Taking Chips Off The Table

The thought of “cashing out” lingers in the back of every business owners’ mind. Confronted daily with time constraints, market volatility, hawkish competition, profitability and growth objectives, and employee satisfaction, owners often neglect taking the necessary actions to establish a viable exit strategy. There are simply not enough hours in the day.

However, business owners must realize that inaction creates vulnerabilities and few alternatives at the time of transition. A practical exit strategy for a business will identify and correct problematic issues, determine and enhance the value drivers, accelerate growth, and increase profitability. Businesses are the most valuable asset of a majority of business owners, and an exit strategy is too important to disregard!

Business owners preparing for a liquidity event well in advance of its execution will insure maximum value from their M&A transaction. Every buyer will eventually become a seller; planning for the liquidity event should begin on the first day of operations!

Do Taxes Matter?

Mergers and Acquisitions (“M&A”) are complex, multilayered, excitingly negotiable with endless options. M&A transactions present numerous tax planning and compliance issues. Below are tax considerations that appear repeatedly in middle market deals and only serve as a starting point for delving into more intricate and tedious tax issues:

  • Structure – most commonly used structures are asset or stock purchases
  • Reorganizations – tax-free reorganizations are subject to a myriad of IRS requirements
  • Purchase price allocations – allocation to assets that generate capital gains versus or ordinary income tax rates
  • Tax treatment of earnouts
  • Installment elections available
  • Gifting prior to sale
  • Reinvesting after the sale
  • State and local tax (“SALT”) implications – vary from state to state and include income, sales and use, excise, gross receipt taxes, registration or licensing fees and successor liability for unpaid taxes

M&A transactions require delicate tax planning and negotiation on a deal by deal basis to ensure that the represented party receives optimal tax treatment at closing. Identifying areas of potential tax exposure and implementation of specific tax strategies should begin in the first stages of planning for a transaction.


In addition to the future earnings of a business, mergers and acquisitions require the delivery of the ordinary and necessary balance sheet of the business to the buyer. The balance sheet should be adequate for the continued operation of the business and exclude cash and long-term debt. Due to the varying nature of the balance sheet, sensible targets for cash (if any), net working capital, and net assets are standard.

Net working capital, or current assets minus current liabilities, tends to be the most vague and contentious balance sheet target. With significant fluctuations in cash, receivables, and payables from negotiation to close and varying definitions of the term, net working capital targets may require further negotiation between parties. Approaches to a negotiated target may include:

  • Average working capital for a specified period around the time of negotiations
  • Average working capital for a specified period as a percentage of quarterly or monthly sales
  • Average working capital from comparable companies in the industry

An experienced M&A Team understands the complexities of deal structures and will identify and resolve any potential issues early in the transaction process.


Owners and stakeholders of companies with strong cash flows, defendable market positions, products and services in expanding markets and a management team capable of driving the business forward must consider private equity (PE) groups, or financial buyers, as a viable alternative to exiting their business. Although these groups vary in size and focus, most PE groups bring a level of sophistication to the transaction process rarely matched by other prospective buyers. Return on investment is the name of the game; therefore, cash flows and management team depth and quality drive value and purchase prices.

The advantages of PE buyers:

  • Flexibility with transaction structure;
  • Cash/access to capital – new acquisitions, diversify risk;
  • Management drives growth; shares upside potential;
  • Additional returns for owners/stakeholders; i.e. “2nd bite of apple;”
  • No business disruption; maintain customer loyalty, employee morale;

The disadvantages:

  • Growth-focused; upside potential reliant on management team solely;
  • May be highly leveraged; Debt – no room for error;
  • Short-term owner/stakeholder participation;
  • Increased reporting requirements; financial/operational;

An experienced M&A Team can help business owners understand their alternatives and choose the right option to maximize the value of their business and achieve their long-term goals.

Intellectual Property Rights: Don’t Forget?

Intellectual capital is often the key objective in mergers and acquisitions. Despite the importance of intellectual property rights (IPRs), intangible assets and goodwill, the assets are routinely misunderstood and are often under-valued, under-managed or under-exploited.

“The cardinal rule of commercial valuations is that the value of something cannot be stated in the abstract; all that can be stated is the value of a thing in a particular place, at a particular time, in particular circumstances.” Before a valuation of IPRs, intangible assets and goodwill can be carried out, the questions “to whom?” and “for what purpose?” must be asked. The context is all-important for the seller to receive potentially a higher value for their business.

Sell-side valuations must include the values of the talents, skill and knowledge of the workforce, training systems and methods, technical processes, customer lists, distribution networks, trademarks, patents, copyrights, etc. Specific drivers of owner (enhanced) value will vary from buyer to buyer.

Lack of adequate preparation before beginning the selling process is always a major pitfall. Optimizing value and closing requires that IPRs, intangible assets and goodwill are included in all discussions of shareholder value.


There are a host of prospective buyers for lower middle market companies (less than $75 million in revenues), and every possibility should be explored, vetted and considered. One buyer-type that must be on every business owners’ radar are Private Equity Groups (PEGs). PEGs provide access to capital, offer insights and expertise, assist with improving market share and operating efficiencies, and have a clear exit strategy.

Cash is rarely an issue for PEGs. Depending on the sellers’ objectives, the investment philosophies and transaction structure may take on many different forms.  These may include:

  • Family Succession – active family members control with a financial partner; ownership acquired from the senior generation, achieving liquidity.
  • Growth Capital – provides access to non-recourse capital, diversifying risk.
  • Management Buyout – provides key employees with a cash partner for ownership.
  • Outright Sale – provides for the seller to transition into retirement.
  • Recapitalization – owner sells a portion of the company, retains an equity interest and participates in the upside potential of the company.
  • Strategic Buyout – maximizes sale price; cross-selling to PEG’s portfolio companies with same customer base.

The strategy and focus of PEGs vary widely; sellers’ goals and benchmarks must be stated upfront for a winning acquisition.


In the mergers and acquisitions marketplace, competition from multiple prospective buyers is an absolute necessity to maximize the sale’s value of an owner’s business. An experienced M&A Advisor will develop a Confidential Information Memorandum (CIM) designed to stimulate competition among potential buyers. The CIM reflects sales and marketing strategies to efficiently, effectively and confidentially attract qualified buyers from two major groups:

  • Financial Buyers – long-term investors; primarily interested in the return that can be achieved from the acquisition.
  • Strategic Buyers – same business or industry; financial condition of the seller may be secondary to complementary attributes.

These groups may include:

  • Private Equity Groups – raise capital, invest to gain influence over operations in pursuit of maximizing return on investment; four to seven-year investment horizon.
  • Operating Companies – same business or industry; seeking new markets, products and services.
  • Individuals – have the resources to invest; willing to examine different types of businesses or industries.

The distinctions between financial and strategic buyers may be numerous and significant; however, persistence may be the most important quality that your M&A Advisor possesses to develop multiple qualified buyers for the sale of your company.


Whether a sale is in the imminent future or not, business owners who run their companies with a “for sale” attitude keep their companies tuned up, generating increased profits and boosting enterprise value.

Fundamentals for positioning your company “for sale” value include:

  • Have a plan, align organizational objectives, focus on what creates value, i.e. profitable and reliable.
  • Review contracts with customers, suppliers and employees, address all the issues from a buyers’ prospective.
  • Shore up accounting systems, profits must be documented; buyers, investors and bankers do not recognize undocumented profits.
  • Improve the quality of financial information, highlight key financial metrics and management tools.
  • Secure and protect the rights to the company’s intellectual property, future due diligence should not expose hidden weaknesses.
  • Delegate responsibility, build the business to run without you, make yourself expendable.

The New Year is an excellent time to review your company’s systems, culture, protocols and personnel.  If you position your business well, you stand to gain enormously from profitable operations or a sale.  With the actual events triggering a sale possibly unknown, owners should always regard the prospect of a sale.

The Confidential Information Memorandum

The mergers and acquisitions (M&A) sales process begins with the preparation of a thorough Confidential Information Memorandum (CIM). This critical document provides the framework for profiling a company and positioning it for sale.
An effective CIM requires collaboration between the Sellers and the M&A Advisor to capture the essence of the business. These conversations will include:
• Company overview – history, who we are, what we do
• Define the core business – processes, technologies
• Strengths and weaknesses – success factors, opportunities, challenges, shortcomings
• Description of the industry and competition – market analysis
• Financial and/or contractual obligations
• Description of the work force – key executives/managers, backgrounds, personnel
• Major contracts and customers
• Normalized and recast financial statements – including original statements prepared by an independent CPA
A properly prepared CIM should summarize essential business information with the intent to engage numerous prospective buyers in a negotiated sale of the business. The CIM will serve as the backbone of the negotiations process; providing a clear and detailed story, ensuring a successful transaction.


The value of a company is in the eye of the buyer; therefore, sellers of lower middle market companies should position their businesses to drive the strategic value and attractiveness before a possible sale transaction. Enhancing the value of a company is an ongoing process, and sellers should begin preparing their company for sale 18 to 24 months before marketing their company. The following actions will help start the process:

  • Clean up the balance sheet: remove excess cash and securities through dividends; write-off uncollectable accounts receivables and obsolete inventory; sell non-producing assets; eliminate stockholder and employee loans; record all company liabilities, including vacation time and other employee benefits.
  • Put “change of control” agreements in place for key employees:the buyer’s perception of value is strongly influenced by the retention of key employees. Incentives in compensation and change of control agreements with key management will help maximize company value.

Position the company for income and opportunity: identify the drivers of value; elevate existing processes; control the expenses; eliminate excessive compensation; negotiate leases that will not hinder a sale; prepare financial projections for the next few years.