10 Steps to Plan Out of a Mid-Market Distribution Business
“He who fails to plan, plans to fail” – Old saying
You have worked hard for years to build your distribution business. It has given you income, satisfaction, prestige and purpose. Now is the time to do one final deal on the business and exit your business while making sure that you get what you deserve.
Mid-market distribution businesses, the type of business you have, are typically characterized by strong customer relationships, good logistics and materials management systems, moderate quantities of equipment, and sometimes large quantities of inventory. This combination of assets creates a unique set of challenges when it comes time to sell.
Here’s a 10-step plan for maximizing the return on sales of your mid-market distribution business.
1. Be aware that for distribution companies with valuations in the $3 million to $100 million range, funding from the Small Business Administration is not feasible and few individual buyers can afford to finance these types of deals on personal credit. The most likely acquirer is another private company, public company, or PEG (see “Is Private Equity the Right Choice For Your Business”). These are professional buyers who have experience from several transactions. Hire a competent M&A advisor or investment banker to provide a deal-making experience. Acquirers think in terms of multiples of EBITDA for comparable companies in terms of valuation. A good M&A specialist will help increase EBITDA, increase multiples, and expose business strategic value to bring you more for your business. M&A advisors will also be very understanding of the tradeoffs required to maximize your after-tax returns.
2. Check if your company structure is suitable for business sales. Are you a C-Corp? S-Corp? LLC? Do you have multiple entities with multiple purposes? Regardless of the type of company you own, if your distribution company owns a large amount of depreciating assets, the depreciation drawdown may be a big problem for you. For distribution companies with a large number of assets, becoming a C-Corp can be a major tax disadvantage as most acquirers prefer selling assets over selling shares. In the sale of C-Corp assets you are taxed twice – once at the corporate level and once at the individual level! For most distribution company owners, it’s a good idea to ask your M&A advisor to fight a stock sale.
3. Ensure that your books are tidy and that your financial statements are prepared, reviewed or audited as appropriate for your business. Your current bookkeeping practices and tax structure may be designed to keep your taxes operationally low but may not be appropriate for exiting your business (see “What Every Business Owner Needs To Know About Taxes & Valuations”). If your CPA firm does not have deal-making experience, consider working with a firm that has experience. In mid-market deals, good tax advice may be worth hundreds of thousands, if not millions of dollars.
4. Keep the right attorney for the deal. An attorney with transactional experience compared to litigation experience is more likely to help draft a successful deal. Many deals fall apart because lawyers are not familiar with negotiating deals.
5. Understand how your competitors are performing and how you can measure them. How good is your profit margin? What about inventory turnover? Is your equipment outdated? Do you have a lot of dead supplies on the books? Some of the value in the deal comes from the acquirer’s perception of how you rate within your peer group. Excellent companies get very good ratings and mediocre companies get mediocre ratings. A competent M&A advisor can also help package your company to get the best deal out of it.
6. Reduce risk by diversifying the customer and supplier base. What percentage of your business is tied to a single customer? How dependent are you on one supplier? What can you do to ensure customers and suppliers will continue to stay with the business after the sale of the business? Are your contracts written so they can stay with the business regardless of the change of ownership?
7. Understand and have a documented plan for your growth. How do you plan to grow? A wider product line? More services? Increasing geographic coverage? Which part of your business is online? How good is your website? Do you do business outside the nearest geographic area? What sets you apart in the non-local market? A good growth plan makes sales projections more credible.
8. Take steps to ensure that your distribution business transitions easily to an acquirer. What percentage of your business is under contract? Are they long term? How much of your business is repeat? Do you have a maintenance contract? Are there supplier contracts that provide meaningful exclusivity? Do you have a reliable sales team or does the customer relationship start and end with you?
9. Do you have any known latent liabilities? Legal action? Worker company problem? ESOP problems? Do you have reasonable insurance coverage or are you hit by one shipment or warehouse that catches fire and takes you down with it? If possible, address these and other similar issues before selling the business. If not, discuss this with your M&A advisor to make sure that they don’t become a judgment block or deal killer. Addressing this issue is especially important if you are looking for a tax-profitable stock sale.
10. Be aware of the fact that business valuation is not written in stone and there is great variability in what you can get for your business (see “Fair Business Valuation Myths”). The more you want to get for your business, the more planning and work your dealmaking team will have to do and the longer it will take. Plan ahead if you want to maximize your profits.
Good luck with your business sale and let us know if we can help you.