Forget feelings, the company is being sold for profit

The decision to sell made due to illiquidity and the need for rapid restructuring usually does not yield good results. The sale of a company should be a planned fulfillment of an investment goal. As the old saying goes: Buy with luck, sell with wisdom

written by Ivan Bilić, senior manager
Ernst & Young

The business books are closed, financial reports submitted, and most of the workforce in Croatia is going on a well-deserved annual vacation. However, summer has been a season of acquisitions, opening new facilities, and going public for many years before the recession. All these transactions were the result of acquisition strategies, with due diligence performed by teams of investors, advisors, investment bankers, and lawyers.
The recession is an indicator of the need for smarter investments. However, one lesson that many do not see is the need for smarter exit strategies. It is precisely in a recession that a smart sales strategy, clearly defined deadlines, preparation of analysis, and transparency of documents for potential buyers should come to the fore. The sale of a company will always be a complex mix of many factors, but these activities, if properly executed, will most often help achieve the highest possible profit: 1. formulation of strategy, 2. readiness test for sale and identification of key issues, and 3. preparation of documentation, presentation, and search for investors.

More than a decision
At the European level, Ernst & Young conducted a study of investment fund transactions. One of the conclusions is that in 28 percent of cases, detailed preparation in sales resulted in a significant increase in sales value. Strategy is by definition a process and not an event, in this case, the sale. A larger number of Croatian private owners view their companies sentimentally, which is natural given the effort and time they have invested in their success. However, for every private company, investment comes first. The purpose of every company is to generate profit for the owner by utilizing its resources. 

Therefore, the exit strategy must be much more than a decision to sell and a decision to engage advisors in the sale. The strategy should be written, with clear goals for the owner’s exit, a plan to satisfy all stakeholders (for example, employee relocation), and time-defined. The strategy will primarily help owners view their companies as investments, through the definition of clear goals. It will also assist in selecting advisors and clearly defining expectations from them. However, for some owners who are in a hurry, the development of a strategy will still boil down to a decision for an urgent sale. They should be more interested in the next two steps.

Buyers do not like surprises
The primary goal of the sale is profit. The secondary goal is often to sell in the shortest possible time. Profit will be smaller and the time of sale prolonged by every problem that the buyer finds during their due diligence. Therefore, identifying and resolving potential issues before the sale begins is very important. The readiness test through a series of questions should cover the following aspects of sales planning: the business strategy of the company (is there evidence of advantages and disadvantages compared to competitors?); operational segment (is there a possibility of operational improvement that is not currently in financial plans?); tax and legal structuring (do we understand the tax and legal effects of the sale or separation from the group?); financial picture (are the information prepared in a way that buyers want to see them; by segments, by customers, by margin, seasonality of working capital, key performance indicators?) and the sales process (are all key employees ready and able to assist in the sales process?). The readiness test will result in a series of potential problems that may diminish the company’s value in the sale or prolong the sales process. The solution to each of the potential sales flaws will depend on resources and time frame, but even identifying problems has its value. Buyers do not like surprises. Therefore, presenting both advantages and disadvantages positively affects the buyer’s valuation of the company.

How open to be
If the preparation of documentation is taken lightly and poorly organized, the sale of the company could paralyze accounting and controlling functions for some time, but also negatively affect the buyer’s valuation of the company. Depending on the size of the company, its industry, the nature of the reports generated for management purposes, and the profile of targeted buyers, the seller should decide on the detail of the documentation to be prepared, openness in presenting confidential data to potential buyers, and the amount of contact with key employees that interested parties would have.  In 11 years of advising clients in Croatia, I have rarely participated in a process where the buyer was absolutely satisfied with the quantity and quality of the seller’s collected data. In every case, this resulted in additional requests for explanations and documentation, and sometimes even reductions in the company’s value and the offered price.

Investment memorandum
In addition to preparing documentation, the sales process often involves the creation of an investment memorandum, a document in which the company is briefly presented in a somewhat more subjective format than statutory financial reports regulated by reporting standards. Investment memorandums, along with financial reports, also contain parts of internal reports to management, plans for future business, describe the advantages of investing in the company, and potential synergy opportunities. In the sale of larger companies, vendor due diligence reports are also prepared. These detail important aspects of the company being sold, aiming to reduce the scope and duration of the buyer’s due diligence. The three described steps, defining strategy, testing readiness, and preparing documentation, can help accelerate the sales process and increase profits in the sale with the lowest possible costs of the process itself.  The exit strategy should not just be a decision to sell made based on external factors (e.g., illiquidity and the need for restructuring) but a long-term process in which the sale of the company is a planned fulfillment of an investment goal. One shareholder saying goes: Buy with luck, sell with wisdom.