Our firm is well known for advising founders/business owners when it’s time to sell their companies. Fewer people know that we also advise buyers–like private equity firms–when they are acquiring these businesses. It’s in the latter where we see a seller’s mistakes firsthand.

Building a business and selling a business are two different skill sets. Even smart business people can overlook important details in unfamiliar situations. And for many founders, that’s exactly the position they are in when selling their businesses.

Here is an example. In 2002, the online payment processor Paypal was acquired by eBay for $1.5B. Even then, Paypal was a dominant player in the online payment space. While its potential wasn’t fully realized, Paypal was already known as a formidable pioneer in fintech, and many people argue that this price was too low.

As a founder, you’re invested in inspiring growth. And when you sell, you’re hoping to capitalize on that investment. For many, it’s a decades-long journey. Here are five steps you can take to make sure you don’t lose out in the final inning when it’s time to sell.

Mistake #1: Skipping the Seller’s Quality of Earnings (QofE)

When a buyer and a seller enter a negotiation, each one has a range of numbers in mind. This means there is an opportunity to settle on a higher (or lower) price based on how value is communicated during the negotiation phase.

As the seller, how do you know that your numbers are realistic–or that any offers on the table are materially appropriate? First, you need to know what your value is based on real data. That means calculating EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

This common financial metric is used to determine the profitability of founder-owned companies.

Enterprise Value = EBITDA x Multiple

The mistake that sellers often make is focusing on the multiple in this equation when they really should be focused on the EBITDA. If you spend $20k on a QofE and you trade at a multiple of 10x, but we find an additional $20k in adjustments, your return on the QofE is 10 times the cost of the assessment.

At Embarc Advisors, we typically find at least $100k (and sometimes even $1M+) in adjustments, even for companies that are doing less than $5M EBITDA. While sellers might shy away from the upfront price tag on these assessments, it’s easy to see the value when you look at the potential adjustments.

Foregoing a QofE is like selling a home without knowing the true square footage. At best, you’re making a guess at what it’s worth. Take the time to conduct a sell-side quality of earnings so that you can market and negotiate with strength.

Mistake #2: Marketing on LTM (Last 12 Months)

Again, sellers are often focused on the multiple. They look backward at the last 12 months and apply their multiple, assuming that’s going to provide an accurate value representation. The problem is that growing businesses have very different forward-looking numbers compared to historical numbers.

Consider the difference between your last 12 months (LTM) and your 2023 forecast. Are those numbers consistent? Or are you projecting growth? If you are projecting growth, it’s probably going to make a meaningful difference. Wouldn’t you rather capitalize on the projected growth that you set into motion?

“When I was in investment banking, we never valued a company off backward-looking numbers. It was always a forward multiple applied to forward earnings –don’t shortchange yourself.”

– Jay Jung, Founder, Embarc Advisors

The reason that sellers tend to look backward is because it’s challenging to adequately support future projections. How do you get a potential buyer to value you on a forward-looking EBITDA?

At Embarc Advisors, we take the QofE and then build out a bottom-up forecast model using our team’s private equity experience. We build a detailed, highly defensible forecast model like what the PE investors would build so they recognize it. This familiarity and level of detail give them the confidence to underwrite the forecast. It’s not easy, but it’s worth doing.

Mistake #3: Being Vague with LOI Details

The letter of intent (LOI) is an important preliminary document. It’s the first iteration of what will eventually become a contractual agreement. While the LOI is non-binding, this is where buyers and sellers start to put a deal together.

Skimping on the LOI details under the assumption that it will all get worked out later is a mistake. Up to this point, you’ve been hashing hypothetical scenarios. However, this is the moment that you start to change from ‘what ifs’ to ‘I want and I need.’

A clear and detailed LOI shows that the buyer is serious and committed to the transaction. It sets a positive tone for the negotiations that follow. It clarifies terms, protects interests, and facilitates due diligence.

The seller loses 95% of their negotiation power after the LOI is signed and the seller enters into exclusivity. As soon as the LOI is signed, the game goes from playing offense to defense. Make sure you ask for everything you want before you sign the LOI.

Mistake #4: Skipping Diligence Work on Buyers Stock

Another common mistake that founders make is that they don’t do any diligence or valuation work when they take rollover equity. If you are selling your business for $20M, you should walk away with $20M in cash. However, more often, the buyer asks you to roll over a portion of that value.

If you sell your company for $20M and agree to take $4M in roll-over equity, this means you walk away with $16M in cash, and the buyer keeps $4M of your money to invest back into the acquirer company. Buyers typically say that the rollover equity will be worth 3-5 times more in five years when they sell the platform business. But, of course, you’ll have to wait until then to get your second bite of the apple.

If you are investing in the stock market, you should do thorough research on the company you are investing in. Rolling over millions of dollars in equity is effectively a multi-million dollar investment into the buyer’s company. There’s a good chance that it will be your largest investment position.

Here is an example that illustrates why this is important:

When you roll over equity, you are buying shares at a fixed dollar-per-share price. So, if you pay $2 per share and five years later, the company’s per-share value triples to $6 per share, your $4M investment is now worth $12M.

Alternatively, if you pay $1.50 per share, your investment quadruples, and your $4M investment is now worth $16M.

That’s a sizable difference in the return on your investment. Research and due diligence on buyers’ stock will help you determine if the buyer company’s stock is worth $1.50 or $2.00 (or some other negotiable price).

At Embarc Advisors, we ask buyers for diligence information, and often, they’re surprised by this request. This indicates that it’s a less common request, but it’s not necessarily a less important request. Every time that it is requested, the buyer does provide it. This due diligence is how you can make sure that you’re not overpaying for buyers’ stocks.

Mistake #5: Overlooking the Net Working Capital Target

One of the final items in an M&A transaction is to agree on a net working capital target. The definition of the net working capital target seems fairly benign, but it is actually a complex concept that requires an understanding of accounting, operations, and deal mechanics.

Setting a favorable target can have an estimated 2-5% adjustment (sometimes more) to the purchase price, which can go positive or negative.

Many sellers share nightmare stories about net working capital adjustments that went wrong. Most often, they don’t fully understand what happened. According to the documents, they agreed to the terms, but it’s a little inconceivable to think that they knowingly agreed to a 5% negative adjustment on the purchase price.

The net working capital target is typically set about one week before signing the purchase agreement. At this point, the long and intense sale price is coming to an end, and the seller often lets their guard down. Most of the tough negotiations are done, and they’re too distracted or exhausted from all the diligence work to focus on all the potential scenarios.

It’s imperative to stay focused until the final moment, making sure to negotiate a buttoned-up net working capital target that is as favorable as can be.

The Takeaway on How to Avoid Mistakes When It’s Time to Sell

Many founders have invested a significant amount of time, money, and sweat equity into building their companies. When it’s time to sell, there is a lot riding on what is often considered the most important deal in their business–putting a final dollar value on years of culminated investments. The sale of a company is such an important deal that it’s well worth investing a little more into a seller QofE and proper diligence work to ensure that all the numbers check out.

Embarc Advisors can Help Founders Maximize Value When They Sell

It’s heartbreaking to see founders lose out on value when they sell over avoidable missteps in the last leg of their entrepreneurial journey. For many founders, access to high-level advisory services has been a challenge.

Success-based fee models can take a significant chunk out of the sale price. As one founder/owner put it–he would rather sell to a buyer he already knows than to give someone 8% of his company for sell-side advisory.

“My dad was an entrepreneur, and I am on my second company, so I’ve been in the founder seat, and I can empathize with every scenario that you are considering as a founder.” Jay Jung says, as he talks about why he founded Embarc Advisors.

This is why we offer a different approach. At Embarc Advisors, we bill using an hourly-based fee model that makes our services scalable to fit your needs. It better aligns our incentives with the business owner, delivers higher quality services and costs less. It’s our goal to help founders ensure that their last leg is well-executed to maximize their value.

Contact our team today to talk more about your needs.