When Selling Your Business – Planning is Critical

When Selling Your Business – Planning is Critical

We have all heard Alan Lakein’s quote “Failing to plan is planning to fail”. However, the problem today is that many middle market entrepreneurs sell their businesses without proper planning for the sale event and thus leave millions on the table.

I am sure that many of these entrepreneurs would say that they did plan to sell, hired an investment banker, and went through a process. However, this is the end part of the process and planning needs to start 3+ years in advance to be truly effective. In the sub $100MM market, to maximize the value of a business is not hoping some banker knows a buyer that will pay substantially more, but rather properly preparing the company for sale.

The lack of planning I believe is due to two issues: (i) entrepreneurs don’t fully realize the benefits of planning, and (ii) they don’t look at their business with external objectivity.

Proper planning will:

  • Allow your tax and wealth advisors to minimize your taxes and maximize wealth transfers;

  • Enable you to implement profit improvement measures and show the effect of those to a potential buyer;

  • Ensure that the company has a strategic plan that it is executing, and that the management team knows it, breathes it and lives it;

  • Ensure that your customer base is diverse, and you have developed recurring revenue lines, if possible;

  • Provide the opportunity to ensure that your contracts will allow for a sale and that they are relatively similar; and

  • Allow you to improve the company’s performance, to ensure it is performing in the top quartile of similar businesses.

All of these steps will increase the value to a buyer and increase the net proceeds to the seller. However, they take time to develop, implement and show results. They cannot be done overnight. This is like running a marathon, you can go out and run one, but if you train and work on it, you will do much better, but that takes time. Thus, the planning needs to start well in advance.

Finally, markets operate in cycles, which may not coincide with your plans. As inconvenient as this is, you have no control over market timing and must deal with the market conditions as they occur. Therefore, if the market window closes before the sale is complete, you can either sell at a lower price or wait 6 – 8 years for market conditions to return. To minimize this risk, always run your business as though you are going sell it “tomorrow.” Doing so will allow you to take advantage of market conditions when they occur and maximize your proceeds.

 

© 2015 Marc Borrelli All Rights Reserved

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Selling Micro Caps to Reverse into Public Shell Companies – Snake Oil?

Selling Micro Caps to Reverse into Public Shell Companies – Snake Oil?

I recently saw an article saying, “Reverse Mergers are more Popular than Ever.” The author was extolling the virtues of such transactions for MicroCap Stocks. However, this solution I rarely find delivers as promised,  in many cases, is more of a poison chalice.

 

How it works

A private entity reverses into a public shell company to go public. The shareholders in the private corporation exchange their shares for the public company’s shares. The number of shares issued to the private company gives its shareholders control over a majority of the stock of the shell, and so they are running the public company.

The legal structure for this type of merger is called a “reverse triangular merger.” The process of a reverse triangular merger is:

  1. The public shell company creates a subsidiary entity.
  2. The newly formed subsidiary merges into the private company that is buying the shell.
  3. The newly formed subsidiary has now disappeared, so the private company becomes a subsidiary of the shell company.

Using a reverse triangular merger avoids the shareholder approval process usually required for acquisitions. The deal requires shareholder approval – the shareholders of the private company and shareholder of the new subsidiary entity. However, the only shareholder of the new subsidiary is its parent company.

The process is beneficial because there is no change in control of the private company, and the private company continues to operate as a going concern; thus, preventing any potential damage to the business from loss of contracts if either of those events were to occur.

However, a reverse merger still requires the filing of a Form 8-K with the SEC, which requires much of same the information found in an initial public offering prospectus.

 

The Case for Reversing into a Public Shell

The of advantages with a reverse merger are:

  • Speed. A reverse merger takes just a few months.

  • Time commitment. A reverse merger requires far less effort than an initial public offering, allowing the management team to continue to focus on the business.

  • Timing. As this is a discussion about Micro Caps, raising cash is not a likely scenario, so that a reverse merger can take place regardless of stock market conditions.

  • Tradable currency. As a public company, it is easier for a corporation to use its stock for acquisitions. Also, the value of its stock is theoretically more certain and realizes a higher multiple, increasing the company’s value.

  • Liquidity. Sometimes the existing shareholders of a private company favor the reverse merger path to have an exit for selling their shares. Especially in cases where the shareholders are unable to sell their shares to the company or other shareholders, and the majority of shareholders don’t want to sell the company.

  • Stock options. As a public company, stock options are more valuable to recipients and so can be used to incentivize management and employees. If the option holders elect to exercise their options, they can then sell the shares to the general public rather than having the company have to buy them.

 

The Problems of Reversing into a Public Shell

The disadvantages are:

  • Cash. Since we are discussing Micro Caps, an IPO is not a possibility. Thus, the company will not be able to raise money through the reverse.

  • Cost and Loss of Value. While the reverse merger typically is cheaper than an IPO, there is still considerable ongoing expenditure to meet the requirements of being public. An active business can expect to at least $500,000 a year on auditors, attorneys, SOX compliance, filing fees, investor relations, etc. which are required by being public. Also, assuming the company is trading on an 8x multiple and has a tax rate of 35%, this will reduce the value of the company by $1.8MM

  • Prior life. Following the Great Recession, there is currently a glut of failed dot-com shells on the US and Canadian Shell markets. Unless the Buyer is very familiar with the Principals and previous business involved, bear in mind the words from Lost in Space – “Danger, Will Robinson!” Without spending a small fortune and investing vast amounts of time, it is almost impossible to find all their contracts and obligations, as well as the legal actions, launched them. As such, there will always be questions about what you are buying. Also, many of these companies have a terrible will with existing stockholders, and a bad reputation is hard to shake.

  • Liabilities. Not all shell companies are actual shells. In additional to unresolved litigation and disgruntled shareholders, as mentioned above, many have undisclosed financial obligations and regulatory history that will not go away after the reverse merger. Sellers of shell companies often are economical with the truth, the problems, or potential problems with the company. On completion of the transaction, the sellers have little incentive to solve these issues, leaving litigation as the only remedy, and an imperfect solution it is. Acquiring only a shell that has been inactive for several years can ameliorate this risk.

  • Stock price. When a company does a reverse merger, many of the existing shareholders seek to exit. However, all these selling shareholders put downward pressure on the stock price since there are now more sellers than buyers. A falling stock price reduces the effectiveness of stock options issued to employees and increases the dilution of the existing shareholders if they plan to use the stock for acquisitions.

  • Thinly traded. Usually, there is only a minimal amount of trading volume in the stock of a public shell company. Immediately following the reverse merger, only the shares held by the original shell shareholders are tradable, as no other shares are registered with the SEC yet. Building trading volume takes time, an active public relations and investor relations campaign, as well as the registration of additional stock. Besides, if the market capitalization of the company is below a certain threshold, no analysts will follow it, and most mutual funds cannot buy it. The lack of analyst coverage and fund demand will reduce interest in the company further.

Finally, thinly trade shares are volatile, and the price will tend to move a great deal on any sizable order. However, any untoward movement in the stock price could lead to class action litigation, and the costs of fighting these lawsuits can be substantial.

As can be seen, there are significant issues with public shell companies that should keep companies from buying them. In particular:

  • The annual cost of being a public company – which should prevent any micro-cap from considering this path, and

  • Being a thinly-traded stock – this offsets the main reason for being a public tradable stock.

 

© 2015 Marc Borrelli All Rights Reserved

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