Preparing for the “corporate scrub”

The fourth in our series of articles for distributors that are contemplating a sale of their business focuses on enhancing “curb appeal.”

by Jane E. Baynard and Scott Benfield

When you decide to sell your wholesale distribution business, one of the most important things you can do to ensure a successful and profitable transaction is to take steps to properly position the business for sale. There are dozens of reasons why a distribution business is difficult to sell, most of which can be attributed to insufficient planning. In our last article, we suggested working with a transaction team to increase the probability of a successful sale at the highest possible value. In this article, we’ll overview some key categories when readying the business for the auction block.

Selling a business, in many ways, is like selling anything else. The better and more salable you make the product look, the faster it sells and at a more favorable price. Every owner dreams about selling at some point and time. The dream usually includes reaping the monetary and emotional rewards of their time and life’s investment. Some distributors want to retire at a particular age, while others realize the need to diversify their personal net worth for other financial planning purposes, while still others grow weary of the business. Whatever the reason or timing, here’s a place to start in the preparation process.

We refer to the process of preparing a distributor for divestiture as the “pre-sale positioning.” Positioning your company, its personnel, you and your family for the eventual sale is equally as important as closing the deal. All too often, distributors want to sell their business yesterday, yet they have done nothing to position themselves or the company for the transaction. In such cases, little things like not securing a lease with a short tenure can be a deal killer because a facility owner may not be interested in renewing or entering into another lease with reasonable terms. Prospective buyers will evaluate such details and these types of issues can make your distribution company either the belle of the ball or the ugly ducking.

A common situation for example: In wholesale distribution companies in particular, succession is a critical issue. If you as the owner make every decision and do not want to remain with the business after the sale, then the buyer will be at a loss without assistance from other key employees and/or secondary management.

In addition to showcasing the company in the best light possible, the objective of pre-sale positioning is to address any and all negative characteristics that might hinder or prevent the sale of your business, like in the situation outlined above. While each state of affairs is unique, and there can almost always be numerous solutions to any one set of circumstances, the following are a few of the chief qualitative concerns distributors must deal with in positioning a distribution business for sale.

1) Focus. You’ve probably focused a good bit of effort on carving out a profitable niche. Refining and staying on point with targeting a significant market share in a narrow segment is an attractive proposition to buyers.

2) Concentrate on profits. The better your wholesale distribution business does, the higher the multiples will be. We’ll address specifics in our next article but suffice it to say here that earnings will be 50 percent or more of the foundational valuation of your company. So keep you eye on the bottom line so to speak.

3) Batten down the hatches. Confidentiality is an extremely important issue. If you use an M&A advisor, one thing he will most certainly require is an agreement from every potential buyer. This mindset is also applicable in-company. Every key staffer should sign a non-disclosure agreement. If your management team is top-heavy, trim it down. Once you’ve established your core team, start to introduce them to customers so that they become less dependent on the owner.

4) Clean up shop. So many times when owners decide to sell, they don’t think it is worthwhile to continue to invest in capital improvements. In fact, just the opposite is true. Buyers deeply discount companies in apparent disrepair. Our recommendation is to critically assess your capital expenditure; it will significantly hurt the price if you don’t.

5) Honesty. Your mother may have told you, “honesty is the best policy.” She was right! Be up front about the company’s strengths and weaknesses. Surprises are not a good thing in the middle of a transaction. It’s best to lay out all the cards; be honest about weaknesses and proactively put a positive spin on them. 

If, for instance, your distribution business is weak in inventory management but earnings have been good, the prospective buyer can think to himself, “I have really solid experience in this area and can overlay my experience here at little additional cost. If the business is generating earnings at this level without it, we anticipate a higher level of earnings once we implement.” 

Granted, you won’t receive the monetary benefit of the additional earnings due to their expertise but you also won’t suffer as severe a discount for not having this component. Simply running financial ratios of your company vs. the industry performance analysis reports (PAR) can go a long way toward relaying the honesty maxim. You can be sure that the buyer’s advisors will. Potential buyers are impressed and feel better about the deal when the seller discloses the pros and cons of the business.

6) Organize. When you turn the keys over to someone else, they’ll need more than just the keys. You’d better be prepared to hand over everything! This means that you’ve got to get everything in order. Everything means just that. Included are corporate papers, records, customer lists, inventory lists, leases, deeds, etc. As we mentioned in the last article, by working with a team, this can be transformed from an onerous nightmarish task to an orderly and manageable undertaking.

Now that we’ve highlighted some of the non-numerical issues, let’s get to the heart of the matter: true value. And we’re not talking hardware stores either! This is perhaps the sticking point for all sales. Ultimately, the actual value of any distributor is determined directly by the negotiation between seller and buyer. In this respect, the marketplace is the only true and accurate valuation method; a business is worth what a qualified buyer is willing to pay for it. Having said that, there is a very definite methodology to assess what your particular company is worth at a specific point in time. 

In practice, there are four types of value standards:
1) Fair market value. Fair market value can be defined as the price at which an asset or operating entity would change hands between a willing buyer and a willing seller, both adequately informed of all material facts and neither compelled to buy or to sell. Under this hypothetical buyer-seller standard, fair market value reflects the consensus opinion among all the buyers and sellers constituting the market for a company as to its worth, rather than the opinion of any individual investor. 

Fair market value is the most widely used standard of value in business. It applies in almost all appraisals for federal and state tax purposes, including income, estate, gift and property taxes; and it’s a great place to start when valuing a wholesale distribution business for sale. However, depending on the situation, another standard may be more appropriate.

2) Intrinsic value. The term intrinsic value is most often applied to the valuation of publicly traded equities, but can be applied to any asset. It is defined as the theoretical value of an asset as defensible by the facts. Since value is a function of expected future earnings, an asset’s intrinsic value can be discerned from an objective analysis of those fundamental factors that give rise to those earnings specifically attributed to that asset in particular. 

In the case of a distributor, this would include products, channels, market share, quality of management, expected growth, etc.

3) Investment value. Unlike fair market value, which implies the consensus opinion of all investors, investment value is based on the opinion of a specific investor. Thus, it indicates a particular individual investor’s expectation of the benefits to be derived from ownership, perception of and tolerance for risk, mix of debt and equity to be used in making the investment, as well as such factors as the investor’s tax status and overall investment portfolio, etc. 

The investment value of an asset may be higher than its fair market value, providing the investor with an incentive to buy, or it could be lower, affording a motivation for selling. This standard of value is usually applicable with strategic buyers where synergies are involved.

4) Fair value. While fair market value and investment value are rooted in economics, fair value has its origin in legal terminology. It usually applies in specific transactions, most often in the case of dissenting minority shareholder rights cases. Most often, the courts are responsible to define value in this context, forcing appraisers to seek guidance from attorneys and others in order to get the valuation process started.

The term value is also used in countless other contexts as well, including insurance value, transaction value, collateral value, liquidation value, etc. Our position is that a distributor must first understand what standard of value is appropriate to valuing his company before delving into the methodology, lest he find himself with a value that is of no consequent value to his ultimate objective: in this case, divestiture.

In summary, there can be hundreds of items to take into consideration when positioning your company for sale, but the effort and expense is well worth the reward. So, when you start the evaluation process, you may want to make sure you have the help you need to complete the process successfully and profitably. We’ve put together a list of things to help you in assessing your company for sale; just send us an e-mail request and we’ll forward it straightaway. In the next installment of our series, we’ll continue the preparation process, focusing specifically on the valuation methodology.

Jane E. Baynard is an investment banker and Scott Benfield is a consultant for distribution. They have co-authored two books on wholesale distribution, including Pricing Management: Capturing Value for Distributors, and can be reached at their respective e-mail addresses: Jane E. Baynard at jb@baymengroup.com and Scott Benfield at bnfldgp@aol.com.

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