This latest issue of the Privately Held Company is compliments of Gary Papay, CBI, M&AMI. Gary is president of CK Business Consultants, Inc. and is an active member of the M&A Source. Gary has been involved in the sale and acquisition of businesses for over 30 years, and is available to handle all of your merger, acquisition or divestiture needs.

P: 570-584-6488
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There once was a family-owned bakery that had sales in the millions. The bakery sold bread to restaurants, supermarkets and some retail outlets. The founder gave each of his 5 children 20 percent ownership of the business. The kids really didn’t want to work in the business so they turned the operation and management over to 2 members of the third generation. For some years the business had been operating on a break-even basis, and sales were not increasing.
The founder’s children decided that they wanted to sell the business since they were close to retirement age. A professional business intermediary was retained to do this. He contacted as many of the larger bakeries as possible, hoping to find a suitable acquirer, but there was very little interest. The intermediary continued his search, willing to do the hard work required to find a good buyer. He finally found a successful businessman who offered a price equal to 50 percent of sales – a generous offer.
The intermediary presented the offer to the five children – all equal partners. Little did he know that he had walked into the proverbial hornet’s nest. A huge family argument ensued, and finally the intermediary was asked to leave the room so that the siblings could decide what to do.
The offer was turned down flat. There was no counter-proposal or even any negotiation on price, terms or conditions. The offer was dead. The intermediary had worked on trying to find the right buyer, figured he had – all to no avail, six months wasted.
It turns out that the major obstacle was thrown up by those two members of the third generation who had been operating the business. They feared that they might lose their jobs even though the prospective buyer assured the sellers that he would retain them. Were they being unreasonable? The reality is that the operators were “family” – related in one way or another to the five owners, ands blood is usually thicker than water.
Flash forward some 20 years. The bakery is still in business with very little growth and still operating on a breakeven basis. The five owners are now in their 70s, they have never
 

received anything for their equity, and there is very little hope that they ever will.
The above is a true story. It shows how a family can own a business and not be prepared or in agreement when it comes time to sell it. Although the bakery is still in business, it is barely hanging on. The story is sad as well as true. The proposed deal could have satisfied all of the owners’ goals and made their retirement years a lot more comfortable.
Family-owned businesses make up a lot of the non-public companies in the U.S., and according to industry reports, many of them will be up for sale in the near future. In situations where the family owned business is owned by more than one person, it is crucial that a meeting be held with all of the family owners prior to electing to sell, unless a strong buy-sell agreement has already been agreed to. This agreement should establish, among other things, specific guidelines about what happens if one family member wants out of the business.
At this meeting, the company attorney and accountant should be in attendance along with a business intermediary. The reason to include the intermediary at this early stage is that he or she knows what the pitfalls are, what buyer concerns will be, and what should be done prior to going to market.
One of the major problems when there is more than one owner is communications. For example, one owner who is active in the business decides that he needs a new, expensive car and that the company should pay for it. This is the kind of issue a decision-forming meeting should bring to light and address. Strict guidelines should also be in writing concerning salaries, benefits, etc. When one family member wants to cash out or another one spends a lot of money furnishing their office – it is too late to have an agreement drawn up to cover these possible roadblocks. The time is now!
Family-owned businesses do have some options when it comes time to sell. Selling the entire business may not be the best choice when there are no other family members involved. Here are some choices to be considered:


•Hire a CEO – This approach is a management exit strategy in which the owner retires, lives off the company’s dividends and possibly sells the company many years later.
•Transition ownership within the family – Keeping the business in the family is a noble endeavor, but the parent seldom liquefies his investment in the short-term, and the son or daughter may run the company into the ground.
•Recapitalization – By recapitalizing the company by increasing the debt to as much as 70 percent of the capitalization, the owner(s) is/are able to liquefy most of their investment now with the intent to pay down the debt and sell the company later on.
•Employee Stock Ownership Plan (ESOP) – Many types of companies such as construction, engineering, and architectural are difficult to sell to a third party, because the employees are the major asset. ESOPs are a useful vehicle in this regard, but are usually sold in stages over a time period as long as ten years.


•Third party sale – The process could take six months to a year to complete.  This method should produce a high valuation, sometimes all cash at closing and often the ability of the owner to walk away right after the closing.
•Complete sale over time – The owner can sell a minority interest now with the balance sold after like five years. 
 

Such an approach allows the owner to liquefy some of his investment now, continue to run the company, and hopefully receive a higher valuation for the company years later.  
• Management buy-outs (MBOs) – Selling to the owners’ key employee(s) is an easy transaction and a way to reward them for years of hard work.  Often the owner does not maximize the selling price, and usually the owner participates in the financing.
• Initial public offering (IPO) – In today’s marketplace, a company should have revenues of $100+ million to become a viable candidate.  IPOs receive the highest valuation, but management must remain to run the company.     
Source: “Buying & Selling Companies,” a presentation by Russ Robb, Editor, M&A Today
The following are situations where the price was not the deciding issue in the successful sell of a business. The ultimate buyer may be the only one who really understands the situation. A business intermediary really understands the issues and can lead the buyer and seller to a successful resolution.
• One seller had 60 shareholders who needed to walk away from the deal.  The losing buyer wanted all selling shareholders to be accountable for the “reps and warranties.”  The winning buyer waived the reps and warranties at closing.
• A seller's management team wanted some future upside in the deal.  The losing buyer offered all cash and normal compensation.  The winning buyer offered 80% cash, 20% stock plus 3- year earnout on revenues -- including acquisitions.
• Time was of the essence.  The losing buyer needed 30 day due diligence and negotiations plus a 60-day window to close the deal.  The winning buyer offered to close within 40 days of the Letter of Intent and agreed to have limited due diligence.
“Clichés Matter:  It is well known that relatively speaking, large publicly traded companies receive higher valuations than small ones.  The size premium is attributable to, among other things, the market’s perception that larger firms have greater access to capital and other resources, seasoned management, a strong infrastructure, and market stability.  It’s also the reason why, tempting as it may be, if you try to take the public market valuation multiple of a billion dollar company and apply it to a million dollar firm, you get a huge valuation
 

– and a visit to the principal’s office at merger and acquisition school.  But that doesn’t mean size premiums don’t exist at the lower end of the size spectrum.  In fact, recent research conducted by Business Valuation Resources analyzing more than 2,300 acquisition transactions of companies across seven standard industrialization (SIC) codes reveals conclusively that the size premium extends to deals valued substantially below $10 million in revenues.  And we’re not talking ‘math-geek’ differences that are statistically

A buyer was interested in a building products manufacturer that did $70 million a year in sales. Although the business was profitable, it seemed that their margins were lower than they should have been for this industry. The buyer asked the seller how they priced their products. As the seller was explaining his pricing strategies, he happened to mention that a price increase of 1.5 percent would not really impact sales. He failed to see that the price increase of 1.5 percent on $70 million in sales would bring $1 million in profit. A smart buyer would realize how to get an additional $1 million in bottom-line profit simply by increasing prices by 1.5 percent.
A recent book titled The Art of Pricing by Rafi Mohammed went immediately to the business best-seller list, and no wonder The author stated:
 “One of the biggest fallacies in business is that a product’s price should be

significant; we’re talking real-world irrelevant.  Consider the SIC sectors that cover many health care service providers.  Compared to deals valued at less than $1 million, transactions valued at $1-10M received EBITDA valuation premiums of 42-102 percent. 
based on its costs.”Here are some of the author’s suggestions:
•Restaurants: Keep the entrees priced attractively, but expect to make up the profit shortfall on drinks, desserts and extras.  MacDonald’s profit on hamburgers is marginal, but it has substantial profits on French fries and soft drinks.
•Television Advertising: Sell 75-85% guaranteed slots six months in advance, then sell the balance of advertising to the spot-market with little advance notice at premiums of 50%.•Financial Printing: Price the printing of
And compared to the same $1-10M deals, those worth $10-50 million captured additional premiums of 16-73 percent. In addition to the basic reasons described above, these small to mid-market premiums are also attributable to the reality that larger deals cost no more than smaller ones in terms of legal, due diligence, or administrative expense.  So from a consolidator’s perspective, they are simply more efficient and hence more attractive.  In the world of valuation, it may be a cliché but -- size matters.”
Source: the braff report
IPOprospectuses at near break-even, and then charge exorbitant fees for last minute changes.
•Investment Banks: Quote a relatively modest accomplishment fee as a percentage of total consideration, but insert a rather substantial minimum fee.
•Another notable quote from Rafi Mohammed is: “Companies should develop a culture of producing profits. Through better pricing, companies can increase profits and generate growth. In many ways, smart pricing is like hidden profits.”
This takes us back to our first premise: Small pricing increases can greatly
increase profits.