Mergers and acquisitions have become an integral part of doing business today. We cannot say exactly how much activity there is because so many of these transactions take place between private companies, and few, if any, documents are made public.

What is known, however, is that in year 2000 publicly held American companies completed an amazing 9,566 transactions valued at $1.3 trillion. Worldwide, the number of transactions increased to 17,424 and reached a whopping $1.9 trillion in value.

One of the most important strategic decisions that a person has to make as the owner of a closely held business is whether or not to sell the company. Once the decision to sell is made, the owner has to determine how to get the best price for the company.

My goal is to demonstrate what factors influence the selling price of the company and what can be done to increase this price.

Each week a new, bigger merger is announced. Why is this taking place? Growth in the business world, especially in a prosperous period, is critical to the survival and competitive position of a company in its industry.

A company can grow internally and through mergers with other businesses. A company in a maturing industry, in order to compete, has to make investments in technology, communications, or other assets. With shrinking profit margins due to competition and a greater need for cash, a capital demand is placed on the company, which it may not be able to fund through internal growth alone. In this situation, the company may choose to acquire another company.

In the best-case scenario, the company will have gained new revenues to amortize the capital demand, grown much faster than it could have internally, and reduced the competition in the market place.

One of the most difficult decisions an owner-manager will ever make is the decision to sell his or her business or merge it into a larger entity. Ultimately, this will mean relinquishing control, and the decision will be fraught with emotion.

However, demographics of our country indicate that more and more business owners will make the decision to sell. A few years ago, Merrill Lynch conducted a study showing that sometime in the next decade $7 trillion--that's trillion with a "T"--will transfer from one generation to the next. A lot of that $7 trillion will be in the form of business enterprises that have changed hands.

Of course, when a seller decides that he wants to sell his company, he wants to get the highest price he can for the company. The price that the buyer will be willing to pay, and at which a seller would theoretically be willing to sell, is based on the value of the company today based on expectations about the future.

Valuation theory suggests that a business is worth the future cash flow that the company will generate, based on a formula that takes into account the future growth rate and a risk-adjusted discount rate. In order for the company to have a greater future value, it must demonstrate several characteristics.

A company that demonstrates accelerating growth in its assets and earnings is considered to be a greater value company because that growth is used to predict the future cash flow of the company. If the same company shows contraction in its growth and earnings, that trend will adversely affect the future cash flow of the company and its inherent value.

Other indicators of value include comparable company analyses and the implications of minority equity valuation of appropriate listed companies. Such indicators validate or refute the decision to buy or sell.

This is fairly straightforward, and in a perfect world the price at which buyers are willing to buy and sellers are willing to sell would be the same. However, coming to an agreement on the future makes price negotiations complex.

When does an owner know it's the right time to sell? This decision regarding the timing of an exit may in fact be the single most important driver in attaining the highest price for an enterprise.

For any business, value is greatest when the stock market is high, and yields (interest rates) are low. Today, the stock market is at about 11,000, relatively high, and the prime rate is at 7.0 percent, relatively low. However, this market and the prime rate are following a substantial market correction and economic slowdown. Today, buyers are often looking for distressed sellers and commensurate pricing.

What it also means is that if the stock market retreats, or the interest rate increases, a company will be worth less, even if its performance remains unchanged. In fact, maintaining value will require earnings growth that exceeds the downward pressure created by a retreating market or increasing interest rates.

Therefore, the timing of a transaction relative to the performance of the broader capital markets can have greater impact on price than the actual performance of a company. A buyer who can strategically enhance the value of his enterprise by capturing another company's market share, proprietary technology, or other strategic advantages will be willing to pay a premium to make the acquisition.

Indeed, this desire to gain strategic advantage through acquisition and to prevent competitors from doing so is one of the drivers of consolidations within an industry. Today represents the best of all worlds for the sage CEO who recognizes our current environment as one of unique opportunity, brings his best skills to bear to prepare a company for sale, engages talented professional advisors, and reaps tremendous rewards for his efforts.

However, the path to reaping these rewards, once the decision is made to sell, is not without peril. The courtship and negotiation of a sale must be handled with the utmost privacy.

Competitors are quick to use the news of an impending sale to damage a company in the marketplace. "Perhaps you should reconsider placing that two-year contract for kryptonite with Superman Industries. I've heard they're on the block, and the fulfillment of your contract might suffer." Or, just as damaging, rumors of a sale can leave your sales and executive ranks ripe for the picking--putting a dent in revenues and earnings. Likewise, the knowledge of a pending sale can de-focus management and operations and adversely impact performance.

These risks can be mitigated with proper planning and quality advisors. Proper planning means being very sure of one's decision to sell and then continuing to run the business as if you were going to be there forever.

Putting together a quality team comprising experienced investment bankers, legal counsel, and auditors is key. This team will maintain a confidential environment, be very judicious about what type of company information is made available, and perform due diligence on the buyers.

Let me return to this concept of what information is and is not made available to a potential buyer. For starters, any potential buyers must be vetted for their ability and willingness to close a transaction.

Do not waste time with unqualified buyers. As much due diligence as possible should be conducted offsite, and certain information, such as customer lists, is guarded until an agreement is signed.

Confidentiality agreements are good practice, but do not depend upon them. Suing a competitor for breach of such an agreement is small recompense after your business has been damaged and your window of opportunity is closed.

The greater the degree of certainty that the entire price will be paid at closing, the lower the price that the buyer will be willing to pay for the company. The reason is that the buyer is basing price on future performance; the buyer is buying uncertainty. Therefore, as a hedge against uncertainty of future performance, the buyer seeks to pay a lower price and has more of the price contingent on future outcomes.

Earn-outs reduce certainty and increase price. Buyers are often willing to pay a higher total price if the price is based on demonstrated future performance. Thus, the earn-out. In actuality, this is favorable from the seller's standpoint.

I have known of sellers that have received almost twice as much total price based on the operation of an earn-out formula. However, there are some things to watch for; among the most important--"rules of post-acquisition operation."

Simply stated, a seller should be very wary of relinquishing the operation of the company to new management during the earn-out period and require that the accounting principles and methods used post acquisition are the same as those used pre-acquisition. Otherwise, operations may not maximize earnings, or the earn-out may be defeated by accounting entries.

Buyers, of course, want to insure as much as they can about the future. Buyers attempt to maximize representations and warranties about future realization of assets, absence of undisclosed liabilities, etc.

Since satisfaction of any of these factors reduces the total amount that the seller realizes ultimately from the sale of the company, it is in the seller's interest to limit the nature and duration of the representations and warranties. If the buyer has done comprehensive due diligence, then the seller's position should be that there is very little that requires representations or warranties other than specific uncertainties, since the price incorporates the results of the extensive due diligence.

Alternatively, if extraordinary representations and warranties are requested, then query the need for extensive due diligence. Some escrow of price may be in order.

Continuing management will become the loyal employees of new ownership after closing. Accordingly, their post-closing performance will affect their future compensation and bonuses. Predictably, this usually means that non-ownership management is interested in limiting promises of future pre-closing performance because a failure to achieve equivalent post-closing performance will reflect badly on them.

Accordingly, it is appropriate to consider ways to incorporate incentives for management to maximize price. The most effective way is to allow management to participate in the proceeds from the sale based on the magnitude of the selling price achieved.

One can also protect management with change in control agreements, employment contracts, and severance agreements. However, these promises may lower or reallocate price away from the seller and to non-ownership management. Above all else, management must run the company effectively prior to sale because this is essential to maintaining price and proving the reliability of projected performance. It is entirely possible, indeed likely, that a transaction may not be closed and yet value will be impaired.

Negotiating skills are necessary to keep as many qualified buyers in the competition as possible to ensure the seller has real alternatives from which to choose. Both seller and buyer will bid competitively under the realization that they might otherwise lose the acquisition.

It is up to the negotiator to understand each buyer's drivers and present the seller appropriately in response. The negotiator's responsibility is to maximize the effective use of time by settling on price as early in the transaction process as possible by: ·

• Allowing only qualified buyers to participate in the process ·
• Keeping the process private and sensitive information restricted as long as possible ·
• Getting written expressions of interest to narrow the field ·
• Completing terms and proposed agreements in principle.

For the seller it is usually a once-in-a-lifetime event. An able negotiator is necessary to make it all it can be.

After going through the work required to get a company sold, no one wants the transaction to fall apart. Accordingly, it is important that all buyer objections be isolated and addressed as early in the process as possible.

Early on the seller should establish the buyer's ability to finance the proposed transaction. I favor getting the issue of price out of the way prior to any due diligence, essentially by agreeing with the buyer that if all representations are true, the price will be as agreed upon based on the information provided.

I consider terms to be a part of price; therefore, it is important to complete terms as well as price. Certainty of close is enhanced when there are fewer conditions prior to closing.

This is typically accomplished by driving more than one buyer through the drafting of an agreement in principle to ensure that the conditions agreed upon are only those that are necessary to close a completed transaction.

My objective today has been to discuss in real-world terms the complex factors and potential pitfalls involved in a successful transaction.

The good news is that today's active deal flow has created a pool of very experienced professional advisors. I cannot emphasize enough the importance of a talented team.

Transactions are high risk, high reward endeavors. I hope these comments have provided insight to support you and your clients in recognizing the issues and pulling together the right team.

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