Introduction

Pat: Hey there, this is Pat Ennis of Ennis Legacy Partners. Welcome to the Exit Readiness Podcast. I’m here with co-host Walter Dial. Our mission is to provide you, the business owner, with subject matter expertise on building salable business value and planning your eventual exit from the business. We want to help you build a business that is transferable, and then exit successfully on your own terms and conditions.

Most business owners understand the importance of confidentiality during a sale process. What many do not fully appreciate is just how fragile that confidentiality can be once the business is actually taken to market. A single conversation, an unusual document request, or a shift in behavior can create concern among stakeholders like employees, uncertainty among customers, and speculation among vendors or competitors. Once fear or uncertainty enters the picture, value can begin to erode long before a transaction ever closes.

So how do you explore a potential sale without disrupting the very business you’re trying to protect? That’s the focus of today’s conversation: selling in stealth mode, or how to market your business without alerting customers, vendors, or employees.

Joining us today is Greg Kovsky. Greg is the president and CEO of International Business Associates (IBA), the Pacific Northwest’s oldest and largest business brokerage firm, established in 1975. With over 30 years of experience as a transaction intermediary, Greg has personally facilitated over 300 transactions involving privately held companies and family businesses across multiple states and industries, typically ranging from $1 million to $30 million in enterprise value. He’s a published author, a seminar speaker, and an advocate for entrepreneurship. He also follows a personal work-life balance philosophy of working 45 weeks per year while keeping a family-first approach to business.

Greg, welcome to the podcast, and thanks for getting up early out there on the West Coast to join us today.

Greg: It’s an honor to be here, Pat. It’s a pleasure to join you and Walter.

When Should Employees Find Out?

Walter: Greg, I’m going to start us off. Thanks for joining us. Let me ask you about a situation we’re dealing with right now. We have a client with a very niche personal service business. The owner is 100% central to the business. She has about a dozen employees, all professionals, and she’s in her 70s. She’s very concerned about them knowing that she’s thinking of transitioning the business in some way. We haven’t determined the best course yet, whether it’s a third-party sale or some type of inside transfer.

Part of me thinks that in a lot of situations, it’s good for your team to know you’re thinking about the future. Otherwise, aren’t they thinking, “What’s going to happen if she dies?” So isn’t there a trade-off between keeping it close to the vest and inviting your team in? How do you handle those situations, and what variables help you decide?

Greg: Certainly. You’re unpacking a significant issue in the sale of businesses. There is no slavery in America, and to the buyer, the employees are a significant asset, just as they were to the seller. So you want to transition them smoothly from one tenure of ownership to the next, but you want to mitigate the fear. Employees can make decisions in their own self-interest.

What we try to do as an M&A firm is diminish the black cloud on the horizon. It can take six months to two years to sell a business. If word gets out to the employees that a sale is being considered, they could leave and join a competitor who has been recruiting them for years. They’ve been loyal to the existing owner, but if the owner is leaving, why not make a decision in their own self-interest? It’s no different than a professional athlete who becomes a free agent and changes teams. You go where it’s in your best interest.

So we want to control the narrative and introduce the sale to the employees strategically, at a point where we know the buyer. Then it’s not an ambiguous black cloud of uncertainty. It’s someone we can present to the employees. We can talk about the buyer’s experience, background, and vision for the future, and how this party was selected from numerous choices in the best interest of the employees, customers, and vendors.

There is a point where it needs to be disclosed, and buyers often have contingencies related to retaining key employees. If you have a restaurant famous for its Italian food and you lose the head chef and the sous chef at the time of sale, I don’t care how nice the wine is or how good the ambiance is. If they can’t deliver the same quality product, it’s not the same business. Employees matter. They are the human capital in a business sale. You want to go through the process strategically to make sure they’re listened to, the business is protected up to the sale, and the buyer has the best opportunity for success after the sale.

Walter: Those are really interesting points, especially the word “strategically.” As you were speaking, I was thinking that if you go to your employee group and say, “I’m going to retire in five years, and we haven’t figured out whether we’re doing an insider sale or a sale to an outsider,” you’re setting yourself up for problems. People start thinking, “I’m going to have an opportunity to own the company.” Then you come back and say you’re going the third-party route, and now you’ve upset a bunch of people. So you don’t want to let them in until you have a road map they can see.

Greg: Exactly. There’s also a leverage point for employees that can jeopardize a sale: they can ask for a raise. If they know the sale is contingent on their retention, that could impact the sale. I’m watching the NBA playoffs right now. If one key player is a free agent and chooses to go somewhere else after the season, it’s not going to be the same team next year.

Walter: Good point.

Common Mistakes Owners Make

Pat: Greg, in light of what you’ve said so far, what are some of the common mistakes you see owners making with this critical communication strategy?

Greg: I think it’s not creating a corporate culture where employees want to stay with the company, where they’re playing for the brand rather than for an individual. You’ve heard this: work on the business, not in the business. It also enhances value if you have a good middle management layer, so you could go away on a two- or three-week vacation and the business would do just fine.

You hope to develop an ownership mentality with your employees. We frequently see golden handcuff arrangements. Sometimes owners have proactively given employees a minority share of the business so they benefit at the time of sale. Again, that gives them a vested interest in getting the most value in a smooth transaction.

Many times I’ve also seen owners leave dollars in escrow for employees and say, “I need your help with this transition of ownership. I value your contribution over the years. If you’re still here in six months to a year, I’ve left this amount of money in escrow for you. If you help me with the transition and are still here, it gets paid out to you. If you’re not, it comes back to me as the owner. It’s your judgment whether you want to do it.”

My experience has been that the fear factor is highest on the date of ownership transfer. Three months later, most people don’t want change. They’re happy where they are, the anxiety diminishes, and they say, “Actually, this new owner is better, because they’re listening to me. I wasn’t necessarily getting my ideas heard by the old owner.”

Pat: We call those stay bonuses.

How Leaks Happen

Pat: Greg, how often do confidentiality leaks actually happen, and where do they usually originate?

Greg: Leaks do happen. It’s a fire drill we do not like at our firm when it happens.

I think one of the advantages of having a third-party M&A firm is that they are the storefront for the transaction. When the business is advertised for sale, it’s not necessarily known where it is. For example, Walter is in North Carolina. I sold a business in the Triangle in North Carolina, and with a firm based in the Northwest, you would never have guessed that’s where this niche client was located.

So the firm serves as the storefront. It obtains non-disclosure agreements from potential buyers, and those need to be enforceable if someone has loose lips.

One piece I think is underperformed by owners and by our industry is vetting the buyer on their intent and on their financial capability. Are they just dreaming about this acquisition, or do they have the chips to sit at the table and play the game? We get great inquiries from buyers with relevant experience who could probably run the business fine but don’t have the financial capability to buy it. That party should never learn the business is for sale. You need a really strong upfront process.

And Pat, you’re correct. The more parties brought into the loop, the more people learn that a business is for sale. I’m based in Seattle, and we sell aerospace companies. There’s really one company in America you want to sell aerospace components to: Boeing. Boeing may use a transition of ownership as an opportunity to shop a component parts contract, and that can get out into the public domain.

Another risk is the landlord once they learn the business is for sale. We’re dealing with REIT-owned and private equity-owned real estate, and they don’t seem to care much about the impact on the business, because the default is that they keep their present tenant, which they’re fine with. They can be problematic in keeping information confidential. They may pass the information to an administrative person, and inevitably that person’s brother-in-law works at the company, and at a barbecue they say, “Hey, did you know your company’s up for sale?” That’s how things get into the public domain with no malicious intent.

The Risk of Unsolicited Offers

Walter: Greg, based on what you’re saying, it sounds like it could be really risky to pursue an unsolicited offer. You haven’t really thought about selling, but you’d like to know what somebody thinks the company is worth. Now you run the risk of it leaking and everyone thinking you’re trying to sell. So you have to be really careful with those.

Greg: You do. Many times unsolicited offers come from a competitor in your space who’s looking to grow by acquisition. This is another of our vetting pieces. Many of them are trying to gain field knowledge. They may not intend to buy, but they want to learn your secret sauce.

They’ll sign a non-disclosure agreement, but that only goes so far, because it’s the same industry. You know the same customers and the same vendors. All they can say is that you’re for sale, but they can use what they learn. Say they’re looking at customer concentration, which every buyer should look at. They notice that your biggest customer is one they also do business with, but they’re only getting a small percentage of that customer’s orders. Now they wine and dine that customer: “Can I take your team on a golf holiday?” And things cascade.

You have to play three-dimensional chess when selling a business, because it’s not a linear situation.

Leaks During Due Diligence

Pat: Greg, what about leaks during due diligence? Those can happen too.

Greg: Due diligence is encouraged. You want a buyer purchasing in an environment of full disclosure, because that mitigates liability for the seller. If the buyer knows a fact before purchasing the business, like customer concentration, and then loses that customer, they can’t hold you responsible, because they made the acquisition knowing that customer was 30% of sales.

But due diligence can be very invasive. The buyer may want to interview key employees, key customers, and key vendors as part of the process. You can be a little strategic about it, but at some point the cat is going to get out of the bag. You want to be far enough down the trail that the buyer is committed.

If you’ve emphasized an environment of full disclosure, due diligence should be a verification process, not a discovery process. I’ll stay with customer concentration because it’s an easy example. Say you were upfront: “I manufacture aerospace components, and Boeing is my biggest customer. Losing Boeing would be very detrimental to the business. It may not kill it.” Then when the buyer looks and sees that Boeing was the top customer and generated a certain amount of revenue in each of the last three years, that shouldn’t be a deal-killing element.

Compare that to only sharing topline revenue: “We did $8 million a year. We’re in the aerospace industry, and we sell into the space segment, which is growing and thriving.” That may all be positive, but the buyer didn’t know about the customer concentration.

Pat: That makes sense.

The Time Commitment for Sellers

Walter: Greg, I’ll share our experience. Business owners seem to underestimate the amount of time, energy, and emotion that goes into this process. They think their business is just going to keep running while they’re in the middle of it. That can be really difficult, right?

Greg: It’s very difficult. Our sellers are generally taking on another part-time to full-time job facilitating the sale of the business, and they still have to run the company. Right now, we’re dealing with people laid off in the tech industry who are buying companies. They have all the time in the world to work on the acquisition, and they send a stream of requests, while our sellers don’t have the same availability.

Planning the Communication Strategy Early

Pat: Greg, given all the ways leaks can happen, is the general rule to start the communication strategy well in advance of a potential LOI and due diligence? It seems like it should be, because of the potential for leaks, the uncertainty that results, and the value of the business going in the wrong direction.

Greg: I would say yes, coupled with having good legal counsel and making sure you have non-disclosure and non-solicitation agreements in place during the process, to set expectations with the buyer and other appropriate parties.

Three Action Items for Selling in Stealth Mode

Pat: This has been terrific, very helpful information. We like to give listeners one, two, or three action items to consider on the topic we’re discussing. Can you share one to three practical considerations for listeners today?

Greg: Sure. First of all, let’s say we’re dealing with a retirement sale, and I’ll talk about it in that context. It’s beneficial to learn what your business is worth before you put a strategy in place. Are there enough proceeds coming from the sale for retirement, legacy, and charity? A business is an annuity. Let’s say you’re earning $1 million a year. You may get a five multiple, which is a $5 million exit. But if you need $7 million, it’s simple math: run it two more years and then sell. If nothing else changes, you’ve put $7 million in your pocket rather than harvesting immature fruit. So that would be my first piece of advice. My second…

Pat: Greg, let me interject. Let’s give three action steps on how to sell in stealth mode: how to market a business without alerting customers, vendors, or employees.

Greg: Sure. Staying on that specific topic, first, have good legal documentation, which I talked about: non-disclosure and non-solicitation agreements. Second, vet your buyers, as I touched on before. Make sure they have the chips and the intent to complete the transaction. There’s no reason to start a game you can’t win. Third, be strategic about sharing information with parties at the proper time.

Pat: On number one, non-disclosure and non-solicitation, are you referring to restrictive covenant documents with employees, and with potential buyers?

Greg: More with the potential buyers, but having good agreements in place with employees is important too. Non-competes with employees are also important, though different states have different levels of enforceability.

Pat: On your number three suggestion, having a strategy, would you agree that the strategy for one seller may look quite different from the strategy for another?

Greg: 100%. If you’re selling to the next generation of ownership in a family business, and that family member has worked at the company for 20 years, everyone knows them, and everyone is planning for that succession, your disclosure issues are greatly mitigated compared to an external sale. It’s night and day.

Closing

Pat: Very good. Walter, any last questions before we wrap up?

Walter: No. Greg, I really appreciate you coming on. This has been very helpful. I’m sure our listeners have learned a lot, and Pat and I have as well. Thank you.

Pat: Greg, is there anything you want to promote today, and how can listeners get in touch with you?

Greg: Certainly. The best way to reach me is through our website, ibainc.com. My mother was a schoolteacher, and one reason I’m doing this podcast is that I believe in education. There are two parts of our website I would point you to. First, our blog publishes content two to three times a week and has had 200 authors in its history, covering all aspects of buying and selling a business and entrepreneurship. You can gain a lot of education there. Second, our video page has corporate videos along with podcasts and interviews we’ve been on. I believe the best decisions are made from a foundation of knowledge. People can also always call me at my corporate headquarters at 425-454-3052.

Pat: Fantastic. Thanks again, Greg. And to our listeners, thank you for listening. Until next time on the Exit Readiness Podcast, this is Pat Ennis and Walter Dial signing off.