Friday, May 27, 2016

How Middle Market Business Acquisitions Are Financed

Valuable article by John Carvalho on Divestopedia.
I have found that many owners of lower mid-market businesses lack adequate knowledge on how a business sale is actually financed by a potential third-party acquirer. This is understandable given that most business owners will only go through the process of selling a business once. Unfortunately, this lack of knowledge is a contributing reason many deals are not consummated. Sellers are not the only ones to blame, though. Many buyers, and even their advisors, don't realize what it takes to finance the purchase of a business in the lower middle market. Buyers make unrealistic offers and when they approach a financing institution, the deal is rejected. Here we'll take a look at the specifics of financing in middle market business acquisitions.

Lower Mid-Market Deals 101

The lower middle market accounts for more than an estimated 90 percent of the total number of all middle market companies in most global economies, so the lack of knowledge on deal structures is a significant succession planning issue.

Businesses in the lower mid-market, especially those with enterprise values below $20 million, are often stuck in no man's land. They are too small to be an impactful acquisition target for sizable strategic buyers or private equity groups, but too large for an individual buyer to finance. Typically, a competitor of relative size, high-net-worth individuals or investor groups are the most likely potential buyers. For these buyers, capital is not endless and they want to stretch their own equity investment as much as they can. 
When I assist clients in the acquisition of a business, I start by assessing an appropriate valuation, while at the same time determining a financing structure that I believe is achievable. All financing structures will consider some level of the following:
The appropriate amount of each source of capital is based on the specific circumstances of the deal.

Bank Financing

The level of bank financing that can be obtained on the purchase/sale of a business is based on two things:
Let's take, for example, the purchase of a business with a negotiated purchase price of $10 million. If this company has $8 million in assets, an acquirer will be able to obtain more bank financing than if the business had $5 million in assets. Similarly, if this business has $4 million in EBITDA, the purchaser will be able to get more financing than if there was only $2 million in EBITDA. This is a pretty obvious and straightforward concept.

At a very high level, banks will require the acquired company to maintain a number of specified covenant ratios. Covenants that I have commonly encountered are debt to equity of 2.5:1 and a debt servicing coverage of 1.25:1. A financial model that forecasts profitability, asset levels and free cash flows will assist in determining the right level of bank financing that can be obtained. The allowable level of bank financing in a deal is a very mathematical calculation, but it is based on very subjective future projections. Having clear and defensible assumptions within these projections will go a long way toward obtaining the necessary level of financing from a bank. 

Vendor Financing 

The right level of vendor financing is not as easy to quantify as bank financing. From my experience, vendor financing on lower middle market deals range from 0% to 30% of the purchase price. This level moves up or down depending on a number transactional risk factors including, but not limited to:
The appropriateness of the amount is based on qualitative characteristics and, of course, is negotiated between the vendor and purchaser. Banking institutions also like to see a certain level of vendor financing in a deal because it ties the selling owner to the business and ensures (to some extent) that they are committed to a successful transition.

Vendor financing is one of the most contentious issues in closing the sale of a lower mid-market business. Vendors raise concern over the security (or lack thereof) available for aseller's note because bank financing will always take priority. The banks will also most likely ask for assignment and postponement, which will place restrictions on the repayment of the seller's note if the company is in breach of its covenants. 
No doubt there is risk for the seller around vendor financing, but buyers require a certain amount to compensate for the transitional risk items noted above. If a vendor is adamant about reducing the level of the vendor financing, they will need to provide evidence on how the transitional risks can be mitigated.


The appropriate equity level is the easiest amount to figure out because it is just the remaining required capital to close the deal. Unfortunately, you must first nail down both the bank and vendor financing, which is sometimes difficult to do.

A bank will always require the purchaser to have some skin in the game. Much like vendor financing, banks want to ensure that the buyer is committed to making the deal work. From my experience, the lowest level of equity from a third party purchaser that a bank will allow is 15%. This might be lower in the case of a management buyout where the bank is already comfortable with the expertise and commitment levels of the existing management team
Buyers will usually stretch to use the least amount of their capital in order to increase their return on equity. Sophisticated buyers are looking to generate equity returns of 25% to 35%. No buyer (at least in my experience) will use all of their own cash to finance a deal.
Most business owners don't understand how a business for sale is financed by a third-party acquirer. Unfortunately, this lack of knowledge can be the fundamental misunderstanding that causes such deals to fall through. If your mid-market business is on the auction block, take some time to learn about how potential purchasers will pay for it. It can make all the difference in getting the deal you want.

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

Friday, May 20, 2016

Positioning a Business for a Merger or Acquisition (Part 1)

A very helpful article purblished by Jim Grebey on Divestopedia

Takeaway: Be sure to prepare your business and yourself before you go to market.

Selling a business, in whole or in part, requires considerable strategic planning and preparation. Whether you are the CEO of a corporation looking for a new financial partner for a merger or acquisition, or the sole owner of a small business you’ve worked years to build and hope to find someone to carry on your life's work, successfully closing a deal and putting together an optimal sale will depend on the steps you take to prepare for this unique event in the life of the business.

Validate Your Value Proposition

An M&A event is unique because it is outside the day-to-day operation of the business and will require additional effort and, potentially, the addition of dedicated resources to be performed effectively. You will need to plan for this additional effort. Whether you are looking for someone to acquire the entire business or just trying to bring on a financial partner that will leave you in charge of operations, you need to position the business to fully demonstrate its value proposition.
Your business should be positioned well ahead of the anticipated deal closing date. Ideally, planning will start at least a year ahead of your intended closing (and two years is not unreasonable) to capture and optimize your return. Of course, you may not be able to delay the closing for that long for many reasons, which will then constrain the activities you are able to take to prepare. The steps you take to position your business, and the extent to which you are constrained from taking those steps, will affect the outcome of the deal.
There is a school of thought that you should always operate a business as if it’s for sale. I fully support that approach because it means paying constant attention to the optimization of the business' operating efficiency and paying close attention to its position in the market. This could potentially help limit your positioning activities. In practice, it may not be possible to do because there may be differences in the long-term versus short-term strategic approach you use when planning an exit. The argument is that continuing to emphasize a long-term strategy may enhance the value of the business, but are you ready to make the same capital commitments to a business when you’re looking for a near term exit as one you intend to operate long term? You will very likely be trading near-term financial performance against long-term capital improvements. Unless there is a quantifiable value proposition improvement, it may not make sense to invest in long-term improvements. Strategic planning that includes the detailed development and maintenance of a roadmap with key decision points for the business, including both near-term and long-term goals, is an important tool in making these decisions.

Set Reasonable Expectations

There are many reasons for seeking an M&A event, but some can best be described as "getting out from under." If you’re holding a fire sale and in a rush to exit, you probably won't achieve the same level of return as a business poised to move to its next stage of growth. It’s important that you have a clear understanding of your goals and reasonable expectations of the businesses potential. More importantly, you have to be prepared to take the necessary steps and provide the needed resources to accomplish your goals. If you are holding a fire sale, though, don’t be discouraged. Keep in mind that there are investors who look for fire sales.
Closing a good deal with the right investor takes planning and forethought. You may be an executive who regularly closes deals and moves from one business to another, or this may be the one time in life you make a deal to sell a business you’ve built from the ground up. You’re preparing to enter a high stakes game that you may just be beginning to learn the rules to... and there are people who play the game all the time.
Given the stakes, don’t be surprised if you find there are people who make up their own rules. Selling a business, whether you sell businesses frequently or this is a once-in-a-lifetime event, and whether you are looking for a strategic buyer or a financial investor, always includes an element of risk. This is a case of "let the seller beware." Given the stakes, it makes sense to seek professional help.

This is Not Like Selling Your Home

Some people mistakenly believe positioning a business is like staging a house. Staging a vacant house, by minimally furnishing it, is a marketing technique that allows prospective real estate buyers to envision themselves living in the home. Since your business is operating and not "vacant," a staging approach won’t work. An investor wants to see products moving off the shelves and services being provided to understand how the business operates and you’ll want the investor to see the business in operation to validate its value proposition.
For other people, positioning a business is about hiding the truth or somehow misleading potential investors about the shortcomings of the business. This is the "let the buyer beware" scenario. Hiding or falsifying information about the business is unethical and a fool's game that will be discovered in an effective due diligence and could end in litigation. Neither staging nor intentionally misleading is a good reason to position a business. Even problem businesses can be sold honestly to an investor looking for an opportunity to restore the business.
Even when you find yourself positioning a business for an asset sale, you will have work to do. The nature of business is that things can and do go wrong. Keeping a business at its peak operating efficiency is difficult. Markets change, major clients leave for reasons outside the business' control, and even nature disrupts the business' operations. Smart investors know this and understand that all businesses have warts somewhere. Investors will try to find the warts during their due diligence to help negotiate a better price. Be prepared to take the high road in negotiations by explaining, “We tried something. It didn’t work and we moved on.” Your goal is to be able to negotiate from a position of strength. You can’t do this if you ignored an issue or tried to hide it. You should have already factored any issues in your valuation. “Yes, we introduced a loss leader product to see if we could sell into that market, but withdrew when it became clear our price wasn’t supported.” “It wasn’t part of our normal operations.” “We included the expense of our experiment as an adjustment when we calculate the EBITDA for the business.”

It's More Like Selling Your Car

Actually, positioning a business is more like selling a car than selling a house. It’s hard to keep the car clean, waxed and polished when you're driving around town, but when you know a potential buyer is coming by to see it, you will want to wash it and vacuum the floor mats. If you’ve been performing regular maintenance on the car you won’t need to take the time to change the oil or do any of the other things that should be done as part of the normal maintenance.
Routine maintenance should be done on a periodic schedule... and you should have those records to show a buyer. A car buyer may look at the dipstick to see that the car has clean oil, but showing the receipts for the regularly scheduled maintenance you've performed adds value. Showing the records for the normal operation of your business is also a primary way to demonstrate value. You want to demonstrate that the business has been maintained. If the car’s oil is dirty or the level is low, the buyer is likely to try to use this to negotiate a lower price. The same is true for a business. If your business uses specialized equipment, showing maintenance records for that equipment or a regular upgrade of your software says a lot about the value of your business.
If the business is operating well but starting to show its age, you may want to improve its value by updating the software to the latest version or installing the latest machine tools. To continue the car analogy, you might improve the curb appeal of the car by adding a new set of tires to get more value.
Effective positioning means you are prepared to make the tradeoff between the expenses of an upgrade against your sale price and keep a potential investor from negotiating the price down by saying it will cost them to do the upgrades. Positioning needs to be performed with your anticipated negotiating strategy in mind well before you get to the deal table.

Prepare to be Prepared

It takes committed resources to correctly position a business. Collecting your records in preparation for due diligence, recasting your financials to identify valid financial adjustments, identifying potential strategic partners, reviewing the legal structure and ownership of the business, writing a business plan that will serve as a marketing brochure for the business and on, and on... If your business is going to operate at its most efficient, your staff will be busy and may not be available for these additional duties, and you will not want to expose yourexit strategy to your staff. You need to consider bringing on a team that is committed to the success of the sale.
Read more in part two of this series where we explore some of the specific steps you will need to perform in order to effectively position your business and improve its value proposition.

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, May 09, 2016

Deal Momentum: A Key Factor When Selling Your Company

Great Article on Divestorpedia by Rose Stabler.

When you're selling your business, the worst enemy is time. Don't be a casualty; follow these 14 tried and true ways to push deal momentum forward to a successful close.

When selling a business, time is not your friend. Time is the enemy of all deals. In fact, "Time kills all deals" is an expression that can be associated with a number of different industries, but is especially relevant to business acquisitions.

So, the key to a successful deal is to prepare well, come out strong, and maintain momentum throughout the business sales process. The deal clock is set in motion as soon as your company hits the business-for-sale market, not later in the process when a buyer presents the first offer.

So, to generate deal momentum, a business owner should be ready for the trip to the marketplace before the train leaves the station. This means organize your documentation and vet potential roadblocks that can derail or delay reaching the done-deal destination.

Don’t let time work against you. Ready up with these 14 karats of knowledge so when the sale train does leave the station, it will have the momentum necessary to reach a timely closing:

1. Know when it is a good time to sell YOUR business.

Usually the best time to sell is when sales and profits have been increasing each year and signs indicate the trend will continue. Current market conditions also play a role in prices paid for good businesses. Since "today’s market offers the best environment for small business sales that we’ve seen in years," selling a little early in order to ride the rails of a good market may be a better risk than waiting for the next train that may never come. Lance Tullius, Managing Partner of Tullius Partners, spells out the all-too-familiar scenario of waiting too long in his article, "Sell Too Early."

2. Know why you want to sell.

A committed resolve to sell is essential. One of the first questions buyers ask is, "Why is the owner selling?" They ask this question to measure, in their minds, the probability that there may be skeletons in the closet.

3. Know the company’s best features and its blemishes.

Yes, highlighting the awesomeness of your business should take center stage. But no company is perfect. Be ready to disclose the warts too. Buyers do not like surprises, nor do business brokers or other members of the professional team involved in the sale process. Problems uncovered late impugn your integrity and threaten the price--and the deal. The more issues brought to the table and worked out in advance, the better chance of a smooth closing.

4. Know what you will do after your business is sold.

If you don't have a plan in mind, you might find yourself getting cold feet or feeling a little off balance when that first offer comes along. Be sure you won't balk when momentum starts picking up.

5. Know the value of your business.

Get a business valuation by a reputable firm to understand what to expect in the current marketplace. This is an initial step in determining if the sale would meet your objectives.

6. Know that your asking price is based on reality....

…a reality that buyers and their lenders can believe in. The buyer will look at return on investment and their lenders will require that the deal make sense in terms of debt repayment. Over-priced businesses do not get sold.

7. Know that you are current on all taxes.

This includes sales taxes, unemployment taxes, payroll taxes, state income taxes and federal income taxes. Delinquencies in taxes of any kind can stop a deal in its tracks.

8. Know that operational details are not just in your head.

Buyers want organized records, files, contracts, policies, employee records, training manuals, how-to manuals, business processes, systems and controls that are reliable and organized to keep things going after you're gone.

9. Know that your business can operate without you.

The value of a business is built upon the sustainability of operations without its leader. Key employees and staff who run daily operations are the key to its future. Most businesses are unsellable if the owner "IS" the business.

10. Know who you are, who you are like, and who your competition is.

Buyers will survey your company’s landscape to scope its position in the market.

11. Know your numbers.

Be able to provide accurate financial statements and tax returns and produce key financial reports and performance metrics.

12. Know that your team is ready.

Be sure that your trusted advisors will be able to assist you in the transaction. A meeting with your attorney and accountant, for instance, will play a role in gathering all necessary documents for your business broker before going to market. Your team of advisors needs time for preparation in order to effectively support you in the transaction.

13. Know that you can provide the roadmap to even greener pastures.

Buyers are interested in the future. A growth plan and marketing plan will help a prospective buyer understand where opportunities exist and what could be done to take the business to the next level.

14. Know what's most important to you in the grand bargain.

Be prepared for the pull and tug. Don't get bogged down in minor details. Stay focused on your key issues. Understand your absolutes vs. wishes. Such preparedness will go a long way while negotiating the different scenarios on price and terms. How the deal is structured to meet the needs of buyer and seller can make or break a transaction.

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, April 25, 2016

How to Stop Your M&A Deal from Blowing up Late in the Process

New Article just published on Divestopedia

I believe one of the biggest reasons for M&A deals blowing up is a poorly worded letter of intent (LOI). The standard process to solicit offers from buyers in the form of an LOI includes terms and conditions that are negotiated until one winner emerges and the seller and buyer dual sign the LOI, which is non-binding. This basically gives either party an "out" should something be discovered in the due diligence process that is not to their liking or is not as presented in the initial materials. Buyers Have the Advantage of Experience

When I say poorly worded, what I really should have said is that it is worded much to the advantage of the buyer and gives them a lot of wiggle room in how the letter is interpreted and translated into the definitive purchase agreement. The best comparison I can make is a lease agreement for an apartment. It is so one-sided in favor of the landlord and protects him/her from every conceivable problem with the renter.

Business buyers are usually very experienced and the sellers are generally first-time sellers. The buyers have probably learned some important and costly lessons from past deals and vow never to let that happen again. This is often reflected in their LOI. They also count on several dynamics from the process that are in their favor. Their deal team is experienced and is at the ready to claim that "this is a standard deal practice" or "this is the calculation according to GAAP accounting rules." They count on the seller suffering from deal fatigue after the numerous conference calls, corporate visits and the arduous production of due diligence information.

When the LOI is then translated into the definitive purchase agreement by the buyer's team, any term that is open for interpretation will be interpreted in favor of the buyer and, conversely, to the detriment of the seller. The seller can try to fight each point, and usually there are several attacks on the original value detailed in the dual-signed LOI that took the seller off the market for 45-60 days. The buyer and his/her team of experts will fight each deal term from the dispassionate standpoint on one evaluating several deals simultaneously. The seller, on the other hand, is fully emotionally committed to the result of his/her life's work. He/she is at a decided negotiating disadvantage.

The unfortunate result of this process is that the seller usually caves on most items and sacrifices a significant portion of the value that he/she thought he/she would realize from the sale. More often than not, however, the seller interprets this activity by the buyer as acting in bad faith and simply blows up the deal, only to return to the market as damaged goods. The implied message when we reconnect with previous interested buyers after going into due diligence is that the buyers found some dirty laundry in the process. These previously interested buyers may jump back in, but they generally jump back in at a transaction value lower than what they were originally willing to pay. How to Even the Playing Field

How do we stop this unfortunate buyer advantage and subsequent bad behavior? The first and most important thing we can do is to convey the message that there are several interested and qualified buyers that are very close in the process. If we are doing our job properly, we will be conveying an accurate version of the reality of the deal. The message is that we have many good options, and if you try to behave badly, we will simply cut you off and reach out to our next best choices. The second thing we can do is to negotiate the wording in the LOI to be very precise and not allow room for interpretation that can attack the value and terms we originally intended.

We will show a couple examples of LOI deal points as written by the buyer (with lots of room for interpretation) and we will counter those with examples of precise language that protects the seller.

Sample Earnout Clause Within an LOI

Buyer's Proposal

The amount will be paid using the following formula:

-75% of the value will be paid at closing

-The remaining 25% will be held as retention by the BUYERs to be paid in two equal installments at the 12 month and 24 month anniversaries, based on the following formula and with the goal of retaining at least 95% of the TTM revenue. In case at the 12 and 24 month anniversaries the TTM revenue falls below 95%, the retention amount will be adjusted based on the percentage retained. For example, if 90% of the TTM revenue is retained at 12 months, the retention value will be adjusted to 90% of the original value. In case the revenue retention falls at or below 80%, the retention value will be adjusted to $0.

Seller's Counter Proposal

The amount will be paid using the following formula:

-75% of the value will be paid at closing

-The remaining 25% will be held as earnout by the BUYERs to be paid in four equal installments at the 6, 12, 18 and 24 months anniversaries, based on the following formula:

We will set a 5% per year revenue growth target for two years as a way for SELLERS to receive 100% of their earnout (categorized as "additional transaction value" for contract and tax purposes).

So, for example, the TTM revenues for the period above for purposes of this example are $2,355,000. For a 5% growth rate in year one, the resulting target is $2,415,000 for year one and $2,535,750 in year two. The combined revenue target for the two years post-acquisition is $4,950,750.

Based on a purchase price of $2,355,430, the 25% earnout would be valued at par at $588,857. We can simply back into an earnout payout rate by dividing the par value target of $588,857 by the total targeted revenues of $4.95 million.

The result is a payout rate of 11.89% of the first two years' revenue. If SELLER falls short of the target, they fall short in the payout; if they exceed the amount, they earn a payout premium.

Below are two examples of performance:

Example 1 is the combined two years' revenues total $4.50 million - the resulting two-year payout would be $535,244.

Example 2 is the combined two years' revenues total $5.50 million - the resulting two-year payout would be $654,187.

Comparison and Comments

The buyer's language contained a severe penalty if revenues dropped below 80% of prior levels, the earnout payment goes to $0. Also, they have only a penalty for falling short and no corresponding reward for exceeding expectations. The seller's counter proposal is very specific, formula-driven and uses examples. It will be very hard to misinterpret this language. The seller's language accounts for the punishment of a shortfall with the upside reward of exceeding growth projections. The principle of both proposals is the same - to protect and grow revenue, but the results for the seller are far superior with the counter proposal language.

Sample Working Capital Clause Within an LOI

Buyer's Proposal

This proposal assumes a debt free cash free (DFCF) balance sheet and a normalized level of working capital at closing.

Seller's Counter Proposal

At or around closing, the respective accounting teams will do an analysis of accounts payable and accounts receivable. The seller will retain all receivables in excess of payables plus all cash on cash equivalents. The balance sheet will be assumed by the buyer with a $0 net working capital balance.

Get the Specifics

The buyer's language is vague and a problem waiting to happen. So, for example, if the buyer's experts decide that a "normalized level of working capital" at closing is a surplus of $400,000, the value of the transaction to the seller dropped by $400,000 compared to the seller's counter proposal language. The objective in seller negotiations is to truly understand the value of the various offers before countersigning the LOI. For example, an offer for cash at closing of $4,000,000, with the seller retaining all excess net working capital when the normal level is $800,000, is superior to an offer for $4.4 million with working capital levels retained at normal levels.

These are two very important deal terms and they can move the effective transaction value by large amounts if they are allowed to be loosely worded in the letter of intent and then interpreted to the buyer's advantage in translation to the definitive purchase agreement. Why not just cut off that option with very precise and specific language in the LOI with formulas and examples prior to execution by the seller? The chances of the deal going through to closing will rise dramatically with this relatively easy-to-execute negotiation element.

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, April 12, 2016

How to Avoid Lowball Offers When Selling Your Company

My article was just published on Divestorpedia.

Takeaway: The only way to encourage buyers to make fair offers is to conduct a marketing campaign to industry buyers that have strategic reasons for making acquisitions.

We are in the middle of a merger and acquisition engagement representing a human resources consulting company. We had contacted several industry players and had received some good initial interest. Several buyers dropped out because their entire management team was comprised of family members. We asked our client to take their company off the market and to bring in at least one non-family executive that had the authority and the ability to run the company. They successfully implemented this change and asked us to take them back out to market.

Because their business is counter cyclical and actually grew during the recent economic downturn, they posted some pretty impressive growth and profit numbers. It was difficult to determine how much of the improvement was due to the addition of the new senior manager.

Avoid Buyers Who Use 'Fuzzy Math'

As we re-launched our marketing efforts, we identified several interested buyers. One buyer was particularly interested and, after signing the confidentiality agreement and reviewing the memorandum, contacted us almost daily with additional detailed information requests. Before long he started to grill us about selling price expectations. As we usually do, we deflected his requests and asked him to put together his letter of intent based on the value of the business to his company.

He started giving us a lecture about valuing service companies whose assets (meaning people) walked out the door every evening. He pointed out that their revenues were based on new sales each year and not “contractually recurring revenue.” We had our client put together for us a chart that showed the “historically recurring revenue” generated from their top 20 clients over the past five years. This was our way to demonstrate some consistency and predictability of revenues.

As we conversed further, my radar started buzzing loudly. This guy was getting ready to provide a lowball offer and was trying to sell me on all the reasons why I should go back to our client and pitch his offer. I politely listened to his well-practiced approach for a little while longer. Then he came up with the statement that I just could not let go. He said that last year’s revenues were an unusual upward spike and “I am just going to use the year prior to last year's revenues as my basis for my offer." Well, I just could not let that one go. I asked him how he would have made an offer if last year was unusually bad, but the prior five years were strong. He would not respond, but of course, the answer was that he would have made his offer based on the new trend.

Avoid Buyers Who View You as Just a Number

There are thousands of business buyers out there that are just like this guy. There is a famous residential real estate investor that has written a book and gives classes to help individuals become real estate moguls. I could sum up his book and his class in one sentence: Find 100 people with their homes for sale, then approach them aggressively and make a lowball offer and one of them will take it.

When I reviewed where our buyer had originated, I traced it back to a posting we had made on our business broker’s association website. As I think about it, these "Business-for-Sale" websites actually give these buyers a powerful tool to actively and aggressively contact their 100 potential sellers. As I thought about this, sure enough, I have seen this behavior repeated multiple times and the source was always a "Business-for-Sale" website.

So, we are always preaching to our prospective clients to get multiple buyers involved in the process. If they post their business on one of the "Business-for-Sale" websites, they may get multiple buyers interested, but they are those buyers that are contacting 100 sellers very efficiently through the power of the Internet in order to make their lowball offers.

Avoid Buyers with Lowball Offers By Making a Plan

But I digress. Let’s get back to our client. The good news is that we had six other industry buyers that we had contacted and they were looking for acquisitions that were based on acquiring new customers or adding another product offering, or leveraging their sales force or install base. In other words, their buyer motivation was not to buy a company with a lowball offer.

The only way we can encourage buyers to make fair offers is to conduct an outbound marketing campaign to industry buyers that have strategic reasons for making acquisitions. If we can get several involved, then the buyer that comes in and says that he/she is going to base his/her offer on the year prior to last year's performance, is easily eliminated from consideration. If a business seller is only going to attract these inbound, bargain-seeker buyers from websites or otherwise, he/she will only be getting lowball offers and wasting a lot of time.

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, 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