It is now common knowledge among business owners that between 2014 and 2018, approximately 80,000–120,000 companies in Germany were up for sale, mostly due to a lack of succession within the family, and sometimes due to disputes among shareholders or illness.
In each of these cases, however, the goal is to preserve the company—including its products and services, its customers, suppliers, and employees, as well as their expertise—and thereby safeguard the company’s value. This applies regardless of whether the company is transferred within the family, to employees, or to third parties. So-called “third parties” in this context include strategic investors—such as competitors, suppliers, or even customers— in addition, MBO (management buyout) or MBI candidates—that is, external individuals who purchase a company to become independent entrepreneurs—are also potential buyers; and in recent years, investment firms and private equity firms have increasingly emerged as buyers of companies.
With approximately 50% of business transfers going to family members, they still represent the largest group in terms of numbers, albeit with a sharply declining trend. The frequency of sales to the aforementioned strategic investors or, alternatively, to MBI candidates depends primarily on the size of the company. Generally speaking, as the size—and thus the enterprise value—of a company increases, the proportion of acquisitions by MBI candidates decreases, a trend that can also be attributed to rising equity requirements in acquisition financing. Since the number of investment firms and family offices has risen steadily—partly due to the currently low interest rates in the Eurozone—there is also an increasing number of corporate acquisitions in which MBI candidates and investment firms jointly acquire a company.
The seller of a company should be aware that, when dealing with investment firms and private equity firms, they are always dealing with professional prospective buyers; this means that excellent preparation and support throughout the sales process—for example, by an M&A firm—is necessary in most cases to ultimately achieve a purchase price that reflects the company’s value while minimizing—or, ideally, eliminating—tax and legal risks.
1. Preparing for Business Succession
The BDU’s professional association “Startup, Development, and Succession” has published “Standards for Proper Succession Consulting,” the key points of which are also referenced here. During the preparation phase—which represents a significant professional milestone for every entrepreneur— the first step is to identify the long-term options for continuing the business, the strengths and weaknesses that characterize the company, and—last but not least—the contingency plans in place for the company, including short-term or temporary takeovers, such as in the event of illness. These include provisions in a will and powers of attorney, the question of the future legal form, the entrepreneur’s future role and life plans, as well as clarifying personnel decisions within the company.
In most family-run businesses, addressing the issue of future management is often dismissed as a so-called “soft factor” of insufficient importance; however, it regularly emerges as a major stumbling block during the actual transfer of the business, since virtually all prospective buyers—even for smaller companies—rightly place the utmost importance on a functioning second level of management. The business owner must always ask himself: What (and not, initially, how much) is the value of the business? If this value—for example, in the company’s know-how, customer loyalty, innovative strength, etc.—resides solely with the entrepreneur, and if, from the prospective buyer’s perspective, much of that value is lost when the entrepreneur leaves, this represents a significant reduction in the company’s value—regardless of past revenue and profits!
In addition to these strategic personnel decisions at the second management level, hard facts—such as preparing optimal tax strategies in connection with a future business transfer—are, of course, also important. This involves not only addressing questions regarding the widely discussed implications of the planned changes to the inheritance tax, but also, for example, determining how to safeguard tangible assets, such as business-use real estate. As part of the business planning process, in addition to the aforementioned issues, a medium-term revenue and profit forecast should be developed, which in turn serves as the basis for the business valuation to be prepared.
Phase 2: Planning the Business Acquisition
The planning phase of the business transfer focuses on the specific “how”—that is, to whom and at what price the transfer should take place. If the business owner decides to sell the company, the question arises as to whether to sell the entire business or just a portion of it, and if so, what percentage and to whom the sale should be made. Before taking any concrete steps, however, preparations for the sale must be made. These include, for example:
Reviewing and planning the resolution of factors that could hinder the sale—such as whether the business has pension liabilities, which always require careful review during a sale process and, in many cases, must be spun off
Conducting a business valuation using standard valuation methods appropriate to the industry and size of the company
Reviewing all legal and tax implications that affect the sale as a whole or the sale price (e.g., choice of legal form, whether to retain or spin off company-owned real estate, patents, distribution rights, etc.), to name just a few important examples.
It is of the utmost importance to strictly maintain the confidentiality of the intention to sell. Announcing the intended sale of the company too early can not only jeopardize existing customer and supplier relationships but also often unsettles employees and reduces the chances of selling the company at the best possible price.
The question of how long the business owner can and is willing to be personally available for the handover and to provide training also determines the timing of the sale. As a general rule, the less the entrepreneur has delegated responsibilities to the second level of management in advance, the longer it will take to train the successor or investor. The handover period tends to be shortest in the case of a sale to a competitor; in contrast, MBI candidates, investment firms, or private equity – firms often require a two- to three-year transition period to ensure the transfer of know-how and customer relationships.
Valuation Methods for Business Acquisitions:
The most common valuation methods for business transactions are the income approach, the multiples approach, and the discounted cash flow (DCF) method; the AWH-standard valuation method and the net asset value approach are significantly less frequent and relevant. While the AWH Standard method tends to be used for small businesses (often craft businesses with a strong dependence on the business owner), the income approach, the multiples method, and the discounted cash flow method are used much more frequently and are often employed in combination to determine the enterprise value. The net asset value method may be considered by the seller if the value of the fixed assets is significantly higher than the company’s income value, as may be the case, for example, in highly capital-intensive industries or for companies that have recently made significant capital investments whose impact has not yet been reflected in earnings.
What all valuation methods have in common is that they can provide a significant indication of the company’s value; however, the decisive factor for the actual realized value—that is, the company’s sale price—is always the price a buyer is willing to pay on the market. This optimization of the sale price is generally only possible if the company is offered to potential buyers discreetly—without public disclosure of the intention to sell—through an M&A firm specializing in corporate sales, and is sold to the highest bidder on the market. Larger M&A firms typically maintain their own database of several thousand potential buyers; furthermore, for the entrepreneur looking to sell, determining whether the M&A firm has offices throughout Germany and operates internationally, as well as assessing its industry experience, can provide important criteria for selecting the right advisory firm.
Since prospective buyers are increasingly being sourced via the Internet, the question of whether the M&A firm is also prominently represented on the leading online business marketplaces is another possible indicator of its market presence. Since selling a business is often more complex than it initially appears, given the tax and legal implications and risks involved, the tax and legal expertise of a consulting firm specializing in business sales rounds out its profile.
3. Execution Phase
The execution phase is the decisive phase of the sales process. During this phase, potential buyers are approached, their creditworthiness and professional competence are assessed, and—after signing a so-called NDA (non-disclosure agreement)—they are presented to the business owner only if they are deemed suitable. In practice, it unfortunately happens all too often that business owners negotiate for too long with the wrong prospective buyers due to insufficient credit checks, thereby wasting valuable time and disclosing confidential information to unsuitable buyers. It is also the responsibility of the M&A firm to protect its clients by conducting a broad and thorough selection of suitable prospective buyers. Once suitable prospective buyers have been selected, a letter of intent is signed with them, setting forth all relevant information regarding the timeline for due diligence, the purchase price, legal issues, and the handover process. Particular attention must be paid to ensuring the data room is fully set up. The documents provided therein—which typically comprise a multi-page list of requirements—must not only be truthful but also complete. Incomplete documentation always poses a future legal risk, which the seller should always avoid—in their own best interest. In extreme cases, this can result in subsequent claims for a reduction in the purchase price or even the reversal of the sale.
Whether the data room is set up online or offline is of lesser importance; the use of virtual data rooms on the Internet—which, of course, must be secured against third-party access and must properly log the documents viewed by prospective buyers—has now become the most common method for conducting due diligence.
The decision to grant exclusivity in the subsequent purchase agreement negotiations versus conducting an open bidding process must be weighed on a case-by-case basis against the pros and cons of the specific transaction; it is just as difficult to provide a general recommendation here as it is to answer the question of whether an assetor a share deal is the appropriate form of business transfer. Here, too, the seller’s transaction advisor’s professional expertise certainly pays off. But it can also be of great benefit to the buyer if, through the experience and expertise of the M&A firm, they receive useful advice and—in consultation with the seller—the M&A firm—in consultation with the seller—to receive relevant advice and explore options for purchase price financing and, if necessary, additional equity financing, in order to accelerate the sales process as a whole.
Time and again, it is evident that the contract is not awarded to the prospective buyer offering the highest purchase price, but rather to the buyer who, from the entrepreneur’s perspective, is the best overall fit for the company and its culture and who is able to promptly provide appropriate financing confirmation. Once the purchase agreement has been negotiated and finalized (signing) between the contracting parties and their legal advisors, the final phase of the sale process begins: the closing and the subsequent handover or start-up phase for the new owner (post-merger process).
4. Handover Phase, Post-Merger
When planning the sale process, the entrepreneur should anticipate a handover period of approximately 2 years, provided the transaction involves the complete sale of the company. During the first 6–12 months, the entrepreneur typically maintains a temporary presence within the company; after this period, a “as-needed” collaboration is usually agreed upon on a fee basis. Particularly for companies with a high degree of dependence on individual customers (such as repeat customers of mechanical engineering firms), sufficient time should be allocated to the handover of customers during the onboarding period.
Careful planning and structuring of the post-merger process can also be beneficial in cases where employees and expertise —are exposed to a cultural shift between corporate cultures, as is the case, for example, when a smaller family-run business is acquired by an internationally active corporation. Here, too, it often pays off in the long run if personnel decisions at the management level are made early on and these executives are actively and responsibly involved in the transaction process.
