I tried and I gave up. When we started out high-tech Merger and Acquisition Practice, I thought it a natural fit to also offer finder services for Entrepreneurs seeking Venture Capital Funding. That service is no longer available. Why not you ask? We failed miserably. Our firm has successfully completed several small high tech M&A deals at great multiples, but finding venture capital turned out to be a very frustrating and unproductive experience.
Unfortunately many high tech entrepreneurs have eventually landed on our doorstep totally drained from their experience of trying to raise venture funding themselves. Quite frankly, the process has caused several of these businesses to fail. According to venture industry statistics only 2% -3% of firms seeking venture capital actually are successful in receiving funding. Only 2 out of 10 of those firms that receive funding provide the target returns for the Venture Firms. Since their failure rate is so high, they are looking for a 30 to 1 return on their money in their three or four year exit period.
It is generally not a good idea to alienate my readers, but the biggest problem that entrepreneurs have is that they are naïve about this whole process. They generally have unbridled optimism about the value of their company, idea, product, or technology in the marketplace. These entrepreneurs are usually the inventor or the author of the computer code and are not sales or business development guys.
They do not understand the sales process. After all, raising Venture Capital is the ultimate sales job. These tech-focused individuals will be strung along by the Venture firms unless they have a track record of starting a company and making investors rich. In that case the Venture Firms fight for their place in line to give you money. I would often speak with high-tech entrepreneurs who just completed "a great meeting" with XYZ Ventures. They would excitedly tell me that XYZ asked them for a report on this, pro-forma's for that, projections for this, a competitive analysis of the major players, etc. They would then schedule another meeting.
Our entrepreneur is thinking they are on the verge of landing the big one. My response is, "How much are they paying you for educating them on your space." The image that comes to mind is when you were a kid and were using a magnifying glass to burn up ants on an ant hill – kind of sadistic torture.
For you tech guys out there, this is not Field of Dreams – If you build it they will come. It is business and the mantra is – If you sell it they will come. Get over your bias of not valuing the sales process and go tap the best available sales and marketing person you can find to partner with you. Build a customer following that demonstrates a trend rather than a couple of isolated successes. Then go find a large strategic partner to acquire you at fantastic multiples. Work through your non-compete period and then launch your next great idea. Go to the venture guys from your new-found position of strength and tell them to get in the queue.
Tuesday, February 20, 2007
Monday, February 19, 2007
Business Sellers - Beware of the C Corp Asset Sale
We recently completed a Merger and Acquisition engagement to sell our client to a large publicly traded company. Our client had started her company 25 years ago and had set it up a C Corp. She never was advised to change that structure in preparation for a much better tax treatment on the sale of the business.
The buyer had an acquisition policy of only asset sales and no stock sales. The tax implications to our client were punishing. In a C Corp Asset Sale, there is no such thing as a long-term capital gain for the corporation. Since our client's basis (a software and consulting firm) was essentially $0, the entire sale amount would have been treated as ordinary income and would have been taxed at a rate of about 30%. Once taxes are paid by the corporation and a distribution is made to the stockholders, the stockholders are then taxed at the 15% individual long-term capital gains rate.
Let's say that the purchase price was $5 million. With an asset sale, the Corporation would first pay 30% of $5 million, or $1.5 million. On the distribution, the shareholders would pay 15% of the $3.5 million distribution or $425,000. The total tax paid is a whopping $1,925,000. Net proceeds to the seller are $3,075,000. A stock sale, on the other hand is far superior for this C Corp. A stock sale is not taxed at the corporate level, so the gain of $5 million is taxed only once at the shareholders' long term capital gain tax rate of 15%, for a total tax of $750,000. Net proceeds to the seller are $4,250,000, an improvement of $1,175,000.
We simply had to turn this into a stock sale. Our approach was to use this issue as a negotiating point to bridge the valuation gap. The seller wanted more and the buyer wanted to pay less. We had pushed the value as far as could with the buyer, but our client still wanted more. We suggested to the buyer that if they were willing to do a stock sale we may be able to get our client to accept their current offer.
We argued that since this was a technology and services firm, the risk of any environmental or product liability was minimal. We proposed that they cover any perceived risks with stringent Reps and Warranties language in the purchase agreement. Finally, because a significant portion of the transaction value was an earn out, they had a built in escrow account. It worked! Our client was able to realize an additional $1,175,000 through a stock sale and we were able to bridge the valuation gap between buyer and seller.
The buyer had an acquisition policy of only asset sales and no stock sales. The tax implications to our client were punishing. In a C Corp Asset Sale, there is no such thing as a long-term capital gain for the corporation. Since our client's basis (a software and consulting firm) was essentially $0, the entire sale amount would have been treated as ordinary income and would have been taxed at a rate of about 30%. Once taxes are paid by the corporation and a distribution is made to the stockholders, the stockholders are then taxed at the 15% individual long-term capital gains rate.
Let's say that the purchase price was $5 million. With an asset sale, the Corporation would first pay 30% of $5 million, or $1.5 million. On the distribution, the shareholders would pay 15% of the $3.5 million distribution or $425,000. The total tax paid is a whopping $1,925,000. Net proceeds to the seller are $3,075,000. A stock sale, on the other hand is far superior for this C Corp. A stock sale is not taxed at the corporate level, so the gain of $5 million is taxed only once at the shareholders' long term capital gain tax rate of 15%, for a total tax of $750,000. Net proceeds to the seller are $4,250,000, an improvement of $1,175,000.
We simply had to turn this into a stock sale. Our approach was to use this issue as a negotiating point to bridge the valuation gap. The seller wanted more and the buyer wanted to pay less. We had pushed the value as far as could with the buyer, but our client still wanted more. We suggested to the buyer that if they were willing to do a stock sale we may be able to get our client to accept their current offer.
We argued that since this was a technology and services firm, the risk of any environmental or product liability was minimal. We proposed that they cover any perceived risks with stringent Reps and Warranties language in the purchase agreement. Finally, because a significant portion of the transaction value was an earn out, they had a built in escrow account. It worked! Our client was able to realize an additional $1,175,000 through a stock sale and we were able to bridge the valuation gap between buyer and seller.
Wednesday, February 07, 2007
Selling Your Business - What Would Sam Zell Do?
If you were thinking of making an investment it might be a good idea to watch how Warren Buffet does it. If you are going to sell your business, maybe you should emulate Sam Zell, multibillionaire founder of Equity Residential (EQR). He is selling his company in one of the largest private equity deals ever.
Sam agreed to take an initial offer from Blackrock Private Equity at $48 per share with a break-up fee of $500 million. EQR has 292.13 million shares outstanding, resulting in a total bid of $14.02 billion. This is where most privately held business owners stop. They put the word out through their professional network, get an introduction to an owner of another related business, and begin the process. If they get an offer, it is low and is driven down during the due diligence process because there is nothing to stop this behavior from a single buyer.
Back to Sam Zell. Sam tells his investment bankers to continue to solicit more buyers. Surprise, enter Vornado with the backing of a couple of very large private equity competitors of Blackrock. Their first counter offer is $52 per share. It goes back and forth with these heavyweights slugging it out. When I last checked, Blackrock had increased their bid to $56.35 per share, making the total bid $16.46 billion. That is an increase of $2.44 billion over the initial bid.
We tell our clients that a competitive bid will produce a 20% premium or more over a single bid. In the case of a single non-solicited bid, the differences can be much greater. This one sits at a 17% premium over the initial offer. The process will net the shareholders about an additional $2.5 billion.
What can we learn here? Blackrock is a very smart buyer. They were trying to buy at a bargain. When they made their first offer they knew exactly what EQR was worth. Sam Zell is a very smart businessman. He knew that getting multiple buyers involved is the only way to maximize the sale proceeds for himself and his shareholders.
If you are a business owner and are approached by a buyer, do not think that your lawyer or accountant is going to do for you what the investment bankers did for Sam Zell. They will not contact hundreds of potential buyers and create the soft auction required to drive up your selling price.
Don't get me wrong. Your attorney and your CPA will play critical roles in your business sale with their contract work and accounting work. However, the role of your investment banker or merger and acquisition advisor is to bring the right buyers to the table and then assist them is seeing the full value for your company.
Sam agreed to take an initial offer from Blackrock Private Equity at $48 per share with a break-up fee of $500 million. EQR has 292.13 million shares outstanding, resulting in a total bid of $14.02 billion. This is where most privately held business owners stop. They put the word out through their professional network, get an introduction to an owner of another related business, and begin the process. If they get an offer, it is low and is driven down during the due diligence process because there is nothing to stop this behavior from a single buyer.
Back to Sam Zell. Sam tells his investment bankers to continue to solicit more buyers. Surprise, enter Vornado with the backing of a couple of very large private equity competitors of Blackrock. Their first counter offer is $52 per share. It goes back and forth with these heavyweights slugging it out. When I last checked, Blackrock had increased their bid to $56.35 per share, making the total bid $16.46 billion. That is an increase of $2.44 billion over the initial bid.
We tell our clients that a competitive bid will produce a 20% premium or more over a single bid. In the case of a single non-solicited bid, the differences can be much greater. This one sits at a 17% premium over the initial offer. The process will net the shareholders about an additional $2.5 billion.
What can we learn here? Blackrock is a very smart buyer. They were trying to buy at a bargain. When they made their first offer they knew exactly what EQR was worth. Sam Zell is a very smart businessman. He knew that getting multiple buyers involved is the only way to maximize the sale proceeds for himself and his shareholders.
If you are a business owner and are approached by a buyer, do not think that your lawyer or accountant is going to do for you what the investment bankers did for Sam Zell. They will not contact hundreds of potential buyers and create the soft auction required to drive up your selling price.
Don't get me wrong. Your attorney and your CPA will play critical roles in your business sale with their contract work and accounting work. However, the role of your investment banker or merger and acquisition advisor is to bring the right buyers to the table and then assist them is seeing the full value for your company.
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