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HOW TO INCORPORATE

Seller's Market

Even as the MA market heats up, unloading a company gets trickier.
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Lesley Berglund wasn't planning to sell her business. The co-founder and CEO of the Winetasting Network in Napa, Calif., was just looking for a strategic investor, someone who could help the $10 million business -- which sells wine to consumers via catalogs, membership clubs, and an online store -- capture a bigger share of the $22 billion U.S. wine market. But when Berglund began calling potential investors last July, she found herself inundated with purchase offers. "I called an investment banker to explore my options," she says.

It was the right call. Berglund soon found herself swept up in the hottest M&A market since the dot-com boom. In 2004, about 10,000 U.S. companies changed hands -- a 15% increase from the previous year -- almost half of them businesses with less than $100 million in annual revenue, according to FactSet Mergerstat, a Santa Monica, Calif., research firm. And the market is expected to gather more steam in 2005. What's driving all the activity? For the first time in years, acquisitive companies have cash on hand to fund purchases, and low interest rates make financing affordable. Meanwhile, with company valuations on the rise, business owners are increasingly willing to entertain suitors. Finally, managers on both sides are changing their focus from near-term cost-cutting to long-term growth, says David Lobel, managing partner at the New York City private equity firm Sentinel Capital Partners. "People are optimistic about the future again," he says.

Selling a company, of course, has always been an arduous process -- and that's more true than ever in the current M&A market. The main reason for the change is the Sarbanes-Oxley Act of 2002, which established stricter corporate-governance standards. Though the standards apply only to publicly traded companies, many acquirers nonetheless are demanding that their purchases have strict controls in place -- such as an outside board of directors and clear accounting procedures, including at least three years of financials that have been reviewed or audited by an accounting firm. A business may still attract publicly held suitors without taking such measures, but it will be at a disadvantage at the negotiating table. Getting a company in shape to sell "can't be done overnight," Lobel says. "But it can be done." Many firms enlist temporary CFOs to help get their financials into shape.

Berglund, for her part, had always had an outside board of directors. She also maintained meticulous financial records and kept detailed minutes at board meetings. Over the course of five months, she entertained offers from 13 potential buyers, many of whom toured her company's facilities, met with her staff, and pored over her financials. In fact, Berglund was so busy that she handed off day-to-day operations to her executives. "Thank goodness I have a strong CFO and head of retail," she says.

Berglund also enlisted outside help, hiring Bill Hambrecht, of San Francisco investment bank W.R. Hambrecht and the Winetasting Network's lead investor. Hambrecht guided her through the entire sale, from compiling a list of attractive buyers to negotiating the final terms of the deal. Enlisting an investment banker can be a smart move, especially for deals of $10 million or more. But with demand for their services on the rise, such assistance is getting pricier; Berglund paid Hambrecht $450,000, or 5% of her company's sale price. Simpler deals can also be handled less expensively by a business broker and an M&A attorney.

Of course, even though the market is gaining strength and valuations are rising, buyers are as likely as ever to drive a hard bargain. "This is different from the go-go days," warns Ned Minor, a business lawyer at Minor & Brown in Denver. At the same time, sellers are becoming more realistic when negotiating a price. In early 2001, Jonathan Lieberman came close to selling Focalex, the Boston-based Internet advertising and marketing company he founded with his brother, Seth, in 1998. Then the buyer's board cut the offer in half just before the deal was about to close. Insulted, Lieberman backed out. It's a move he came to regret last fall, when he sold his company to Intermix Media, a publicly traded marketing company in Los Angeles, for $4.3 million in cash and stock -- less than his first suitor's reduced offer. "Now I realize that was generous," he says. "Those were heady days. Our expectations have certainly been reduced."

Selling a company may get even tougher in the next couple of years. Experts expect the current M&A boom to last a while, but a huge number of baby boomers are on the verge of retirement; one out of every two company owners plan to sell their businesses during the next 10 years, according to a recent survey by PricewaterhouseCoopers. That could result in a glut of companies on the market, driving down valuations and giving new leverage to buyers.

No matter what the state of the market, never make the first move. You'll usually get a better deal if you let buyers approach you. "As a serial entrepreneur, I've learned the best time to sell a company is when someone wants to buy it," Lieberman says. Just ask Berglund. Last fall, she sold the Winetasting Network to flower purveyor 1-800-Flowers.com for $9.1 million. The deal offers the best of both worlds. Berglund and her staff run the company with little input from their new parent. And the Winetasting Network's distribution center is undergoing a major upgrade to handle 1-800-Flowers' 15 million customers. "I'm still passionate about my business," Berglund says. "I still have dreams. I just needed the resources to achieve them."

On the Buy Side

It's a seller's market, but with so many companies up for grabs, it's not a bad time to go shopping. Here are four tips to consider before you do:

Bank On It

These days, it's a lot easier to finance an acquisition. Why? Lenders are optimistic about the economy for the first time in years, and many banks and commercial lenders are aggressively marketing loans to small businesses, says David Malizia, managing director at Florida Capital Partners, a Tampa-based private equity firm. Meanwhile, interest rates are still low enough to make borrowing affordable.

Build Rapport

Not surprisingly, competition is tough. To set yourself apart, establish credibility right away, says Lee Reams, CEO of TaxSmart in Chatsworth, Calif. After approaching an acquisition target last year, Reams showed he was a serious contender by providing financial documents proving he could afford the purchase. He also built trust by negotiating one-on-one with the seller, rather than with a cadre of attorneys.

Set a Price

Figure out how much you're willing to pay and stick to it, advises Gary Moon, senior director of San Francisco-based investment bank Viant Group. Determining a sale price doesn't necessarily require a pricey formal valuation, Moon says. Instead, consider the company's earnings, growth potential, and the valuations of similar-size peers. Tap an investment bank for help or, for smaller deals, enlist a seasoned entrepreneur.

Stay Cool

Some business owners get so excited about making an acquisition that they forget why they're doing it. The phenomenon, dubbed "deal heat," is especially common during periods of increased M&A activity. To avoid overheating, focus on your reasons for making the purchase and think about potential pitfalls. If a problem crops up, restructure the deal to include safety nets, like contingency payments. Or walk away.

Hot Tickets

Last year, about 5,000 small companies were sold. Below, the most active sectors:

Industry Name No. of Deals Avg. Price* (mm)
Computer Products & Services 948 $19.0
Miscellaneous Services 644 $18.9
Financial Services 286 $24.8
Wholesale & Distribution 244 $16.9
Leisure & Entertainment 232 $24.1
Insurance 220 $23.0
Construction & Engineering 218 $17.0
Retail 190 $12.7
Communications 164 $16.2
Printing & Publishing 160 $22.2
Banking & Services 152 $28.1
Health Services 133 $19.5

Resources How much is your company worth? Learn more about valuing your business on the Business Valuation Resources website (www.bvresources.com). Also, check out Scott Gabeheart's Upstart Guide to Buying, Valuing, and Selling Your Business, which features sample forms and contracts.

Last updated: May 1, 2005




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