For many business owners, the sale of their company represents the culmination of decades of work and is likely to be the single largest, most important transaction of their lifetime. With so much money at stake, and likely the retirement security of the founder, it is important that the highest price is secured, and that the sale is executed flawlessly.
Much of the responsibility for success or failure of these transactions rests on the shoulders of the CFO. For the business owner, understanding the role of the CFO through all phases of the process is essential to having the right person on the team–whether that be a full-time employee or a suitably-qualified consulting CFO. Below, we explore essential elements of a successful deal and the role of the CFO in each of them.
Transaction Readiness: Preparing the Company for Sale
Long before the formal sale process is initiated, the company must be made ready for sale. Early in my career, I was fortunate to work for a quintessential entrepreneur and wonderful mentor named Errol. Errol taught me that “good luck” happens when “preparedness meets opportunity.” As we grew the company from $3.5m to $105m in revenue in less than four years, we were prepared for every opportunity that came our way. For many of the acquisitions we made, we took advantage, with Machiavellian ruthlessness, of the lack of preparation on the part of the sellers. We used valuable information that came to light in due diligence as an opportunity to re-trade the deal on much more favorable terms.
To ascertain a company’s readiness for sale, a “Transaction Readiness Assessment” (TRA) should be conducted. This involves a systematic and brutally honest examination of every area of the business through the lens of a potential buyer. In summary, there must be assurance that the company has complete and accurate financial records. This includes audited (or auditable) annual financial statements prepared in accordance with GAAP (Generally Accepted Accounting Principles) and interim statements prepared on a timely monthly-close cycle. The TRA report will assess the company’s readiness across multiple areas (legal, finance, HR, IP, etc.) and list defects to be remedied.
In some cases, audits should be augmented with a Quality of Earnings (QOE) report. A QOE report entails an in-depth analysis of a company’s revenues and expenses and is warranted when there may be doubt about future business solvency or when elements of a sale may run counter to past performance. An example of the latter could be someone attempting to sell a business based on a predicted growth rate of 30% when the historical growth rate is 10%. The QOE can highlight qualitative factors that an audit will not. Keep in mind audits are, by definition, an opinion on the accuracy and completeness and integrity of historical financial information. QOE factors could include customer churn rates, where revenue has and will continue to come from, lease considerations, and contractual details. While QOEs do add to the overall transaction costs, these costs are almost always recouped upon sale of the business.
A QOE report can also help the seller identify add-backs for non-recurring expenses that should not be considered in framing the company’s picture of future performance. Examples could include acquisition-related expenses, one-time costs of preparing for sale, one-time systems implementation costs, etc. The QOE can verify such adjustments to provide potential buyers confidence in the validity of those adjustments as a non-recurring expense that will not negatively impact future performance. In addition to the credibility boost it provides, a QOE report can surface holes in a business that may need to be addressed before advancing the sale process. Lastly, many current QOE reports are reflecting EBITDA as EBITDAC, with the “C” meaning COVID-19. Buyers want to understand both the short- and long-term effects the pandemic has had, and is expected to have, on the business.
Transaction Timing: Understanding the Season
All markets are cyclical. An astute CFO will be broadly aware of the macro-economic environment, including trends in M&A (mergers and acquisitions) activity and valuation benchmarks of both private and public companies – especially those whose business is comparable to the company they are serving. The CFO will be paying particularly close attention to M&A transactions in the company’s industry and will be aware of who is on the acquisition trail, the valuation metrics, and the strategic rationale that is driving deals.
Transaction Team: Experience is Essential
A team of rookies playing out of position will not win many ball games. Assembling a seasoned and competent deal team, including a CFO with M&A experience, is vital to a successful sale transaction. The CFO will also assist in the selection of the other members of the deal team including legal, tax, audit and, most importantly, the right investment bank. If the company’s incumbent CFO is not experienced in M&A, it is advisable to include a consultant with M&A experience on the deal team to guide the overall process and mentor the inexperienced CFO in the art of the deal.
Transaction Marketing: Target Identification / Deal Collateral
There is an old adage in real estate that “one buyer is no buyer.” The highest price will be obtained for the business when it is marketed through an experienced investment bank to a select group of qualified potential acquirers via a process that generates serious interest from multiple parties. The goal is to set up a competitive auction for the business.
Understanding the strategic rationale of potential buyers will help illuminate the true value of the business to them, which may far exceed the value calculated by using industry benchmarks. The seller’s CFO should try to think like a buyer CFO in terms of strategy, synergy, and integration to estimate the strategic value of the business for a range of potential buyers.
Understanding the strategic motivations of potential buyers will guide the production of the marketing collateral for the deal. This will comprise a non-confidential teaser, an executive summary, 3- to 5-year financial projections, a confidential information memorandum, and/or a pitch deck. The CFO should work closely with the seller’s investment bank to ensure these documents accentuate the strategic appeal of the business.
Transaction Execution: Due Diligence / Deal Points
Sellers often focus disproportionately on the price that they are being offered for their business. This can be a big mistake as other terms and conditions in the agreement may create liability, risk, and potentially reduce the eventual proceeds of sale. The price clause of the sale and purchase agreement often comprises one or two paragraphs in an agreement that might run 40 to 70 pages and include several hundred pages of attached exhibits. It is the CFO’s job to understand the nuance and potential implications of all the respective clauses, calculate risk and reward, and optimize the deal terms accordingly.
The CFO is often the conduit through which due diligence information flows to the deal room. He or she should work with the rest of the deal team (especially the investment bank) to carefully review and approve all docs before they are uploaded.
Post Transaction Integration: Day One and the Next Hundred Days
As the due diligence process nears completion and closing is set, the CFO should work with the buyer’s CFO to develop a comprehensive integration plan. This plan should include feedback loops and measurement criteria to create accountability, as well as answer questions such as “how quickly can we integrate the back-office functions?” and “what is the target for deal synergies and how quickly can we capture them?” A wise person once very astutely answered these questions by replying “as fast as we can and no faster.” Going too fast introduces the risk of disruption to the business and damage to the culture, whereas moving too slow can dissipate the benefits of the deal.
The Bottom Line
It is important to remember that the preceding points barely scratch the surface of the CFO’s critical role in successfully consummating the sale of a business. Having the right experienced team on board is essential to an optimal transaction.
Have questions about the sale process or need an experienced CFO to support you through a successful sale of your business? Request a free consultation today from a vcfo expert who will bring their expertise, wisdom and experience to bear for you.