Selling Your Business
Ten Critical Strategies that Must be Initiated to Maximize Value in a Divestiture

By Dexter W. Braff

In a vibrant health care service merger and acquisition environment, selling a business is easy. If your goal, however, is maximizing value, that's an entirely different story. It takes planning. Strategy. Execution. Not unlike what was necessary in building the business in the first place. There's a multitude of stratagems - far too many for the scope of this article - that sellers can employ to ensure that they reach their goals and objectives. But there are 10 strategies in particular that - with virtually no room for error - must be initiated to maximize value in a divestiture.

Perfect the Timing. For every company, there is a unique and ideal time to sell (and rarely is it when a buyer happens to pop the question). Rather, the perfect timing arises (a) when a business begins to shift from "hyper-growth" to "mature growth" in its growth cycle, (b) when factors such as reimbursement, operating strategies, supply and demand and others contribute to favorable merger and acquisition market dynamics, and (c) when passion turns to burnout, alternative investment opportunities become attractive, the "psychic" value of incremental equity becomes "marginal", and other highly personal goals and objectives are consistent with a divestiture. The best prepared sellers, then, continually and carefully monitor these three Decision Spheres to determine when they are in optimal alignment - the point at which both financial and intangible value can be maximized. We can't emphasize the importance of this approach enough. Without question, more value is lost by mistiming a transaction (and more value gained by right-timing a transaction), than by any other miscalculation (or well conceived plan) in a divestiture [1].

Determine the Components of Value. Quite simply, you can't maximize value if you don't define its constituent components. Sure, you want cash. The more the better. But for virtually every seller, there are other tangible and intangible transaction elements that can create substantial additional value - value that can significantly distinguish one offer from another.

For example, for large, platform-sized entities with an owner/management team interested in developing the business further, extraordinary value can be created by selling to a private equity group (PEG) and retaining a minority interest in the firm going forward. With an influx of financial and other additional resources to support layer-on acquisitions and organic growth, PEG sponsored firms can grow to such an extent that the value of the owner/management team's retained minority interest can sometimes exceed that of the initial transaction. As such, value is derived not only by retaining an equity position, but more importantly, from partnering with the "right" private equity group.

Other examples: Many sellers assign a high value to divesting to a buyer that is likely to retain all of its key employees (this is often the case with hospital based and not-for-profit entities). For others, timing is a crucial determinant of value, particularly when the seller wishes to pursue other business, personal, or financial goals. For C corporations, given the double taxation that occurs upon the sale of assets - the preferred structure for virtually all buyers - extraordinary value can be created (or retained) by identifying a buyer willing to acquire stock. Finally, while "cash is king", sellers who want to maximize value will not limit their consideration to cash only proposals. Buyers naturally want to leverage their cash on hand to complete as many, and/or as sizeable, transactions as possible. Accordingly, many will bestow additional premiums to sellers willing to accept notes or stock. Though non-cash remuneration certainly carries risk, the returns can be significant and when carefully structured, large portions of this risk can be mitigated. Furthermore, when large gaps exist between buyer and seller regarding future performance, when appropriately used and properly structured, deferred compensation in the form of earnouts have the potential to be exceedingly valuable.

Re-Cast Financials Completely and Credibly. On the surface, re-casting financial statements to eliminate expenses a buyer is unlikely to incur seems quite simple. In fact, therein lies the problem. On the surface it is simple. Getting beyond the surface, though, is far more complex, yet essential in maximizing value. Miss hard to identify add-backs buried in arcane accounting principles and you can substantially understate earnings potential - a miscalculation that is compounded when these figures are subsequently applied to valuation multiples. Overstate, inflate, or unsubstantiate add-backs and you compromise credibility, which buyers, in turn, often reflect by discounting those same multiples. So re-casting financials must be done aggressively and delicately at the same time - a difficult balance to achieve.

Few sellers miss the easy add-backs - excess owner's compensation and perks, relatives on payroll, one-time expenditures, and the like. Most sellers even pick up on the impact of expensing vs. capitalizing equipment. But the overwhelming majority miss out on the income statement impact of how financials are prepared (cash, accrual, or modified accrual); how revenues are recognized; how billings on hold are treated; the impact of the direct write-off vs. the allowance method for accounting for bad debt and uncollectibles; the affect of classifying leases as operating vs. capital leases; the impact on cost of goods sold of conducting (or not conducting) annual inventories; the proper treatment of new start-ups, just to name a few.

While missing valuable and reasonable add-backs can substantially undermine value, it can be equally damaging to overstate them by claiming adjustments that don't hold up or are simply unreasonable. Key personnel, incentive programs, promotional activities, and the like - resource investments that support the sustained growth that buyers crave - don't magically disappear post transaction. Likewise with customer service and billing and collection overhead. While large strategic buyers have administrative infrastructures in place, it is somewhat over zealous to believe that these infrastructures consistently have substantial excess operating capacity to absorb acquisition after acquisition without having to add such personnel and other supporting resources. To maximize re-cast earnings and maintain credibility, adjustments of these types must be considered carefully. Moreover, sellers should not hesitate to include "negative" add-backs where appropriate - expenses the buyer will incur that they have not - as any "loss" of earnings will likely be more than offset by a valuation multiple unfettered by mistrust and increased risk.

Orchestrate Controlled, Multiple, and Simultaneous Presentations. Far too often we see sellers pursue, what we refer to, as Sequential Presentation; a process by which sellers pre-determine the likelihood that individual buyers will deliver maximum value, queue them up accordingly from "best" to "least best", and approach them in order, one after another. The theory underlying sequential presentation is that (a) "best fit" buyers can reasonably and accurately be determined and (b) limiting presentations to buyers one-at-a-time reduces "exposure" in the market, thereby lessening the chance that confidentiality will be breached. Interesting theory. But utterly and completely wrong. First, with so many variables that have nothing to do with a particular seller and everything to do with a particular buyer impacting merger and acquisition demand and valuation, it is simply impossible to accurately predict which buyer will "step up" in any given acquisition opportunity. Second, rather than minimize potential exposure, sequential presentation actually increases the likelihood that confidentiality will be breached. Unless the first buyer in queue submits and closes on the best offer (and how would one know if an offer were the best if they haven't entertained proposals from others), time on the market expands as each new buyer is brought in. And counter to conventional wisdom, we have found that the greatest threat to maintaining confidentiality is substantially more a function of time than a function of the number of buyers brought to the table. Given the above, the only way to identify the "right" buyer for the "right" seller at the "right" time in a compressed time period is to pursue a controlled, multiple, and simultaneous presentation strategy.

Proactively Develop and Monitor BATNAS. Typically, once a seller has identified a buyer that they believe will likely meet their divestiture needs, all attention is re-focused on this party, foregoing discussions - at least for the time being - with other potential suitors. This is particularly the case when sellers pursue a sequential presentation strategy as described above. In doing so, they forego the opportunity to develop strong BATNAs (Best Alternatives to Negotiated Agreements) other than simply not selling. Absent these BATNAs, sellers give up extraordinary real and cognitive negotiating leverage that can prove critical in moving from letter of intent (LOI) to closing (a) at the price and terms initially agreed to and (b) under the most favorable definitive purchase agreement language. In order to maximize value then, it is vital that prior to signing an LOI (which typically contains "no-shop" provisions barring sellers from continuing dialogue with other buyers over a defined period), sellers proactively and strategically identify, develop, and queue one or more "back-up" buyers. While this requires a deft and sensitive negotiating touch - no buyer likes to be in second place - (a) the payoff as described above can be huge and (b) it is not at all unusual for "secondary" buyers to ultimately close a deal.

Only Negotiate that which is Written and Complete. While rarely done as a negotiating tactic, amidst a backdrop of excitement, anxiety, and zeal to close a deal, buyers and sellers alike often find themselves initially and verbally negotiating a limited number of terms - typically price - the theory being that until price is nailed down, the details can wait. Unfortunately, absent the details there is simply no way to assess the "real" value of an offer. An "expected value" net of taxes can be worth more or less than it initially appears based on structure (asset vs. stock transaction), terms (cash, notes, stock, contingent payments, etc.), balance sheet considerations (liabilities assumed by buyer or not; assets retained by seller or not), timing, financing contingencies, owner transition requirements, non-compete terms, and other intangibles that may convey value to the seller (see Determining Value Components above). When offers are put in writing, the "ante" is raised, and buyers typically include some or all of the details above in their proposals. Only then can a seller begin to negotiate a transaction that maximizes value.

Continue to Manage the Business as if You'll Own it Forever.You Just May. Perhaps the most common behavioral phenomena we see in mergers and acquisitions is that once a seller makes the difficult and emotionally gut-wrenching decision to sell, they immediately begin to distance themselves from the day-to-day operations of the business, focusing entirely on completing a transaction as quickly as possible. Inasmuch as the principal shareholder(s) typically directly or indirectly drive, facilitate, or inspire performance (even in large, platform sized companies), any re-allocation of real or emotional resources can have a quick and deleterious affect on the company. Moreover, from a merger and acquisition perspective, any unfavorable changes in performance between the time frame captured in the letter of intent and final due diligence creates extraordinary doubt in the buyer's mind regarding the credibility of the original numbers as well as go-forward expectations - assumptions upon which the deal was originally crafted. Accordingly, price is often renegotiated; typically disproportionate to the downward trend. So a 10% reduction in performance can easily yield a 20%, or more, reduction in price. Accordingly, difficult as it may be, during the divestiture process, sellers can literally not afford to do anything other than continue to manage the business as if they were not contemplating a transaction.

Do Not Disclose Divestiture Plans to Key Employees for as Long as Practical. This one can be very difficult, especially for owners that have developed strong bonds with key staff. Pursuing a divestiture strategy covertly feels like an act of bad faith, a violation of trust, and disloyalty. In actuality though, keeping your plans to yourself is anything but. The problem is that when a seller decides to divest, until they know (a) that a potential deal is possible, (b) who the buyer is and (c) under what circumstances they are acquiring the firm (i.e. opening up a new market or folding into an existing operation), the seller simply has no idea what the future holds for key staff. Accordingly, informing them of divestiture plans early in the process only serves to create anxiety for the very employees you care for most, anxiety that cannot be addressed or alleviated for many months. Accordingly, key staff may try to relieve their tension by confiding in other staff, seeking employment elsewhere, or simply distancing themselves from the business, all of which can start a downward performance trend that can often spiral out of control during a protracted period of the "unknown". And given the impact of declining performance post letter of intent as described above, this can destroy the opportunity to maximize value.

The above notwithstanding, buyers increasingly recognize that in order to sustain revenue and profit streams, they must have a transition strategy in place prior to closing a deal - a plan that includes a clear identification of the employees they intend to retain post-transaction. To accomplish this, it is necessary to meet with and interview key staff - at the very least - prior to closing. So how can a seller accommodate buyers' needs and minimize the risk described above? The answer is lies in a staged due diligence. When deals fall apart, it is generally due to problems in financial reporting and/or regulatory compliance. Accordingly during initial stages, due diligence can be limited to offsite review of financial records and a random review of charts. Only after the buyer has indicated that they are comfortable with these findings do they begin to expand the scope of due diligence activities, including employee interviews, which are held off until as late in the process as reasonable. At that point, the likelihood of closing is high, thereby mitigating the risk associated with employee notification.

Prepare for Due Diligence as if the Outcome of the Deal Depends on it...it Does. After the difficult process of moving from preparation, to presentation, to negotiation, through the letter of intent, many sellers begin to fade as they enter the due diligence stage - a laborious and detail laden point in the M&A cycle that can either make or break a transaction. Accordingly, due diligence preparation often suffers. Certainly, sellers can make up for this by scrambling to pull together information for buyers on an ad hoc basis, but in doing so, they give up the opportunity to create extraordinary goodwill, confidence, and trust with buyers - intangible elements that can be extremely helpful in working through difficulties that inevitably arise between due diligence and closing. Don't underestimate this point. To a buyer, sloppy due diligence raises all kinds of red flags regarding any business operations that require organization and attention to detail - notably billing, collections, and regulatory compliance. Well prepared due diligence on the other hand, communicates just the opposite and inspires confidence. As a result, some of the best prepared sellers perform mock due diligence prior to even signing a letter of intent. Not only does this help in organizing the volumes of paperwork required in due diligence, but it also gives sellers a preview of difficulties that may arise later on - and the chance to fix them before they can undermine a transaction.

Obtain Experienced Merger and Acquisition Counsel. If your first reaction to this last point is that it is merely self serving (we are M&A advisors), think again. Entrepreneurs are expert in building companies. Skilled intermediaries are expert in converting them to value. Very different skill sets. That is why regardless of their knowledge, experience, and business savvy, no self respecting CEO of a publicly traded firm would ever dream of entertaining an M&A transaction without the counsel of an experienced deal maker; a deal maker well versed, in, among other things, developing and initiating each of the strategies listed above.  There is simply too much risk going it alone.  Too much unfamiliar territory. Too much distraction.  And most importantly, too much at stake (i.e. financial security). Additionally, sellers must obtain sound legal counsel; counsel that is explicitly familiar not only with mergers and acquisitions in general, but health care mergers and acquisitions in particular. Only those that fully understand the nuances of health care M&A - notably compliance and indemnification - will have the proficiency to close transactions reasonably, safely, and expeditiously.

1 For a more comprehensive review of this critical topic, see "A Three Part Construct for Determining the Best Time to Approach the Merger and Acquisition Market", Dexter W. Braff, HomeCare Magazine, June 2005.