Wednesday, February 20, 2019

Business Exit Strategy - Sell Now But Retire in 3 Years

Takeaway: Too many business owners view their business sale and their retirement as a simultaneous event and end up delaying the sale to the day they want to stop working. That mis-perception can be very costly. 

The Baby Boomers are retiring in large numbers and according to New Economy Week, over the next ten years Trillions of Dollars of businesses will be changing hands. The number of businesses that change hands will very closely mirror the number of baby boomers that are retiring.

Price Waterhouse reported in a Trendsetter Barometer Survey of Business Owners that 51% were planning on selling their company to another company compared with 18% anticipating passing on the business to a family member and 14% planning a sale to the company's management.
The trends point to more than a doubling in the number of businesses that will hit the market looking for a buyer by 2020. Simple economics and supply and demand would suggest that unless the number of buyers increases significantly, there will be an erosion in valuations for business sellers during this rush to the exits. Compare that to the relatively robust environment business sellers have enjoyed over the past 3 years. This period was supported by unprecedented Private Equity investments, in addition to the available cash from corporations with rising profits, and very favorable interest rates.
Given this backdrop, what is a business owner who is anticipating selling his business in 2020, to do? Move up your sale time frame, but
not necessarily your exit time frame. No, I am not talking in riddles. What I mean is that you should take your chips off the table with a sale transaction sooner rather than later. Your eventual exit could be in 2020 after working full time for the new owner for 1 year to transition customer relationships and intellectual property, followed by a limited consulting engagement for two years.

Too many business owners view their business sale and their retirement as a simultaneous event and end up delaying the sale to the day they want to stop working. That mis perception can be very costly. Too many owners wait too long and end up selling because of a negative event like a health issue, loss of a major account, a shift in the competitive landscape, or just plain burn out. As you can see, none of these major reasons for selling puts you in a favorable negotiating position. As a general rule, the faster you want to disassociate yourself from your business, the more the buyer will want to deduct from his purchase price. Your desire to leave quickly is a red flag of risk to the new owner.

Your best outcome is to sell your business near the top and stay involved as an employee or consultant for a reasonable period. If you look at the transaction structures that are popular in the acquisition of closely held businesses, this approach makes a lot of sense. The more a business depends on the owner for its success, the greater the risk to the buyer. The greater the percentage of a selling company's projected earnings that is dependent on future new sales, the lower percentage of transaction value that the seller will receive as cash at closing. The greater the concentration of company sales to a small number of customers, the lower the price and the greater the earn-out component of transaction value.
Most privately held family businesses have one or a combination of these value detractors. Your selling strategy can mitigate the negative impact on selling price. By exiting before the necessity of exiting, your sales trajectory will more than likely be on the increase than on the decline. Buyers pay a premium for growth and discount for flat or falling sales. Unless your entire revenue stream is contractually committed over the next several years, most buyers will introduce an earn-out as a component of the total transaction value. This is a risk avoidance strategy that ties the total acquisition price to the future performance of the business post acquisition. It is also designed to keep the business seller engaged in the near term performance of the business.
In spite of the normal response from business sellers who want the entire sale price in cash at close, we believe that under the proper circumstances and properly memorialized in the definitive purchase agreement, earn-outs can be a big win for a seller. We normally try to tie the earn-out to future revenues of the acquired property. That is usually very easy to measure and to audit if necessary. Earn-outs based on future EBITDA or division profitability are more problematic because of the greater possibility for interpretation by the buyer. You all of a sudden get an accounting entry of corporate overhead in your financial reconciliation and your profit disappears.
Count on your original champion who negotiated your agreement not being involved by the end of the earn-out period. Make the agreement air tight in terms of how it is interpreted. A subtlety that we negotiated into an earn-out for a client was that the earn-out would be paid based on the greater of the sales price for the seller's product or 80% of list price, whichever was greater. You see, we cannot control how the buyer runs the business once he has the keys, but we can control how the earn-out is calculated. This prevented the buying company using the seller's product as a loss leader in combination with their other products and shifting the revenue to other products at the seller's expense.
If you look at this preferred structure in conjunction with your sell now, exit later strategy, it can work in your favor. Wouldn't you want to be fully engaged and energized during your earn-out period and drive the value of the earn-out? As part of the new company, you now have 325 installed accounts instead of 25. Your sales force is now 25 strong compared to 2 sales people from your prior company. Your advertising budget is twenty times your old budget. You now have a network of 50 manufacturers reps supporting sales. Your new company's access to growth capital dwarfs what was available to your little company. Do you think you have an environment where you can achieve a sales growth far greater than what you could do on your own? The key is to negotiate the earn-out that gets you to a transaction value comparable with an all cash at close offer that assumes your company sales grow at their historical rate.
For example, your offer if you back the buyer into the all cash at close offer is $5 million. Compare that to a deal that would provide you $3.5 million at close and another $1.5 million in earn-out if sales grew at 10% per year (your company's historical rate) for the next three years. Our contention is that the earn-out deal could be far superior. Given the much greater distribution power of the new owner, you could reasonably expect sales to jump by 25% per year, driving your earn-out to $2.5 million and resulting in a $1 million improvement in transaction value. You want to be fully engaged to achieve this result and that is exactly what the buyer wants.
As a business seller you have many factors that can greatly impact your selling price. Getting multiple buyers involved is probably number 1. A very close second, in the near term future is the timing of your sale. The economic trends are against you postponing the sale part of your exit. You can always sell now and retire later.
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, March 23, 2017

It Is Time To Sell Your Business Watch for These Danger Signs

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, January 20, 2017

What Drives the Value of Your Business?

Very helpful article By  

Takeaway: Knowing what is responsible for creating and increasing the value of your business matters. Are you focusing on these 8 key value drivers?

Business value drivers are those aspects of a business that can and do add value.
Today’s business environment is not just about survival, it’s about focusing on and creating sustainable value. But, which elements of a business are capable of creating value? Equally important: which elements of a business are capable of destroying value? Proper business planning is the process of uncovering and identifying what creates and drives value.
Start by using the SWOT Analysis  Strengths, Weaknesses, Opportunities and Threats — this will help you identify the "value drivers" for your business. With this approach, you can focus on key value drivers.
There are many value drivers that have been identified in businesses. But, typically no more than 8-12 are critical in any given business; here are the most common 8.

Financial History:

Are your books accurate and up to date? Over the last few years, are there patterns of growth or decline? If in decline, are there good reasons for the decline? Accurate and current financials are important for determining how the company fares in its industry and amongst competitors. A comparison to industry ratios can identify strengths and weaknesses in the business.

Management Depth:

Can the company operate without the owner for more than a week or two? Is there any cross-trained management to fill in if you were gone? What is the average age of management? Will they retire soon? What levels of experience and education do they possess? Having a good management team can add value to the business.

Customer Diversity:

Do you have one or two major customers that account for more than 25% of your gross sales? What would happen to the value of your company if you lost one? Are most of your customers considered “blue chip”? A good overview and a rating analysis of the customer base can be beneficial not only for added value, but is also crucial for where, how and when you advertise — not to mention a much better understanding of your accounts receivable and aging.

Owner Involvement:

Are you the “rainmaker” in the business? Does everything from sales to production revolve around you and your decisions? How difficult would you be to replace? The more the business depends on you, the owner, the more likely the value will be lowered. One of the things I see the most is that, over the years, the business owner and number one sales person is now an office manager. Maybe it’s time to get back out in the field with your sales people or provide on-going sales training.


Does your company compete in a clearly defined market niche which is defensible? Or, have your products or services become a commodity that is becoming more difficult to defend?

Customer Satisfaction:

Are your customer relationships based on great products and service or lowest price? How long and what type of history have they had with you? Are they satisfied and loyal? Do you have systems in place to identify your customers and communicate?

Loyal Employees:

Outside of ownership, are there people in place whom you can rely on and are capable of doing their job, day in and day out? Are they considered knowledgeable for your industry? Again, what levels of experience and education do they possess?
What is the average length of employment amongst your staff? A responsible business buyer will be looking for opportunities where the current staff, especially management, will remain in place, following the current owner’s exit from the business. Having key employee contracts, non-competes, but more importantly a loyal, dedicated staff that is committed to the company’s success regardless of ownership change will be highly valuable to a prospective buyer and thus reflected in a business valuation.

Proprietary Technology:

Has your company developed a unique application, tool or technology as part of its ongoing operations? Does it give you a competitive advantage? If so, this proprietary innovation or intellectual property can be positioned as a key value driver for your business. Technologies or processes do not have to be patented to carry value but privacy and confidentiality must be maintained. It is critical that non-compete and confidentiality agreements be strictly adhered to and enforced by the company, before and after a transfer of ownership. The benefits, application and purpose of your proprietary technology should be explained to a business valuation consultant.
Intangibles (intellectual property) and human resources (who go home at night) can be protected and leveraged through a combination of business strategies and legal protections. Business strategies include incentive compensation plans to recognize, reward and retain high-performing employees. Legal protections include requiring key employees to sign non-compete agreements, registering Trademarks and Copyrights, and taking steps to protect proprietary information/trade secrets such as recipes and formulas. Contracts with key players, including partners, customers and suppliers are also important.

In conclusion, it's easy to be distracted by all the demands competing for the business owner's time and attention. To maximize the value and profitability of your company, you need to focus on the key value drivers — which may be intangibles and employees — in addition to having up-to-date equipment and systems.

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, August 25, 2016

Selling Your Business - Beware of the Tire Kicker

If you are approached by an unsolicited offer to buy your company, you might think this a good thing. If not handled properly, it could be a real drain on your company's performance. We are often contacted by a business owner after he has been approached by a buyer. He wants information from us on the merger and acquisition process, which we are happy to provide. He wants to wait, however, to engage our firm to sell his company  "until this situation with the buyer plays itself out."

The Single Buyer's Game Plan

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 drain your time, resources, 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.

I recently read a great article from a UK Business Advisor, Clinton Lee, that takes a little different but equally cautionary view of this Tire Kicker.

Once You Pin Them Down

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.  A second potential outcome is that when the offer does come, the owner doesn't know if it is a good or bad offer. Finally, once the buyer has tied up the owner with the LOI, he then proceeds to attack transaction value through every step of due diligence. He is the only suitor so there is nothing to stop bad behavior.

This is so costly to the business owner. Many owners repeat this process several times before they acknowledge the damage being done to their business. When they do eventually hire a merger and acquisition firm or a business broker, the company value has eroded substantially.

Even though we have watched this situation unfold from a distance many times, we have been frustrated by our lack of success in changing the owner's incurable optimism about this buyer.  Being the deal guys that we are, we needed to come up with a creative solution and a deal structure to move the business owner toward a better outcome. If we feel so strongly that this buyer will not be the actual buyer in the end, we should be willing to "carve out" that buyer in the form of a discounted success fee.

Put the Buyer into a Competitive Bid Situation

By George, that's it! If an owner has an identified buyer, we can incorporate a sliding scale discount on the success fee over time if this identified buyer becomes the actual buyer. If he becomes the actual buyer very quickly the discount is big. If the deal closes after five months of our M&A work, the discount has slid to zero because we have thrown him into the mix with several other qualified buyers and his offer will have been leveraged higher by 25% or more.

The benefits to the business owner with this approach are meaningful. First, if this is that rare occurrence of a legitimate buyer with a legitimate offer, the owner will not pay a big success fee for a small amount of work. Secondly, the owner can turn the burden of the process over to the M&A firm, freeing him up to successfully run his business during the process. Next, we end the endless, resource draining, tire kicking that erodes business value. Finally, by changing this from an auction of one to a truly competitive bidding situation involving the universe of qualified buyers, the owner will have no doubt that he got the best the market had to offer for his business.

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, August 12, 2016

Do You Know What Your Company is Worth?

Good insights from John Carvalho from Divestopedia

Do you know the value of your business? When I asked this question to business owners in attendance at a presentation I recently delivered, I was not surprised the majority weren’t 100 percent sure. Why should they care about value? No one ever asks for it. Banks, shareholders and government agencies never ask private business owners what their company is worth.
In reality, though, there are a lot of different stakeholders valuing your business every day, such as your employees, other banks, investors and customers. I would venture to guess that that alone should be a good enough reason to care about value.

What Buyers Look for in a Business

I recently found myself watching NBC’s "Shark Tank," where aspiring entrepreneurs pitch their business concepts and products to a panel of business moguls who have the cash and the know-how to make it happen. Hands down, the fastest way to get thrown out of the tank is to have an unrealistic valuation of your business.

So, think about it this way: If you had your eye on an acquisition, what would you look for? Putting yourself in a buyer's shoes is a great exercise to temper valuation expectations. I bet you would be looking for things like a diversified customer base, a systematic way of generating recurring revenue, barriers to entry from competitors and high margins, to name a few. So, be honest: Does your company have these characteristics?

Great Companies Drive Value

If building a company was a sport, the value of the company would be how we keep score. Jim Collins, author of "Good to Great," identified elite companies that have made the leap from good to great. Companies that make the leap were defined as meeting the following criteria:
  • 15-year cumulative stock returns at or below the general stock market
  • Followed by a transition point
  • Then cumulative returns of at least three times the market value over the next 15 years
What this suggests is that measuring corporate value is a key tool in tracking a company’s transition from good to great.

The Benefits of Regularly Updated Business Valuations

For me, the same question always come to mind: Why haven’t valuations become more commonly adopted as a strategic planning tool for private businesses? Every year, companies engage accounting firms to audit, review or compile their books. This requirement is driven by banks, tax authorities and others that require financial statements verified by an independent third party. I truly believe that an annual valuation would provide most business owners with more insight into their company than audited financial statements.

As I see it, the benefits of using periodic business valuations as a strategic planning tool are:
  • Business valuation provides business owners with a quantitative measure of the corporate value created through the execution of a strategic plan.
  • Frequent business valuations will give owners a better understanding of which financial levers they can pull to drive the value of their business.
  • Like in "Shark Tank," knowing the value of the business gives owners increased credibility with potential investors and lenders.

A Better Valuation Tool

Here are my thoughts on a better valuation model compared to traditional valuations currently offered by most advisors:

Traditional Valuation:
  • Based primarily on financial information;
  • Only provides a value of the business at one point in time;
  • Limited recommendations on how to increase value; and
  • Engagement is over once a value is determined.
A Better Valuation Model:
  • Digs deeper into key market and operational value drivers of the business;
  • Current valuation sets a benchmark and provides a comparison to where you want to be;
  • Provides a clear understanding of strengths and weaknesses in the business, plus recommendations on how to improve; and
  • Determining the value of the business is just the beginning. The engagement provides constant monitoring and measurement of value to help business owners achieve wealth creation goals.
So, my question to you, private business owner, is a crucial one: How can you know if you are moving toward greatness if you don’t know or frequently measure the worth of your business?

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 28, 2016

Most Business Owners Have a Serious Asset Allocation Issue

If several market meltdowns have taught us anything it is to make sure you are diversified over several investments and asset classes. Would your financial advisor recommend that you put 80% or more of your assets into a single investment? Of course not, but a large percentage of business owners actually have that level of concentration. On top of that, privately held businesses are illiquid assets often requiring one to two years to sell.

So for your baby boomer business owner, it is time to recognize the importance of planning for your business exit or business sale. It is time to move your thinking about your business from the method to provide income to your family and start thinking about it in terms of wealth maximization.  Above is a graphical comparison between a business owner and another high net worth individual. 

Business owners are typically not proactive when it comes to exit planning or succession planning in their business because it forces them to embrace their own mortality. If an owner has a sudden debilitating health issue or unexpectedly dies, instead of getting full value for the company, his estate can sell it out of bankruptcy two years later for ten cents on the dollar. This is a punishing financial result for the lack of appropriate planning.

There are many complex issues involved in a business transition or a business sale. Poor decisions at this critical time can result in swings of hundreds of thousands or even millions of dollars. If you can take away one thing from this, it would be to actively get out in front of the process with your professional advisors. This decision and how it is executed will be the single most impactful event in your family’s financial future. You should consider assembling a multidisciplinary team that can include:

The Financial Advisor – Coordinate all the pieces for a holistic wealth maximization plan

Attorney – Create the necessary documents, wills, trusts, family LLC's, corporate structure, etc

Estate Planner – work with financial advisor and attorney to create the properly documented estate roadmap

CPA/Tax Advisor – review corporate structure, analyze after tax proceeds comparison of various transaction structures, create tax deferral and tax avoidance strategies

Investment Banker/Merger and Acquisition Advisor – Analyze the business, create value maximization strategies, position the company for sale, and create a soft auction of multiple buyers to maximize selling price and terms.
 As business owners approach retirement, they often seek help with investment decisions that employ sound diversification and liquidity strategies. Your business is generally the largest, most illiquid, and most risky investment in your total wealth portfolio. Your successful business exit should be executed with the same diligence, knowledge, experience and skill that you have regularly applied to the organizing, running and building your business.
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, July 26, 2016

During Due Diligence What's Good for the Goose is Good for the Gander

One of the things I like best about representing small business owners as an M&A Advisor is that no two days are the same. Yes, deals have common elements, but it is those unique details at the margin that must be handled on the fly that can mean the difference between success and failure. To prepare our clients for those 80% deal elements in common we have written articles on each stage of the process and we review those articles with our client prior to the stage. So for example we will review the most commonly asked questions from buyers on conference calls and we will role play with our clients on answering these questions.

If the client knows what to expect prior to the stage, any bump in the road does not turn into a deal threatening event. We try to manage and control what we can, but more often than not something new surfaces that is new to our experience. How those surprises are handled often can be the difference between closing and the deal blowing up. In a recent transaction that we completed, we had one of those first time surprises. Luckily we were able to get past it and improve our preparation for the next deal and as an added bonus, resulted in this article.

Due diligence was coming to a satisfactory close and the definitive purchase agreements, seller notes, and employment contracts were moving through the process without a hitch. We were set to close on April 30 and ten days prior to closing the buyer said, we just want to see your closing numbers through April, so let's move the closing back 5 days. What were we going to do tell them no? I said, well you have already completed due diligence, are you concerned about the April numbers? He said, no, we just want to make sure everything is on track.

My radar went off and I thought about all of the events external to our deal that could cause the deal not to  close.  How many deals failed to close, for example, that were on the table during the stock market crash of 1987? The second part of my radar said that we needed to be prepared to defend transaction value one final time. I suggested he bring in his outside accountant to help us analyze such things as sales versus projections, gross margins, deal pipeline, revenue run rate, etc. We were going to be prepared. We knew that if things looked worse, the buyer was going to request an adjustment.

Now here comes the surprise. The outside accountant discovered that there was a revenue recognition issue and our client had actually understated profitability by a meaningful amount. This was discovered after the originally scheduled closing date and it meant that the buyer had based his purchase price on an EBITDA number that was too low. Easy deal, right? We just take his transaction value for the original deal and the EBITDA number he used and calculated an EBITDA multiple. We then applied that multiple to our new EBITDA and we get our new and improved purchase price.

I knew that this would not be well received by our buyer and counseled our client accordingly. He instructed me to raise our price. The good news is that we had a very good relationship with the buyer and he did not end discussions. He reminded us that he had earlier given in to a concession that we had asked for and we added a couple of other favorable deal points, but he did not move his purchase number.

We huddled with our client and had a serious pros and cons discussion. He did recognize that we had fought hard to improve his transaction. He also recognized that the buyer had drawn his line in the sand and would walk away. The risk that we discussed with our client was that if we returned to market, that would delay his pay day by minimum of 90 days. Also we pointed out that the market does not care why a deal blows up. When you return to the market, the stigma is that some negative surprise happened during due diligence and the new potential buyers will apply that risk discount to their offers.
Our client did agree to do the deal and is very optimistic about the company moving forward with a great partner.

In a post deal debrief with our client I told him that had I to do it again, what I should have said when the buyer requested the delayed closing is, "We know that if you find something negative, you are going to ask for a price adjustment. If we discover something positive will we be able to get a correspondingly positive adjustment. What is he going to say to that?

In reflecting on this situation, I wanted to use my learning to improve our process and I believe that I have come up with the strategy. In our very next deal I incorporated our new strategy. We got several offers with transaction value, cash at close, earnout, seller note and net working capital defined. In our counter proposals  we are now proposing the following language:

We propose to pay a multiple of 4.43 times the trailing twelve month (ending in the last full
month prior to the month of closing) Adjusted EBITDA, which using full year 2015 Adjusted
EBITDA of approximately $1,000,000 results in a valuation of $4,430,000. Adjusted EBITDA for the purposes of this determination will be defined as Net Income plus any One-time professional fees associated with this business sale (currently $42,000 for investment banker fees additional legal and accounting services).

What we are accomplishing with this language is that if the price can go down during the due diligence process, then the price can go up during the process. Why not formalize it because we know that in 99 times out of 100, if the company performance goes down from where it was when the bid was submitted, an adjustment will be applied by the buyer.  If the seller does not relent, the buyer will walk away.  The unwritten buyer's rule is that the price can only go down during due diligence. We are out to change that one-sided approach and even the playing field for our sell side clients.

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