4 Traps to Avoid When an Acquirer Approaches

You may be eager to sell your business, but are you prepared for the numerous questions a potential purchaser will have before they start looking inside every corner of the business?

 

Many of these questions will be objective in nature, such as:

• When does your lease expire and what are the terms?
• Do you have signed, up-to-date contracts with your customers and employees?
• Are your products and processes protected by patent or trademark?
• What kind of technology do you use and are your software licenses up to date?
• What are the loan covenants on your credit agreements?
• Do you have any litigation pending?

There will also be more subjective areas a purchaser will be interested in, including figuring out just how integral you are to the success of your business.  After all, one of the biggest value drivers and areas of concern for potential purchasers is the extent to which the target business is dependent on the owner and the risk associated with the transferability of the business to new owners.

 

An experienced purchaser will be creative in assessing this issue before providing a letter of intent and conducting detailed due diligence.  Here are 4 possible traps for business owners to avoid when being courted by a potential purchaser.

 

Trap #1: Last-minute meeting changes

An acquirer may ask to make a last-minute change to your meeting time.  How you respond to this request may provide a clue as to how involved you are personally in serving customers.  If you can't accommodate the change request, the acquirer may probe to find out why and try to determine what part of the business is so dependent on you that you have to be there.

 

Trap #2: Checking for consistency in your business vision

An acquirer may ask you to explain your vision for the business, which is a question you should be well prepared to answer. However, they may ask the same question of your employees and key managers.  If your staff members offer inconsistent answers, the acquirer may take it as a sign that the future of the business is in your head.

 

Trap #3: Asking your customers why they do business with you

A potential purchaser may ask your pre-selected customers "Why they do business with you and your company?"  If your customers answer by describing the benefits of your product, service or company in general, that can be a sign of a valuable and transferable business.  If they respond by explaining how much they like you personally, that can be indicative of a business that is too dependent on its owner.

 

Trap #4: Mystery shopping

 

Acquirers will conduct initial research before expressing an interest in buying your business.  They may pose as a customer, visit your website, or come into your company to understand what it feels like to be one of your customers.  If they see you personally as the key to wooing new customers, they will be concerned that business could dry up when you leave.  Make sure the experience your company offers a stranger is consistent and try to avoid being personally involved in finding or serving brand new customers. 

 

You may not be expecting an acquirer any time soon, but it is never too early to be prepared to deal with the traps a potential purchaser will set to assess owner dependence.  Contact us at www.vspltd.ca for assistance with your succession and continuation planning.

Ex-Ante or Ex-Post - Which Do You See More Often?

When quantifying damages where the damages period extends beyond the anticipated trial date, there are issues to address with respect to discounting the future damages.  An earlier post addressed the issue of applying an appropriate discount rate to present value future damages. [1]  The issue of which date the damages should be present valued to, however, was not discussed.  The Ex-Ante and Ex-Post approaches address this issue.

The Ex-Ante approach computes damages (e.g. lost income) as of the assumed alleged breach date (or beginning of damages period), relying only upon information known or knowable at that time.  Under this approach, projected future damages are discounted to the beginning of the damages period using a discount rate that reflects the risk of the asset.

The Ex-Post approach, however, computes damages (e.g. lost income) as of the anticipated trial date, relying upon all known information at that time.  Damages incurred between the beginning of the damages period and the trial date are not discounted back to the beginning of the damages period but are measured as incurred.  Future damages that extend beyond the trial date are discounted back to the trial date.

The fundamental differences between the Ex-Ante and Ex-Post approaches lie in which information subsequent to the alleged breach is used, the date of the damages measurement and how the future damages are discounted.  These are summarized below:

	Ex-Ante Approach	Ex-Post Approach
Information	Use information known or knowable on the date of the alleged breach; ignore subsequent events (hindsight)	Use all available information (including hindsight information)
Measurement Date	Date of alleged breach.	Date of analysis (or anticipated trial date)
Discounting	Discount all cash flows back to date of alleged breach using a rate that reflects the risk of the asset.	Discount only future cash flows (beyond date of analysis or trial) to date of analysis or trial.

 

Proponents of the Ex-Ante approach argue that since the plaintiff was deprived of both asset returns and uncertainty surrounding those returns, it is improper to use hindsight, which effectively removes the uncertainty component.  In other words, awarding the plaintiff with all the benefits of a successful project without the plaintiff having to assume the project risk would overcompensate the plaintiff.

 

Proponents of the Ex-Post approach, however, argue that the Ex-Ante approach effectively imposes a forced sale upon the plaintiff at the time of the violation, which denies the plaintiff of any compensation for the loss of continued ownership property rights.  Using hindsight, however, correctly returns both the intrinsic risks and rewards of asset ownership to the plaintiff.  In addition, by virtue of the alleged breach, the defendant precluded the plaintiff from taking the risk associated with earning the cash flows.  Since the plaintiff wanted to take those risks, the defendant should not benefit from preventing the plaintiff from taking those risks.

 

Damages experts will sometimes apply a hybrid approach, wherein lost profits are discounted back to the breach date, but subsequent information (i.e. hindsight) is relied upon for purposes of the calculations.

 

Which approach do you see more commonly applied in expert reports quantifying economic damages?

 

 

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1. http://jasonkwiatkowski.blogspot.ca/2013/01/critiquing-expert-report-step-7.html

 

 

10 Ways to Increase Your Odds of Getting an Offer

The Sellability Score is an extremely valuable pre-sale planning tool for business owners to help assess the current "sellability" of their business. 

 

In the fall of 2012, the Sellability Score researchers analyzed data from users over the past 12 months.  The research team compared the data provided by users that had received an offer to buy to data provided by users that had not received an offer to buy.  The sample included 2,300 companies from around the world, with the majority of users being from Canada, US, UK, Australia and Ireland. [1]
 

The results reveal an interesting picture of the qualities and attributes acquirers look for in a business.  Focusing on the factors that are more closely linked to getting an offer will help increase the odds of attracting numerous suitors for your business.  The 10 factors that will increase your odds of receiving an offer for your business include:

The business can survive without you – you are twice as likely to get an offer if your business can operate and thrive without you
Your top sales person is replaceable – you are twice as likely to get an offer if you could easily replace your most important sales or marketing person
You are personally responsible for less than 75% of your sales – you are half as likely to get an offer if you are responsible for more than 75% of sales
Your top product/service design and delivery person is replaceable – you are almost twice as likely to get an offer if you could replace your most important product/service design and delivery person
Your annual revenues are over $3 million – companies with annual revenues over $3 million are twice as likely to get an offer compared to businesses with annual revenues below $500,000
Your key suppliers are replaceable – you are almost twice as likely to get an offer if you could replace a key supplier
Your business has a formal management team – you are almost twice as likely to get an offer if you have a management team as opposed to being a sole owner operator
More than 25% of your revenues are recurring in nature – you are more likely to get an offer if you have created a recurring revenue stream
Your business has over 10,000 followers – you are almost twice as likely to get an offer if you have more than 10,000 followers (i.e. aggregate of e-mail subscribers, Twitter followers, Facebook fans, Google + connections or LinkedIn connections)
You are younger than 33 years of age – although beyond your control, younger owners were twice as likely to get an offer than mature owners (it is speculated that this occurs in instances where the purchaser is interested in acquiring a company for the people or ‘talent’ building the product)

You may not be looking to sell your business today.  However, more than 310,000 businesses in Canada are poised to change hands over the coming five years.  The increasing supply of businesses for sale will create a buyer’s market putting downward pressure on sale prices over this time period.  The Sellability Score can provide you with vital information needed to command a premium price when it comes time to sell your business, especially in a competitive buyer’s market. 

 

Visit us at www.vspltd.ca or http://www.sellabilityscore.com/vsp/jason-kwiatkowski to find out your company’s Sellability Score.

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1.  Sellability Tracker Q4, 2012 – Increasing Your Odds of Getting an Offer.

Critiquing an Expert Report: Step 8 – Consider the Contract

You have nearly completed your review of an expert’s report by conducting the following steps:

1. Review author’s credentials and qualifications;
2. Identify scope limitations;
3. Assess underlying assumptions;
4. Consider conclusion as opinion versus calculation;
5. Identify damages approach;
6. Identify damages period; and
7. Ensure future damages appropriately discounted.

Step 8 to critiquing an expert report is relevant to legal disputes involving a breach of contract.  Such breach could include a breach of buyer/seller agreement, warranty agreement, franchise/distributorship agreement, construction contract, service agreement, lease agreement, non-compete agreement, insurance contract, etc. 

 

Step 8 involves asking the question "Did the expert consider and refer to the terms of the original contract in quantifying the damages?"  Ultimately this question is meant to help ascertain whether the assumptions underlying the damages conclusion are reasonable and consistent with the terms in the contract.  If the expert report relied upon assumptions that are inconsistent with the terms in the original contract, the conclusions could be inaccurate and unreliable.  Such key terms, which may be relevant for purposes of quantifying damages, could include: volumes, prices, costs, time period/duration, renewal period, termination clauses, etc.

 

It may seem obvious to suggest that an expert should refer to the actual contract in a breach of contract matter.  However, I was once retained by the defendant in a legal dispute (involving the alleged mismanagement of client funds by an investment advisor) to review the plaintiff’s expert report with respect to a claim for damages.  The plaintiff’s expert report did not consider or refer to the original client agreement with the investment advisor.  The expert report relied upon an assumption with respect to a suitable portfolio mix (e.g. risk-free, income, equity, etc.) based on instruction from counsel which was inconsistent with what the client stated and agreed to in the original contract.

 

Our responding report highlighted this as one of our concerns with the conclusions contained in the plaintiff’s expert report.  The case never did proceed to trial as the parties ended up settling the matter out of court for an amount less than the plaintiff expert’s assessment.

 

Taking the time to find out whether or not the assumptions underlying the expert’s conclusions are consistent with the original contract is a step that should not be avoided in order to conduct an effective review of that expert’s report.

Highlights from the Latest CFIB Research on Succession Planning

"The value of business succession planning cannot be underestimated given that about one trillion dollars of business assets could be transferred to the next generation in the next decade." [1]

In November 2012, the CFIB released the results of a study on business succession planning that was conducted over the period from March 9 to May 4, 2011.  Over 8,300 Canadian business owners responded to the study. Some of the highlights are as follows:

1. Business succession planning is a long-term process and not a one-time event requiring high investment on behalf of the business owner.
2. 51% of business owners do not have a business succession plan (formal or informal).
3. 51% of business owners started their business from scratch (as opposed to acquiring the business). As a result, many may not see the value of succession planning since they did not take part in the past.
4. Close to 50% of business owners plan on exiting their business in the next five years with more than 75% planning to exit within the next 10 years.
5. Nearly 50% of business owners plan on selling the business to a third party with over 33% planning to sell or transfer the business to a family member.
6. The top 4 barriers to completing a business succession plan include:
a)  Finding a buyer/suitable successor;
b)  Valuing the business;
c)  Financing for the successor; and
d)  The business being too heavily dependent on the owner's active involvement.
7. The top 4 reasons for not having a business succession plan include:
a)  Too early to plan;
b)  No time to deal with the issue;
c)  Can't find adequate advice/tools to start; and
d)  It is too complex.

Being able to measure the value of the business is a critical aspect of the business succession plan.  Any disconnect between the expected value of the business and the actual valuation will make exiting the business extremely difficult.

In conclusion, the CFIB advises that a well designed succession plan will help ensure the future stability and value of the business and ultimately a smooth transition for the business and business owner.

 

For those business owners that recognize the importance of beginning the exit planning process early, especially in light of the expected increase in the supply of businesses that will be for sale over the coming decade, but have no time to deal with the issue, can't find adequate advice and think it is too complex, let the trained professionals at VSP assist you through the process (www.vspltd.ca).

 

 

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1.  Canadian Federation of Independent Businesses (CFIB) Research – Survey Results on Small Business Succession Planning, November 2012. 
http://www.cfib-fcei.ca/cfib-documents/rr3277.pdf

Could You Sell Your Business As Is?

Have you ever wondered if you could sell your business as is?  You may think you have an attractive and valuable company but, would a potential purchaser agree?  Are you ascribing value to sweat equity that a potential purchaser may not attribute value to?  Are you even aware of what a potential purchaser would be willing to pay for your business today?  To answer these questions, you must start thinking like a potential purchaser.

 

Knowledge is power and arming yourself with the knowledge of how potential purchasers view your business and what they would be willing to pay for your business is very powerful.  The Sellability Score questionnaire is a useful planning tool to help business owners think more like a potential purchaser.

The Sellability Score is an online tool developed by John Warrillow, author of "Built to Sell: How to Create A Business That Can Thrive Without You".  This innovative software helps business owners determine how easy it would be to sell the business as is and predicts the likelihood of receiving a premium over industry average multiples if the business were packaged for sale today.

 

The Sellability Score is a free and completely confidential self-assessment tool that scores your business in a number of key areas and provides information to help determine:

 

• Whether your business is easy or hard to sell;
• How to improve the sellability of your business; and
• The questions you need to be asking before you sell your business. 

 

Business owners simply complete a brief online questionnaire to receive an immediate Sellability Score of between 1 and 100 for the business.  A detailed report is produced that provides insights into how buyers evaluate the business.  The report contains more detailed information on the eight key attributes of a sellable business and why these factors are so important.  It will help you pin point the areas in your business that need improvement in order to maximize the value of your company.  The 8 key attributes (which will be discussed in more detail in future entries) include:

1. Financial performance
2. Growth potential
3. Switzerland structure
4. Valuation teeter totter
5. Hierarchy of recurring revenue
6. Monopoly control
7. Customer satisfaction
8. Hub and spoke

The Sellability Score is the easiest way for business owners to begin the pre-sale planning process by identifying the company’s strengths and weaknesses (in terms of its sellability).  This questionnaire should be taken at least 3 years in advance of a sale or transition to allow time to implement value enhancement initiatives and other vital pre-sale planning activities.

 

You may not be looking to sell your business today.  However, an estimated $1.9 trillion in business assets (or 310,000 businesses) are poised to change hands over the coming 5 years.  The increasing supply of businesses for sale will create a buyer’s market putting downward pressure on sale prices over this time period.  The Sellability Score can provide you with vital information needed to command a premium price when it comes time to sell your business in a competitive buyer’s market.

 

To find out your company’s Sellability Score: http://www.sellabilityscore.com/vsp/jason-kwiatkowski

　

Critiquing an Expert Report: Step 7 - Discounting Future Damages

Step 7 to critiquing an expert report on damages in a commercial dispute involves identifying the extent to which the damages period extends beyond the current date (or anticipated trial date) and assessing whether or not the expert reasonably present valued the future damages (e.g. lost profits) to the breach date or the trial date at an appropriate discount rate.

 

The discount rate used to present value future losses in a commercial dispute is often one of the major assumptions underlying a damages calculation which, if altered, can have a significant impact on the conclusions.

 

As you review the expert report, the following questions should be addressed:

1. Does the damages period extend into the future (beyond the trial date)?
2. Have the future damages been present valued to the trial date or the breach date?
3. What discount rate was used to present value the future damages and does it accurately reflect the risks underlying the projections?

According to The Litigator’s Guide to Expert Witnesses:

"Where a stream of future income is being analyzed to determine damages, an appropriate discount rate has to be determined.  The discount rate, when applied to monetary sums receivable in the future, expresses these sums at their current worth, taking into account the time value of money and the future risk that these future sums may not be received."

 "In several provinces, there is a prescribed discount rate. However, in cases of commercial litigation, careful consideration must be given to the appropriateness of this prescribed discount rate which always carries with it two assumptions:

• All revenues and costs will increase in line with the rate of inflation; and
• The long-term rate of return is equivalent to that available on Government of Canada bonds.

If one or both of these assumptions are inappropriate in a commercial situation, then a different discount rate will have to be calculated." [1]

Prescribed rates reflect risk-free rates and are commonly used in personal injury matters.  They are generally not appropriate in commercial disputes as cash flows associated with a business are not risk-free (i.e. the long-term rate of return for businesses is generally not equivalent to the rate of return on Government of Canada bonds).  In other words, where an expert has present valued future losses in a commercial dispute you should expect the discount rate applied to be higher than the prescribed rates.  

This is an important point because applying a higher discount rate to future losses will result in a lower value being attributed to the breach.  Conversely, a lower discount rate will increase the value attributed to the breach.  As a result, the application of prescribed or risk-free rates in a business loss matter is a red flag that the expert’s damages conclusion may be overstated. 

 

Where the expert’s discount rate assumption is not reasonable under the circumstances, you should consider the impact of using a more appropriate discount rate assumption on the conclusions.  The assistance of an independent expert CBV may be required in this regard. Determining an appropriate discount rate requires a comprehensive assessment as to the business, financial and economic risks facing the business along with research regarding industry transactions and/or public company trading multiples as well as experience and judgment on the part of an expert trained in this area.

 

The discount rate used to present value future damages is often a major assumption underlying a damages calculation.  Taking the time to understand what the expert assumed in this regard and assess its reasonableness in light of the facts and circumstances of the case is critical to conducting an effective review of that expert’s report.

 

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1.  The Litigator's Guide to Expert Witnesses, Mark J. Freiman and Mark L. Berenblut, 1997, pages 91 - 92.