I got a call from a guy – let’s call him Steve – who has a twelve-million-dollar-a-year heating and air conditioning (HVAC) business. Steve, along with his sister and mother, inherited the business a year ago when his father died at age 70 after 35 years of building the business.

Steve was looking for advice because he had been approached by a much larger HVAC business looking to expand. Although Steve hadn’t been looking to sell, getting an unsolicited offer of $11.5 million (just shy of 5 times their EBITDA last year) got his attention.

After talking to his controller, a few key installers and his HR manager, Steve signed a Letter of Intent (LOI), giving the potential acquirer 60 days to do their due diligence, during which time Steve is restricted from negotiating with anyone else.

Steve’s reaction was natural, but he is regretting his haste. Now that the LOI is signed, one of the partners from the buying firm says their offer of $11.5 million was too rich and the business is actually worth around $9.5 million.

In my view, Steve made some serious mistakes. Here are four things to do when you get an unsolicited offer to buy your business:

1. Slow down.

Steve’s business has been around for 35 years, so there’s no rush. It’s typical for acquirers to create a sense of urgency; once they have their target in sight, they want to go in for the kill, which is to get you to sign an LOI, giving them exclusivity to pick over your business without other acquirers applying pressure to the price or process.

2. Do not sign anything until all the fine print has been discussed.

Once you sign an LOI, you lose your negotiating leverage. One reason Steve’s deal is melting away comes down to the bonuses on the P&L. Steve’s argument is that the employee bonuses paid last year should not be treated as expenses on the P&L (thereby increasing the EBITDA line) because the larger company would not need to pay bonuses, given that it has a rich pension scheme. I’m not sure I agree with Steve’s logic, but in any case, this is an issue Steve should have discussed before signing the LOI.

3. Do not tell your employees.

Would you tell your kids the family is going to Disney World if there was only a one-in-three chance you would actually go? Once you tell your employees, your business can spin out of control on a sea of innuendo. It’s legit to allow the would-be buyer access to a couple of senior people, but not to the rank and file employees.

In Steve’s case, the acquirer wanted to talk to all of his hourly employees before closing the deal. Why would the acquirer want to do that? 1) to find out if they have concerns about the transaction; 2) to get access to employees they would like to hire if the deal falls apart; and 3) to rob Steve of even more negotiating leverage – once his employees know, it will be very hard for Steve to walk away from the deal when the acquirer drops their original offer price, which they will most certainly do if they sense Steve has to sell.

4. Get representation.

A good M&A professional would charge Steve 4 or 5% of the deal, and I would suggest the $500,000 is money well spent (I’m not an M&A professional so I can say this in good conscience). Steve has now lost his negotiating leverage because he has signed an LOI and told some of his employees. The buyer is threatening to drop the price to $9.5 million and will likely drop it further as Steve struggles to juggle the roles of company CEO and M&A professional. Would you spend $500,000 to save $2,000,000? A good intermediary would have gotten a couple of competing offers (there are hundreds of private equity firms salivating for deals like Steve’s business) to gin up the price and ensure the price stuck through due diligence.

It’s both flattering and intoxicating to get an offer from someone who wants to buy your business. While the offer is a great first step, there is still a lot of chess to play and avoiding some of Steve’s mistakes will allow you to hang on to as much leverage as you can in the negotiating process.

You’ll get the most for your business if you sell it to a “strategic acquirer”.  A strategic may think it can sell your product to its customers, thereby tripling the size of your business in a few months. Or maybe it sees your company as the perfect complement to one of its existing business units. Or it wants to enter the city where you dominate, and acquiring you is easier than battling you for every new customer. Or perhaps you’re snapping up its customers, and rather than compete, it figures it’ll buy you.  Microsoft made a strategic acquisition when it paid $8.5 billion for Skype even though the free calling service was losing money.

16 people climb inside the black box of selling to a strategic

If you’d like to position your company to be acquired by a strategic, I’m hosting a 16-person workshop on September 28 and 29 at the Four Seasons Hotel in Chicago.

The Sellability Workshop is an intensive, two-day program designed for business owners running profitable companies with between $500,000 and $7 million in annual revenue who want to make their business attractive to a strategic acquirer. I’m accepting just 16 people into this workshop.

Selling your business to a strategic acquirer is hard work, and only a small fraction of business owners who want to be acquired ever get an offer from a big fish. But just because something is hard, doesn’t mean you shouldn’t try. Like climbing Everest, selling your business represents the top rung of your entrepreneurial adventure. There is no magic formula or recipe book on how to do it. But, based on my experience, there are some things you can do to improve your odds.

If you’re one of the 16, you’ll learn how to:

• Prepare your business to be an attractive acquisition candidate:
  • Create a recurring/subscription revenue model (how to implement, mistakes to avoid)
  • Increase your valuation multiple
  • Create a positive cash flow model
  • “Productize” a service
  • Tell your employees you’re selling and get them to help you in the process
• Negotiate a deal to sell your business:
  • Reduce or eliminate an earn-out
  • Get multiple, competitive offers for your business
  • Handle management presentations to potential buyers
  • Evaluate a letter of intent (things to look for, mistakes to avoid)
  • Shorten the due diligence period
  • Increase the likelihood that your offer will survive from letter of intent to closing day

Being part of a small group is a luxury. You’ll have the opportunity to address your specific situation, questions and challenges. I’ll lead the conversation in a workshop format, but there will be lots of Q&A, time to reflect on your own business, and plan your takeaways from the session.

Confidentiality

Your identity will be kept in strict confidence. The attendee list will not be published before or after the event, and attendees will be introduced by first name only in the session.  The decision to reveal your full name or your company name to your fellow attendees will be left at your discretion.

Who is the Sellability Workshop for?

The workshop is for business owners running profitable companies with between $500,000 and $7 million in gross annual revenue and interested in positioning themselves for a strategic acquisition in the next five years.

Who is the Sellability Workshop not intended for?

This is not an exit-planning event.

I assume you have evaluated your exit options and made the decision that you want to position your company to be acquired. Therefore, if you’re considering passing your business on to your kids, this session is not for you. If you’re considering selling your business to your managers, this session is not for you. If you’re hoping to attend to pitch your services to the business owners in the room, please do not apply.

Please note, I’m not a mergers and acquisitions professional, lawyer, exit planner or insurance salesman. There will be no sales pitch or veiled agenda. You won’t be asked to buy a time share, either. My only goal is that the 16 participants walk out with confidence, inside knowledge and an action plan to position their business for a strategic acquisition.

Grab one of the 16 spots now

To apply, scroll down to the bottom of this page and complete the application form.

About a year before I sold my last business, I started working with a friend — let’s call him Rick — to help me prepare my company for sale. Rick had sold his own business and had gone on to lead M&A for a public company.  He had seen the guts of a lot of deals.

Our first few conversations were frustrating because I wanted to focus on how to maximize the multiple someone would pay for my business and Rick always responded in the same way:

“Multiple of what?”

“Multiple of earnings of course” would be my response, annoyed because I knew he was acting dumb.

Over time, I came to appreciate what Rick was talking about. It took me about a year — call me a slow learner — but I finally got it. So in this post, I’ll try to pass on Rick’s wisdom to you.

A multiple of course is M&A parlance for the multiple of your Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA) that you’ll fetch for your business when you go to sell it. Smaller businesses use something called Sellers Discretionary Income (SDI). Like fishing stories, cashed-out entrepreneurs often brag about the multiple they got for their business leading owners to a distorted view of what their business is worth.

Like a golf handicap or a marathon time, it’s tempting to fixate on getting a certain multiple for your business. It’s natural to want an objective measure for the value of your business and your multiple looks clean and simple to calculate.

But just like any other number on a spreadsheet, multiples can be manipulated.

Let’s say you’re having lunch with a potential acquirer and you ask her how much she thinks your business is worth. To answer your question accurately, she would likely do a discounted cash flow analysis.  Instead of making your eyes roll with complex financial equations, she responds by saying  “four times”. That sounds like a straightforward offer but, as the example below illustrates, there is a lot of room for interpretation:

Time

Let’s say you expect your business is going to generate $500,000 of EBITDA for the year ending December 31, 2011. Therefore, you might assume her offer of “four times” would equate to $2,000,000.

However, most buyers would argue that they’re going to peg their offer on your most recent completed financials.  If you only did $300,000 in EBITDA last year, then her “four times” offer now amounts to $1,200,000 – almost half of what you thought.

What’s more, some buyers will take a blended approach and average the last three year’s EBITDA. Assuming you just broke even in 2009, and you can get them to include your current year forecast, your average would be $266,000 and their “four times” offer is half of what you were expecting.

“Normalized expenses” – the market rate effect

Not only can an offer of four times vary on when you calculate EBITDA,  the price you get for your business will also go up or down depending on how you keep your books.  A buyer will want to “normalize” your earnings which means they will want to figure out how your business would perform if you stopped using it as a tax shelter.

For example, you might pay yourself a below market salary to minimize your personal tax bill. An acquirer will argue that, if they buy your business, they will have to install a manager with a market rate salary and will therefore recast your Profit and Loss statement with a fatter salary for the manager and corresponding lower EBITDA.  Therefore, if you’re paying yourself $100,000 a year but it would cost $200,000 a year to replace you, then your “normalized” EBITDA is going to be $400,000, not the $500,000 you told the buyer. Their “four times” offers will go down from $2,000,000 to $1,600,000 (4 x $400,000).

“Normalized expenses” – the piggybank effect

Normalization can work the other way too. Let’s say you’ve been running your business like a personal piggy bank (don’t worry, I won’t tell). Your spouse is on the payroll and the kitchen renovation you did at the house last year found its way on to your list of business expenses as an “office renovation”. You can argue to an acquirer that these costs should be deducted from your expenses when calculating EBITDA. So maybe, once you eliminate the piggy bank effect, you actually make more like $600,000 of EBITDA which means an offer of “four times” should garner more like $2,400,000.

Hard assets

When you’re talking about multiples you also have to take into consideration any hard assets. If your motel is generating $500,000 a year and you get offered “four times”, $2,000,000 may sound like a fair price until you take into consideration the land your motel is sitting on (that you own) is worth $1,000,000.

Working capital

Sometimes buyers will offer you an abnormally large multiple only to take it all away with an overly stingy working capital calculation. Working capital is the money you need to leave in your business at closing. If you’re able to pull out $200,000 in excess cash based on the working capital calculation a buyer proposes in their offer, you’re putting an extra $200,000 in your jeans even though the multiple the buyer is offering has not changed.

Fully loaded

Some buyers casually refer to a multiple they would pay including an earn out. For example, let’s say for a business generating $500,000 in EBITDA an acquirer offers $2,000,000 at closing with another $1,000,000 in consideration available if certain performance targets are met in the future. Most would agree that the acquirer is offering “four times” based on the cash changing hands at closing. But a sly buyer, looking to optically inflate their generosity, may choose to characterize their offer as “six times” basing the multiple on the full price paid if the earn out is achieved. That’s a big if.

Savvy buyers know that we entrepreneurs get fixated on getting a certain multiple for our business and the smart buyers use our obsession to their advantage.

Before you agree to discuss a potential acquisition based on a certain “multiple”,  peel back the layers of the offer to understand the details.

Just curious, how else have you seen multiples manipulated?

When I started to contemplate selling my last business, I was looking for data on what similar private companies were selling for. The media reported big company deals, but I knew they didn’t bare much relevance to my situation.

When I did hear about a private company sale, the details were never released publicly. Sometimes, the selling price was announced but rarely would they include the details of the multiple paid or the terms the sellers agreed to. >> More

I got an email yesterday from a friend who is looking for someone to help him sell his business.  I have found intermediaries (mergers and acquisitions professionals or business brokers) to be a valuable resource for selling a business (and preparing it to be sold). In the video above, I share my experience with how to find an intermediary to represent you and what you’ll need to pay them to help you sell your company. Please use the comments section of this blog to share your own experience with finding and working with a business broker or M&A pro.

On a separate note, I found out this morning that my book Built To Sell has been recognized by Inc. Magazine as one of the top business books of 2010. I’m still peeling myself off the ceiling. A great big THANK YOU to you for reading the book (and this blog) which I know helped the editors at Inc. make their choices.

Finally, here are some new articles for this week about selling your business:

Three tips for negotiating your earn-out

~ published November 30, 2010

The other day I met with two entrepreneurs running a $1-million per year graphic design business. They were in the final stages of negotiating a deal to sell their company to a large multinational marketing services firm. »more

The mercenary vs. the missionary entrepreneur

~ published December 1, 2010 Globe and Mail

Do you have a purpose in your business that goes beyond making money?

• Harley-Davidson’s mission is to “fulfill dreams through the experience of motorcycling.”

• Southwest Airlines is trying to “democratize air travel so that all Americans can visit a loved one or relative at a happy and sad time in their lives.” »more

How to get employees to care

~ published December 2, 2010 Globe and Mail

To build a valuable company you can walk away from – whether to sell or to leave just for a vacation – requires that you figure out how to get your employees to care as much as you do.

For his advice, I spoke to Ken Blanchard, whose books, including Raving Fans and The One Minute Manager, have sold millions of copies worldwide. »more

Ready to Sell Your Business? Avoid These 8 Mistakes

~ published December 2, 2010 BNET

Are you planning to step away from running your business in the next few years? Here are eight mistakes to avoid before hitting the eject button:

Mistake 1: Being boring

While it is true buyers like predictability, they also like growth. Set aside a small slice of money for experimenting on new things (product ideas, etc.). »more