Wednesday, October 28, 2015

Business Buyers are Savvy Shoppers

The business sale process is a complex battle for leverage. A seller wants to invite many qualified buyers to the table and position his company to produce strategic value. The experienced professional business buyer has his own arsenal of tools to move the balance of power in his favor. This article examines how Private Equity Groups approach the process and try to stack the odds in their favor.
We preach to our business seller clients the benefits of testing the markets and inviting many qualified buyers to participate in the process. The ultimate goal is to get two or more buyers that recognize the tremendous synergies that the combined companies could realize and produce offers that are not based on a financial multiple, but on a strategic value premium. A financial multiple would be a purchase value something like 4 X EBITDA (basically cash flow) or 70% of annual revenue.
What would produce strategic value? The good news is that this can be created in a number of different ways.  The evil "Wall Street stereotype" is to eliminate duplicate functions and save a tremendous amount in payroll expenses. I am not a big fan of this as the reason for doing an M&A deal. Somehow tearing something apart does not represent any particular management imagination or skill. Identifying ways to build value by creating the sum of the parts that far exceeds the inputs is real visionary management.
This strategic value can be created by acquiring a complementary product line that can be added to a strong sales and distribution network.  Acquisition targets can provide superior systems, business models, product technology, and  management talent that can be leveraged by the new combined company to produce revenues and profits that far exceed the two separate companies.
This sounds easy on paper and makes a lot of sense, but the truth is that most acquisitions fall short of expectations because, integrating all the systems, personnel, culture, locations, customers, etc. is complex. This makes buyers cautious. When buyers get cautious, they revert back to the conservative financial multiple which basically provides a safety net to their investment if the post acquisition synergies are not realized.
We subscribe to a private equity group database which helps us identify likely buyers of our sellers based on searching their investing criteria and identifying their portfolio companies. A surprising discovery I made is that in this particular universe of the largest 3500 private equity groups, they owned a combined 46,000 companies. If you wanted to draw any conclusions about business buyer behavior, this would be your group of target subjects.
First conclusion is these guys want to win. Sure it's money, but it is the game and the competition and thrill of the conquest that also drives these serial business acquirers. They think they are the smartest guys in the room (hey check their educational, and job history background) and on paper  they may just be. But you only need to have one failed $20 million acquisition to instill some real rigor and financial conservatism into your process.  They want to stack the deck to put as much as they can in their favor to make these investments winners.
The first thing they do is look for Warren Buffet type businesses. You know the ones that have a durable competitive advantage, positive cash flow, steady growth rate, loyal customers…… They want to draft Payton Manning coming out of Tennessee - Great start. 

The next tenant of their success formula is to take advantage of the large company valuation premium. This is how it works. Their first acquisition into a market space is generally a bigger company, say $25 million in revenue. Let's say that this valve and pump company sells for a 6.1 X EBITDA multiple. They then attempt to make a series of tuck-in acquisitions of a $5 million valve company here and a $4 million pump company there. These smaller companies command a smaller valuation multiple than the large company, say 4 X EBITDA. The day the acquisition is completed, the PEG has already won because the acquired company is now valued at the higher EBITDA multiple of its new parent. They make a series of these investments, grow the company organically as well for 7 years and then sell their $150 million in revenue company to a strategic buyer at an EBITDA multiple of 7.8 X.
These sophisticated buyers are very disciplined in their acquisition process and very seldom stray from the strict EBITDA multiple offer.  In order to stick to that discipline, they have to look at a lot of deals. We normally ask our buyers that have signed NDA's and looked at our client, and then withdrew, why they dropped out. We get a lot of different answers, but the top answer is that they were in another deal and would not be able to process both at the same time. Most of these firms invite 50 - 100 potential acquisitions into the top of the funnel for each one that they complete.
So, what they are doing is creating the counterbalance of the leverage we are trying to create by getting lots of potential buyers involved.  They have multiple options, so if the price gets too high, they go for easier prey. If the sellers are difficult, they move on. If the financial reporting is shaky and unclear they find a company where it is transparent.
Please don't let me give you the impression that this process is totally by the numbers. There are great companies that will command a premium, but just like buying a luxury automobile, they are still shopping.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Monday, July 28, 2014

The Unsolicited Offer to Buy Your Company - It Is Not a Fair Fight

If you are approached with an unsolicited offer to buy your business, be careful. Often times it is a bottom feeder looking to get a bargain and your company is one of dozens that are similarly contacted. If you become intoxicated with the thoughts of future riches, you could put your company in jeopardy. This article examines how you should manage this process.

When a company approaches you and broaches the subject of acquiring your company, it is very difficult to suppress those feelings of riches beyond your wildest dreams. Your thoughts start to move from the twelve hour work days, personnel issues, keeping your clients happy, and drift toward the tropical island with the grass hut, the perfect climate, the umbrella drinks, and the abundant leisure time. Snap out of it! Put that Champaign away and get back to
We had been engaged by a client to sell her business recently and while we were in the planning meeting, the assistant walked in with a letter from a larger industry player expressing an interest in buying her company. She was feeling pretty special until we uncovered that this same letter was sent out to 50 other companies. Buyers are looking to buy at a discount if possible. The way they do that is similar to the approach that many of those get rich quick real estate programs recommend. Go out to 50 sellers and make a low-ball offer and one of them may bite. These buyers are way better informed about the value of a company than 90% of the business owners they approach.

The odds of a deal closing in this unsolicited approach are pretty slim. In the real estate example, the home owner is not hurt by one of these approaches, because they have a good idea of the value of their home. The price offer comes in immediately and they recognize it as a low ball and send the buyer packing. For the business owner, however, valuations are not that simple. This is the start of the death spiral. I don't want to sound overly dramatic, but this rarely has a happy ending. These supposed buyers will not give you a price offer. They drain your time, resources, your focus on running your business and, your company's performance. They want to buy your business as the only bidder and get a big discount. They will kick your tires, kick your tires, and kick your tires some more.

If they finally get to an offer after months of this resource drain, it is woefully short of expectations, to the surprise or chagrin of the owner. The owner became intoxicated with their vision of riches and took their eye off the ball of running their business.

How should you handle this situation so you do not have this outcome? We suggest that you do not let an outside force determine your selling timeframe. However, we recognize that everything is for sale at the right price. That is the right starting point. Get the buyer to sign a confidentiality agreement. Provide income statement, balance sheet and your yearly budget and forecast. Determine what is that number that you would accept as your purchase price and present that to the buyer. You may put it like this, " We really were not considering selling our company, but if you want us to consider going through the due diligence process, we will need an offer of $6.5 million. If you are not prepared to give us a LOI at that level, we are not going to entertain further discussions."

A second approach would be to ask for that number and if they were willing to agree, then you would agree to begin the due diligence process. If they were not, then you were going to engage your merger and acquisition advisor and they would be welcome to participate in the process with the other buyers that were brought into the process.

A major mistake business owners make in this situation is to focus their time and attention on selling the business as opposed to running the business. This occurs in large publicly traded companies with deep management teams as well as in private companies where management is largely in the hands of a single individual. Many large companies that are in the throes of being acquired are guilty of losing focus on the day-to-day operations. In case after case these businesses suffer a significant competitive downturn. If the acquisition does not materialize, their business has suffered significant erosion in value.

For a privately held business the impact is even more acute. There simply is not enough time for the owner to wear the many hats of operating his business while embarking on a full-time job of selling his business. Going through an extended process with a buyer who only wanted to buy at a bargain can damage the small company. If you are not for sale, you must control the process. Why would you go through the incredible resource drain before you knew if the offer would be acceptable? Get a qualified letter of intent on the front end or send this buyer packing.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Thursday, July 17, 2014

Before You Sell Your Business, Look at it Through the Eyes of an Experienced Buyer

Business buyers do not often reveal their hands about why they feel a business is an attractive acquisition prospect for fear of driving up the price. They do, however, reveal those features that detract from a business' value in order to try to drive down the price during negotiations. This article discusses the value drivers and value detractors in a business sale transaction.

As it turns out, buyers are astute business valuation analysts. They look for certain features when they assess the desirability of a business acquisition. Private equity groups are particularly rigorous in this process. Without exaggeration, we receive at least five contacts per week from private equity groups describing their buying criteria. The most surprising statement contained in a majority of these solicitations is the statement, "We are pretty much industry agnostic."

They may add in a couple qualifiers like we avoid information technology firms, start-ups and turn-arounds. Below is a typical description: Example Capital Group seeks to acquire established businesses that have stable, positive cash flows and EBITDA between $2mm and $7mm. We will consider investments that satisfy a majority of the following characteristics:


Revenues between $10mm and $50 mm 
EBITDA between $2mm and $7mm
Operating margins greater than 15%


Owners or senior management willing to transition out of daily operations 
Experienced second tier management team willing to remain with the company


Long term growth potential 
Large and fragmented market
Recurring revenue business model
History of profitability and cash flow
Medium to low technology

I chuckle when I get these. You and 5,000 other private equity firms are looking for the same thing. It is like saying I am looking for a college quarterback that looks like Peyton Manning. Pretty good chance that he will be successful in his transition to the pros. That is exactly what the buyer is looking for - pretty good chance that this acquisition will be successful once we buy it. Just give me a business that looks like the one above and even I would look good running it.

On the other hand, more often than not we are representing seller clients that do not look nearly this good. Getting buyer feedback on why our client is not an attractive acquisition candidate is often a painful process, but can be quite instructive. Unfortunately it is usually too late to make the needed changes during the current M&A process. Many businesses are great lifestyle businesses for the owners, but do not translate into an attractive acquisition for the potential buyer because the business model is not easily transferable and scalable.

In these businesses the value the owner can extract is greater by just holding on and running it a few more years that he can realize in an outright sale. What are these characteristics that reduce the salability of a business or diminish its value in the eyes of a potential buyer? Below are our top 5 value destroyers:

1. The business is too transactional in nature. What this means is that too much of the company's revenues are dependent on new sales as opposed to long term contracts. Contractually recurring revenue is much more valuable than what might be called historically recurring revenue.

2. Too much of the business is concentrated within the owners. Account relationships, intellectual property, supplier relationships and the business identity are all at fish when the business changes hands and the owners cash out and walk out the door.

3. Too much of the business is concentrated in too few customers. Customer concentration poses a high risk for a new owner because the loss of one or two accounts could turn the buyer's investment sour in a big hurry. The buyer fears that all accounts are vulnerable with the change in ownership.

4. Little competitive differentiation. Buyers are just not attracted to businesses with no identifiable competitive advantage. A commodity product or service is too difficult to defend and margins and profits will continually be challenged by the market.

5. The market segment is too narrow, has too little potential, or is shrinking. If your market place is so narrow that even if your company had 100% market penetration and you sales were capped at $20 million, a larger company would not get very excited about an acquisition because you could not move their needle.

A business owner that is contemplating the sale of his business could greatly benefit from this rigorous buyer feedback two of three years prior to actually beginning the business sale process. A valuable exercise to take business owners through is a simulated buyer review. During this process we help identify those areas that could detract from the business selling price or the amount of cash he receives at closing.

This process is certainly less painful than when we were negotiating a letter of intent with a buyer from Dallas and he said to our client, "Brother, your overhead expenses are 20% too high for this sales level." Another buyer in another client negotiation said, "I can't pay you a lot in cash at closing when your assets walk out the door every night. It will have to be mostly future earn out payments."

As a business owner you can both identify and fix your company's value detractors prior to your sale or you can let the new owner correct them and keep all that value himself. Viewing your business as a buyer would well in advance of your business sale and then correcting those weaknesses will result in a higher sales price and a greater percentage of your transaction value in cash at closing.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Sunday, June 29, 2014

While Selling Your Business - Steady as She Goes

When we first engage with a new client, we sit down with them and give them the talk. No, not the birds and the bees talk, but the talk about what they should and should not be doing while the sale process is going forward.

Our first bit of advice is to keep your eye on the ball. It sounds simple, but the business sale process is disruptive. The smaller the company with fewer management personnel, the more disruptive. We tell our clients to maintain their focus on running the business and rely on their mergers and acquisitions advisors to manage the business sale process. That being said, there are many demands placed on the owners for answering buyers' questions, conference calls, corporate visits, evaluating buyers and their offers, and negotiating.
If the disruptions cause the sales and profits of the business to fall, the buyer does not care that they fell because the owners were distracted. They only care about the bottom line performance of the business. The sale process generally runs for a period of eight months to over a year in many cases.

The original financials in the offering memorandum are often supplemented several times as each quarter passes. If you have received purchase offers based on one set of financials and those financials deteriorate, you can count on the offers being lowered across the board to reflect your company's new reality. If the downturn is sizable, it may interfere with the buyer's ability to secure financing, especially if the buyer is a private equity group.
Many owners want to juice their sales while the business is being sold to drive every last bit of value into their business sale price. They want to bring on that extra salesman or launch that big marketing campaign in order to spike their sales and profits and then get rewarded with a 5 X EBITDA bump in the business selling price. This is very expensive flawed logic on the part of the business owner. A new salesman, even an outstanding new salesman is a drain on the company profitability for 9 months to a year. That is the best case scenario. In the majority of cases the new salesman does not make the grade and is fired. His loss, however, hits the company's financials.
A marketing campaign is not always the sales driving engine the owner hopes it will be. But, for discussion sake, let's say that the campaign was well conceived and executed. The full impact of the campaign is usually delayed by six months to a year. If this occurs during the business sale process, the financials reflect the drop and the lowering of the buyers' offers will follow as surely as the next sunrise.
The cruel irony of this dynamic is that you are investing to make the business more valuable for you to sell, but instead are giving the buyers an opportunity to buy at a discount. Your investment then pays off a year after the new owner has taken over.
OK, I admit, I have painted the worst case scenario. So let's say that the salesman you hired was a real star or your marketing campaign caused sales and profits to spike in the near term. You, the business seller, now with the upper hand, go back to your buyers with a business selling price increase commensurate with the buyer reductions sited above.  The reaction you get from the buyers is not at all what you expected, however. Instead of raising their offers by your increase in EBITDA multiplied by your prior offer valuation metric, they refer to this increase as an anomaly or an outlier. Instead of rewarding you proportionately in the purchase price, they want to normalize this over the prior three years.
For clarification, let's look at the following example. Your 2011 EBITDA was $2,000,000, 2012 was $2,200,000 and 2013 was $2,400,000. You are selling your business starting in June of 2014 and you launch your successful marketing campaign that boosts your EBITDA to $3,200,000 in 2014. Your offer on the table was 5 X 2013 EBITDA or $12,000,000. You go to your buyer and say my new price is 5 X 2014 EBITDA or $16,000,000. The buyer (especially if they are a Private Equity Group or financial buyer) will say, wait just a minute, this was an anomaly and we need to normalize that over the past 4 years. So they add up all of the EBITDA numbers and divide by 4 to get a normalized EBITDA of $2.45 million. They raise their purchase offer from $12,000,000 to $12,250,000.
So you have taken on a large financial risk to invest in your business to increase your sales and profits. You beat the odds in achieving a short term bump and your buyers attempt to minimize the impact on their offer price.
On the other side of the ledger, some owners attempt to significantly cut costs during the business sales process.  We advise against this approach as well. If the market does not provide the selling price that the owners are satisfied with, they will simply not sell. If you have temporarily slashed your Research and Development or Training budget for the sale, those cuts could come back to hurt you, should you not sell your business near term.

The lesson here is steady as she goes while you are in the midst of your business selling process. A fall in profit is punished and an increase is not rewarded in proportion to the investment or the risk.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Tuesday, June 17, 2014

Listen to Interview by The Exceptional Entrepreneur

We presented/were interviewed in a Webinar entitled 10 Keys to a Successful Business Exit

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Wednesday, March 05, 2014

Selling Your Business - Elements of a Successful Sell Side Process

I just posted a new video on YouTube that discusses the steps involved when a merger and acquisition professional engages in selling your business. We briefly describe the elements of the business sale - from signing the engagement agreement, to the blind profile and confidentiality agreement, to building the prospect data base, contacting the potential buyers, corporate calls and visits, negotiating letters of intent and finally the closing. Enjoy

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist