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The decision to sell a business or bring in new investors is a significant event. The reasons for considering an exit must be discussed and understood by all the stakeholders and the emotions of selling the company must be prepared for. Sometimes transactions are structured that allow the management team to stay on in their existing capacity after a deal is consummated. In addition to dealing with the emotional aspects of a sale, the owner must also deal with the financial considerations of a sale. The all-important question of "what is the business worth?" must be addressed.

Hiring the right professionals makes the process of selling a company proceed more efficiently and also likely allows the owner to maximize proceeds. Surrounding a company with the right advisors will allow the owner to continue running the company on a day-to-day basis while the transaction is pursued. A team of advisors should include an accountant, a lawyer experienced in transactional work and possibly an investment banker. The accountant should certainly be the trusted advisor and should possess a thorough understanding of the financial workings of the business. The accountant, along with the lawyer, should provide expert tax advice on the structuring of the transaction, so that taxes are minimized and cash in the owner's pocket is maximized.

The law firm that is chosen to represent an owner on this transaction may not be the same firm used for general legal purposes. An owner wants to retain a law firm that is experienced in mergers and acquisitions, including experience in preparing letters of intent, term sheets, definitive agreements, employment contracts, non-disclosure agreements and non-compete agreements.

An investment banker will certainly help "package" the business to make it appear most valuable to an investor or acquirer. The investment banker will primarily coordinate the sales process and should have the appropriate level of industry knowledge and experience. Investment bankers are typically compensated with a success fee which is contingent on the size of the transaction. The owner should compensate the investment banker so that they have an incentive to get the highest price possible for the company. It is very important to select an investment banker to whom the transaction size is important. Large investment banks typically do not get very excited with companies at the lower end of the middle market. Remember, for the investment banker there is "no such thing as a small deal, just a small fee."

Like everything else in life, timing is an important part of selling a business. There is always the trade-off of selling a company today in a relatively attractive market or waiting until the company improves its margins and operating results, risking the fact that the market may not be as attractive in the future. Currently, with the abundance of private equity and the willingness of the banks to lend into leveraged transactions, it is truly a wonderful market to be a seller of a quality business. Last year the private equity community raised $500 billion, which is approximately $70 billion more than the prior year. All markets go through cycles, so there is no guarantee of a frothy market when an owner decides to enter the market to sell the business.

Determining the value of a business is probably a more exact science than most people believe. There are several valuation criteria that are used to determine value: market comparison with other companies in your industry, multiples of revenues or multiples of EBITDA (earnings before interest, taxes, depreciation and amortization) and present value of future earnings. In addition to these valuation criteria, there are also several subjective factors which, if trending in the right direction, can positively impact valuation. These influencing factors include consistent revenue growth, margin improvement, realistic growth prospects, predictable performance against plan and positive end-user market conditions.

When selling a privately held company and calculating EDITDA, there are certain adjustments to EBITDA that must be given consideration. Typically, one will adjust EBITDA for expenses that a buyer would not be paying in future years or other non-reoccurring type expenses. The most common EBITDA adjustment is "excess owner compensation." The difference between the owner's total compensation package and what a CEO in a similar type company would earn is added back to EBITDA as "excess owners compensation." Another EBITDA adjustment frequently seen in middle market deals is recent costs incurred to develop or market new products. These costs, when not capitalized, generally occur in one year and generate no immediate revenues for the business owner.

The buyer of a business will fall into one of two categories – strategic buyer or financial sponsor. These two types of buyers are quite different in approach and could also create two different types of outcomes for the seller. Strategic buyers are usually from within the company's industry and quite often are one of its competitors. Strategic buyers tend to sell their product or service to a customer base very similar to the owner's target audience. In a strategic deal, the buyer will usually purchase 100% of the company and attempt to integrate it into their operation and at the same time eliminate redundant expenditures. One area where strategic deals fail is in the integration phase. Putting two companies with different cultures and values together is often more difficult than originally expected. Buyers often underestimate the integration costs and overestimate the savings from eliminating redundant and excessive expenses.

On the other hand, financial sponsors are primarily private equity funds and hedge funds who raise pools of capital from limited partners to invest in companies. Over 50% of the investments in private equity and hedge funds comes from institutional public and private pension funds. The balance comes from endowments, foundations, insurance companies, banks and individuals. Financial sponsors structure their deals in three different ways: purchase a minority position in a company invested alongside of management; purchase a majority position with management staying on-board as a minority shareholder; or buy-out of the entire company. Financial sponsors prefer management to stay in the deal and to have financial interests in line with them. They prefer to leave operating responsibility for the company with the company's management team. The private equity fund will have board representation and will generally play a strategic or advisory role. Private equity buyouts are typically leveraged transactions, that is, debt financing represents up to 70% of the purchase price and equity makes up the balance. If an owner decides to sell a majority of the company to a private equity fund, the owner will have two potential opportunities to "cash-out." The first liquidation event will occur when a majority stake in the enterprise is sold. The second liquidation event occurs when the private equity firm decides to sell the company, probably in the next three to seven years, depending on the contractual life of the fund. Hopefully, the private equity fund will provide good strategic guidance, capital for growth and financial discipline resulting in revenue and cash flow growth. If all these things happen and the owner can execute the growth plan successfully, the second payday could possibly be larger than the first.

Now that the owner has made the decision to sell the business, has a good idea of the range of values, has retained all the necessary professionals and has dealt with the emotional side of selling the company, let's discuss a successful sales process. The investment banker will take the initial step of preparing the confidential Offering Memorandum, which will communicate the company's operational and financial story and also communicate the strategic vision for future growth. It is critical to get an executed non-disclosure agreement from any suitor that is receiving the Offering Memorandum.

As the offering materials are being prepared, the investment banker will prepare a list of the most appropriate buyers for the business. The owner will review the list to make sure that everyone on the list is appropriate to contact. The seller might have a strong opinion to avoid contacting certain parties (e.g. direct competitors). If competitors know that a business is up for sale, it is probably only a matter of time before valuable customers have the same information. Customers may feel differently about giving an owner business if they know the company may be sold. If an owner is concerned about competitors discovering the exit strategy, then perhaps limiting the buyer list to only financial buyers might be the more appropriate strategy.

The investment banker should develop and run an orderly process, thus allowing the owner and the management team to continue to run the company. The investment banker will have all communication with the potential buyers and set deadlines for the submission of non-binding offers. Once the offers are received and evaluated, a small number of suitors will be selected to meet with the management team and to hear the pitch. Subsequent to meeting with management, final term sheets are submitted and a final buyer is selected. During the sales process, the investment banker should try to keep as many alternatives open as possible and should also monitor the performance of the business very closely in order to verify that its financial performance is on track with the numbers presented in the offering materials. A good investment banker will exhibit high effort and diligence from the beginning of the process through to closing.

Retaining the services of an attorney experienced in transaction work will help ensure a successful sales process. The attorney will be of critical importance in drafting and negotiating the letter of intent terms as well as the terms of the definitive agreement. The attorney should be intensely involved in the sales process from the preparation of the first non-disclosure agreement through to the execution of the definitive agreement and employment agreements.

Selling a business does take a considerable amount of time, typically four to six months, so there are a number of things that can happen to slow or disrupt the process. The most common reason for the timeline slipping is probably the seller failing to provide information on a timely basis. As a result, the investment banker is not diligent in getting the offering materials completed. Poor buyer identification and potential buyers slow to react also disrupt the process. Not spending the appropriate amount of time researching buyers will result in an excessive number of offering documents being circulated in the market. Another area where time is lost during the sales process is during due diligence. The owner should have all the requested due diligence materials available either electronically or in hard copy format. If necessary, set up a data room at the facility, where all the due diligence materials may be catalogued and available for potential suitors to review. Issues and possible adjustments to the purchase price always develop during due diligence. Deal with these issues with good judgment and the transaction should close in a timely manner.

A deal is not closed until the agreements are executed and the funds are wired into the appropriate accounts. It is not uncommon to see a transaction fall apart at the closing table. There are a number of things that can happen during the sales process that can cause a deal to "tank." Misrepresentations in the Offering Memorandum will certainly put any potential transaction in jeopardy. Since a typical sales process takes up to about six months to complete, the company will report two quarters of results. If those results show a significant decline from prior years and from projections, then future projected performance and the resulting valuation would certainly be questioned.

Higher levels of customer concentration than originally expected or losing a significant customer can also put a deal at risk. Sometimes significant issues discovered during due diligence prevent a deal from being completed. If the buyer proposes a significant reduction in purchase price as a result of issues discovered in due diligence and the seller is not willing to accept the new terms, both sides will probably walk away from the deal. Some other reasons that a deal might "tank" include proposed synergies with buyer do not really exist, personality conflicts between the buyer and seller, the buyer's stock suffers significant decline during the sales process period and the failure to work with competent professionals.

Selling a business can be a rewarding experience, both emotionally and financially for an owner. It is an opportunity to put a value on an asset that the business owner helped to create and manage. It is also an opportunity to maximize the value of an investment. Corporations exist to maximize shareholder value. A middle market company does not have thousands of shareholders, but the owner would certainly like to maximize the exit value for all stakeholders, who worked tirelessly to make the company successful.