eight percent carried over nine years will double the amount carried. Over a nine-year period, $100,000 at eight percent will result in the seller receiving $200,000.)
  • With interest rates currently the lowest in years, sellers can get a much higher rate from a buyer than they can get from any financial institution.
  • The tax consequences of accepting terms can be much more advantageous than those of an all-cash sale.
  • Financing the sale helps assure the success of both the sale and the business, since the buyer will perceive the offer of terms as a vote of confidence.

Obviously, there are no guarantees that the buyer will be sucessful in operating the business. However, it is well to note that, in most transactions, buyers are putting a substantial amount of personal cash on the line–in many cases, their entire capital. Although this investment doesn’t insure success, it does mean that the buyer will work hard to support such a commitment.

There are many ways to structure the seller-financed sale that make sense for both buyer and seller. Creative financing is an area where your business broker professional can be of help. He or she can recommend a variety of payment plans that, in many cases, can mean the difference between a successful transaction and one that is not. Serious sellers owe it to themselves to consider financing the sale. By lending a helping hand to buyers, they will, in most cases, be helping themselves as well.

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What Is Goodwill?

In the practical sense, when selling a business, goodwill is all the hard work and effort the seller has put into the business over the years. When acquiring a business, goodwill is the difference between the tangible assets and the purchase price.

Goodwill value should not be confused with going-concern value. There is a big difference. One leading business appraiser has defined going-concern value as, “The premise that a business will continue to operate consistent with its intended purpose as opposed to being liquidated.” In other words, the value of a business for just being in business is the going-concern value. It has nothing to do with whether the business is profitable, “on its last legs,” or merely breaking even. Essentially, if the doors are open, a business is a going concern.

Most business owners view goodwill as good service, products and reputation. One dictionary defines Goodwill as, “A desire for the well-being of others; the pleasant feeling or relationship between a business and its customers.”

The M&A Dictionary defines goodwill as: “An intangible fixed asset that is carried as an asset on the balance sheet, such as a recognizable company or product name or strong reputation. When one company pays more than the net book value for another, the former is typically paying for goodwill. Goodwill is often viewed as an approximation of the value of a company’s brand names, reputation, or long-term relationships that cannot otherwise be represented financially.”

Some Examples of Goodwill Items

  • Phantom Assets
  • Local Economy
  • Industry Ratios
  • Custom-Built Factory
  • Management
  • Loyal Customer Base
  • Supplier List
  • Reputation
  • Delivery Systems
  • Location
  • Experienced Design Staff
  • Growing Industry
  • Recession Resistant Industry
  • Low Employee Turnover
  • Skilled Employees
  • Trade Secrets
  • Licenses
  • Mailing List
  • Royalty Agreements
  • Tooling
  • Technologically Advanced Equipment
  • Advertising Campaigns
  • Advertising Materials
  • Backlog
  • Computer Databases
  • Computer Designs
  • Contracts
  • Copyrights
  • Credit Files
  • Distributorships
  • Engineering Drawings
  • Favorable Financing
  • Franchises
  • Government Programs
  • Know-How
  • Training Procedures
  • Proprietary Designs
  • Systems and Procedures
  • Trademarks
  • Employee Manual
  • Location
  • Name Recognition

What goodwill is and how it is represented on a company’s financial statements are two different issues. For example: until recently, if a company sold for $5 million, but only had $1 million in tangible assets, the balance of $4 million was considered goodwill. Under previous accounting standards, this goodwill had to be amortized by the acquirer over a 15-year period. This especially affected public companies, since an acquisition could negatively impact earnings, thus reducing the price of its stock. One result of this was that public companies were reluctant to acquire firms in which goodwill was a large part of the purchase price. On the other hand, purchasers of non-public firms received a tax break because of the amortization.

The accounting profession recently took another look at goodwill and changed the way goodwill is handled. The reason for this was to bring accounting into today’s business world. For years, companies were built around hard assets such as heavy equipment and machinery. Many of today’s industrial giants are not really industrial at all. They are built around intangible assets such as patents, brand names, intellectual property, etc. – basically what are considered goodwill items. These businesses don’t have huge factories full of workers on assembly lines.

Some new rules or standards were created by the Federal Accounting Standards Board (FASB) and implemented on July 1, 2001. Under this change, goodwill may not have to be written off (unless it is carried at a value in excess of its real value). However, the standards now require that companies, both private and public, have their intangible assets, including goodwill, valued by an outside expert on an annual basis. The rules basically define the difference between goodwill and other intangible assets and how they are to be treated from an accounting and tax reporting standpoint. How they are treated can impact the bottom line and have tax consequences. Also, completely identifying the items that may have been combined into goodwill and establishing separate values may increase the true intangible asset basis.

The upshot of all this is that the meaning of goodwill just got more complicated. Here’s a simplification: prior to acquiring a company or placing your business on the market, you should definitely consult your accounting professional. Goodwill may still represent the hard work and effort the seller has put into his or her business over the years — it just has to be accounted for differently and in more detail.

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Confidentiality Agreements

“Confidentiality Agreement – A pact that forbids buyers, sellers, and their agents in a given business deal from disclosing information about the transaction to others.”

The M&A Dictionary

It is common practice for the seller, or his or her intermediary, to require a prospective buyer to sign a confidentiality agreement, sometimes referred to as a non-disclosure agreement. This is almost always done prior to the seller providing any important or proprietary information to a prospective buyer. The purpose is to protect the seller and his or her business from the buyer disclosing or using any of the information provided by the seller and restricted by the confidentiality agreement.

These agreements, most likely, were originally used so that a prospective buyer wouldn’t tell the world that the business was for sale. Their purpose now covers a multitude of items to protect the seller. A seller’s primary concerns are to insure that a potential buyer doesn’t capitalize on trade secrets, proprietary data, or any other information that could essentially harm the selling company. A concern of the prospective buyer may be that similar information or data is already known or is being developed by his or her company. This can mean that both parties have to enter into some discussion of what the confidentiality agreement will cover, unless it is general in nature and non-threatening to the prospective buyer.

A general confidentiality agreement will normally cover the following items:

  • The purpose of the agreement – it is assumed that in this case it is to provide information to a prospective acquirer.
  • What is confidential and what is not. Obviously, any information that is common knowledge or is in the public realm is not confidential.
  • What information is going to be disclosed? And what information is going to be excluded under the disclosure requirements?
  • How will confidential information be handled? For example, will it be marked “confidential,” etc?
  • What will be the term of the agreement? Obviously, the seller would like it to be “for life” while the buyer will want a set number of years – for example, two or three years.
  • The return of the information will be specified. For example, if the sale were terminated, then all documentation would be returned.
  • Remedy for breach, or determination of what will be the seller’s remedies if the prospective acquirer discloses, or threatens to disclose any information covered by the confidentiality agreement.
  • Obviously, the agreement would contain the legal jargon necessary to make it legally enforceable.

One important item that should be included in the confidentiality agreement is a proviso that the prospective acquirer will not hire any key people from the selling firm. This prohibition works both ways: the prospective acquirer agrees not to solicit key people from the seller and will not hire any even if the key people do the approaching. This provision can have a termination date; for example, two years post-closing.

The sale of a company involves the disclosure of important and confidential company information. The selling company is entitled to protection from a potential acquirer using such information to its own advantage.

The confidentiality agreement may need to be more specific and detailed prior to commencing due diligence than a generic one that is used initially to provide general information to a prospective buyer.

Tips on Maintaining Confidentiality

  • Use a code word or name for the proposed merger or acquisition.
  • Don’t refer to any principal’s names in outside discussions.
  • Conversations concerning the merger or acquisition should be held in private.
  • Paperwork should be facedown unless being used.
  • All documents should be kept under lock and key.
  • Important data maintained on the computer should be protected by a password.
  • Faxing documents should be done guardedly.