Take steps to build company value before selling

• There are approximately 12 million privately owned companies in the United States.

• Of those, 8.4 million are expected to change hands in the next 10 to 15 years.

• Private equity groups raised $173.5 billion in 2005 to invest in private companies.

The approximately 76 million boomers who have dominated the U.S. population are now entering their mature years (defined as 60+) like a tidal wave. President Bush and former President Clinton, and celebrities including Cher and Dolly Parton, are among the group stepping into its sixth decade this year. Boomer-owned companies will change hands in greater numbers and at a faster pace, creating a massive impact on merger and acquisition activity, market pricing and capital recourses.

Take M&A and market pricing, for example. The seller’s market the United States has experienced for the last three years will change when the boomers’ companies begin to hit the market in large numbers. Within the next three years, we will likely change from a seller’s market to a buyer’s market because of the number of boomer companies for sale, and because much of the private equity available now is coming from retirement accounts.

Sources of liquidity

There are approximately 2,500 to 3,000 private equity groups looking for companies to acquire. Private equity groups collectively raised $173.5 billion in 2005, compared to $42 billion in 2004 and $24 billion in 2003. In addition to the current funds raised, there’s an estimated $100 billion surplus of private equity funds looking for acquisitions.

In addition to private equity groups, S&P 500 companies had more than $600 billion in cash at the end of 2004. And approximately 9,000 hedge funds have $1 trillion under management.

All of this money, along with relatively low interest rates, has fueled the seller’s market of the last few years. That could change. Much of the available investment money today is from pension funds. As more boomers retire, there will be fewer pension dollars available, which will change the market dichotomy. Interest rates also are a big part of the equation. With many more companies coming to the market in the next 10 years, it will be more important than ever to evaluate exit options, select the right timing of a sale and take steps to enhance the value of your company.

Timing, planning and exit options

Every private company owner faces the challenge of transferring ownership at some time. This transfer may be a sale to a third party, the transition of ownership to an employee stock ownership plan, a management buyout, becoming a public company, or a transfer to family members by sale or gift. The 2003 MassMutual Financial Group/Raymond Institute American Family Business Survey reports that 42 percent of those owners planning to retire in five years have not chosen a successor or exit plan. Of those 61 years of age or older, 55 percent have not chosen an exit plan. Yet we know a typical exit-planning timetable can take three to seven years: six months to a year to prepare a plan, a year or more to execute value enhancements and tax planning, another year to execute the plan, and one to three years or more for the transition process.

Building value now

To build your company’s value before the market is overwhelmed with companies for sale and capital markets are less favorable, you need to act now by managing certain business fundamentals, understanding the impact of certain uncontrollable industry and market fundamentals, and working with an experienced adviser. To increase the value of your company, proper timing, planning and execution of these components must be built into the sale process. Let’s look more closely at the three components of company value: business fundamentals, uncontrollable industry and market fundamentals, and transaction components.

• Business fundamentals – revenue growth, sustainable cash flows and a clean balance sheet – set the foundation of your company’s value and lay the groundwork for enhancing value. Other important business fundamentals are reliable financial information, product quality and service, reputation, condition and ownership of facilities, customer concentration, management experience and expertise, employee quality and dedication, and reliable and supportable information technology systems.

It is important to prepare for the sale or transfer of your company well in advance and examine these areas for opportunities to enhance value.

• A company’s value also is affected by industry and market conditions beyond the control of the company owner. Many owners underestimate the impact industry and market conditions have on a private company’s value and how important timing can be to achieving higher company values.

Like the market as a whole, each industry has its own market cycle. Be aware of industry cycles by watching fundamentals, such as industry growth and consolidation, customer demographics, competition, substitute products and obsolescence, all of which can affect company value. Industry cycles may be seven to 10 years in duration, and very few company owners are able to predict with certainty the exact peaks and valleys.

Because of this, it is important to consider a “window” of time in which to complete a sale. The window may be one to three years in length, and it is always better to be selling when the cycle is going up rather than peaking or coming down.

The number of M&A transactions and values being paid are good indicators of how receptive the strategic and financial-buyer communities are to a prospective acquisition. An improving economy, large amounts of private equity, low interest rates and rising corporate earnings drove M&A volume in 2005 to its second-highest total in history. As M&A activity for small and mid-sized companies continues to be very strong, transaction values have approached record highs, and the outlook for 2006 looks good as well. We may have reached a peak in terms of multiples being paid for companies; however, there continues to be strong competition for good companies, and this will continue to be good news for sellers.

• An often-overlooked component that affects deal value is the way a transaction is managed. An experienced adviser adds value by providing market and financial knowledge of factors that will affect the value of your company, negotiation and marketing skills, and a successful strategy for closing a transaction. All are important factors in unlocking the total market value of a company.

Here they are in more detail:

Recasting financial performance. An experienced adviser can help present financial information to reflect the true earning capacity of the company, which may be dramatically different from the historical financial statements. This can add significantly to your company’s value. Recasting the income statements and balance sheet are important steps in the process.

Successful marketing. An experienced adviser can help identify multiple, viable buyer prospects, many of which the seller may be unaware. The buyer group includes strategic buyers, as well as thousands of private equity groups. Advisers also understand the importance of confidentiality and positioning the company in its best light.

The competitive environment this combination creates translates into higher valuations and better options for sellers.

Successful negotiations. Experienced advisers also are skilled negotiators, able to highlight the benefits and value of each component that increases a company’s value. Negotiating with multiple buyers further increases the seller’s leverage. Increasing the competitive nature of the sale through a professionally managed process helps sellers achieve a higher value for their company. It’s essential for your company to continue operating at a high level throughout the sale process. Business owners who try to manage the sale can put their company’s operations at risk and reduce its overall value.

With greater numbers of boomer-owned companies for sale, the sellers who prepare in advance will achieve higher values. Stay focused on your business fundamentals, understand how favorable industry and market conditions can add value and utilize an experienced advisor to add value to the transaction.

If you follow these suggestions, you could be among the boomers who realize their share of the trillions of dollars in available wealth.

Steve Blumreich is president of BKD Corporate Finance LLC, a wholly owned subsidiary of the CPA and advisory firm of BKD LLP. He can be reached at sblumreich@bkd.com.