Before Selling A Middle Market Business: Five Lessons For Owners

The kids had no interest in continuing to run the company. Based in the Mid-Atlantic region, the company was founded by a husband and wife who had invested many years in growing the business and had transferred some leadership responsibilities to their children. But as “Mom and Dad” began to think about the next phase of the business, the family realized that their respective interests were best served by exploring a sale of the business.

The challenge facing the owners of this industrial services firm is not an uncommon circumstance for family-owned and privately held businesses. When they engaged our law firm for assistance with a transaction, we discussed different paths they could pursue for the company.

Ultimately, the family accepted an offer from a strategic buyer. The new owner planned to consolidate the company into its existing operations and following a brief transition, the family would no longer be involved in the business.  This suited the family well as they had concerns that a financial buyer (e.g., a private equity firm) may well have wanted some family members to stay involved in the business, post-closing.

This family engaged a team of professionals early in the process, they benefitted from the advice of these professionals, and ultimately closed a transaction that was very beneficial to them and addressed their goals.  But that doesn’t always happen. As a legal advisor on many middle-market M&A transactions over the years, I have found that too often Sellers engage professionals too late in the process or disregard the advice of those professionals. Owners are not as prepared as they should be for the numerous complex decisions – operational, financial and even emotional – that they’ll need to make on the way to selling their business.

This matters, considering the sheer numbers of middle market enterprises and their enormous impact on our economy. There are an estimated 200,000 middle market businesses in the U.S., which represent about one-third of private sector GDP and close to 50 million jobs.

What many of these middle-market businesses have in common is that they are often privately owned and managed by the founding entrepreneurs and/or their family members. Today, a large number of those owners are thinking about the legacy of their businesses. A survey by the National Center for the Middle Market found that more than three-quarters (77%) of middle market businesses have either experienced an ownership transition in the past five years or expect one in the next five years.

Tips For Selling Middle Market Businesses

As more and more middle market businesses contemplate a sale, here are five key points owners need to know to ensure a successful transaction that aligns with their goals.

1. Know Your Objectives

The most important consideration, before beginning the sale process in earnest, is to look closely into the reasons for a possible sale and your objectives for the transaction. Founders who are seeking a complete transfer of ownership, as in the above example, will make very different decisions than those who wish to maintain a role in the company’s future operations. Is the main goal to monetize the value of the business, pass along wealth to the next generation, gain access to the capital needed to invest in growth, or some combination of all these or other factors? Many owners don’t always know.

2. Assemble the Right Team

The success of a transaction often depends on the “partnership” between the owners and various outside consultants, including legal, investment banking, accounting, valuation and benefits/compensation advisers, to name just a few. Beyond the basics of what the business is worth, there are a host of related issues that will impact the final structure of any deal, such as estate and tax planning, succession planning, retention of key employees and many others. Finding the right advisers is essential to achieving a satisfactory resolution of any outstanding issues. It pays to shop around and ask about experience in handling similar transactions, and yes, personal chemistry matters, too.

3. Put the Business on a Sound Footing

For many middle-market businesses, organizational and financial structures that were built to suit the needs of the founding owners may not be conducive to a sale at an optimal valuation. It may be beneficial for prospective sellers, working with a team of advisers, to obtain an independent audit, clean up the balance sheet, “rationalize” certain arrangements (such as real estate or intellectual property owned in separate vehicles by the founders or related parties), or convert “handshake” agreements into enforceable contracts. Importantly, business owners should present a unified front when dealing with potential suitors as strife among owners provides a lever that can be applied by suitors to erode value. If there is strife, owners may even want to consult an industrial psychologist, to the extent that family or organizational dysfunctions could impede a sale.

4. Evaluate Strategic vs. Financial Buyers

In the example above, the decision to sell the company to a strategic buyer was guided, in part, by the fact that none of the family members wished to remain in the business. While there is no one size for all answer to the question “Am I better off with a strategic or financial buyer?”, it is a question that is often asked by potential sellers.  Typically, the evaluation of strategic vs. financial buyers (when offers from both are in play) will require a complex set of calculations. In addition to deal pricing and terms, it may be important to know how the buyer plans to build the value of the business, whether by investing in growth or seeking cost efficiencies (or both).  What role will the seller’s principals have in the business post-closing? Will they be expected to invest in the Company post-closing? Is there an opportunity for the acquired business to be a platform for future expansion? Does the potential buyer have relevant expertise and relationships that will benefit the business?

5. Consider Both Values and Value

Finally, the bottom line is not the only consideration in a sale transaction. Most owners of middle-market businesses have spent years building the company; establishing relationships with employees, customers and supply chain partners; engaging in the community and in general nurturing the intangible elements of a corporate culture and values. If sustaining that culture is important, then finding a buyer whose values are in alignment with your own must be part of the process. Sometimes, the highest bidder is not the right bidder.

Conclusion

In 2022, the US middle market had nearly $481 billion in M&A transactions, eking out a slight increase over the prior year to set a new record. As more founders seek to monetize assets, transfer wealth to the next generation, or obtain the capital to grow and thrive in a fast-changing economy and marketplace, it is likely that the volume of middle market M&A deals will continue to reach new heights. Asking the right questions – and taking the right actions in advance of any transaction – will help ensure that the sellers of middle market businesses achieve their financial and personal goals, while leaving the company on a solid footing.

Robert C. Creighton is Managing Partner at Farrell Fritz, P.C. in New York, specializing in M&A for middle market, closely-held and privately owned businesses.