Recent emails focused on steps to prepare a company for sale including accounting preparation and the value of preparing budgets and projections. In this email, we will consider the benefits of “simplifying the story.” Simplifying the story means reducing the number of items that must be explained to buyers such as multiple legal entities, non-core business activities, and non-operating assets.
Over time, the company’s legal structure can become increasingly complicated with multiple entities that operate a single business including the operating company, companies that lease facilities and equipment to the operating company, and employee leasing companies. All of the entities have legitimate business, economic, and/or tax purposes; however, multiple entities make it more difficult for buyers to understand the quality of earnings (“QOE”) of the business and the acquisition opportunity. The complexity increases further if the entities have different fiscal years.
Does the original reason for creating multiple entities remains valid? If not, then the owner should consider combining the entities into one company.
If the reason for creating multiple entities remains valid and each of the entities will be included in a sale, then the entities should be presented in a “combined financial statement” that presents the group of companies as a consolidated entity. This presentation makes it easier for buyers to understand what is being offered for sale.
If the owner expects to retain certain entities subsequent to a transaction, such as a real estate leasing company, then it would be helpful to have formal agreements in-place setting forth the terms of the relationship between the entities, e.g., a lease. This formality establishes an expectation with respect to go forward operating costs and amounts payable to the owner post sale.
Some businesses operate small divisions that are unrelated to the core business. There was a reason for creating this division and the division may generate positive cash flow; however,
the non-core activity creates a distraction for buyers as they try to understand the QOE of the core business.
If the division shares space and resources with the core business, does it pay for these resources? Are the payments arms-length? Regardless, this activity creates confusion and distracts from the evaluation of the primary business. The non-core division should be “spun-off” into a separate entity to eliminate any confusion regarding QOE.
Some businesses have dormant subsidiaries that were created for a specific purpose, but no longer have a business activity. Subject to legal and tax considerations, the owner should consider dissolving these entities in order to simplify the legal structure of the company and the explanation to the buyers.
Private businesses also tend to accumulate assets that are “non-core” to the business, i.e., assets that could be liquidated without impacting the company’s ability to generate earnings and cash flow. Examples of non-core assets include outdated equipment that is dormant, vacant land that was once considered to be the future site of the company, or empty buildings that once served a purpose.
If possible, these assets should be liquidated in order to simplify the understanding of the balance sheet.
It is common for a private company to maintain life insurance on the owner. While this asset serves an important purpose for the current owner, it is also likely that the owner will want to retain this asset after selling the company, particularly if the life insurance has accumulated considerable cash value. This asset should be segregated so that it is clear that the owner intends to retain it post sale and in order to simplify the understanding of the balance sheet.
More exotic non-operating assets include vacation homes, antique cars, or an art collection.
The owner will want to retain these assets post sale and buyers will not want to purchase them. In the meantime, the book value of these assets creates confusion with buyers when they review company financial statements, not realizing that there are assets with considerable book value that are non-core and not included in the sale.
In conclusion, non-core assets should either be liquidated or segregated to create a “balance sheet for sale” in order to provide buyers with a clear understanding of the balance sheet that is necessary to operate the company.
As itemized above, there can be a variety of distractions that detract from the evaluation of the company. Addressing these items early and proactively will help buyers focus on evaluating the QOE and balance sheet for sale, avoid tangent discussions, and contribute to maximizing the purchase price and optimizing the terms of a transaction.
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