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Half of all business sales fall apart during due diligence.

The Denver Post | BUSINESS

Here’s how to avoid it.

By Gary Miller | Gem Strategy Management

POSTED:  June 3, 2018 at 6:00 am

When a seller tries to hide facts, or doesn’t disclose them to buyers and they are uncovered during due diligence, say goodbye to the deal. According to Forbes, “approximately half of all deals fall apart during the formal due diligence stage, and one of the most common reasons this happens is due to the buyers uncovering  issues which the sellers didn’t disclose earlier.” These situations are never pretty. Accusations are made, lawsuits follow, buyers lose their investments, sellers forfeit any earn-outs and face “financial claw backs” and businesses deteriorates rapidly. Nobody wins. These situations are all too common and in most cases should never happen.

Think about it. You spend years building a successful business. You decide to sell, spend time trying to find a qualified buyer to sign an LOI (letter of intent to purchase your company) and begin negotiations, only to have your potential deal fall apart because of undisclosed items arising during the due diligence process. So what can you do about it? Below are four “musts” for successful deal making.

First, don’t rush to go to market. Rushing to market can be caused by age, illness, burnout, divorce, legal problems, partner squabbles and myriad other reasons. But, in spite of these reasons, rushing to market could significantly impact your ability to get an optimal deal for your company. Going to market unprepared is a recipe for disaster. Since most business owners will only sell a company once in their lives, it’s a good idea to engage a professional M&A adviser to help prepare for the transaction process in general and the due diligence process in particular.

Second, prepare for the buyers’ due diligence process. Prepare for intense buyer scrutiny.  Far too often business owners simply do not do their homework prior to the process and pay the price in the end when their deal falls apart. If a seller is not prepared in advance, due diligence can drag on for weeks; and, often, if it does, buyers get cold feet and move on to other, more attractive opportunities. Have an adviser create a typical due diligence check list and put you through the rigor of answering questions that could arise.

Third, disclose, disclose, disclose. Throughout the discussions, negotiations and the due diligence review between a buyer and seller, credibility is being tested. In your discussions with the buyer, explain your challenges before they find them; understanding them will allow the buyer to get comfortable with your business. Disclosing the challenges actually builds trust and credibility. As long as the parties deal honestly with each other, trust builds. But, if either side tries to hide material information that surfaces during due diligence, trust will be shattered. The cardinal rule of deal making, during the due diligence process, is disclose all material information.

For example, in a transaction involving a moving and storage company, a large percentage of the company’s revenue came from a single government contract. The buyer wanted to read the master contract between the company and the government agency to be sure it was transferrable as the seller had represented. However, the seller knew it was not really transferable and would have to be reviewed by the government agency because of change of ownership. He figured he could convince the buyer to buy the company’s stock instead of the company’s assets after the buyer was emotionally invested in getting the deal done. Wrong strategy. The buyer agreed to complete all other components of due diligence and would review the contract afterwards. Sure enough, the buyer discovered that the contract was not transferable and could only continue with an entirely different deal structure complicated by tax issues and potential liabilities. The buyer felt mislead and the deal disintegrated.

Remember, the goal is to sell the business. Disclosing the good and the bad about the business, warts and all, is just prudent deal making.

Fourth, think like a buyer. Look at your business as if you were a buyer. Ask yourself, what would I need to know about this company if I were buying it?  What are its strengths and weaknesses?

A great exercise for sellers is to put together a list of everything that worries them about their own business – those that keep them up at night. Then, detail potential solutions to each problem that can mitigate a buyer’s concern. For example, if the business has some old equipment, the seller can be proactive and have a spreadsheet ready that details replacement costs and financing options along with the potential improved efficiencies that will contribute to the bottom line.

Despite the dismal statistics of failed deals, transparency between the parties is the key to success. When a buyer wants to buy and a seller wants to sell, and the parties like and trust each other, they will find a way to get the deal done.

Gary Miller is CEO of GEM Strategy Management Inc., based in Greenwood Village, which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. gemstrategymanagement.com | 970.390.4441

 

Could your employees be stealing from you? Fraud is more common than you may think

The Denver Post | BUSINESS

Employees attempt to steal from their employers in many ways. The most prevalent schemes center on asset misappropriation

by Gary Miller | GEM Strategy Management| gmiller@gemstrategymanagement.com

A business owner I know was seeing a slight decline in his gross revenues and gross margins last year at three of his five retail locations. He couldn’t understand what was going on. So he installed an enterprise resource planning system including a point-of-sale inventory management system. He hoped that these new systems would isolate the problem and improve his company’s profitability.

But things didn’t change. Product margins were less than expected; product sales were flat; cost of goods sold were inconsistent; and, the inventory analysis never reconciled with the company financial books and records. Something was radically wrong. The business owner contacted a management consulting firm for help. After an extensive review, the firm found that the company was a victim of fraud. Someone or several employees were embezzling money through misappropriation of assets.

That business owner isn’t alone. According to the Association of Certified Fraud Examiners, nearly 40 percent of fraud occurs at privately held companies and 30 percent occurs at companies with fewer than 100 employees. The association estimates that fraud causes average revenue losses of 5 percent annually.

Employees attempt to steal from their employers in many ways. The most prevalent schemes center on asset misappropriation. It accounts for almost 80 percent of employee fraud schemes. Below are the top asset misappropriation employee schemes:

  • Authorized check maker. An employee authorized to sign checks for the company makes a company check payable to himself/ herself. The employee then changes the payee’s name in the company’s accounting records so it seems as if the check was written to an authorized vendor.
  • Altered check or forgery. An employee intercepts a signed company check and alters the original payee name or the check amount using items such as correction fluid, “check washing” solution or a pen eraser. The scheme is perpetrated by an employee who receives bank statements and performs bank reconciliations.
  • Billing manipulation. An employee submits fictitious invoices from a “shell company”, set up by the employee, and then issues payment to the shell company.
  • Non-cash misappropriations. Rather than stealing cash, an employee steals inventory or other physical assets. A physical inventory count would reveal lower inventory levels than those reflected in the company’s perpetual inventory records, a concept often referred to as “shrinkage.”
  • Payroll and expense reimbursements. Employees submit false documents or manipulate the payroll system to create unauthorized payroll disbursements or expense reimbursements, alter data used to calculate performance-based incentives, generate paychecks to non-existent employees, or steal checks payable to terminated employees.
  • Cash register disbursements. Fraud often occurs at the point of sale when an employee processes a false product return or voids a sale that was previously recorded and steals cash paid in the transaction. Alternatively, a salesperson may purposely skip entering a sale into the company’s point-of-sale system when a cash payment is made and pocket the proceeds.
  • Lapping schemes. An employee applies a payment amount on a customer’s invoice that is different than the invoice listed on a customer’s remittance advice. This occurs when the employee is using a lapping scheme to conceal the skimming scheme. For example, if the customer intended to pay invoice #003 per the remittance advice, but the employee instead applied the customer payment to invoice #002, it is likely that the employee previously skimmed the payment for invoice #002 and must now conceal the misappropriation.
  • Unusual number of customer charge-offs or credit memos. An employee identifies an amount as uncollectible when the customer’s payment was actually received and misappropriated by the employee; or, conceals a company’s refund of a customer’s deposit that were initially misappropriated.

Business owners should recognize the signs that might identify fraud:

  • Understand how various asset misappropriation schemes work, and which schemes pose the greatest threat to your company’s operations;
  • Maintain stringent oversight of all accounting operations, and hire a third party to audit your financial operations periodically;
  • Restrict employees from accessing information they do not need to perform their duties, and segregate cash receipt duties among several different employees;
  • Regularly review manual journal entries focusing on entries posted to cash, accounts receivable and sales, and,
  • Install active and passive customer/employee complaint mechanisms such as customer password protected website screens.

Employers want to trust those they have hired, but remember an ounce of prevention is worth a pound of cure. Losses from fraud can have a significant impact on your company’s profitability, as the business owner above found out. He was being skimmed by one employee who had been with him for over 15 years and two accomplices who reported to her.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. 970.390.4441 gemstrategymanagement

Selling your business? Focus on the key business drivers so buyers pay top dollar.

The Denver Post |  BUSINESS

 POSTED:  January 21, 2018, at 6:00 am

Gary Miller, staff photo

By GARY MILLER | GEM Strategy Management

If you’re thinking about selling your business in 2018-2019, the time is right.

Why? First, the value of companies has never been higher. Buyers are paying premiums for well-run companies. Second, we are on the edge of an upward economic cycle, which is the best moment to sell your business. As of the time of this writing, the Dow Jones Industrial Average reached an all-time high of more than 26,000. Third, low-interest rates make it possible for buyers to lower their cost of capital when acquiring companies. Fourth, the unprecedented abundance of capital available for investments has never been higher. And finally, due to increased confidence in the economy, a record number of investors are looking for potential acquisitions.

However, receiving top dollar for your business is tied to how buyers perceive their financial risks and rewards. The more future potential reward a buyer perceives, the more a buyer is willing to pay for your business. The strength and quality of your key business drivers are critical to receiving the highest possible price.

There are 10 to 12 major business factors that drive value, but they vary by industry. Nevertheless, four of these transcend almost all other drivers regardless of the industry: strong recurring and diversified revenue streams, profits, margins and scalability; strong strategic business plans driving revenues from a diversified and loyal customer base; strong expected future cash flow and EBITDA (earnings before interest taxes depreciation and amortization) growth; and strong management bench strength and operating systems.

Focusing on these four business drivers can position you to maximize your company’s purchase price.

The No. 1 business driver among buyers is a history of increasing revenues and profits year over year for the past three to five years. Remember, buyers, buy businesses to make money. While they will examine your past financials, operations, and other due-diligence areas, they are really buying future expectations of revenues and earnings.

A second major business driver is a strategic business plan that is demonstrating strong organic growth (sales from existing and new customers), and inorganic growth (acquisition plans to gain share of market and expanded sales if any). The plan must show strong competitive advantage in high-growth industries. If the products/services can be sold in multiple industries, so much the better. The value of your company will be even higher than those companies that serve only one industry.

A third major business driver is expected future cash flow. This includes a trio of key performance areas: expected EBITDA performance; expected working capital investment requirements, and expected fixed-asset investment requirements (also known as capital expenditures, or Cap Ex).

The higher your expected future EBITDA, the higher your company value – all else being equal. To drive expected EBITDA higher, be certain your strategic business plan is demonstrating sustained sales growth, market share gains, consistent improvement in EBITDA and gross margins. The plan should clearly articulate how you are generating both your organic and inorganic sales.

Surprisingly, your existing debt load is not necessarily meaningful in these expectations, as buyers can change the capital structure as part of the transaction.

Next, the lower your expected Cap Ex and working capital investment requirements (often ballparked as receivables plus inventory minus accounts payable) are, the higher your valuation.  Ways to decrease your working capital requirements include cutting your average accounts receivables days outstanding, cleaning up bad debts, increasing your working capital turns, removing obsolete inventory and not paying vendors faster than necessary to earn your discounts. In other words, don’t pay your vendors faster than necessary just because you can.

Finally, the lower expected working capital investment means higher expected cash flow. To lower expected Cap Ex, keep your facility, equipment and rolling stock well-maintained and invest in fixed assets prudently. Palatial facilities do not translate into a higher value for your business unless they also translate into higher future expected cash flow.

A fourth major business driver that lowers risk includes having a strong management team in place (bench strength) and strong operating systems. The more your business revolves around only you or another “key man/women,” the greater the perceived risk among buyers. Therefore, strange as it may sound, owners should strive to work themselves out of a job. A corollary to a strong management team is a quality employee base with low turnover. Both of these infer a strong culture and a stable labor force for future growth.

I recommend to clients that they obtain a detailed business assessment (audit) and analysis from a business consultant so they can identify their business’s strengths and weaknesses. The recommendations from the business assessment should identify which business drivers to improve so owners can obtain the highest price paid by a potential buyer.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. You can reach Gary at 970.390.4441. gmiller@gemstrategymanagement.com GEMSTRATEGYMANAGEMENT.COM

 

Let’s make a deal. M&A outlook bright for 2018, but don’t wait too long

A near record year for M&A transactions could occur

The Denver Post |  BUSINESS

Gary Miller,SDR Ventures. He writes a monthly column for The Denver Post.

By GARY MILLER | GEM Strategy Management. He writes a monthly column for The Denver Post

December 17, 2017, at 12:01 am

__________________________________________________________________________________

As the year draws to a close, I can’t help but think about the economic outlook for mergers and acquisitions deal making in 2018. Before we discuss 2018’s economic outlook, let’s summarize 2017.  Following the election of President Donald Trump and the UK’s decision to leave the European Union, 2017 has been a period of apprehension for dealmakers.

These two events caused great uncertainty about the global economic outlook and left businesses worried about the implication of other key elections in 2017, particularly those in France and Germany. However, with repeated defeats for populist politicians in Europe, business and investor confidence has increased significantly coupled with the Eurozone’s rapid recovery. Since the worlds’ economies are interdependent, the global stage is set for solid economic performance in 2018.  A near record year for M&A transactions could occur.

This is a positive sign for the U.S. as the U.S. economy has its own numbers to brag about. According to Market Watch, on the one-year anniversary of Trump’s election win, the Dow Jones Industrial Average is showing its biggest post-election day gain in more than 70 years. The S&P 500 as added $2 trillion in value, up 16.3 percent since the election. The unemployment rate stands at 4.1 percent – a 17-year low. With less regulation, expanding trade deals, low-interest rates, low inflation, consistent corporate earnings increases, a rising GDP and now tax reform becoming a reality, deal making in the U.S. is set to rebound very strongly in 2018 over 2017. Deal-making could reach over $1.6 trillion in 2018 – up to $200 billion higher than in 2017 — according to multiple sources.

According to Deloitte’s fifth M&A Trends Report, about 68 percent of executives at US-headquartered corporations and 76 percent of leaders at domestic-based private equity firms say deal flow will increase in the next 12 months. Further, Deloitte reports that leaders see both the number of deals and the size of those transactions increasing significantly.

However, it is important to realize that the significant growth that we have seen in the markets to date is concentrated in two major sectors: technology and financial services. While other sectors such as healthcare, telecommunication, consumer and business services, and manufacturing are all expected to increase next year, there are wider differences among expert’s predictions.

So what does this mean for lower middle market and small-business owners? According to the 13 Annual, M&A Outlook Survey released by the law firm Dykema, respondents were bullish on the prospects of a strong M&A market. For example, over 70 percent of the respondents predict that the volume of small deals (under $50 million) will increase over the next 12 months. Sixty-eight percent of respondents said they would be involved in an acquisition in the next 12 months. An astonishing 80 percent of respondents expect an increase in M&A activity involving privately owned business in the next 12 months – increasing by 10 percent from last year’s results. According to Jeff Gifford, co-leader of Dykema’ s M&A practice, more companies are pursuing small to middle market strategic transactions.

According to some economists and financial research firms, 2019 and 2020 will reveal a decline in M&A activity in both the number of transactions and the value of the transactions. Some economists are predicting a downturn or a mild recession as early as 2019 – more likely in 2020–2021. Therefore, 2018 through 2019 are the year’s businesses will be looking to maximize their deal structures and values in their exit strategies.

I am recommending to clients who are thinking about selling their businesses to start immediately preparing their exit strategies in this uncertain business cycle. Even though it is impossible to forecast the ups and downs of the business cycles several years ahead, even six to 12 months ahead, preparing now for a sale in 2018, 2019 or 2020 is your best strategy to maximize the value of your company.

At a minimum, clean up your books and records; secure a valuation of your company from an outside professional valuation firm; update your governance and legal documents; secure a quality of earnings report; have your last three years of financials reviewed or audited by an outside independent accounting firm; develop strategies to secure your major customers for long-term sales; develop long-term employee agreements for your most valuable personnel; and develop a three-year strategic business plan for 2018 through 2021. Taking these steps could increase the value of your company to potential buyers as much as 30 percent. Next year could be the best of your life when it comes to cashing out. Based on what we know now, you have only a two-year window to sell your company.

 

The most important document you need when selling your business

Avoid overly optimistic projections and unclear company storyline

The Denver Post |  BUSINESS

Gary Miller, staff photo

By GARY MILLER | GEM Strategy Management

POSTED November 19, 2017, at 12:01 am

It was late on a Saturday afternoon when Don and his management team were finishing up an internal review of their company operations. The company had been on the market for 18 months without much interest from potential buyers. Don wanted to know why. At the end of the day, Don, the founder,  and majority shareholder,  gave up as he and the management team could not reach consensus on the reasons there was such little buyer interest. Don was beside himself since revenues were strong and earnings had continued to improve over the past five years.

The following week Don asked our firm for help. We agreed to conduct a business review and analysis of his company to determine what the company needed to do to attract potential buyers. After an exhaustive review, we found a glaring void in his management systems. There was no strategic business plan — only a hodge-podge of numbers, schedules, and projections that made little sense.

We met with Don and his team (all shareholders) and explained that without a solid business plan, no potential buyer would seriously entertain purchasing their company. We advised that a formal business plan was critical to the process of selling Don’s company.

Writing a strategic business plan can take weeks, even months of intense research, writing and rewriting – particularly if you have never gone through the process before. So you might ask, is it worth it? Absolutely. First, you’ll have a better understanding of your own business as well as your industry. More important, you’ll have a set of clearly articulated goals. This will help you organize and manage your business and give you a benchmark against which you can measure future performance.

Before you can begin to put the plan together, you will need to gather solid information about your industry. Every claim your plan makes will have to be supported by authentic sources and accurate information. Information sources include trade associations, magazines, newsletters, industry research reports and annual reports from publicly traded competitors.

Your plan will include your company’s past financial records, including a quality of earnings report from an outside accounting firm. Your financials should be audited or at the very least, reviewed by an independent accounting firm. Also, your business plan should include marketing plans and statistics from competitors so you can compare your numbers to firms of similar size in your industry. You will need research to identify who is buying products or services like yours and what current trends might be changing buying patterns and behavior. Compare this information to who is buying your own products and services.

In addition, find out who finances companies like yours and the details of the loan structure. Also, identify the kinds of companies buying businesses like yours.

Passion and enthusiasm for your company’s storyline is important for the sale of your company, but your target audience will see through hype and sales speak. Instead, strive for clarity, simplicity,  and thoroughness. Here are guidelines you should follow:

  • Don’t exaggerate
  • Make your sentences short and factual
  • Guide the reader with bulleted lists, numbered sections and clearly named subject headings and subheadings
  • Do not clutter the text with small details that will slow the reading process. Refer the reader to the appendix for more detail
  • Provide a table of contents so readers can skip to relevant sections they are interested in
  • Keep the plan to about 20 to 40 single-spaced pages, plus the appendices. The appendices can be as long as necessary to include significant detail

After you’ve completed this work, you can begin filling in the various outlined sections of your plan. Regardless of your industry, at a bare minimum, your plan should include a table of contents, executive summary, company/product/services analysis, competitive analysis, investment/purchase opportunity, industry analysis, market analysis, marketing plan, operating plan, manufacturing plan, management team, human resource plan, integration plan guidelines, financial plan and projections, buyer’s exit plan and appendices. More may be required depending on your industry.

I have read scores of business plans of companies and I’ve found the same mistakes over and over again. Here are some mistakes to avoid:

  • Rose-colored glasses
  • Unsubstantiated claims
  • Overly optimistic projections
  • Unrealistic cash flow projections
  • Numbers that don’t add up
  • Not understanding the entirety of the plan
  • Not proofreading the plan
  • Unclear company storyline

After all the work you’ve invested, make sure you don’t shoot yourself in the foot with spelling errors or incorrect grammar. Double check the numbers again and again. Produce a professional-looking document.

Remember, you never get a second chance to make a good first impression.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies.  970.390.4441     gmiller@gemstrategymanagement.com

 

 

 

To maximize the sale of your company, build business value

The Denver Post | BUSINESS

Gary Miller, staff photo

By GARY MILLER | GEM Strategy Management

October 15, 2017, at 12:01 am

It can take two to three years to prepare a business for sale

Imagine sitting at your desk and reading a registered letter from a potential buyer. The letter states that the buyer is retracting its offer to purchase your company as a result of the due-diligence review and analysis the buyer just completed.

This happened to Nathan White, owner of a small uniform manufacturer serving clients throughout the U.S. This was the second time in two years that a potential buyer had withdrawn its offer. Nathan was discouraged.

Nathan called me to see what he could do to sell his company. His story was one I have heard many times before. Nathan’s company suffered from poor exit planning, a checkered record of revenues and profits, a weak strategic business plan, inaccurate books and records, and the loss of two major clients. As a result, the potential buyer believed that the business was overpriced relative to its business value, therefore, the buyer could not justify completing the transaction.

For many owners, the last 10 years have been a difficult period for growth and profitability. Other companies, however, have done extremely well. What is the difference?

Owners do not plan early enough to sell their businesses. Since many owners have never sold a business before, they fail to realize that it takes time and careful planning to optimize the business value in order to maximize the sale price. As a result, they try to sell their businesses before they have maximized the enterprise value of their companies. This situation leads to a lower purchase price from a buyer, or worse, no sale at all.

The process of selling a business has become more complex as buyers today are more cautious and much more rigorous in their due diligence efforts due to the Great Recession.

Regardless of your personal goals, there are some key issues every business owner must address in order to be ready for a business transaction. The business landscape changes every three to five years, and your company’s exit plan needs to keep pace.

The key to increasing business value is to understand how a potential buyer views your business. Here’s what I recommend to my clients: First, obtain an independent professional valuation from an accredited valuation firm. Next, engage an objective business adviser to conduct a business audit and assessment revealing the strengths and weaknesses of the business.

The adviser can help you pinpoint the value drivers and ultimately increase your business’s value and sale price from 10 percent to 35 percent or more. If the assessment reveals that some of your business drivers are weak, prioritize them and begin work immediately to correct or improve them. Once you understand the current value of the business and the value drivers, you can identify tactics to increase its value.

Key business value drivers may include sales growth trends, balanced and growing customer mix, strength of sales backlog, strength of the market niche, strong products and services brand, highly skilled, efficient and loyal workforce, solid vendor relationships, product differentiation, product innovation, strong management team that can transition to the new owner, up-to-date technology and modern work-flow systems and processes, strong management information systems, continuous growth in profitability, barriers to competitive entry, strong company culture and loyal customer base.

At least two years will be required to increase and improve the value drivers of your business. During this time, you will be able to correct minor cosmetic issues to help build incremental value.

Company culture and existing customer relationships are two critical areas that concern most buyers. Here is where you can add business value. If a business is sold, it is important to ensure that employees will embrace the culture of the buyer. Both these buyer concerns can be mitigated if the seller stays on as an employee or consultant for a reasonable period of time.

After two or three years of focusing on value optimization, your business worth should increase in the eyes of potential buyers. Understanding your company’s value and building upon it leads to a larger sale price and maximizes the wealth transfer to the business owner. If the business value process has been carefully carried out, the added value will stand up under the most rigorous buyer due diligence.

Continued owner involvement and the development of a strong management team have become even more important to buyers in today’s merger-and-acquisition environment. As earn-out requirements are commonly integrated into a sale price, performance stipulations tied to profits and revenue are frequently included in the sale contract to obtain the full purchase price.

If you are considering selling your company, act now. You must allow sufficient time to prepare for a transaction to correct any issues and build incremental value in your business. While the market is strong now, strong markets do not last forever. Time is of the essence. Remember, poor exit planning can erode the value of a lifetime of success.

Gary Miller is the CEO of GEM Strategy Management Inc., which advises middle-market private business owners in preparing to raise capital, selling their businesses or buying companies. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.