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Business Growth: Liquidity Events and Capital Raises – How Do I Get There (Successfully)?


Today’s capital environment is one where the stars have (mostly) aligned. Many companies have strong cash reserves on their balance sheets, private equity firms have billions in dry powder, debt financing is readily available and affordable, CEO confidence levels are relatively high, and the equity markets are strong. Financial and corporate investors are aggressively looking for quality investment opportunities. The timing may be right for many business executives to pull the trigger on a liquidity event or capital raise. But not all liquidity or capital raising events are created equal.  Some transactions will fail, some will succeed, and unfortunately, some will come to fruition under less-than-ideal circumstances. When it comes to a business owner seeking growth capital or a strategic investment partner, preparation is the driver of success. 

1. Have a strategic plan

The decision to raise capital should be a tactical response to a strategic need. A liquidity event is not something that companies fall into. It should be something that the management team has planned and prepared for, taking into consideration the long-term implications of the transaction on the company and its owners, the impact on value, and the ability to keep growing the business.

One of the first things that investors look for in an acquisition target is a business that meets their particular vision. Some investors focus on buying companies as add-ins to satisfy a particular need for their existing portfolio investments. Others have a particular expertise within an industry and typically only buy what they know. However, most investors do both – look at add-ons as well as new companies that are within their area of expertise. As such, investors will closely scrutinize the nature of the business they’re buying including financial condition, growth opportunities, and strength of the business’ management team.  Further, and equally important, investors analyze how a company will fit into their overall investment thesis.

It is essential for companies to be in control of their own destiny and have a strategic plan of their own when approaching the market.  They need to understand why selling the business makes the most sense at this particular time, and why the company will make an attractive acquisition target. The business plan needs to be crystal clear - explaining and supporting the long-term value of the company as well as the strategies and opportunities for growth.

2. Shore up your management team – it can be a factor

In real estate, the mantra is location, location, location. For investors, it is people, people, people. Some investors will only invest in companies with strong management teams while others will look to replace management with their own hand-picked team. Firms that require a strong management team from the outset do not want to get involved in the day-to-day operations of the company. They want an established management team they can trust to run the business.

Target companies need to ask themselves whether they have the best people on board who can impress an investor. Does every person on the management team possess the proper skill set required to keep growing and reinventing the business? If not, some difficult decisions may need to be made.

So what do buyers look for in a leadership team? They weigh whether a management team has been able to grow the business from both a top and bottom line perspective and attract new customers year after year. From an operational perspective, they also want to see that a team has been able to develop new products and stay responsive to a changing marketplace. Product teams that have succeeded in continually reinventing the business and keeping it relevant in the marketplace are worth their weight in gold.

If the investor’s plan is to grow its companies 15 percent each year for the next three years, the buyer will want to ensure that your company has the internal talent to achieve that goal. The investor will generally be able to identify any weak links in the management chain. For example, does the CFO only act as a glorified controller who does not have the skill set to think creatively? Does the management team have the vision and insight required to make strategic decisions and take the business to the next level? Those are questions any potential acquirer will be asking.

3. Get your financial house in order

In financial reporting, two concerns are paramount: the quality and reliability of the financial statements and supporting financial data. When potential buyers analyze a target company, they want to know that the right systems, processes, and internal controls are in place to ensure that the numbers they are scrutinizing are accurate.

For instance, does the company have an employee who has the ability to both create new vendor accounts and approve invoices? If so, there is a risk – from an investor’s perspective – that this employee has set up dummy vendors and made fraudulent payments. You need to have the appropriate internal controls in place to guard against fraud and bolster the validity of your financial data.

Some companies may not have a CFO who has the experience required to execute a liquidity event. Accordingly, it is important that a company recognize this limitation in its CFO capabilities and turn to its financial and legal advisors for appropriate advice. For those that do have a CFO with the appropriate liquidity capabilities, it is critical that the CFO identifies the critical indicators that drive the business—such as margin by product and customer—and creates a structure that allows for the measurement and reporting of those success factors. A strong CFO should be the architect of the liquidity event and offer insight into how it should be executed. This includes everything from negotiation approaches to how the deal will be financed. The CFO is the manager of the right-hand side of the balance sheet which is important in determining the ideal balance of debt, equity, and capital of the business.

Also important is the ability to close the books quickly. Buyers are not impressed with companies that cannot close their books swiftly and accurately. However, it is not just speed that investors require, it is also quality. An investor will want to have confidence that your company is closing the books on a timely basis, but not at the expense of compromising needed analyses and management reporting packages. They want to ensure that your financial department is not just pushing a button every month but, rather, is conducting the proper analyses to understand the results of operations.

Audited financial statements are another must-have. Many companies think they will deal with having an audit conducted once they actually have an offer on the table. That is not true. Buyers often want to see at least two or three years of audits before they will even consider pursuing an acquisition. CohnReznick encourages clients to consider having an audit performed well in advance of a liquidity event. In addition, some investors may require at least two years – sometimes three years of audited financial statements due to their banking arrangements with a lender who may be financing the transaction.

4. Polish your operational processes

When a potential acquirer is contemplating an acquisition, it wants to know that the target company is running its operations efficiently, including everything from information technology (IT) and finance to corporate governance and compliance.

With IT, for instance, an investor wants to see that all business systems, including customer support, manufacturing, and HR applications, are modernized and, hopefully, well-implemented and integrated. Is your company using the current version of software packages that render your information safe? Is your software still supported by the manufacturers? Are the systems suitable for a company of your size? Is the technology scalable and can it grow with your business? Are your systems operating effectively and producing the timely, accurate information your company needs to stay ahead of the competition?

The same goes for technology used for your company’s financial accounting and reporting systems. Do you have executive dashboards that enable your people to best manage the business? Does your company have the ability to automate financial processes and gain a comprehensive picture of available cash flow—anytime, anywhere?

Regulatory compliance is another hot-button issue with investors. Before they acquire a company, investors want to know that everything is in order from a regulatory standpoint. For example, companies in the retail or restaurant space need to adhere to the Payment Card Industry (PCI) guidelines for protecting credit card information and safeguarding against fraud. Likewise, target companies in the healthcare space have to be fully compliant with Health Insurance Portability and Accountability Act (HIPAA) requirements which place a premium on the protection of patient data.

5. Choose the right advisors at the right time

The right investment banking, accounting, and legal partners are crucial to the liquidity process. In choosing the right advisor, it is critical to select those who possess specialized expertise so that you can maximize the return on what can be the most important transaction in the life cycle of your organization. Start by finding a banker, financial advisor, and attorney with whom you can establish a rapport. The right attorneys can have invaluable input on the “representation and warranties” terms of the contract and can be an instrumental part of the negotiation process. You will be spending a significant amount of time with these resources, so CohnReznick recommends setting up a “dating period” to get to know them. During that period, you will need to decide which of them you can work with and whether they share your strategic goals.

It is difficult to contemplate a liquidity event when you are busy building a business. However, the most successful transactions are carefully planned events.  It is important to engage advisors earlier than you might think, perhaps even a couple of years ahead of a planned sale. It can take six months to prepare for a liquidity event and another six months to complete it. CohnReznick recommends that management teams spend at least a small portion of their time getting in touch, and staying in touch with, talented, compatible bankers and accountants at least six months to a year before beginning the prospecting process for a sale.

6. Prepare for invasive due diligence

The financial crisis changed the relationship between buyers and sellers. Investors are now conducting a degree of due diligence never seen before. They are demanding—and getting—an enormous amount of detail that extends far beyond financials. The due diligence process is no longer a routine check-up. It could feel like a root canal.

The due diligence process is new to most companies that are preparing for a liquidity event and it usually comes as a shock. The first time through the due diligence process, no one is fully prepared. The first step on the path to a successful due diligence effort is to engage a reputable accounting firm to provide sell-side due diligence and/or audit services which are the backbone of your credibility.

From there, the potential acquirer may scrutinize every material contract, every document, every settlement and lawsuit, every vendor agreement, and every confidentiality agreement your company has signed in the recent past. Maintaining a document file that provides easy access to documentation is one of the most productive due diligence support measures any company can take.

Companies need to be meticulous about managing paperwork and holding onto all contracts. Otherwise, they will find that the diligence process becomes extremely painful as they attempt to reconstruct years of records. Consider using a Virtual Data Room that allows you to securely store and share files between team members and prospective buyers.

For any company contemplating a liquidity event, now is the time to start preparing for the diligence process. If it is not performed now, it will have to be done later. Analyze all your major agreements. Contemplate going back to investors and banks to renegotiate terms that may become problematic. If any agreement is open-ended, or if any terms are not crystal clear, clean them up.  The due diligence process is likely to uncover that hastily written contract of several years ago. Consider engaging competent legal expertise to determine whether contracts and agreements should be cleaned up for problem areas.

To streamline and increase the chances of a more efficient due diligence process, sellers should designate a representative from their group to drive the due diligence process. Ideally, this should be a detail-oriented person who can compile the necessary documents and data while also managing the day-to-day interaction with your advisors—while keeping all of these tasks on a reasonable timeline.

The Importance of Due Diligence

Whether an organization is on the buy or sell side of a transaction, it is important to have the information intelligence needed to make informed risk/reward decisions.  Each business attribute should be carefully analyzed on both a stand-alone and deal-context basis in order to identify unseen opportunities and potential risk exposures. Enter due diligence. Some assumptions and many “estimations or approximations” are made about a target prior to performing due diligence.  Due diligence provides comprehensive analyses of those assumptions, thereby providing a more accurate understanding of the target, and the risks associated with the transaction.

  • Financial due diligence involves reviewing historical financial performance, analyzing quality of earnings, identifying key business drivers, profitability trends, and significant concentrations of risk, validating sustainable earnings and future cash flows, analyzing working capital, and identifying potential hidden liabilities and costs. 
  • Tax due diligence aims to minimize the tax burden and maximize the return on investment by identifying alternative deal structures, reviewing tax returns to identify potential risks and tax planning opportunities, and reviewing and evaluating tax attributes, credits, and incentives.
  • Information technology (IT) due diligence seeks to identify IT-related risks, opportunities to reduce costs, and increase the efficiency of the IT department. A typical IT due diligence review includes assessment of current systems and data, review of data and network security, assessment of IT organization, review of the software development life cycle, assessment of third-party service and software providers, and assessment of synergies and redundancies. 
  • Human capital due diligence includes assessing management retention risks, reviewing compensation structure and expenditures, evaluation of retirement plan benefits, evaluation of health and welfare programs and costs, review of union labor contracts and collective bargaining agreements, if applicable, and assessment of culture fit.

Many times, sellers leave value on the table because they fail to think like a buyer and do not prepare adequately for the rigors of buyer due diligence.  They do not anticipate buyer concerns, and are not prepared when confronted with questions concerning operations, customer concentration, and projections.  So, what is a resolution option to these breakdowns? One option is to conduct a sell-side due diligence report. This type of report is an opportunity to showcase the company and provide a shortlist of interested buyers with financial and operational information from which to thoroughly evaluate the business and make an informed offer.  It enables the seller to maintain credibility, eliminate surprises, maintain control of the process, minimize disruptions, and increase the likelihood of a successful transaction.

EBITDA Considerations

Typically, most buyers value a business using a multiple of earnings before interest tax, depreciation, and amortization (EBITDA).  Often, the EBITDA target is specified long before the purchase agreement and sometimes as early as the Letter of Intent.  An organization should remember that every potential adjustment or item found during due diligence may result in a multiple dollar effect that may ultimately impact EBITDA.  Therefore, it is important to assess and present sustainable and recurring earnings that negate the impact of one-time events.

Boost Enterprise Value

A savvy business executive knows that, when preparing for a liquidity or capital-raising event, sometimes even a modest investment can increase the value of his or her company appreciably.  Consider that an investor or acquirer will likely assess the integrity of the target’s data, the accuracy of its financial reporting, the security of its information systems, and its level of compliance with relevant regulatory and legal requirements.  It is therefore prudent for a company to invest in evaluating and strengthening its internal controls in order to achieve the most favorable financial results from a capital transaction.  A well-maintained business with robust internal controls is attractive to investors and acquirers because it not only offers increased confidence in the financial reporting function, it also provides assurance that risks are effectively mitigated and assets are properly secured.

Upcoming Articles

Your business is probably the largest asset you own. If you’re like most successful business owners, you’ve invested your heart, brains, energy, and resources to make it work. In upcoming articles, we’ll drill down on the issues associated with preparing your business for a liquidity event or capital raise. 

Can’t wait for the next article?  Learn more here.
Liquidity and Capital Raising National Forum Baltimore

CohnReznick is pleased to present our Fourth Annual Liquidity and Capital Raising National Forum. The 2014 Forum will take place on Wednesday, November 5, 2014 at the Four Seasons Baltimore. The program is designed for key decision makers at mid-sized companies who want to: 

  1. Increase their knowledge about liquidity issues and capital raising
  2. Meet and network with private and public sources of capital

The Forum offers a comprehensive overview of the latest trends and successes for liquidity events and capital raises. In-depth panel discussions include CEOs, private equity investors, investment bankers, and other capital markets experts who will share their insights, experiences, and advice. In addition to the three panel discussions, CohnReznick’s Fourth Annual Liquidity and Capital Raising National Forum offers an ideal networking venue – enabling key decision makers, private equity groups, and investment bankers to connect and develop beneficial relationships.  Learn more here.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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