Selling up : The lessons learnt from that failed attempt that led to a successful exit five years later
April 6, 2023
In 2006, Victor Lewis took his conference company, World Trade Group, to the market. After a gruelling eight months, the deal to sell to private equity eventually fell through. In this extract below from his recently published book ‘Turning Points: An Entrepreneur’s Tale’, Victor shares the lessons learnt from that failed attempt that led to a successful exit five years later.
Selling Up
A few months after I sold World Trade Group in 2011, Paul Herman, who had been our corporate advisor asked me to speak at a seminar he was holding for Bluebox, the new company he had formed. I was pleased to oblige as Paul had negotiated a great deal for us. We had tried and failed to sell the business 5 years earlier but it was only in preparing my talk for Paul that I came to see just how many hurdles we had overcome to finally get this deal over the line at the second time of trying.
Corporate advisors will tell you how to prepare a company for sale and the documents you need to upload into the electronic data room. That advice is invaluable but the vendor is also confronted with a series of existential problems that arise between accepting an offer and completing the deal. These will be unrelated to the actual performance of the business but they can be potent issues and open up splits within the company that in some cases may determine whether the sale goes through. Some of these issues are minor, some are important but if Paul Herman is right in saying that 90% of companies who go to market fail to sell, then to maximise the opportunity the vendor needs to negotiate all the roadblocks scattered along the route.
To tell or not to tell
When we took WTG to market in our failed attempt in 2006 we were very open and told everyone in the company that we had accepted an offer to sell.
This was because we knew that management would be distracted by having to supply reams of detailed information to the buyers so to keep trading on track we promised each employee 12-months salary as a bonus if and when the deal completed. We hoped this carrot would ensure that everyone in sales and production would maintain performance during the due diligence process.
This strategy was largely successful, in that trading held up. However the deal eventually failed for other more profound reasons and so the promised bonuses never materialised. The effect on morale (and management credibility) was devastating all round.
When we went into the same process in 2011 it was on a strict need-to-know basis. The sale was not revealed to our employees until after completion. There was no anxiety in the company and when the deal was announced it was ‘business as usual’.
Shares, options & rewards
If you haven’t identified key people and granted options by the time you go to market it’s too late to do so.
A sale often presents opportunities for the management team to cash in through a three-year earn-out put in place by the purchaser. This is the best way to incentivise key employees to hit growth targets. An added advantage is that the reward for a successful outcome is borne by the company and not from the vendor’s own pocket.
After I sold my first business, Cornhill Publications in 1987 we set up a discretionary trust fund for a handful of key people in the company. This was because the shareholders were on a three-year earnout and we needed the commitment of senior sales and management to achieve our sales and profit targets.
We decided that the payout from the trust fund would only take place when the three-year period came to an end, and then, only if the named individuals were still employees.
This time delay was an error of judgment. A long-term incentive has no short-term effect on performance. After 18 months or so, in the eyes of the beneficiaries the trust fund was more like a fantasy fund that always promised jam tomorrow.
The beneficiaries began to doubt they were ever going to be paid anything. Realising this we made a substantial interim payment but goodwill had been lost and the money was received as if we had been forced to pay up on a bad debt.
We should have given out more information and paid out from the trust fund as soon as we had received each tranche of the earn-out monies.
Identify the key personnel you need to retain in order to sell the business and grant tax-efficient options at least 2 years in advance of going to the market. Otherwise include key management in any earnout scheme.
Appointing a corporate advisor
This is a vital decision. The ability and experience of your corporate advisor will be a determining factor in your success. Rule one is, do not appoint your High Street accountant. They will tell you they have the expertise to negotiate a sale but they do not. Do research and select someone to represent you who has the relevant experience and industry knowledge and contacts.
We learned from our failed attempt to sell in 2006. Then, on a single recommendation we appointed a team of corporate advisors from a top five firm of accountants. They couldn’t be faulted for commitment but they failed to identify fault lines in our business.
In 2011 things were done differently. We held a beauty contest to find the right corporate advisor. Each of the five directors researched and nominated three or four firms for consideration. In order to be considered on the long list a firm needed to be nominated twice.
Three directors interviewed five firms before reducing this to a shortlist of two. The full board held the final interviews after which the directors were united in choosing Paul Herman as our corporate advisor.. Paul managed the sale process from start to finish and we completed within four months of going to the market.
Don’t pick the advisor who gives you the highest valuation and/or the lowest fee. Don’t appoint the friend of a colleague or relative. Don’t go with your friendly accountant.
Do your diligence and pick an advisor you can trust, who tells you the truth and who has the experience and drive to deliver. Take out references and speak directly with the chairman or CEOs of several companies for whom the advisor has recently completed a sale.
Finally, if at all possible appoint an advisor who only acts for vendors. That way your advisor will not have any conflict of interest.
Maintaining trading throughout the sales process
Once an offer is accepted the buyers will be all over it and the directors will be plunged into the diligence process. The Chief Finance Office (CFO) will be tasked with producing endless schedules, forecasts and odd bits of analysis. The buyers will send in their own auditors to pore through prior and current year accounts and forecasts. The CFO will have little time for normal day-to-day business.
The Chief Executive Officer (CEO) will be required to attend meetings and to clarify issues relating to past performance and the status and treatment of revenues. He or she will also need to back up the budgets and justify credible forecasts for the next three or five years.
All this is incredibly time-consuming and so inevitably the senior management take their eye off the ball. Current year sales forecasts will start to look challenging and performance may drop off. This is hardly surprising; if the management don’t make a difference, what are they doing there?
The reason all this matters is because it is highly likely that the price agreed for the company is calculated as a multiple of current year EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation).
It follows that if the EBITDA looks like falling short of the forecast then the buyer, especially Private Equity, will want to renegotiate the purchase price.
If profits of £1m were predicted then a multiple of six values the company at £6m. However if the forecast is downwardly revised to say £800k, then the same multiple of six reduces the sale price to £4.8m. The vendor has lost £1.2m because their current year EBITDA number came up £200k short.
The buyer may not accept that this was due to the time management spent on the demands of the deal process. They may use the blip as an excuse to chip the price.
To maintain focus, one member of the management team must take primary responsibility for liaising with the buyers and the corporate advisor. Other team members will be there for support but their key function is to run the day-to-day business and meet the profit forecast.
The CFO is likely to be overwhelmed by the buyer’s demand for information. Give them additional temporary support staff at the commencement of the process. The CFO may well believe that he/she can handle this without this support. Generally they can’t.
The business plan
Any glance at the average Information Memorandum or pitch deck (this is the sale document prepared by the vendor company) often shows a sudden and sometimes dramatic spike in forecast profits in the years following the acquisition.
It is only credible to hike the numbers if there is an inciting event. This might be a change of regulation that opens up the market, the demise of a key competitor, a new revolutionary product or application, projected leap in earnings as a result of judicious use of investment.
Business plans should look sensible and achievable. Unjustifiable optimistic forecasts damage credibility.
Back up the forecasts with achievable projections that can withstand scrutiny.
Do products that are in development have a value?
If the company has spent say, £500k developing a product but that product has not been market tested, it will not be valued by the buyer. However, if that £500k would otherwise have added to the profit then there is a fighting case for adding it back to the EBITDA number. That could make a substantial difference in a valuation based on a profit multiple.
Assume the product in development investment carries no value, but it’s worth a fight to have it written back into the EBITDA as profit.
Managing conflict with other stakeholders
Some companies have a single owner whilst others have multiple shareholders. In those cases each of the parties may want something different out of the sale.
This is where conflict arises. Buyers understand that a retiring director will want to cash out in full. They are not so understanding with the other members of the management team. Indeed they do not want the continuing key shareholder employees to be financially independent.
When I first took WTG to the market in 2006 the behavior of all my senior colleagues was disappointing. They resented the fact that I, as a retiring director would be paid out in full whilst they, continuing working in the business, as key employees would have a large portion of their monies retained by the buyer.
There were tantrums, threats to scupper the deal, tears and aggression – both overt and passive. According to experienced corporate advisors I have spoken with this is quite common behaviour from minority stakeholders when a business is in the process of being sold. It did however put considerable additional strain on me.
My advice to any business owner seeking to sell is this; at the first sign of bad behaviour postpone the sale, sort out the troublemaker/s and go to the market 12 months on.
All these areas that Victor touches on in this expert are all vital elements to think about when the time to sell comes. As Victor highlights, the ability and experience of your corporate advisor will be a determining factor in your success. If you’re looking for a corporate advisor, please do get in touch, we would be delighted to chat. Hopefully you can see from our website that we are experienced in what we do and we can assure you that we have numerous referees that would support this assertion.
