Theory of buying and selling companies
Ensuring continuity is a great challenge for companies. Both entrepreneurs and shareholder groups end up having a limited life in time. The reasons can be multiple and can be derived from people, companies, the environment or a combination of all these factors.
The open process of selling a company can present serious image problems before the different interest groups that will interact in the day-to-day life of a company: employees and workers, customers, suppliers, banks, competitors, etc.
However, there are many situations in which an entrepreneur may be interested in transferring ownership of his company without wanting to resort to an open sale process.
An entrepreneur may be interested in selling a company, or part of it, for multiple reasons, which include:
• Change of business or activity.
• Focus on what is the core of professional competence.
• Take advantage of an opportunity to realize the value created.
• Address or avoid the succession of management and shareholders.
• Personal or family reasons or preferences.
• Give liquidity to partners who have no interest in remaining in the company.
When an entrepreneur decides to stop being an entrepreneur, he usually intends to dedicate his time to other activities (business or otherwise) and to recover (in whole or in part) his capital. With this, the company finds it necessary to seek new management and new capital.
The challenge is very important, and proof that not everyone wants or manages to face it is that many companies are closed or absorbed when their employers are unwilling or unable to continue at the helm, with the consequent impact on jobs and on the business project on which the company was based.
A natural way of giving continuity to companies is the acquisition of them either by industrial or financial groups, or by their managers, the so-called “buy-out” management operations, or MBOs. Any business activity requires three ingredients: business, capital and management. Having a business underway and management capacity (provided by managers), it is not impossible to access adequate sources of capital.
A buy-sell operation is a very important step, both for the employer and the manager, as well as for the company, and it should not be started if the factors that indicate that there is a minimum probability of success are not met.
On the other hand, it is a transitional operation that, as such, normally requires financial resources and professional experience that exceed those that the company uses in the normal course of its activity. The objective of this article is to give entrepreneurs and managers the possibility of analyzing the opportunities and challenges posed by a purchase-sale operation of an unlisted company.
A paradigm of analysis when buying and selling
Below is a fairly simple analysis paradigm that focuses on the four basic ingredients without which it is not possible to carry out a buy-sell operation: the business, the buyer, the funds and the seller. With it you can predict with reasonable certainty whether the opportunity really exists. Performance, of course, is subject to many other factors.
1. The business
The company (or the part of it) to be acquired must have the minimum necessary ingredients so that, by applying the strategy envisaged by the future owner, it can realistically expect to generate sufficient value to repay the debt incurred (case of leveraged purchase) and to meet your personal goals if the buyer does so on their own behalf. Interestingly, these ingredients are not necessarily reflected in the income statement. In fact, companies with losses, but with potential for recovery, are often the best profit opportunities. And, on the contrary, there are profitable companies that will inevitably cease to be profitable whatever the management team does.
This means that before undertaking a purchase-sale operation, it is necessary to have a strategy for the company, a first valuation of the company, a quantification of the indebtedness that is considered necessary, achievable and acceptable, and a clear definition of personal objectives of the buyer or buyers. With this background framework, the business potential of the target company must be critically analyzed.
The analysis of the sustainability of the business is a key piece in an operation of this type. All the necessary capital is contributed on the basis of the future profits that the company promises to generate. In this sense, it is less advisable to carry out MBO operations with businesses that involve a high level of risk. As one more element of guarantee for the future generation of funds, it is essential to have a business strategy that offers clear signs of becoming a reality. The financiers of this type of operation are uncomfortable with anything that sounds like an adventure. In other words, they prefer to bet on those things that managers have shown they already know how to do.
2. The buyer
Here, it is possible to distinguish according to the buyer, whether it is an industrial or financial group, or the managers who are considering the decision to access the property. First, we will confine ourselves to reflecting on the second case, since, in our opinion, a series of considerations must be taken into account that may be of vital importance for the success of the operation.
The manager-entrepreneur buyer
The management team is the key piece in this whole process. The viability of the operation depends on them, and on their management capacity. When it comes to analyzing the viability of an MBO operation, you can only bet on winning management teams. However, being a manager and being an entrepreneur are two very different things and not all managers have the necessary characteristics to be an entrepreneur, including (and very importantly) the firm will to be one.
All things being equal, the employer tends to enjoy greater discretion, more power in the company, greater challenges and opportunities for enrichment, the opportunity to leave the company to his own as a result of his successes. In return, your responsibility and your risks, personal and financial, possibly multiply even more. On the other hand, managing the acquired company may require different professional and personal characteristics from the managers than those required by the managers within the business group or under the umbrella of the previous shareholder. This applies to all key functions, whether they are performed by people who are part of the buying team or not.
One must consider whether he has the conditions and the determined will to become an entrepreneur, and whether he has the right equipment (or will be able to acquire it) to carry out the post-acquisition strategy successfully. We are talking, then, of capacity, will and team.
Aspiring entrepreneurs should also take into account that the relationship with those of their former colleagues who do not participate in the MBO will no longer be the same after the operation and that, therefore, the choice of the group that will participate in the MBO, and the conditions in which each will participate, can have a significant impact on the MBO process and the success of the operation.
If the business and the manager-entrepreneur seem to exist, it is time to prepare the business plan and the basic outline of the MBO operation.
3. The funds
Generally, managers do not have significant capital to invest in high-risk operations, and they have to resort, as better alternatives, to sellers' credit or risk capital. This implies that analysis of past and future cash flows is absolutely essential. In a matter of funds there is no place for voluntarism. Financial errors in this type of operation are usually irreparable and lead to the loss of property and, sometimes, the ruin of the company.
To attract the interest of the financial partner it is necessary to present a compelling management team, a coherent business plan and an attractive investment proposal. Venture capital is still capital and, as such, seeks to minimize risk. But it invests in risky and illiquid trades and therefore tries to maximize profit potential. The financier must be convinced that he has a solid plan to carry out a potentially very profitable operation, that the risks are anticipated and covered to the maximum, and that the management team is a proven guarantee.
The search for financing can still be done confidentially with venture capital firms, directly or through intermediaries. But it is good to be properly advised by a legal expert before starting this phase, to be sure that you are not incurring responsibilities when providing confidential company information to third parties. It is very important that both potential financial partners and eventual intermediaries and advisers are of quality. Success will largely depend on them. This is the first open step towards the purchase of the company, and it cannot be ruled out that, from this point on, the control of the process becomes more difficult. If there is business, manager and money available, it is time to approach the seller.
4. The seller.
Shareholder control groups.
The other fundamental piece for the operation to be viable is the shareholders. Too high a level of atomization can be a serious drawback when considering the operation.
The negotiation at the time must be possible with a small group of people who have sufficient representation and legal force to assume commitments on behalf of the selling partners. Obviously, it is not possible to carry out an MBO if the shareholders do not want to sell. Just as obvious is that, above a certain price, everyone is a seller.
The crux is to buy at a good price. Selling one's own company is very often something that arouses strong and complex reactions, at least in the first phase. The buyer, the circumstances and conditions of the operation, and the person who raises it, may have meanings for the seller that go beyond the purely economic.
Generally, the management team is in a good position to evaluate under what conditions the shareholders will want to sell, but it would be better to sharpen their judgment when evaluating how, when and through whom the operation is proposed, because this is the point without return. How current shareholders will assess the manager's desire to acquire their company is difficult to foresee.
Lead the process.
When it has been concluded that the four previous ingredients are present, the real process begins that must culminate in the purchase of the company by its managers. It is a delicate, complex, expensive process that requires a lot of effort because, in the meantime, the management of the company cannot be neglected. Going from manager to entrepreneur will therefore, in many cases, require the conditions of a tightrope walker and juggler, in addition to those of the new role.
Technical aspects.
There is a whole task of defining the terms of the transaction, as well as the organizational, legal and personal aspects, which ends with a detailed investigation process carried out by an independent team by order of the investors, with reference to the team
management, resources of all kinds and the business situation of the target company. It includes a rigorous verification of the assumptions on which the future plans of the company are based, as well as the existence of the main assets of its property and other subjective considerations relating to it (Due diligence).
If success accompanies, the compensations will be well worth the effort made and the risk assumed.
The facilitator of the operation.
The role of the facilitator can be essential. As a general rule, companies do these operations once in their lifetime. Consequently, both parties (property and management) lack experience in the process. In this sense, the presence of a facilitating entity that leads the process is very positive to ensure success.
Small to Medium Businesses
The challenges faced by the owners of a medium-sized, private or family company, are very different from those faced by companies listed on the Stock Exchange:
• What do owners do when they want to retire and have no children who can or want to succeed them in the business? Or worse yet, what if one of the founders or major shareholders of the company died suddenly?
• What to do when almost all of the family's assets are “locked” in the company and you want to release part of the assets to reduce risks and, at the same time, continue working in the company? In the same terms, how to cancel the personal guarantees that they made in favor of the company? Finally, what to do when capital is needed for expansion or liquidity and cannot be obtained from banks?
• How to resolve the conflict when the members of a family who manage the family business prefer to invest in it for their growth; while the other members, who do not work in the company, are only interested in dividends?
• What to do when the company has passed into the hands of the second or third generation and most of these shareholders do not work in the company, have no affection for it, or worse, they are fighting each other?
• What do you do when you want to find a partner to merge, with the aim of complementing the product range, taking advantage of a foreign distribution network, acquiring technology, using brands, trade names, manufacturing licenses or other industrial or intellectual properties?
• How to take advantage of the opportunities of “Joint Venture” and / or international expansion (for example, in Latin America), offered by the current globalization process?
The solution could be to admit an investor or partner; or the total sale of the company.
Normally, the first thing that is done to face the situations described, is to go to lawyers, auditors or tax advisers. Although these professionals are competent in their respective areas of work, they are not specialists in the complex task of locating investors or selling a business. These professionals will play a role in the specific tasks of contracts, financial analysis, etc., but they are not ideal in the independent presentation of a specific area business.
Although business owners know their business and industry better than anyone, they are not specialists in the complex task of selling a business. (Selling a business is more complex machismo than selling a house!). Most likely, never in your life have you had to negotiate an operation of this type.
A family business sells only once!
This is in stark contrast to the typical profile of a buyer, usually a multinational or financial group. These buyers make multiple purchases and are supported by professional teams. As a counterweight, the owners of a company in Latin America must also be advised by a team with equal, or superior, experience.
Business owners also do not have the time to carry out all the essential tasks for the sale of their business.
Obviously, posting advertisements (even anonymous ones) is dangerous and could harm relationships with customers, suppliers, banks or employees and, in addition, alert the competition. In addition, it should not be forgotten that poorly focused contacts can chill investors and deteriorate the image of the company.
To give value to a business, quantitative and qualitative elements can be used, starting from those quantifiable such as the balance sheet, income statement, information on income projection and costs. The accounting information has the characteristic of grouping accounts whose figures are a combination of past, present and future; therefore the resulting amount cannot be the commercial value of the company.
So if the accounting information system does not actually say how much a business is worth: how can it be determined? A business is worth for its ability to generate future profits (Good-Will) in addition to what it owns at a given time, that is, a business is worth for its net assets plus the present value of its future profits. The process that must be followed to determine the commercial value of a company, therefore not only goes through the net asset value, but much more through the determination of the Good-Will value.
To calculate the value of the intangible Good-Will, a projection of the cash flows must be made without taking into account the financial charges and the amortization of the debt during a fair term; This projection can be defined based on criteria such as technological advances, degree of deterioration of productive assets, the possibility of the appearance of substitute products, etc.
All projections must be made at current prices; that is, taking into account aspects such as inflation, devaluation and increase or decrease in the number of units to produce and sell. The discount rate used will be a market opportunity rate that considers the risk in accordance with the nature of the business and must be agreed between the parties that analyze the transaction. It should be borne in mind that as the discount rate increases, the value of the intangible "Good-Will" decreases, all other conditions being equal.
This process of determination - partly financial and partly strategic - is a very likely path to be followed by the work teams of the buyer of a company, for which the financial team of the seller must be very clear on these aspects. But beyond the cold numbers, the buyer will want to know the positioning of the company in its market segments, the knowledge that exists of these, the opportunities, the projection, the power of its brands or its degree of influence. It is here where the strategic advisers of the company must intervene, who must also manage the transfer times of financial, commercial and productive information.
The necessary equipment:
• Strategic Advisor who can explain the Marketing or Business Plan; argue where the company is and where it is going or should go. He usually leads the advisory team.
• Financial Advisor who can support and explain the financial statements of the company.
• Legal Advisor who can take the agreed upon contracts and public deeds, foresee risks and / or legal loopholes
• Shareholders will be prevented, except for a representative of them chosen by the advisory team, from participating in specific parts of the negotiation.
Other factors that affect the value of a company:
Company Related:
• General control
• Expectations
• Capital
• Reports and managerial management
• Economic activity and industrial sector
• Company image
• Labor aspects
• Quality of the administration, honesty, image
• History of the company
• Human and technological resources
Related to financial management:
• Solid
• Cost effectiveness
• Utilities
• Liquidity
• Level of indebtedness
• Financial costs
• Prospects for recovery
• Value of assets
• Dividend policy
• Company value
• Commercial value
Related to the Company's market:
• Sector to which it belongs
• Quality of the products
• Distribution strength, market size, participation
• Knowledge of their markets
• Qualification of sales staff
• Growth / decrease in its main markets
• Strength of the Marketing or Business Plan
Related to state policies:
• Taxes
• Tax Incentives
• Economic policy
Conclusions
- It is very likely that the same business has different values for different people, without this implying an error on the part of anyone, usually price ranges are obtained, but they should be tried to be narrow.
- The factors that are taken into account to determine the Good-Will outside of future profits can be all intangible assets such as industrial property, chemical formulas, technical processes, trademarks, patents, literary and artistic property, the generation of profits, optimal position in the market, experience, good location, quality of merchandise or service, treatment of customers, good relations with workers, job stability, the trust that due to good performance management is created in the financial sector. There are other factors specific to the characteristic of the business, which are difficult to detail.
- To have a good approximation of the value, it is necessary to have sufficient and certain information, and a knowledge of the sector or sectors in which it intervenes.
Download the original file
