The most successful M&A transactions happen to those who plan and prepare in advance. How far in advance you choose to start is somewhat dependent on the value you are trying to achieve and the type of transaction you are looking to achieve (platform vs tuck-in). If you are close to a valuation that works for you, then a good rule of thumb is to start preparing three years in advance of your anticipated sale date so you can achieve your highest valuation. It usually takes that long to get everything clicking along perfectly while you continue to drive revenue and net income. But you need to know what to work on, and that is exactly what this checklist provides.
Here is a holistic checklist to begin working on for an eventual successful sale (or download a PDF version here):
1. Management:
Whether you sell as a platform company or as a tuck-in to a larger existing platform company (more on that below), you will lose value if you don’t have a strong management team to not only help carry the load while you talk to sellers, but to also help integrate after a sale is completed. Plus, if you do plan on retiring or moving on shortly after a sale, your buyer will want to know that the company doesn’t revolve around you and can run on its own should you leave. A great way to demonstrate this is if you can go on a sabbatical: leave your company for 4 – 6 weeks without checking in while you let your team manage the company. If you don’t have someone on staff that can be a good 2iC (second-in-command), now is the time to start looking, as you want that person in that role at least eighteen months before you sell.
2. Employees/Contractors:
Now is a great time to make sure that there are no single points of failure in your business, which means no one on your team has important tribal knowledge that is not documented. This is especially true if you have some sort of IP, if only operational. Also, this is a good time to make sure that all independent contractors and employees have a valid NDA on file. If you currently perform background checks but haven’t done this with your more tenured employees, then get background checks done now (while no one is looking at the company) to avoid creating suspicion amongst your team.
3. Customers/Contracts:
Now is a perfect time to review all customer contracts and the different versions of MSAs that may be floating out there from the past. It is also important to make sure there is an assignability clause or the ability to transition the contract without the client’s consent. This hangs up more deals than you can imagine. If the contract is silent on both, that’s okay; just make sure you don’t have any language in your contracts that will prevent assignability without consent. Secondly, now is a good time to start calculating your customer concentration. A buyer will look to see what percentage of revenue your top 5 customers represent. If you have a customer that represents more than 10% of your revenue, it will become a red flag. The way to remedy this is to try to put this customer on a longer contract term or find other larger customer(s) to help reduce the customer concentration. Even if you have had your largest customer for years, it doesn’t mean you cannot lose them; acquisitions and changes in leadership (e.g., a new CFO) can always lead to some customer changes.
4. Financials:
Nothing ruins a deal like bad financials (i.e., non-GAAP financials). Remember, all deals start and end with your financials, so now is the time to make sure you are as compliant with GAAP (Generally Accepted Accounting Principles) as possible. All financials should be stated on an accrual basis, even if you file your tax returns on a cash basis. Also, make sure you use a deferred revenue account for those customers you bill annually, semi-annually, or quarterly. Recognizing an annual sale all in one month will create issues down the road. Now is also the time to begin matching revenue with expenses, meaning recording the cost of goods sold in the same month you record the revenue. Even if you don’t know the exact amount of the invoice you will receive from the vendor, book an accrual to your best ability and then adjust later. This is also time to make sure your cost of goods sold section is fully defined: all labor and taxes associated with delivering the product or service you sell should be in the cost of goods sold section of your financials. This will allow for a more accurate gross profit margin, and that can be compared against industry best-in-class numbers. Finally, let’s not forget about sales tax. What a state taxes and how they tax it has become very difficult to manage without software, especially if you sell in multiple states. If you do suspect you are deficient, or if you are unsure, there are firms that will do a mini sales tax audit for you in advance so you know if you have an issue or not. It is better to understand this now rather than right before you close, where you’d have amounts held back on the sale to cover potential deficiencies.
5. Personal Assets:
Assume that your company will ultimately sell its stock versus its assets, as it is typically the most tax-advantageous option for a seller. Therefore, maintain a list of personal assets in the company that will need to be distributed or sold to yourself or other shareholders. This includes cars, boats, art, and the building itself, if owned by you. If you do own the building and it is backed by an SBA loan, make sure you understand what the collateral is for that loan. Even if the building is in a separate entity (which it should be), many SBA loans use the company as collateral. This means that if you sell the company, you may need to pay off the loan. Therefore, be sure you understand that in advance. The last thing you want to do is sell your company and have to pay off the mortgage on the building, leaving you with no cash at close.
6. Add-Backs and Normalizations:
As you probably already know, offers are made based upon “adjusted EBITDA” (Earnings Before Interest, Taxes, Depreciation, Amortization), or “normalized EBITDA”. A buyer will not only look at the current year-to-date adjusted EBITDA, but the last three years as well. The best way to begin tracking these personal expenses is to create sub-accounts to your main account. For example, if your travel and entertainment account is 6503, then use 6503.1 as your sub-account. That way, as you record expenses, you can decide whether each one is personal in nature or not. For other items, such as one-time charges like legal, valuations, or other extraordinary income/expense, maintain a log or Excel spreadsheet by month to accumulate these amounts. Otherwise, they will get lost. Here is an excellent blog that can help you identify other adjustments.
7. Understand Your Value:
Nothing is worse than speaking with a seller that has an unrealistic expectation of company value. Just because you heard someone else in your space with $4M in EBITDA got a 10x multiple, that doesn’t mean you will get the same. So, it’s important to set the right expectations for yourself in advance. Here is the good news, though: you don’t need to get a formal valuation of your company to determine your value. There are a number of valuation tools in the marketplace specifically for IT service providers. Here is one that is specifically designed for MSPs like yourself to help determine potential enterprise value and, more importantly, where you might be leaving money on the table: go to the Value Maximizer Assessment™ and use the code RSS2022 to get your results. Remember to read the FAQ on the page before you take the assessment to get more accurate results.
8. Platform/Portfolio or Tuck-In:
Understanding these two types of acquisitions is key, and even more important is knowing which one is suitable for your company. This will prevent you from spending time talking to the wrong people. Every PE group out there is looking for a new platform, but not everyone is suited to be a platform. Unless you have at least $2M in EBITDA, a strong management team, and a well-built-out infrastructure for HR, accounting, CRM, and ticketing, you are probably not a candidate. But a tuck-in might be just the right fit. Knowing which one you are in advance will allow you to focus on the right buyer and not waste your time with the endless phone calls you are no doubt receiving from buyers.
9. Establish a Data Room:
It is never too early to start gathering the documents that you will need for due diligence. Ideally, you want to establish a data room outside of your network so that those who have keys to your kingdom (if not just you) cannot accidentally come across your documents. Many documents are needed that are not financial in nature and can take time to gather, such as incorporation documents, leases (both real property and personal property) and all their amendments, vendor agreements, NDAs with employees and contractors, tax returns (federal, sales tax, property tax, and payroll tax), and the list goes on. It is a time-consuming task that is best done well in advance. Plus, if you need to engage other team members to pull data, they won’t be alarmed if you are not asking for it all at once.
10. Advisors:
This is likely the most important transaction of your life, so you need three good advisors by your side: a good transaction CPA, a transaction attorney, and an M&A advisor. Finding the right advisors can take a while. Plus, you want to get to know them and “try them out” in advance of a sale if you can. Have your M&A attorney review your customer agreements in advance and have your tax CPA give you a pro forma on selling assets versus stock with a pro forma deal structure. That way, you will know in advance what type of structure is best suited for your specific needs and what the tax consequences will be for each structure. When interviewing an M&A advisor, ask to speak to a few of their recent clients (in your industry) that have sold in the last year. These sellers will also be a good reference for attorneys and CPAs. I have an entire checklist of things to ask when evaluating an M&A advisor, which you can find in my book, Get Acquired for Millions.
Conclusion
Before you get into the weeds of an M&A transaction, it is better to step back and look at what needs to be done on a holistic level to prepare yourself for the most important transaction of your life. Doing so and working on this list as early as three years in advance of a sale will allow you to not only find your perfect buyer, but also sail through the transaction with ease…for the highest valuation.
Want to learn more about this process? Check out my course, Ready…Set…SELL, where you will learn how to plan and prepare your company to sell for maximum value.
Finally, don’t lose this checklist: Download a PDF version to save and/or print here.
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