Editor: Even before a company decides to place itself up for sale, what measures do you suggest it take to place its house in order?
Bernstein: The real housekeeping areas include: financial records, (maintaining proper books and records, having accounts that reconcile, all of the sound accounting and bookkeeping practices) and also on the legal side, having all of the corporate documents such as certificate of incorporation, minutes, etc. in order. These things don't affect the business per se, but they could be obstacles if they are not taken care of.
Wink: In addition, other areas to be considered include having all insurance coverage up to date and the formation of a board of directors or an advisory board.
Editor: How many years of audited statements should a company have either before putting itself on sale or going public?
Bernstein: It depends, but certainly having three years is the safest bet. That is what is needed for going public; selling a company to another public company may also require as many as three years. If going back three years to obtain audited statements is too expensive, many companies should start with at least two years. There is a tradeoff between the expense of doing a third previous year's audit and the risk that the transaction may not get done.
Wink: It is also important that the quality of your accounting firm be excellent. If you are going through the expense of having a prior-year audit, it is also desirable to have a well known accounting firm do the work, giving added credibility to the reported numbers.
Editor: Who should prepare the offering brochure if the company is not using an investment banker? What should it contain?
Wink: We certainly believe that if you are not using an investment banker, you might consider using other professionals to help put your private placement memorandum together. Using an investment banker or other professional to run the process allows the business owner to continue running his/her business uininterrupted. The seller is making certain representations to the buyer as to how the business is performing financially. Failure to hit financial projections have caused many a potential deal to stall. The potential buyer may back away or lower the price if financial projections are hit. Selling a business takes longer than a few months. You should be preparing yourself for a couple of years in advance of that date, making sure your financial, legal and organizational house is in order.
In terms of the content of a private placement memorandum, it is an executive summary, a detailed description of how the business works, which includes content on the history of the company, the company's business strategies, operations, marketing, sales, customers and competitors, the organization and management team, facilities, and technology. On the financial side, having historical financial statements and projecting future financial performance with rationale for supporting those projections are essential.
Bernstein: If there is not an investment banker involved, there are probably two documents needed: one is a pitch book, presenting the company to prospective investors or purchasers in summary fashion, and the other is a private offering memorandum which, generally, a lawyer should be involved in.
Editor: What standing committees do you recommend a private company establish - audit, compensation, other?
Bernstein: Generally, companies which have not yet taken in professional money, family-owned businesses, do not have formal, outside board members or these kinds of committees. Some of them have advisory boards which can be very effective. In general, that is not an issue in a prospective transaction. The private equity firm or the purchaser doesn't generally expect a company to have that level of corporate governance infrastructure prior to the transaction. They have the expectation that the infrastructure will be put into place upon the completion of the transaction.
Wink: Upon the completion of the transaction, it is common for the financial buyer to establish an outside board, with at least an audit committee and, sometimes, a compensation committee. You usually don't see a lot of other committees at that stage, not until the company goes public.
Editor: How should a private company keep its minutes?
Bernstein: In the general effort of keeping one's house in order, minutes are kept to formalize key decisions. Minutes are typically not very lengthy. Usually, outside counsel plays a role in preparing them and maintaining them. Occasionally, a private company may have in-house general counsel who will serve that role.
Editor: Do most private companies have boards of directors?Bernstein: Most have boards - not all of them have outside boards. In a typical company with no outside investors, there is a board but it tends to consist solely of existing shareholders and perhaps family members or members of senior management.
Wink: Once professional money is put into a private company, the private equity fund as part of that transaction will require a specific number of seats on the board. Concurrent with the professional money investment, a board is usually established.
Editor: Management is key in any future sale of a company. What recommendations do you make for management contracts, management succession, benchmarking with other companies?
Wink: Usually, in the typical private equity transaction, a private equity fund is as interested in investing in the management team of the company as in the product or services that the company sells. A private equity fund doesn't want to get involved in the day-to-day management of the company; they want to leave that in the hands of the management team or possibly bring in new members to the management team concurrent with the investment. Management is very, very important. As part of the transaction, the management team that runs the business with the private equity fund will probably be incented to grow the business and will be incented to exit the company when the private equity fund exits.
Editor: Another question is about management succession. Isn't this important if the private equity fund wants to sell the company and make sure solid management is in place if it is selling to a financial buyer?
Bernstein: It is important in that scenario. Even if they want to hold onto the business and grow it, they have concerns with management succession both in terms of having a backup plan in case something happens to the existing management team or in cases where the senior executives are older, they are interested in seeing that there are qualified people who can step up. One of the objectives of the management team after the deal is accomplished is to develop or recruit skilled executives.
Wink: A lot of the private equity funds have data bases of former senior executives from several different industries and with several different skill sets. When they make an investment in a particular industry, they will call on those people either to go into an existing company either in an operating or management role or to represent the fund as an advisory board or board of director member.
Editor: What can a small company do to determine its market share? How can it shadow the competition so that it has valuable information about its market?
Wink: I think that falls into the category of "Wall Street meeting Main Street." I think up until fifteen years ago the only real competitive and comparable information about companies was available to the larger companies in this country. Today, there is a tremendous amount of data available on private company transactions. There are databases like Capital IQ, for example, which when purchased gives you access to information on private company transactions around the world.
Editor: Which of the legal structures do you suggest a company use from both a tax and business standpoint?
Bernstein: We see most private companies that have not taken in professional money structured as a Limited Liability Company (LLC), which tends to provide the greatest amount of flexibility. Typically the investors coming in will have a preference to convert the company to a Delaware C Corporation based upon their own legal counsel's advice.
Editor: Why not an S Corporation?
Bernstein: An S Corporation presents less flexibility than an LLC in terms of what a company can do. Both forms avoid double taxation. The LLC provides the greater flexibility on an operational and tax perspective as well as on a business perspective. The LLC actually gives the company the option of being treated as a pass-through entity or as a tax-paying entity.
Editor: What kind of due diligence does a target company's accounting firm need to do to assure a future purchaser (or an underwriter) that a company has no hidden liabilities?
Bernstein: Commencing with a good audit, this forms the basis for giving the purchaser or underwriter an initial sense of comfort. As the purchaser prepares to do due diligence, it is very important that he does not uncover any surprises on his own. Companies are well advised to do the kinds of things upfront that give the other party that level of comfort.
Editor: What role can a company's accounting firm play in negotiating a fair deal?
Wink: I think an important point is that you have to realize that smaller accounting firms probably do not have the expertise in-house to assist a company negotiating a transaction. You probably need a larger firm that would have the expertise to negotiate a good deal. There are several areas where an accounting firm can be helpful: in reviewing comparable transactions in the market place to assist in determining the value of the deal and in the most important area - negotiating the due diligence findings. Typically due diligence process will reveal adjustments that will affect the purchase price.
Published February 1, 2008.
