When it comes to the decision to sell, sellers need to consider a number of things so they can prepare to maximize transaction value, according to Michael McHugh, founder and managing partner of GMB Capital Partners. One of these is how founders and partners answer the question of why they want to sell.
“Do you want to sell and then sit back? Leave the company? Or do you want to take some money and get a second big bite of the pie? Because your approach is going to be exactly the opposite of that,” McHugh said at the Smart Business Dealmakers Conference in Minneapolis.
The question of why the seller is selling is usually the first one he asks.
“Someone told me a long time ago, ‘There’s only one reason people sell their company, and that’s fear,'” he says. “And you have to find out what they’re afraid of. And if it’s bad fear – if I find out that their fear is because their biggest customer is going to the competition – that would be bad fear. Good fear is that they’re worried that they’re not going to have enough time in their life to spend time with their grandchildren or something like that. And so you have to find out why they’re selling.”
And if the CEO has to go, he says, a new CEO should be hired at least a few years in advance.
“You have to do all these things when potential buyers come,” he says. “And if you say you’re no longer involved because your investment banker will tell you to say that, you better back that up with evidence. And we hear that story so often and it’s so obvious that that’s not really the case.”
When selecting a new CEO in such a situation, one must be careful not to leave the task to just anyone, he advises.
“We see this all the time: you give it to a COO, and he’s a great COO, but you immediately realize he’s not a CEO,” he says.
He recommends that anyone who wants to stay until the second attempt should definitely choose the right partner and not just go for the highest rating. It is also important to choose the right partner. Even for those who know they are going to get out of the business and perhaps just want to go for the highest rating, the decision is not always so easy.
“You also usually have an emotional connection to your company – you want the employees to do well, you want the company to be around forever,” says McHugh. “So it’s also important to make sure you find the right partner and not just the one with the highest offer.”
It may be that an owner ready to sell has put a lot of work into operational aspects but has neglected to keep their financial and accounting practices up to date, meaning they have a weakness in this area. However, it is best if potential buyers do not see any weakness as this will result in price reductions.
Buyers, he says, will be doing their own earnings reports and industry studies and calling the seller’s customers and competitors. So sellers need to be prepared because whatever is going on will always come up, and sellers shouldn’t sit idly by when tough questions arise.
He also recommends bringing some key employees on board for two reasons. First, to facilitate due diligence. Second, when buyers hold a management meeting, they want to see the team members as a whole and see how they interact with each other to see if they feel comfortable speaking up and even contradicting what the CEO has said.
“When it’s a whole team, there’s trust in the organization, and everyone feels comfortable voicing their opinions, that really speaks volumes,” says McHugh. “Also, when I do factory tours, half the time I don’t understand the manufacturing processes, but I really see how the CEO reacts to the people in the factory. Because some of them, when the CEO knows everyone’s names, they light up and say, ‘Hey, Bob. How are you? How are the kids?’ That’s pretty cool. But sometimes when I do factory tours, employees walk by and avoid eye contact with the CEO. That’s not so good. I’m not going to base my decision solely on that, but it’s pretty telling.”
If you have customer concentration, you’re likely to get a valuation penalty, so you should try to diversify your customer base. But there are other aspects of diversification and concentration that can affect valuation. An example would be having a diversified customer base but a small sales team with one person responsible for customers who make up 80 percent of sales. That, he says, is just as bad a concentration as customer concentration.
“So there are other types of concentration,” he says. “So as you prepare, don’t just think about customer concentration. Think about other types of diversification as opposed to concentration.”
