Merry Christmas to all and a happy New Year.
May your multiples expand in 2010!
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, December 24, 2009
Selling Your Business - Treat it Like an Investment
Too often a business owner does not properly execute his business exit or business sale. This post explores how the business owner might be able to achieve much better results just by changing his attitude and his preparation.
Think of the joy you feel when you look back and realize that you sold a stock at a big profit and got out within a few percentage points of its all time high. You chuckle a bit as you watch the stock pull back by over 100% while you have redeployed your proceeds into other diversified investments that have performed well. That is a very disciplined approach to investing and unfortunately I have failed to execute that on several very costly occasions.
So now I preach to business owners to execute the same dispassionate approach when it comes to their privately held business. It is so much more than an arm's length investment. It is their life's work, their identity, their pride and joy. The very nature of the entrepreneur means they are confident and optimistic, otherwise they would not have started the business in the first place. This attitude can really cost them in both good times and bad. When things are going well, he projects that they will get even better. When things go poorly, he reasons that this is just a short term issue and he will power through it.
Getting back to investing for a minute, I find that my best decisions are made when the market is closed and I am in planning mode. I might put on a stop loss order for that mining stock that has run up 40% in the last 3 months or put in a sell order if it hits 50% above its previous 52 week high. I might place a buy order for a hot stock anticipating a pullback rather than buying it in a high volume upward move. I am trying to take the emotion out of my decision making by planning ahead for my trigger points.
For a business owner, it is important to recognize something is always for sale at the right price and terms. The business owner needs to recognize trigger points, both positive and negative and should establish a plan to be able to act upon them. Some positive triggers are you just had your most profitable year ever, you just got your first big order from the coveted blue chip account, or you just introduced a promising new product. The owner thinks this trend will continue indefinitely.
On the negative side, triggers might be your largest account runs into financial difficulty, the loss of a key employee, a health issue with the owner, or a competitor that has introduced an improvement on your major product. The owner believes that these are just challenges that he can manage his way around.
On the positive end, you can very effectively sell the trend to potential acquirers. Often times competitive forces act to bring the short term upward trend back closer to the norm. If the owner in his optimism waits to capture a second helping of his initial trend, he may have moved back to the norm and can no longer sell the positive trend.
If, on the other hand, an owner, especially later in his working life, tries to power through a negative trigger, the likelihood is that his business is in for a protracted downward slide. If he recognizes this in advance and has prepared for his exit, he may be able to sell the company before too much financial damage has occurred. A strong buyer can stop the slide if they get involved early enough. Just like you can sell the trend on the upside, the market will impose the negative trend on your company's selling price with a downward trend.
The Basics of Exit Preparation
1. Recognition of potential financial impact
Your business is likely your family's largest asset. In many cases it represents over 80% of your family's net worth.
Your business is illiquid and the price is subject to broad interpretation by the market.
Your business can not be sold quickly. An orderly business sale usually takes between 6 and 12 months.
If you have a debilitating health issue and are not able to work or you die, your business value could drop 20, 30, 40% or more over a very short period of time.
Buyers will be predatory if you are selling from a position of weakness
2. Have your business in move in condition at all times
Have a well-documented procedure manual
Make sure that there is management in place (beside the owner) that has decision making ability and authority
Create a growth plan - a 5 to 10 page document identifying the potential you have created in your business and where you would invest to grow if you had greater resources
Have your books reviewed by an outside CPA
Ensure your data processing systems are updated and reflect best practices in your industry
Institutionalize your customers - they are owned by the company, not by the salesman
Institutionalize your vendors
Move whatever time and materials business and handshake business to contracts if possible
Provide price incentives to move short term contracts to longer term contracts
Once you have acknowledged the importance of your exit strategy and put these disciplines in place, you can be prepared for the triggers that either you create or that have been created in the marketplace. An important point to recognize is that your business sale date will not necessarily be your retirement date. More often than not the new owner will want your continued involvement for some time after the sale.
So let's say that there is a positive trigger like a big consolidation in your industry at very attractive multiples. You could sell now and stay on for one year or perhaps several more in a different or reduced role. You could wind down from the rigors or day-to-day management and take on the role of CEO - Chief Evangelical Officer.
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
Think of the joy you feel when you look back and realize that you sold a stock at a big profit and got out within a few percentage points of its all time high. You chuckle a bit as you watch the stock pull back by over 100% while you have redeployed your proceeds into other diversified investments that have performed well. That is a very disciplined approach to investing and unfortunately I have failed to execute that on several very costly occasions.
So now I preach to business owners to execute the same dispassionate approach when it comes to their privately held business. It is so much more than an arm's length investment. It is their life's work, their identity, their pride and joy. The very nature of the entrepreneur means they are confident and optimistic, otherwise they would not have started the business in the first place. This attitude can really cost them in both good times and bad. When things are going well, he projects that they will get even better. When things go poorly, he reasons that this is just a short term issue and he will power through it.
Getting back to investing for a minute, I find that my best decisions are made when the market is closed and I am in planning mode. I might put on a stop loss order for that mining stock that has run up 40% in the last 3 months or put in a sell order if it hits 50% above its previous 52 week high. I might place a buy order for a hot stock anticipating a pullback rather than buying it in a high volume upward move. I am trying to take the emotion out of my decision making by planning ahead for my trigger points.
For a business owner, it is important to recognize something is always for sale at the right price and terms. The business owner needs to recognize trigger points, both positive and negative and should establish a plan to be able to act upon them. Some positive triggers are you just had your most profitable year ever, you just got your first big order from the coveted blue chip account, or you just introduced a promising new product. The owner thinks this trend will continue indefinitely.
On the negative side, triggers might be your largest account runs into financial difficulty, the loss of a key employee, a health issue with the owner, or a competitor that has introduced an improvement on your major product. The owner believes that these are just challenges that he can manage his way around.
On the positive end, you can very effectively sell the trend to potential acquirers. Often times competitive forces act to bring the short term upward trend back closer to the norm. If the owner in his optimism waits to capture a second helping of his initial trend, he may have moved back to the norm and can no longer sell the positive trend.
If, on the other hand, an owner, especially later in his working life, tries to power through a negative trigger, the likelihood is that his business is in for a protracted downward slide. If he recognizes this in advance and has prepared for his exit, he may be able to sell the company before too much financial damage has occurred. A strong buyer can stop the slide if they get involved early enough. Just like you can sell the trend on the upside, the market will impose the negative trend on your company's selling price with a downward trend.
The Basics of Exit Preparation
1. Recognition of potential financial impact
Your business is likely your family's largest asset. In many cases it represents over 80% of your family's net worth.
Your business is illiquid and the price is subject to broad interpretation by the market.
Your business can not be sold quickly. An orderly business sale usually takes between 6 and 12 months.
If you have a debilitating health issue and are not able to work or you die, your business value could drop 20, 30, 40% or more over a very short period of time.
Buyers will be predatory if you are selling from a position of weakness
2. Have your business in move in condition at all times
Have a well-documented procedure manual
Make sure that there is management in place (beside the owner) that has decision making ability and authority
Create a growth plan - a 5 to 10 page document identifying the potential you have created in your business and where you would invest to grow if you had greater resources
Have your books reviewed by an outside CPA
Ensure your data processing systems are updated and reflect best practices in your industry
Institutionalize your customers - they are owned by the company, not by the salesman
Institutionalize your vendors
Move whatever time and materials business and handshake business to contracts if possible
Provide price incentives to move short term contracts to longer term contracts
Once you have acknowledged the importance of your exit strategy and put these disciplines in place, you can be prepared for the triggers that either you create or that have been created in the marketplace. An important point to recognize is that your business sale date will not necessarily be your retirement date. More often than not the new owner will want your continued involvement for some time after the sale.
So let's say that there is a positive trigger like a big consolidation in your industry at very attractive multiples. You could sell now and stay on for one year or perhaps several more in a different or reduced role. You could wind down from the rigors or day-to-day management and take on the role of CEO - Chief Evangelical Officer.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist
Sunday, December 13, 2009
Sell Your Company for Strategic Value
What does strategic value mean as it relates to the sale of a business? To a business buyer it means that your company is viewed to have a value beyond the value that the historical financial performance might suggest. A financial buyer will typically pay between 4 and 6 times EBITDA or free cash flow. There is no magic here. The theme is that this formula gives the buyer the ability to cover the debt service for the loan while providing a reasonable return on their equity. If the acquired company performs at least at the same level post acquisition, it is a safe investment.
What would cause a buyer to pay a business seller any more than a financial multiple? Buyers certainly do not willingly volunteer to pay more. They must be encouraged to do this and that encouragement generally comes in the form of other interested buyers that also recognize strategic value. What characteristics of a selling company would cause multiple buyers to seemingly over pay for an acquisition?
The key is that the selling company has to create potential that can be leveraged by the new owner. Simply by putting the resources, customer base, brand name, sales force, distribution system, manufacturing efficiencies, etc. behind the acquired assets they can often dramatically improve the return from those assets.
One of our clients with the president as the only salesman had only 12 customers. They had a complementary product to the eventual buying company's product line. The buying company had 27 sales people and 800 customers that were fertile prospects for the newly acquired product. Sales exploded post acquisition.
The buying company understood the potential that they would be able to unleash and was willing to give our client some credit for this projected success. We did encourage them to take this enlightened view with the help of their biggest competitor who was also interested in the acquisition.
One theme that creates strategic value is scalability. Can you take the technology, expertise, processes and procedures and easily translate that from a small company base to a much larger company. At one extreme you have an owner who is the ultimate subject matter expert and all business comes through him. This is not attractive for a buyer. At the positive extreme, the selling company has a well documented procedure manual, a training protocol and a well developed customer relationship management system. This can be more effectively leveraged by the buying company thus setting the stage for driving strategic value.
Sometimes just having a coveted customer base with barriers to entry can immediately turn a selling company into a strategic target. Doing business with the Federal Government or the Department of Defense can be a great business, but getting on the approved vendor list can take years.
One of our clients had gotten technical approvals with several telephone companies' and wireless companies' headquarters. This did not guarantee that the multiple local decision makers would buy from him. It did, however, provide him a valuable "hunting license" within these giant companies.
Innovation is a powerful driver of strategic value. It is not just limited to software, Internet, Bio Tech, or information technology who are often the poster children for some highly publicized generous acquisition multiples.
Innovation can take on many forms including improvements in manufacturing, distribution, training, marketing, sales systems, etc. Your merger and acquisition advisor's ability to recognize, document and articulate this leveragable intellectual property will go a long way toward maximizing your transaction value when you sell your company.
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
What would cause a buyer to pay a business seller any more than a financial multiple? Buyers certainly do not willingly volunteer to pay more. They must be encouraged to do this and that encouragement generally comes in the form of other interested buyers that also recognize strategic value. What characteristics of a selling company would cause multiple buyers to seemingly over pay for an acquisition?
The key is that the selling company has to create potential that can be leveraged by the new owner. Simply by putting the resources, customer base, brand name, sales force, distribution system, manufacturing efficiencies, etc. behind the acquired assets they can often dramatically improve the return from those assets.
One of our clients with the president as the only salesman had only 12 customers. They had a complementary product to the eventual buying company's product line. The buying company had 27 sales people and 800 customers that were fertile prospects for the newly acquired product. Sales exploded post acquisition.
The buying company understood the potential that they would be able to unleash and was willing to give our client some credit for this projected success. We did encourage them to take this enlightened view with the help of their biggest competitor who was also interested in the acquisition.
One theme that creates strategic value is scalability. Can you take the technology, expertise, processes and procedures and easily translate that from a small company base to a much larger company. At one extreme you have an owner who is the ultimate subject matter expert and all business comes through him. This is not attractive for a buyer. At the positive extreme, the selling company has a well documented procedure manual, a training protocol and a well developed customer relationship management system. This can be more effectively leveraged by the buying company thus setting the stage for driving strategic value.
Sometimes just having a coveted customer base with barriers to entry can immediately turn a selling company into a strategic target. Doing business with the Federal Government or the Department of Defense can be a great business, but getting on the approved vendor list can take years.
One of our clients had gotten technical approvals with several telephone companies' and wireless companies' headquarters. This did not guarantee that the multiple local decision makers would buy from him. It did, however, provide him a valuable "hunting license" within these giant companies.
Innovation is a powerful driver of strategic value. It is not just limited to software, Internet, Bio Tech, or information technology who are often the poster children for some highly publicized generous acquisition multiples.
Innovation can take on many forms including improvements in manufacturing, distribution, training, marketing, sales systems, etc. Your merger and acquisition advisor's ability to recognize, document and articulate this leveragable intellectual property will go a long way toward maximizing your transaction value when you sell your company.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist
Sunday, November 08, 2009
Your Accountant Does Not Want You to Sell Your Business
Normally a business owner does not want any contact with a merger and acquisition firm until immediately prior to selling the business. Because of this, one of the strategies we have employed to obtain deal flow for our investment banking practice is to cultivate relationships with local accounting firms or local offices of national accounting firms.
In that process, I have established a few good friendships with accountants that have evolved into social relationships. In spite of these efforts, I have gotten very few referrals, even from the accountants that I would consider close personal friends.
One of the reasons is that many accounting firms are establishing their own merger and acquisition departments. I remember having a discussion with the head of one of those captive M and A firms and she expressed her frustration over the lack of client referrals from the accountants in her own firm. She said that only a handful of the more than 300 accountants in her firm had ever referred an internal client to her investment banking group.
Recently a national accounting firm with offices in 30 major cities and a headquarters in the Chicago area announced the closing of their capital markets group - their merger and acquisitions department. I find that remarkable given the current demographic profile of business owners. Baby Boomers are the owners of almost 50% of all privately held businesses in America.
Baby Boomers are starting to retire in large numbers. According to a BSI Global Research Study, 42% of all CEO's plan on retiring within five years. The translation of this phenomenon to business owners is that a growing number of businesses are changing hands.
According to a Gallup Poll and a VIP Forum study, up to $8.3 trillion in wealth will transfer over the next ten years due to ownership changes in privately held businesses. These businesses are either being sold, passed on to the next generation, acquired in a management buyout or ESOP, or simply shut down.
So back to our accountants. This national accounting firm could not economically justify a merger and acquisition group of 8 people in this environment of exploding opportunity. Yes, I know we have a rough patch, but this will pass and the volume of activity will be steadily increasing for the next decade.
What really happened in this accounting firm? The same thing that is happening in the entire profession. Your accountant does not want you to sell your business. Your accountant has an annuity with your business - your quarterly and annual tax filings, your audit, and an occasional special consulting project that you probably initiated. Guess what. If you sell your business, your accountant loses his annuity. He will have to replace you with a new account. Accountants hate to prospect for new accounts. He does not want you to sell your business.
This position of denial by your accountant may interfere with the planning necessary to get you the best results when you exit your business. Are you planning to transfer ownership to your heirs? Have you formed multiple minority owned LLC's to reduce your gift and estate liability? Are you planning to sell out to your employees? Most of the time this is a bad idea for the owner's net worth.
Do you know the real value of your business? Do you know what to do when a competitor approaches you with an unsolicited offer to buy your business? How will a buyer view your business? Are there some minor changes you could make that would dramatically increase the value of your business? What are the tax consequences of an asset sale versus a stock sale?
The two or three years prior to selling your business are critical to your family's financial future. Normally a business owner sells only one business in his or her lifetime. The process is very complex with many variables. Good planning and good merger and acquisition process can result in swings of hundreds of thousands or even millions of dollars in your after tax proceeds.
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
In that process, I have established a few good friendships with accountants that have evolved into social relationships. In spite of these efforts, I have gotten very few referrals, even from the accountants that I would consider close personal friends.
One of the reasons is that many accounting firms are establishing their own merger and acquisition departments. I remember having a discussion with the head of one of those captive M and A firms and she expressed her frustration over the lack of client referrals from the accountants in her own firm. She said that only a handful of the more than 300 accountants in her firm had ever referred an internal client to her investment banking group.
Recently a national accounting firm with offices in 30 major cities and a headquarters in the Chicago area announced the closing of their capital markets group - their merger and acquisitions department. I find that remarkable given the current demographic profile of business owners. Baby Boomers are the owners of almost 50% of all privately held businesses in America.
Baby Boomers are starting to retire in large numbers. According to a BSI Global Research Study, 42% of all CEO's plan on retiring within five years. The translation of this phenomenon to business owners is that a growing number of businesses are changing hands.
According to a Gallup Poll and a VIP Forum study, up to $8.3 trillion in wealth will transfer over the next ten years due to ownership changes in privately held businesses. These businesses are either being sold, passed on to the next generation, acquired in a management buyout or ESOP, or simply shut down.
So back to our accountants. This national accounting firm could not economically justify a merger and acquisition group of 8 people in this environment of exploding opportunity. Yes, I know we have a rough patch, but this will pass and the volume of activity will be steadily increasing for the next decade.
What really happened in this accounting firm? The same thing that is happening in the entire profession. Your accountant does not want you to sell your business. Your accountant has an annuity with your business - your quarterly and annual tax filings, your audit, and an occasional special consulting project that you probably initiated. Guess what. If you sell your business, your accountant loses his annuity. He will have to replace you with a new account. Accountants hate to prospect for new accounts. He does not want you to sell your business.
This position of denial by your accountant may interfere with the planning necessary to get you the best results when you exit your business. Are you planning to transfer ownership to your heirs? Have you formed multiple minority owned LLC's to reduce your gift and estate liability? Are you planning to sell out to your employees? Most of the time this is a bad idea for the owner's net worth.
Do you know the real value of your business? Do you know what to do when a competitor approaches you with an unsolicited offer to buy your business? How will a buyer view your business? Are there some minor changes you could make that would dramatically increase the value of your business? What are the tax consequences of an asset sale versus a stock sale?
The two or three years prior to selling your business are critical to your family's financial future. Normally a business owner sells only one business in his or her lifetime. The process is very complex with many variables. Good planning and good merger and acquisition process can result in swings of hundreds of thousands or even millions of dollars in your after tax proceeds.
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, June 17, 2009
Software Investment banking - The Art of Business Valuation
One of the most challenging aspects of selling a software company is coming up with a business valuation. Sometimes the valuations provided by the market defy all logic. This post explores the key elements that drive software company valuation multiples.
One of the most challenging aspects of selling a software company is coming up with a business valuation. Sometimes the valuations provided by the market (translation - a completed transaction) defy all logic. In other industry segments there are some pretty handy rules of thumb for valuation metrics. In one industry it may be 1 X Revenue, in another it could be 7.5 X EBITDA.
Since it is critical to our business to help our information technology clients maximize their business selling price, I have given this considerable thought. Why are some of these software company valuations so high? It is because of the profitability leverage of technology?
A simple example is what is Microsoft's incremental cost to produce the next copy of Office Professional? It is probably $1.20 for three CD's and 80 cents for packaging. Let's say the license cost is $400. The gross margin is north of 99%. That does not happen in manufacturing or services or retail or most other industries.
One problem in selling a small technology company is that they do not have any of the brand name, distribution, or standards leverage that the big companies possess. So, on their own, they cannot create this profitability leverage. The acquiring company, however, does not want to compensate the small seller for the post acquisition results that are directly attributable to the buyer's market presence. This is what we refer to as the valuation gap.
What we attempt to do is to help the buyer justify paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, we want to get strategic value for our seller. Below are the factors that we use in our analysis:
1. Cost for the buyer to write the code internally - Many years ago, Barry Boehm, in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite detailed and complex, but I have boiled it down and simplified it for our purposes.
We have the advantage of estimating the projects retrospectively because we already know the number of lines of code comprising our client's products. In general terms he projected that it takes 3.6 person months to write one thousand SLOC (source lines of code). So if you looked at a senior software engineer at a $70,000 fully loaded compensation package writing a program with 15,000 SLOC, your calculation is as follows - 15 X 3.6 = 54 person months X $5,800 per month = $313,200 divided by 15,000 = $20.88/SLOC.
Before you guys with 1,000,000 million lines of code get too excited about your $20.88 million business value, there are several caveats. Unfortunately the market does not care and will not pay for what it cost you to develop your product.
Secondly, this information is designed to help us understand what it might cost the buyer to develop it internally so that he starts his own build versus buy analysis. Thirdly, we have to apply discounts to this analysis if the software is three generations old legacy code, for example. In that case, it is discounted by 90%. You are no longer a technology sale with high profitability leverage. They are essentially acquiring your customer base and the valuation will not be that exciting.
If, however, your application is a brand new application that has legs, start sizing your yacht. Examples of this might be a click fraud application, Pay Pal, or Internet Telephony. The second high value platform would be where your software technology "leap frogs" a popular legacy application.
An example of this is when we sold a company that had completely rewritten their legacy distribution management platform for a new vertical market in Microsoft's latest platform. They leap frogged the dominant player in that space that was supporting multiple green screen solutions. Our client became a compelling strategic acquisition. Fast forward one year and I hear the acquirer is selling one of these $100,000 systems per week. Now that's leverage!
2. Most acquirers could write the code themselves, but we suggest they analyze the cost of their time to market delay. Believe me, with first mover advantage from a competitor or, worse, customer defections, there is a very real cost of not having your product today.
We were able to convince one buyer that they would be able to justify our seller's entire purchase price based on the number of client defections their acquisition would prevent. As it turned out, the buyer had a huge install base and through multiple prior acquisitions was maintaining six disparate software platforms to deliver essentially the same functionality.
This was very expensive to maintain and they passed those costs on to their disgruntled install base. The buyer had been promising upgrades for a few years, but nothing was delivered. Customers were beginning to sign on with their major competitor.
Our pitch to the buyer was to make this acquisition, demonstrate to your client base that you are really providing an upgrade path and give notice of support withdrawal for 4 or 5 of the other platforms. The acquisition was completed and, even though their customers that were contemplating leaving did not immediately upgrade, they did not defect either. Apparently the devil that you know is better than the devil you don't in the world of information technology.
3. Another arrow in our valuation driving quiver for our sellers is we restate historical financials using the pricing power of the brand name acquirer. We had one client that was a small IT company that had developed a fine piece of software that compared favorably with a large, publicly traded company's solution. Our product had the same functionality, ease of use, and open systems platform, but there was one very important difference.
The end-user customer's perception of risk was far greater with the little IT company that could be "out of business tomorrow." We were literally able to double the financial performance of our client on paper and present a compelling argument to the big company buyer that those economics would be immediately available to him post acquisition. It certainly was not GAP Accounting, but it was effective as a tool to drive transaction value.
4. Financials are important so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value components) of 2 X contractually recurring revenue during the current year.
So, for example, if the company has monthly maintenance contracts of $100,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Another component we add is for any contracts that extend beyond one year. We take an estimate of the gross margin produced in the firm contract years beyond year one and assign a 5 X multiple to that and discount it to present value.
Let's use an example where they had 4 years remaining on a services contract and the last 3 years were $200,000 per year in revenue with approximately 50% gross margin. We would take the final tree years of $100,000 annual gross margin and present value it at a 5% discount rate resulting in $265,616. This would be added to the earlier 2 X recurring year 1 revenue from above. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.
5. We try to assign values for miscellaneous assets that the seller is providing to the buyer. Don't overlook the strategic value of Blue Chip Accounts. Those accounts become a platform for the buyer's entire product suite being sold post acquisition into an installed account. It is far easier to sell add-on applications and products into an existing account than it is to open up that new account. These strategic accounts can have huge value to a buyer.
6. Finally, we use a customer acquisition cost model to drive value in the eyes of a potential buyer. Let's say that your sales person at 100% of Quota earns total salary and commissions of $125,000 and sells 5 net new accounts. That would mean that your base customer acquisition cost per account was $25,000. Add a 20% company overhead for the 85 accounts, for example, and the company value, using this methodology would be $2,550,000.
After reading this you may be saying to yourself, come on, this is a little far fetched. These components do have real value, but that value is open to a broad interpretation by the marketplace. We are attempting to assign metrics to a very subjective set of components. The buyers are smart, and experienced in the M&A process and quite frankly, they try to deflect these artistic approaches to driving up their financial outlay.
The best leverage point we have is that those buyers know that we are presenting the same analysis to their competitors and they don't know which component or components of value that we have presented will resonate with their competition. In the final analysis, we are just trying to provide the buyers some reasonable explanation for their board of directors to justify paying 8 X revenues for an acquisition.
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
One of the most challenging aspects of selling a software company is coming up with a business valuation. Sometimes the valuations provided by the market (translation - a completed transaction) defy all logic. In other industry segments there are some pretty handy rules of thumb for valuation metrics. In one industry it may be 1 X Revenue, in another it could be 7.5 X EBITDA.
Since it is critical to our business to help our information technology clients maximize their business selling price, I have given this considerable thought. Why are some of these software company valuations so high? It is because of the profitability leverage of technology?
A simple example is what is Microsoft's incremental cost to produce the next copy of Office Professional? It is probably $1.20 for three CD's and 80 cents for packaging. Let's say the license cost is $400. The gross margin is north of 99%. That does not happen in manufacturing or services or retail or most other industries.
One problem in selling a small technology company is that they do not have any of the brand name, distribution, or standards leverage that the big companies possess. So, on their own, they cannot create this profitability leverage. The acquiring company, however, does not want to compensate the small seller for the post acquisition results that are directly attributable to the buyer's market presence. This is what we refer to as the valuation gap.
What we attempt to do is to help the buyer justify paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, we want to get strategic value for our seller. Below are the factors that we use in our analysis:
1. Cost for the buyer to write the code internally - Many years ago, Barry Boehm, in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite detailed and complex, but I have boiled it down and simplified it for our purposes.
We have the advantage of estimating the projects retrospectively because we already know the number of lines of code comprising our client's products. In general terms he projected that it takes 3.6 person months to write one thousand SLOC (source lines of code). So if you looked at a senior software engineer at a $70,000 fully loaded compensation package writing a program with 15,000 SLOC, your calculation is as follows - 15 X 3.6 = 54 person months X $5,800 per month = $313,200 divided by 15,000 = $20.88/SLOC.
Before you guys with 1,000,000 million lines of code get too excited about your $20.88 million business value, there are several caveats. Unfortunately the market does not care and will not pay for what it cost you to develop your product.
Secondly, this information is designed to help us understand what it might cost the buyer to develop it internally so that he starts his own build versus buy analysis. Thirdly, we have to apply discounts to this analysis if the software is three generations old legacy code, for example. In that case, it is discounted by 90%. You are no longer a technology sale with high profitability leverage. They are essentially acquiring your customer base and the valuation will not be that exciting.
If, however, your application is a brand new application that has legs, start sizing your yacht. Examples of this might be a click fraud application, Pay Pal, or Internet Telephony. The second high value platform would be where your software technology "leap frogs" a popular legacy application.
An example of this is when we sold a company that had completely rewritten their legacy distribution management platform for a new vertical market in Microsoft's latest platform. They leap frogged the dominant player in that space that was supporting multiple green screen solutions. Our client became a compelling strategic acquisition. Fast forward one year and I hear the acquirer is selling one of these $100,000 systems per week. Now that's leverage!
2. Most acquirers could write the code themselves, but we suggest they analyze the cost of their time to market delay. Believe me, with first mover advantage from a competitor or, worse, customer defections, there is a very real cost of not having your product today.
We were able to convince one buyer that they would be able to justify our seller's entire purchase price based on the number of client defections their acquisition would prevent. As it turned out, the buyer had a huge install base and through multiple prior acquisitions was maintaining six disparate software platforms to deliver essentially the same functionality.
This was very expensive to maintain and they passed those costs on to their disgruntled install base. The buyer had been promising upgrades for a few years, but nothing was delivered. Customers were beginning to sign on with their major competitor.
Our pitch to the buyer was to make this acquisition, demonstrate to your client base that you are really providing an upgrade path and give notice of support withdrawal for 4 or 5 of the other platforms. The acquisition was completed and, even though their customers that were contemplating leaving did not immediately upgrade, they did not defect either. Apparently the devil that you know is better than the devil you don't in the world of information technology.
3. Another arrow in our valuation driving quiver for our sellers is we restate historical financials using the pricing power of the brand name acquirer. We had one client that was a small IT company that had developed a fine piece of software that compared favorably with a large, publicly traded company's solution. Our product had the same functionality, ease of use, and open systems platform, but there was one very important difference.
The end-user customer's perception of risk was far greater with the little IT company that could be "out of business tomorrow." We were literally able to double the financial performance of our client on paper and present a compelling argument to the big company buyer that those economics would be immediately available to him post acquisition. It certainly was not GAP Accounting, but it was effective as a tool to drive transaction value.
4. Financials are important so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value components) of 2 X contractually recurring revenue during the current year.
So, for example, if the company has monthly maintenance contracts of $100,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Another component we add is for any contracts that extend beyond one year. We take an estimate of the gross margin produced in the firm contract years beyond year one and assign a 5 X multiple to that and discount it to present value.
Let's use an example where they had 4 years remaining on a services contract and the last 3 years were $200,000 per year in revenue with approximately 50% gross margin. We would take the final tree years of $100,000 annual gross margin and present value it at a 5% discount rate resulting in $265,616. This would be added to the earlier 2 X recurring year 1 revenue from above. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.
5. We try to assign values for miscellaneous assets that the seller is providing to the buyer. Don't overlook the strategic value of Blue Chip Accounts. Those accounts become a platform for the buyer's entire product suite being sold post acquisition into an installed account. It is far easier to sell add-on applications and products into an existing account than it is to open up that new account. These strategic accounts can have huge value to a buyer.
6. Finally, we use a customer acquisition cost model to drive value in the eyes of a potential buyer. Let's say that your sales person at 100% of Quota earns total salary and commissions of $125,000 and sells 5 net new accounts. That would mean that your base customer acquisition cost per account was $25,000. Add a 20% company overhead for the 85 accounts, for example, and the company value, using this methodology would be $2,550,000.
After reading this you may be saying to yourself, come on, this is a little far fetched. These components do have real value, but that value is open to a broad interpretation by the marketplace. We are attempting to assign metrics to a very subjective set of components. The buyers are smart, and experienced in the M&A process and quite frankly, they try to deflect these artistic approaches to driving up their financial outlay.
The best leverage point we have is that those buyers know that we are presenting the same analysis to their competitors and they don't know which component or components of value that we have presented will resonate with their competition. In the final analysis, we are just trying to provide the buyers some reasonable explanation for their board of directors to justify paying 8 X revenues for an acquisition.
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, June 10, 2009
Business Sellers - Beware of Potential Changes in the Capital Gains Tax
Thinking of selling your business? If you have planned it correctly, most of your transaction proceeds should be long term capital gains. Given the current political climate and the upcoming change in the White House, capital gains taxes will come under attack. If you are a business owner and are thinking of selling your business within the next 5 years, you may want to move up your exit timeframe says Dave Kauppi, President of MidMarket Capital, a Merger and Acquisition Advisor.
The reduced 15% tax rate on capital gains, previously scheduled to expire in 2008, has been extended through 2010 as a result of the Tax Reconciliation Act signed into law by President Bush on May 17, 2006. In 2011 these reduced tax rates will revert to the rates in effect before 2003, which were generally 20%.
We believe that with the AMT currently targeted for elimination, the $800 billion will be made up by raising taxes elsewhere, and I believe this "owner of capital" tax is the most vulnerable for increase. I expect that the long term capital gain tax rate will be moved to an upper limit of 28% by late 2010 for the high end income bracket.
Translation, the business seller is going to take a big hit on his after tax proceeds if his business sale is concluded after November 1, 2010. Let's look at a quick example. A 63 year old man started his business 25 years ago and he sells it for $5 million. All his equipment has depreciated so his basis is approximately $0. Under current tax laws he would have a $5 million capital gain from the sale of his business. His after tax proceeds would total $4,250,000.
If he sells after November 1, 2010, and the tax laws change as I am predicting. The same sale would net him $3,600,000. He lost $650,000 because of this change. If you wait until the actual change is voted into law, there will be a rush to the exits causing an unusually high number of businesses to be for sale. That would further reduce proceeds for the seller because of supply and demand pressures.
The most important tax issue, however, for the business seller continues to be the corporate structure (C Corp, S Corp, or LLC) and whether the business sale is an asset sale or a stock sale. First, unless you are planning on going public or have hundreds of stockholders do not form a C Corp to begin with. Use an S Corp or an LLC. If you currently are a C Corp ask your attorney or tax advisor about converting to an S Corp. If you sell your company within a 10-year period of converting to an S Corp the sale can be taxed as if you were still a C Corp.
Here is what happens when there is an asset sale of a C Corp. The assets that are sold are compared to their depreciated basis and the difference is treated as ordinary income to the C Corp. Any good will is a 100% gain and again is treated as ordinary income. This new found income drives up your corporate tax rate, often to the maximum rate of around 34%. You are not done yet. The corporation pays this tax bill and then there is a distribution of the remaining funds to the shareholders. They are taxed a second time at their long term capital gains rate.
Compare this to a C Corp stock sale. The stock is sold and there is no tax to the corporation. The distribution is made to the shareholders and they pay only their long term capital gain on the change in value over their basis. The difference can be hundreds of thousands of dollars.
This anticipated change to the capital gains tax rates will certainly add to the complexity of selling a business. I cannot stress how important a factor taxes will be in your successful business exit. Here is my summary checklist:
Tax Consideration Checklist Get Good Advice on Original Corporate Structure
If C Corp - Retain Ownership of all Appreciating Assets Outside Corporation - i.e. Real Estate, Patents, Franchise Rights: avoid double taxation
Look at Deal Economics First, Taxes Second
Make Sure Your Transaction Support Team has Deal Experience
Before You Go To Market, Work With Your Team to Understand Deal Structure vs. After Tax Proceeds
You Have the Right to Pursue the Minimum Payment of Taxes - Exercise Your Rights
It Is Never as Effective as an Afterthought
The Pros Can Match Your Desired Outcomes With the Right Tools. Be aggressive in your tax positioning of your sale, both with the buyer in your negotiations and with your filing with the IRS. The various deal structure options are very important issues that need to be understood from a tax impact perspective. Remember that a deal term that is favorable to the buyer for tax treatment is correspondingly unfavorable to the seller. You can bet that the buyer's team of advisors is well versed on this topic. Make sure that your team of advisors is equally well versed or you could end up with a much less than you thought in after tax proceeds.
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
The reduced 15% tax rate on capital gains, previously scheduled to expire in 2008, has been extended through 2010 as a result of the Tax Reconciliation Act signed into law by President Bush on May 17, 2006. In 2011 these reduced tax rates will revert to the rates in effect before 2003, which were generally 20%.
We believe that with the AMT currently targeted for elimination, the $800 billion will be made up by raising taxes elsewhere, and I believe this "owner of capital" tax is the most vulnerable for increase. I expect that the long term capital gain tax rate will be moved to an upper limit of 28% by late 2010 for the high end income bracket.
Translation, the business seller is going to take a big hit on his after tax proceeds if his business sale is concluded after November 1, 2010. Let's look at a quick example. A 63 year old man started his business 25 years ago and he sells it for $5 million. All his equipment has depreciated so his basis is approximately $0. Under current tax laws he would have a $5 million capital gain from the sale of his business. His after tax proceeds would total $4,250,000.
If he sells after November 1, 2010, and the tax laws change as I am predicting. The same sale would net him $3,600,000. He lost $650,000 because of this change. If you wait until the actual change is voted into law, there will be a rush to the exits causing an unusually high number of businesses to be for sale. That would further reduce proceeds for the seller because of supply and demand pressures.
The most important tax issue, however, for the business seller continues to be the corporate structure (C Corp, S Corp, or LLC) and whether the business sale is an asset sale or a stock sale. First, unless you are planning on going public or have hundreds of stockholders do not form a C Corp to begin with. Use an S Corp or an LLC. If you currently are a C Corp ask your attorney or tax advisor about converting to an S Corp. If you sell your company within a 10-year period of converting to an S Corp the sale can be taxed as if you were still a C Corp.
Here is what happens when there is an asset sale of a C Corp. The assets that are sold are compared to their depreciated basis and the difference is treated as ordinary income to the C Corp. Any good will is a 100% gain and again is treated as ordinary income. This new found income drives up your corporate tax rate, often to the maximum rate of around 34%. You are not done yet. The corporation pays this tax bill and then there is a distribution of the remaining funds to the shareholders. They are taxed a second time at their long term capital gains rate.
Compare this to a C Corp stock sale. The stock is sold and there is no tax to the corporation. The distribution is made to the shareholders and they pay only their long term capital gain on the change in value over their basis. The difference can be hundreds of thousands of dollars.
This anticipated change to the capital gains tax rates will certainly add to the complexity of selling a business. I cannot stress how important a factor taxes will be in your successful business exit. Here is my summary checklist:
Tax Consideration Checklist Get Good Advice on Original Corporate Structure
If C Corp - Retain Ownership of all Appreciating Assets Outside Corporation - i.e. Real Estate, Patents, Franchise Rights: avoid double taxation
Look at Deal Economics First, Taxes Second
Make Sure Your Transaction Support Team has Deal Experience
Before You Go To Market, Work With Your Team to Understand Deal Structure vs. After Tax Proceeds
You Have the Right to Pursue the Minimum Payment of Taxes - Exercise Your Rights
It Is Never as Effective as an Afterthought
The Pros Can Match Your Desired Outcomes With the Right Tools. Be aggressive in your tax positioning of your sale, both with the buyer in your negotiations and with your filing with the IRS. The various deal structure options are very important issues that need to be understood from a tax impact perspective. Remember that a deal term that is favorable to the buyer for tax treatment is correspondingly unfavorable to the seller. You can bet that the buyer's team of advisors is well versed on this topic. Make sure that your team of advisors is equally well versed or you could end up with a much less than you thought in after tax proceeds.
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, June 03, 2009
Maximize The Selling Price of Your Business - Seminar Announcement
As baby boomers retire, business wealth transfer is expected to reach $10 trillion in the coming years. Join us to hear professionals from Bernstein Global Wealth Management, MidMarket Capital Mergers and Acquisitions, Selden Fox CPAs, and Freeborn & Peters Attorneys at Law discuss ways to leverage the sale of your business to achieve multiple goals.
Among the topics they will explore are:
•Why your business selling price is largely determined by how you sell it
•How to minimize your taxes through proper deal structure
•What wealth planning strategies to consider to achieve your long-term goals
•What the role of the M&A attorney is and why it’s important
The Seminar is designed for businesses with revenues between $5 million and $50 and owners that anticipate an exit, transition to the next generation, or an outright sale within the next several years.
DATE
Tuesday, June 23, 2009
2:00–5:00 p.m.
Followed by a reception
LOCATION
Chicago Marriott Oak Brook
1401 West 22nd Street
Oak Brook, IL
Contact Dave to RSVP for this invaluable seminar!
Dave Kauppi
MidMarket Capital
630.325.0123
davekauppi@midmarkcap.com
Owners' and Companies' identities will be protected with the strictest of confidentiality.
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
Among the topics they will explore are:
•Why your business selling price is largely determined by how you sell it
•How to minimize your taxes through proper deal structure
•What wealth planning strategies to consider to achieve your long-term goals
•What the role of the M&A attorney is and why it’s important
The Seminar is designed for businesses with revenues between $5 million and $50 and owners that anticipate an exit, transition to the next generation, or an outright sale within the next several years.
DATE
Tuesday, June 23, 2009
2:00–5:00 p.m.
Followed by a reception
LOCATION
Chicago Marriott Oak Brook
1401 West 22nd Street
Oak Brook, IL
Contact Dave to RSVP for this invaluable seminar!
Dave Kauppi
MidMarket Capital
630.325.0123
davekauppi@midmarkcap.com
Owners' and Companies' identities will be protected with the strictest of confidentiality.
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, March 09, 2009
Sell or Keep Your Business - The Numbers May Surprise You
Many business owners simply are too emotionally tied to their businesses to analyze it the way they would another investment. This post provides a framework that a business owner can use to dispassionately examine the cost / benefit of owning his business.
In our Merger and Acquisition practice we watch as business buyers go through an exhaustive analysis to determine if it is financially prudent to make a particular company acquisition. Some use EBITDA multiples or free cash flow multiples. Others use the classic discounted cash flow approach while another group might look at a payback period analysis or debt coverage ratios. They all have one thing in common, however. They do a financial analysis as the primary determinant in making a decision to buy or not to buy.
It occurred to me that a business owner, not necessarily a business seller, should do his own financial analysis to determine if he is better off owning the business or selling it. In other words, will a business owner make more money by selling the business and replacing his business salary and dividends with the investment income he would earn by investing the business sale proceeds?
Owner A Owner B Owner C
Owner Comp $137,500 $578,490 $800,000
Sale Price($000) $4,400 $17,600 $26,000
Tax & Fees($000) ($1,100) ($4,400) ($6,500)
Net Proceeds($000) $3,300 $13,200 $19,500
Investment Income $214,500 $858,000 $1,267,500
Gain (Loss)*** $77,000 $279,510 $467,500
*Representative examples for Illustration purposes
**Proceeds invested @ 6.5%
***Calculated as Income from Investments less Income from Compensation
When you look at it using this analytical discipline, it puts things into a whole new perspective. Now let's add another factor to make the analysis even more interesting. When a business valuation firm performs a discounted cash flow analysis to value a business, they typically take the projected cash flows for ten years and discount those cash flows to today's value using a risk adjusted discount factor.
They are attempting to calculate a terminal value which is the value of ten years of cash flow discounted to present value. For a small privately held company those discount factors typically are in the 20% to 25% range. The effective discount rate used in this terminal value calculation is the 20%-25% rate less the company's growth rate.
So for example, if the company growth rate was 5% and you used the 20% risk adjusted rate, your discount rate would be 20% minus 5% or 15%. This says that $1 of cash flow received after 1 year = 87 cents today. That $1 received after 2 years is worth 76 cents, and so on.
This is the same principal used in pricing corporate bonds. AT&T might carry a rate on their 30 year bond of 5% as a triple A credit. Acme Electric, a BBB rated credit, might carry a rate of 16%. This adjusts the rate of return based on the risk of possible default and compensates an investor for taking additional risk.
Back to our privately held company and the risk adjusted discount rate. What this 20% - 25% rate is telling us from a strictly unemotional, analytical standpoint is that future cash flows from a small business are considered quite a risky proposition.
Please refer back to the chart and look at Company C as an example. The owner is taking $800,000 per year out of the business. Why would anyone in their right mind sell this company and walk away from this golden goose? Similar companies in his industry with similar financial performance are selling for $26 million. When this company is sold, the owner will pay a total of $6.5 million in taxes and professional fees. His net cash proceeds are $19.5 million. Investing $19.5 million in a balanced portfolio returning 6.5% annually will provide the former owner $1,267,500 in investment income.
Compare this to the $800,000 that the owner takes home from his business annually and it shows that the owner is actually paying $467,500 for the privilege of running his company.
Of course the owner receives a great deal of satisfaction and psychic benefit from running this very successful business. One can not overlook the pride of ownership and accomplishment, prestige in the community, and the purpose and meaning in his life that business ownership provides. It is very difficult to try to attach a dollar value to that.
With an extra $467,500 of annual cash flow and an extra 50 hours per week many owners could find other equally rewarding activities like philanthropy and charity work, travel, family and friends, or pursuing the career they would want if money were not a concern. Owning a business has many rewards and it is often difficult for an owner to objectively step back and look at his ownership in a totally analytical way. With the number of businesses that we have represented for sale after a significant negative event, however, this kind of thinking would have been quite useful when they were still on top.
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
In our Merger and Acquisition practice we watch as business buyers go through an exhaustive analysis to determine if it is financially prudent to make a particular company acquisition. Some use EBITDA multiples or free cash flow multiples. Others use the classic discounted cash flow approach while another group might look at a payback period analysis or debt coverage ratios. They all have one thing in common, however. They do a financial analysis as the primary determinant in making a decision to buy or not to buy.
It occurred to me that a business owner, not necessarily a business seller, should do his own financial analysis to determine if he is better off owning the business or selling it. In other words, will a business owner make more money by selling the business and replacing his business salary and dividends with the investment income he would earn by investing the business sale proceeds?
Owner A Owner B Owner C
Owner Comp $137,500 $578,490 $800,000
Sale Price($000) $4,400 $17,600 $26,000
Tax & Fees($000) ($1,100) ($4,400) ($6,500)
Net Proceeds($000) $3,300 $13,200 $19,500
Investment Income $214,500 $858,000 $1,267,500
Gain (Loss)*** $77,000 $279,510 $467,500
*Representative examples for Illustration purposes
**Proceeds invested @ 6.5%
***Calculated as Income from Investments less Income from Compensation
When you look at it using this analytical discipline, it puts things into a whole new perspective. Now let's add another factor to make the analysis even more interesting. When a business valuation firm performs a discounted cash flow analysis to value a business, they typically take the projected cash flows for ten years and discount those cash flows to today's value using a risk adjusted discount factor.
They are attempting to calculate a terminal value which is the value of ten years of cash flow discounted to present value. For a small privately held company those discount factors typically are in the 20% to 25% range. The effective discount rate used in this terminal value calculation is the 20%-25% rate less the company's growth rate.
So for example, if the company growth rate was 5% and you used the 20% risk adjusted rate, your discount rate would be 20% minus 5% or 15%. This says that $1 of cash flow received after 1 year = 87 cents today. That $1 received after 2 years is worth 76 cents, and so on.
This is the same principal used in pricing corporate bonds. AT&T might carry a rate on their 30 year bond of 5% as a triple A credit. Acme Electric, a BBB rated credit, might carry a rate of 16%. This adjusts the rate of return based on the risk of possible default and compensates an investor for taking additional risk.
Back to our privately held company and the risk adjusted discount rate. What this 20% - 25% rate is telling us from a strictly unemotional, analytical standpoint is that future cash flows from a small business are considered quite a risky proposition.
Please refer back to the chart and look at Company C as an example. The owner is taking $800,000 per year out of the business. Why would anyone in their right mind sell this company and walk away from this golden goose? Similar companies in his industry with similar financial performance are selling for $26 million. When this company is sold, the owner will pay a total of $6.5 million in taxes and professional fees. His net cash proceeds are $19.5 million. Investing $19.5 million in a balanced portfolio returning 6.5% annually will provide the former owner $1,267,500 in investment income.
Compare this to the $800,000 that the owner takes home from his business annually and it shows that the owner is actually paying $467,500 for the privilege of running his company.
Of course the owner receives a great deal of satisfaction and psychic benefit from running this very successful business. One can not overlook the pride of ownership and accomplishment, prestige in the community, and the purpose and meaning in his life that business ownership provides. It is very difficult to try to attach a dollar value to that.
With an extra $467,500 of annual cash flow and an extra 50 hours per week many owners could find other equally rewarding activities like philanthropy and charity work, travel, family and friends, or pursuing the career they would want if money were not a concern. Owning a business has many rewards and it is often difficult for an owner to objectively step back and look at his ownership in a totally analytical way. With the number of businesses that we have represented for sale after a significant negative event, however, this kind of thinking would have been quite useful when they were still on top.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist
Sunday, March 01, 2009
Selling a Business - New Rules for Merger and Acquisition Success
In today's environment the methods that middle market M&A firms used to complete business sale transactions no longer work. This post discusses the new approach necessary to get the visibility necessary to complete the sale of a privately held business.
If you are a business owner considering selling your business, most likely you will interview several business brokers or merger and acquisition advisors. In the process you might hear, "We have lists of qualified buyers." Some potential business sellers find this phrase almost hypnotic. It congers visions of this group of well funded, anxious buyers who can't wait to pay a generous price the moment they are made aware of this great opportunity.
For the larger business owners that are interviewing M&A firms, this "qualified buyers" claim deserves a careful investigation. These M&A firms have lists of hundreds of private equity firms with their buying criteria, business size requirements, minimum revenue and EBITDA levels and industry preferences. All M&A firms have pretty much the same list. There are subscription databases available to anyone. The better M&A firms have refined these lists and entered them into a good contact management system so they are more easily searchable.
The approach these M&A firms with these Private Equity lists employ is to blast an email profile to their list and if they get an immediate and robust response, they will focus on the deal and work the deal. What happens to the 90% of sale transactions that clearly do not fit either the minimum EBITDA and revenue requirements or the conservative valuations of this group of buyers?
Those deals requiring contact with strategic industry buyers usually go into dormant status. They will not be actively worked, but will occasionally be presented in another email campaign, mail campaign or at a private equity deal mart (industry meeting where many M&A firms present their clients to several PEG's).
For the business owner that has paid a substantial up front engagement fee or healthy monthly fees, this is not what you had in mind. The way to get a business sold is to reach the strategic industry buyers. That is not easy. Presidents of companies (the buyer decision maker) do not open mail from an unknown party. So, mailings do not work. Let me repeat that. In a merger and acquisition transaction, mailings do not work.
Presidents of companies do everything possible to keep their email addresses confidential, so email blasts on a broad scale are not possible. Telemarketers are not skilled enough to pass through the voice mail and assistant screening gauntlet. If you have ever tried to present an acquisition opportunity to IBM, Microsoft, Google, Hewlett-Packard or Apple, let's just say it would be easier to get into a castle with a moat full of alligators.
The investment bankers from Morgan Stanley or Goldman Sachs can generally get an audience with any major CEO. However, the fees they charge limit their clientele to businesses with north of $1 billion in revenues. So how do $15 million in revenue businesses get sold? You need to locate a boutique M&A firm that will provide a Wall Street style, active selling process at a size appropriate fee structure.
What does this mean? The approach that consistently produces a high percentage of completed transactions is the most labor intensive and costs the most to deliver. It is an old fashioned, IBM, dialing for dollars effort, starting at the presidential level of the targeted strategic buyers. It usually takes ten phone dials and a great deal of finesse to penetrate the gauntlet and get a forty five second credibility opportunity with the right contact.
If you are able to pass that test and establish their interest, you ask them for their email address so you can send them the blind profile (two page business summary without the company identity) and confidentiality agreement. This is a qualifying test. The president will not give you their email address unless they are serious about the company you have described for sale. If the president is not the appropriate contact, his assistant will generally direct you to the correct party. When that happens, we update our contact management database with this information so on the next M&A engagement we go directly to the proper contact.
Our first engagement in an industry requires a great deal of this discovery process. With each subsequent engagement in an industry, we become increasingly efficient and improve our credibility and brand awareness. There is generally an advantage to engaging an M&A firm that has experience in your industry. After several transactions in a niche, we become that more efficient and effective. Our list truly becomes a list of "qualified buyers."
For example, by our fourth engagement in healthcare information technology, we know the specialty of the top 300 players, we know the lead on M&A deals, we know his direct dial number, email address, and most importantly he knows us.
So, on engagement four in XYZ industry, we put together the blind profile and confidentiality agreement. We get our seller client to approve our list of targeted buyer prospects. We generate our daily hot list of the 20 contacts we will call. We either talk with them directly of leave a voice mail asking them to watch their email for our acquisition opportunity. Our open rates and response rates go up by a factor of 10 X with this labor intensive approach.
Having credibility and brand awareness in an industry helps because we ask them in the email to reply back if they are not interested. We can then update their status on this deal and not continue to try to contact them.
When they are interested, they sign and return the confidentiality agreement. We then email them the Confidential Acquisition Memorandum (the Book). We enter a hot list follow-up in 5 business days. If they remain interested, they will generally have a list of questions they send us. We work with our clients to provide a written response and update the memorandum with a fluid FAQ section that is constantly updated with each interested buyer. This saves us and our clients a great deal of time answering questions only one time.
We have incorporated our FAQ list into our marketing process very effectively. Any time we provide a written response to a buyer, we update the book and we update a stand-alone FAQ document. This FAQ document contains all the questions in date order from all of the buyers. Every time we update the list with new questions, we send it out to every buyer that has previously executed the confidentiality agreement.
Here is our not so subtle message to the buyers, "You are not the only buyer involved in this process." The impact is amazing. The buyers behave much better and they move the process forward at a better pace than they normally would.
Once a buyer's questions are answered, we usually arrange a conference call and Web Demo if appropriate. If the buyer remains interested, we then arrange a buyer visit. This is prepared with the seller as we coach him on what questions to expect and what message he needs to convey.
We also carefully orchestrate the rules and regulations of the visit with both buyer and seller including the visit premise so the employees do not get worried or suspicious. It could be a new banking relationship, an insurance company, or a strategic alliance.
If the buyer remains interested, they may ask for some much more detailed information. At a certain point we have to draw the line on information flow and push for a qualified letter of intent, LOI. In general a LOI says that if we carefully examine your books and records in a due diligence process and confirm everything you have told us so far and discover no materially adverse items, we will pay you $xx for your company with these deal terms and this transaction structure.
In return for that, the buyer will usually require a quiet period. That means that for the due diligence period – usually 30 to 60 days, the M&A advisors are precluded from shopping the deal any further to other potential buyers. This is also called a standstill. If the due diligence is completed without major incident, the buyer's team starts preparing the definitive purchase agreement.
Buyers will often try to misbehave during this process and attack the transaction value with each little nit they uncover. Because we have provided ample reminders to the buyer that there are other interested and qualified buyers involved (remember the FAQ's), we generally are able to discourage this costly behavior.
Once the due diligence is completed, the buyer's team starts preparing the definitive purchase agreement. This is quite detailed and restates the deal terms and conditions and surrounds that with pages of reps and warranties. The business people refine and negotiate the business points while the respective legal teams negotiate the legal points. If there is an impasse, the top business person on each side generally attempts to balance the risk reward legal issue with sound business judgment.
We are almost there. A closing date is set and the parties usually convene in the conference room of the buyer's or seller's outside counsel. The stacks of contracts are reviewed one final time by counsel and the signors walk around the table, adding their signatures. The banker is called and the order is given, "wire the funds." Mission accomplished.
As a business seller, you must recognize that a business sale is a very difficult process. The closing ratios for many of the bigger middle market firms is well below 50%. Our feeling is that the more passive mailing campaign, Private Equity email blast, approach is simply a model that no longer works in this busy, information overload world of the large company CEO.
Think about Oracle trying to sell a $500,000 software project to Fortune 500 companies with a mailing. What about IBM selling a large company on a 10-year $150 million data center outsourcing project with an email blast?
This sounds pretty silly when you think of it. Of course they do not do that. They have highly trained, highly compensated, and highly skilled salesmen that call at the highest levels of corporate America and present the strategic case for their complex and expensive offering. These companies are the best at what they do and understand what it takes to maximize their performance. With a business sale, you have the same type of highly complex, strategic, and expensive proposition. What makes you think that your business sale will be accomplished by any other process than a direct sales approach by highly trained M&A professionals calling on the presidents of the buying companies?
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
If you are a business owner considering selling your business, most likely you will interview several business brokers or merger and acquisition advisors. In the process you might hear, "We have lists of qualified buyers." Some potential business sellers find this phrase almost hypnotic. It congers visions of this group of well funded, anxious buyers who can't wait to pay a generous price the moment they are made aware of this great opportunity.
For the larger business owners that are interviewing M&A firms, this "qualified buyers" claim deserves a careful investigation. These M&A firms have lists of hundreds of private equity firms with their buying criteria, business size requirements, minimum revenue and EBITDA levels and industry preferences. All M&A firms have pretty much the same list. There are subscription databases available to anyone. The better M&A firms have refined these lists and entered them into a good contact management system so they are more easily searchable.
The approach these M&A firms with these Private Equity lists employ is to blast an email profile to their list and if they get an immediate and robust response, they will focus on the deal and work the deal. What happens to the 90% of sale transactions that clearly do not fit either the minimum EBITDA and revenue requirements or the conservative valuations of this group of buyers?
Those deals requiring contact with strategic industry buyers usually go into dormant status. They will not be actively worked, but will occasionally be presented in another email campaign, mail campaign or at a private equity deal mart (industry meeting where many M&A firms present their clients to several PEG's).
For the business owner that has paid a substantial up front engagement fee or healthy monthly fees, this is not what you had in mind. The way to get a business sold is to reach the strategic industry buyers. That is not easy. Presidents of companies (the buyer decision maker) do not open mail from an unknown party. So, mailings do not work. Let me repeat that. In a merger and acquisition transaction, mailings do not work.
Presidents of companies do everything possible to keep their email addresses confidential, so email blasts on a broad scale are not possible. Telemarketers are not skilled enough to pass through the voice mail and assistant screening gauntlet. If you have ever tried to present an acquisition opportunity to IBM, Microsoft, Google, Hewlett-Packard or Apple, let's just say it would be easier to get into a castle with a moat full of alligators.
The investment bankers from Morgan Stanley or Goldman Sachs can generally get an audience with any major CEO. However, the fees they charge limit their clientele to businesses with north of $1 billion in revenues. So how do $15 million in revenue businesses get sold? You need to locate a boutique M&A firm that will provide a Wall Street style, active selling process at a size appropriate fee structure.
What does this mean? The approach that consistently produces a high percentage of completed transactions is the most labor intensive and costs the most to deliver. It is an old fashioned, IBM, dialing for dollars effort, starting at the presidential level of the targeted strategic buyers. It usually takes ten phone dials and a great deal of finesse to penetrate the gauntlet and get a forty five second credibility opportunity with the right contact.
If you are able to pass that test and establish their interest, you ask them for their email address so you can send them the blind profile (two page business summary without the company identity) and confidentiality agreement. This is a qualifying test. The president will not give you their email address unless they are serious about the company you have described for sale. If the president is not the appropriate contact, his assistant will generally direct you to the correct party. When that happens, we update our contact management database with this information so on the next M&A engagement we go directly to the proper contact.
Our first engagement in an industry requires a great deal of this discovery process. With each subsequent engagement in an industry, we become increasingly efficient and improve our credibility and brand awareness. There is generally an advantage to engaging an M&A firm that has experience in your industry. After several transactions in a niche, we become that more efficient and effective. Our list truly becomes a list of "qualified buyers."
For example, by our fourth engagement in healthcare information technology, we know the specialty of the top 300 players, we know the lead on M&A deals, we know his direct dial number, email address, and most importantly he knows us.
So, on engagement four in XYZ industry, we put together the blind profile and confidentiality agreement. We get our seller client to approve our list of targeted buyer prospects. We generate our daily hot list of the 20 contacts we will call. We either talk with them directly of leave a voice mail asking them to watch their email for our acquisition opportunity. Our open rates and response rates go up by a factor of 10 X with this labor intensive approach.
Having credibility and brand awareness in an industry helps because we ask them in the email to reply back if they are not interested. We can then update their status on this deal and not continue to try to contact them.
When they are interested, they sign and return the confidentiality agreement. We then email them the Confidential Acquisition Memorandum (the Book). We enter a hot list follow-up in 5 business days. If they remain interested, they will generally have a list of questions they send us. We work with our clients to provide a written response and update the memorandum with a fluid FAQ section that is constantly updated with each interested buyer. This saves us and our clients a great deal of time answering questions only one time.
We have incorporated our FAQ list into our marketing process very effectively. Any time we provide a written response to a buyer, we update the book and we update a stand-alone FAQ document. This FAQ document contains all the questions in date order from all of the buyers. Every time we update the list with new questions, we send it out to every buyer that has previously executed the confidentiality agreement.
Here is our not so subtle message to the buyers, "You are not the only buyer involved in this process." The impact is amazing. The buyers behave much better and they move the process forward at a better pace than they normally would.
Once a buyer's questions are answered, we usually arrange a conference call and Web Demo if appropriate. If the buyer remains interested, we then arrange a buyer visit. This is prepared with the seller as we coach him on what questions to expect and what message he needs to convey.
We also carefully orchestrate the rules and regulations of the visit with both buyer and seller including the visit premise so the employees do not get worried or suspicious. It could be a new banking relationship, an insurance company, or a strategic alliance.
If the buyer remains interested, they may ask for some much more detailed information. At a certain point we have to draw the line on information flow and push for a qualified letter of intent, LOI. In general a LOI says that if we carefully examine your books and records in a due diligence process and confirm everything you have told us so far and discover no materially adverse items, we will pay you $xx for your company with these deal terms and this transaction structure.
In return for that, the buyer will usually require a quiet period. That means that for the due diligence period – usually 30 to 60 days, the M&A advisors are precluded from shopping the deal any further to other potential buyers. This is also called a standstill. If the due diligence is completed without major incident, the buyer's team starts preparing the definitive purchase agreement.
Buyers will often try to misbehave during this process and attack the transaction value with each little nit they uncover. Because we have provided ample reminders to the buyer that there are other interested and qualified buyers involved (remember the FAQ's), we generally are able to discourage this costly behavior.
Once the due diligence is completed, the buyer's team starts preparing the definitive purchase agreement. This is quite detailed and restates the deal terms and conditions and surrounds that with pages of reps and warranties. The business people refine and negotiate the business points while the respective legal teams negotiate the legal points. If there is an impasse, the top business person on each side generally attempts to balance the risk reward legal issue with sound business judgment.
We are almost there. A closing date is set and the parties usually convene in the conference room of the buyer's or seller's outside counsel. The stacks of contracts are reviewed one final time by counsel and the signors walk around the table, adding their signatures. The banker is called and the order is given, "wire the funds." Mission accomplished.
As a business seller, you must recognize that a business sale is a very difficult process. The closing ratios for many of the bigger middle market firms is well below 50%. Our feeling is that the more passive mailing campaign, Private Equity email blast, approach is simply a model that no longer works in this busy, information overload world of the large company CEO.
Think about Oracle trying to sell a $500,000 software project to Fortune 500 companies with a mailing. What about IBM selling a large company on a 10-year $150 million data center outsourcing project with an email blast?
This sounds pretty silly when you think of it. Of course they do not do that. They have highly trained, highly compensated, and highly skilled salesmen that call at the highest levels of corporate America and present the strategic case for their complex and expensive offering. These companies are the best at what they do and understand what it takes to maximize their performance. With a business sale, you have the same type of highly complex, strategic, and expensive proposition. What makes you think that your business sale will be accomplished by any other process than a direct sales approach by highly trained M&A professionals calling on the presidents of the buying companies?
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
Saturday, February 28, 2009
Selling Your Business - We Have Qualified Buyers
When business owners interview merger and acquisition firms to sell their business, they are often pitched, "We have lists of qualified buyers." Well, there are lists and there are lists. This post will help you determine which firm to hire based on their list.
If you are a business owner considering selling your business most likely you will interview several business brokers or merger and acquisition advisors. In the process you might hear, "We have lists of qualified buyers." Some potential business sellers find this phrase almost hypnotic. It congers visions of this group of well funded, anxious buyers who can't wait to pay a generous price the moment they are made aware of this great opportunity.
Let's lift up the covers and look a little closer. If this is a business broker who handles main street type businesses like convenience stores, dry cleaners, salons, and restaurants, he is typically selling to an individual who is buying a job. If the broker is one that does not charge an up-front or a monthly engagement fee, he is agreeing to work for a success fee only.
To improve their odds of getting some success fees these contingent fee brokers take on dozens of clients.With dozens of clients, the broker can't really afford to engage in the labor intensive M&A process. Instead he can only list the business. Listing would include posting it on several "business for sale" web sites, placing an ad in the business opportunities section of the paper and putting the word out to his network of professional contacts and lists of "qualified buyers".
These lists are the result of capturing the contact information from individual buyers that resulted from years of this passive listing process.
They have lists because these people almost never buy. Here is why. The business has to be priced low enough and generate enough cash so that it will provide debt coverage (assuming the business has enough hard assets to collateralize a loan), provide a generous return for the buyer's equity, and finally exceed their career high salary when they worked for the fortune 500 employer. On top of that, the business should have a healthy growth rate and not be in a commodity type of business.
The business brokers do qualify these buyers by requiring them to complete a financial disclosure form and a confidentiality agreement. They make sure they have some money, but they have no way of qualifying whether they will actually part with that money. Individual buyers typically pay the lowest valuation multiples when they do buy a business.
For the larger business owners that are interviewing M&A firms, this "qualified buyers" claim takes on a different meaning. These M&A firms have lists of hundreds of private equity firms with their buying criteria, business size requirements, minimum revenue and EBITDA levels and industry preferences.
All M&A firms have pretty much the same list. There are subscription databases available to anyone. The better M&A firms have refined these lists and entered them into a good contact management system so they are more easily searchable.
The approach these M&A firms with these Private Equity lists employ is to blast an email profile to their list and if they get an immediate and robust response, they will focus on the deal and work the deal. What happens to the 90% of sale transactions that clearly do not fit either the minimum EBITDA and revenue requirements or the conservative valuations of this group of buyers? Those deals requiring contact with strategic industry buyers usually go into dormant status. They will not be actively worked, but will occasionally be presented in another email campaign, mail campaign or at a private equity deal mart (industry meeting where many M&A firms present their clients to several PEG's).
For the business owner that has paid a substantial up front engagement fee or healthy monthly fees, this is not what you had in mind. The way to get a business sold is to reach the strategic industry buyers. That is not easy. Presidents of companies (the buyer decision maker) do not open mail from an unknown party. So, mailings do not work. Let me repeat that. In a merger and acquisition transaction, mailings do not work.
Presidents of companies do everything possible to keep their email addresses confidential, so email blasts on a broad scale are not possible. Telemarketers are not skilled enough to pass through the voice mail and assistant screening gauntlet. If you have ever tried to present an acquisition opportunity to IBM, Microsoft, Google, Hewlett-Packard or Apple, let's just say it would be easier to get into a castle with a moat full of alligators.
The investment bankers from Morgan Stanley or Goldman Sachs can generally get an audience with any major CEO. However, the fees they charge limit their clientele to businesses with north of $1 billion in revenues. So how do $15 million in revenue businesses get sold? You need to locate a boutique M&A firm that will provide a Wall Street style active selling process at a size appropriate fee structure.
What does this mean? The approach that consistently produces a high percentage of completed transactions is the most labor intensive and costs the most to deliver. It is an old fashioned, IBM, dialing for dollars effort, starting at the presidential level of the targeted strategic buyers. It usually takes ten phone dials and a great deal of finesse to penetrate the gauntlet and get a forty five second credibility opportunity with the right contact.
If you are able to pass that test and establish their interest, you ask them for their email address so you can send them the blind profile (two page business summary without the company identity) and confidentiality agreement. This is a qualifying test. The president will not give you their email address unless they have real interest and you have established your professional credibility.
If the president is not the appropriate contact, his assistant will generally direct you to the correct party. When that happens, we update our contact management database with this information so on the next M&A engagement we go directly to the proper contact.
Our first engagement in an industry requires a great deal of this discovery process. With each subsequent engagement in an industry, we become increasingly efficient and improve our credibility and brand awareness. There is generally an advantage of engaging an M&A firm that has experience in your industry. After several transactions in a niche, we become that more efficient and effective. Our list truly becomes a list of "qualified buyers."
For example, by our fourth engagement in healthcare information technology, we know the specialty of the top 300 players, we know the lead on M&A deals, we know his direct dial number, email address, and most importantly he knows us.
So there are lists of qualified buyers and there are lists of qualified buyers. When selling your business, make sure that you engage a firm that truly has a list of qualified buyers.
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
If you are a business owner considering selling your business most likely you will interview several business brokers or merger and acquisition advisors. In the process you might hear, "We have lists of qualified buyers." Some potential business sellers find this phrase almost hypnotic. It congers visions of this group of well funded, anxious buyers who can't wait to pay a generous price the moment they are made aware of this great opportunity.
Let's lift up the covers and look a little closer. If this is a business broker who handles main street type businesses like convenience stores, dry cleaners, salons, and restaurants, he is typically selling to an individual who is buying a job. If the broker is one that does not charge an up-front or a monthly engagement fee, he is agreeing to work for a success fee only.
To improve their odds of getting some success fees these contingent fee brokers take on dozens of clients.With dozens of clients, the broker can't really afford to engage in the labor intensive M&A process. Instead he can only list the business. Listing would include posting it on several "business for sale" web sites, placing an ad in the business opportunities section of the paper and putting the word out to his network of professional contacts and lists of "qualified buyers".
These lists are the result of capturing the contact information from individual buyers that resulted from years of this passive listing process.
They have lists because these people almost never buy. Here is why. The business has to be priced low enough and generate enough cash so that it will provide debt coverage (assuming the business has enough hard assets to collateralize a loan), provide a generous return for the buyer's equity, and finally exceed their career high salary when they worked for the fortune 500 employer. On top of that, the business should have a healthy growth rate and not be in a commodity type of business.
The business brokers do qualify these buyers by requiring them to complete a financial disclosure form and a confidentiality agreement. They make sure they have some money, but they have no way of qualifying whether they will actually part with that money. Individual buyers typically pay the lowest valuation multiples when they do buy a business.
For the larger business owners that are interviewing M&A firms, this "qualified buyers" claim takes on a different meaning. These M&A firms have lists of hundreds of private equity firms with their buying criteria, business size requirements, minimum revenue and EBITDA levels and industry preferences.
All M&A firms have pretty much the same list. There are subscription databases available to anyone. The better M&A firms have refined these lists and entered them into a good contact management system so they are more easily searchable.
The approach these M&A firms with these Private Equity lists employ is to blast an email profile to their list and if they get an immediate and robust response, they will focus on the deal and work the deal. What happens to the 90% of sale transactions that clearly do not fit either the minimum EBITDA and revenue requirements or the conservative valuations of this group of buyers? Those deals requiring contact with strategic industry buyers usually go into dormant status. They will not be actively worked, but will occasionally be presented in another email campaign, mail campaign or at a private equity deal mart (industry meeting where many M&A firms present their clients to several PEG's).
For the business owner that has paid a substantial up front engagement fee or healthy monthly fees, this is not what you had in mind. The way to get a business sold is to reach the strategic industry buyers. That is not easy. Presidents of companies (the buyer decision maker) do not open mail from an unknown party. So, mailings do not work. Let me repeat that. In a merger and acquisition transaction, mailings do not work.
Presidents of companies do everything possible to keep their email addresses confidential, so email blasts on a broad scale are not possible. Telemarketers are not skilled enough to pass through the voice mail and assistant screening gauntlet. If you have ever tried to present an acquisition opportunity to IBM, Microsoft, Google, Hewlett-Packard or Apple, let's just say it would be easier to get into a castle with a moat full of alligators.
The investment bankers from Morgan Stanley or Goldman Sachs can generally get an audience with any major CEO. However, the fees they charge limit their clientele to businesses with north of $1 billion in revenues. So how do $15 million in revenue businesses get sold? You need to locate a boutique M&A firm that will provide a Wall Street style active selling process at a size appropriate fee structure.
What does this mean? The approach that consistently produces a high percentage of completed transactions is the most labor intensive and costs the most to deliver. It is an old fashioned, IBM, dialing for dollars effort, starting at the presidential level of the targeted strategic buyers. It usually takes ten phone dials and a great deal of finesse to penetrate the gauntlet and get a forty five second credibility opportunity with the right contact.
If you are able to pass that test and establish their interest, you ask them for their email address so you can send them the blind profile (two page business summary without the company identity) and confidentiality agreement. This is a qualifying test. The president will not give you their email address unless they have real interest and you have established your professional credibility.
If the president is not the appropriate contact, his assistant will generally direct you to the correct party. When that happens, we update our contact management database with this information so on the next M&A engagement we go directly to the proper contact.
Our first engagement in an industry requires a great deal of this discovery process. With each subsequent engagement in an industry, we become increasingly efficient and improve our credibility and brand awareness. There is generally an advantage of engaging an M&A firm that has experience in your industry. After several transactions in a niche, we become that more efficient and effective. Our list truly becomes a list of "qualified buyers."
For example, by our fourth engagement in healthcare information technology, we know the specialty of the top 300 players, we know the lead on M&A deals, we know his direct dial number, email address, and most importantly he knows us.
So there are lists of qualified buyers and there are lists of qualified buyers. When selling your business, make sure that you engage a firm that truly has a list of qualified buyers.
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist
Sunday, January 25, 2009
We Have Qualified Buyers for Your Business
A business owner client that is selling her business handed me a letter she received from a competitor telling her that he had a buyer for her business. This post explores this unfortunate bad practice in the business broker industry.
We were just concluding our first information gathering meeting with a new client who had engaged us to sell her business when she handed us a letter. That letter was from another Merger and Acquisition Advisory or Business Broker firm.
The letter began: "Our buyer group has requested that our firm assist them in locating a company within your industry that would be willing to sell their business. The limited information we have regarding your firm indicates that your business may meet the buyer's requirements. We would like to speak with you further about the opportunity to sell your business."
Our new client asked us what we thought about this letter given that her company was very unique and she did not believe that this company really understood what her business did. As I read the letter, my suspicions were confirmed. This unfortunate practice of soliciting business owners through mass mailing representing supposed buyers gives our profession a real black eye. I don't know where this practice started, but many in the business broker profession have unfortunately been taught that this is a valid way to prospect for sell side engagements.
Here is how it works. If the business owner responds to the solicitation, the business broker schedules an appointment to meet with the business owner. When the broker shows up, one or two things happen. If he says he is representing an industry buyer, somehow the potential selling company just is not a fit. It is either too small, not growing fast enough, in a slightly different niche, doesn't have big enough gross profit margin, etc., etc.
Another approach is to say that he is representing a Private Equity Buyer.
Let me tell you, everyone in our profession could claim that. Our firm gets 5 solicitations per week from Private Equity Buyers. The typical email reads: ……………..should you have any clients or prospects who fit this criteria and our investment parameters below, we certainly would be interested in discussing them with you:
– New investments: $20+ million in revenue, $3+ million in EBITDA
– Add-on acquisitions: $3+ million in revenue
– Investment size: $8 – $50 million
– Geography: U.S. and Canada
– Industry generalist
With that broad criteria and the industry agnostic approach, thousands of businesses could qualify. There are a couple of problems here. First, Private Equity Firms almost never engage an M&A firm on a retainer and success fee basis. In other words, if the M&A firm will go out and find prospects on their own dime and bring those prospects to the PEG, and a deal is closed, then the PEG will pay the M&A firm a success fee. It is entirely a contingency based model. So for an M&A firm or business broker to call one of these PEGs a buyer client is a bit of a stretch. Also, PEG's are strictly financial buyers, so if you want more for your company than 5 X EBITDA you are not going to get it from these buyers.
Let's get back to our client's letter. As I read further, it continued, "The Acme Business Group has over 80 years of combined experience in business brokerage and is an affiliate of America's largest network of business brokers. As a result, we can give your business confidential exposure to these qualified buyers locally and nationwide. We can help prepare your business for sale with the proper documentation and an effective presentation that will position your company most advantageously to receive the highest offer from one of our potential buyers. We are here to assist through the entire selling process from preparation to negotiation to closing documentation."
Gee, it sounds like their original "qualified buyer" has fallen through before the end of the letter and they now want to represent you to all of the other buyers out there that are right at their fingertips or at the fingertips of their large, nationwide affiliate network. Get real!
As a business owner, you probably get one or two of these letters per month. Hopefully you will see through them and put them in their proper place, the waste basket. Unfortunately for the Merger and Acquisition advisors that really do have a retainer fee based legitimate buy side engagement, we have an extra hurdle to clear in order to do our job. The approach that our firm uses to overcome a very skeptical business owner community is to provide a very specific description of the target company in our buy side engagement agreement.
For example, our agreement might read, " The purpose of this agreement is to set forth the terms and conditions under which MidMarket Capital, Inc. ("MMC") agrees to advise Acme Machine Tool and/or its owners, shareholders and affiliates (collectively, "Clients") as consultant, and the sole and exclusive finder, in an effort to locate acquisition targets, described as machine tool manufacturers for the medical device industry with revenues between $20 million and $100 million, and effect the purchase or merger of the identified acquisition target’s business."
If we get interest, but a healthy dose of skepticism from the target company owner we are contacting, we often send him our buy side engagement agreement with the identity and specific contractual terms blacked out. We leave enough of the signature visible so that they can see that it is a real contract, but cannot determine the identity of the client. This generally works to at least begin a dialogue and move to the next step.
Selling a business is not easy and your choice of the firm that you use to represent you can be the difference between a successful outcome and a big waste of time surrounded by a lot of frustration. My hope is that a lot of business owners read this article and reject this unfortunate business process. As I tell our associates, "What a client sees before the sale is what they can expect after the sale." The sale here is selling the business owner on engaging the Merger and Acquisition Advisory firm. Do you really think a firm that approaches clients with this lack of integrity deserves to get 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
We were just concluding our first information gathering meeting with a new client who had engaged us to sell her business when she handed us a letter. That letter was from another Merger and Acquisition Advisory or Business Broker firm.
The letter began: "Our buyer group has requested that our firm assist them in locating a company within your industry that would be willing to sell their business. The limited information we have regarding your firm indicates that your business may meet the buyer's requirements. We would like to speak with you further about the opportunity to sell your business."
Our new client asked us what we thought about this letter given that her company was very unique and she did not believe that this company really understood what her business did. As I read the letter, my suspicions were confirmed. This unfortunate practice of soliciting business owners through mass mailing representing supposed buyers gives our profession a real black eye. I don't know where this practice started, but many in the business broker profession have unfortunately been taught that this is a valid way to prospect for sell side engagements.
Here is how it works. If the business owner responds to the solicitation, the business broker schedules an appointment to meet with the business owner. When the broker shows up, one or two things happen. If he says he is representing an industry buyer, somehow the potential selling company just is not a fit. It is either too small, not growing fast enough, in a slightly different niche, doesn't have big enough gross profit margin, etc., etc.
Another approach is to say that he is representing a Private Equity Buyer.
Let me tell you, everyone in our profession could claim that. Our firm gets 5 solicitations per week from Private Equity Buyers. The typical email reads: ……………..should you have any clients or prospects who fit this criteria and our investment parameters below, we certainly would be interested in discussing them with you:
– New investments: $20+ million in revenue, $3+ million in EBITDA
– Add-on acquisitions: $3+ million in revenue
– Investment size: $8 – $50 million
– Geography: U.S. and Canada
– Industry generalist
With that broad criteria and the industry agnostic approach, thousands of businesses could qualify. There are a couple of problems here. First, Private Equity Firms almost never engage an M&A firm on a retainer and success fee basis. In other words, if the M&A firm will go out and find prospects on their own dime and bring those prospects to the PEG, and a deal is closed, then the PEG will pay the M&A firm a success fee. It is entirely a contingency based model. So for an M&A firm or business broker to call one of these PEGs a buyer client is a bit of a stretch. Also, PEG's are strictly financial buyers, so if you want more for your company than 5 X EBITDA you are not going to get it from these buyers.
Let's get back to our client's letter. As I read further, it continued, "The Acme Business Group has over 80 years of combined experience in business brokerage and is an affiliate of America's largest network of business brokers. As a result, we can give your business confidential exposure to these qualified buyers locally and nationwide. We can help prepare your business for sale with the proper documentation and an effective presentation that will position your company most advantageously to receive the highest offer from one of our potential buyers. We are here to assist through the entire selling process from preparation to negotiation to closing documentation."
Gee, it sounds like their original "qualified buyer" has fallen through before the end of the letter and they now want to represent you to all of the other buyers out there that are right at their fingertips or at the fingertips of their large, nationwide affiliate network. Get real!
As a business owner, you probably get one or two of these letters per month. Hopefully you will see through them and put them in their proper place, the waste basket. Unfortunately for the Merger and Acquisition advisors that really do have a retainer fee based legitimate buy side engagement, we have an extra hurdle to clear in order to do our job. The approach that our firm uses to overcome a very skeptical business owner community is to provide a very specific description of the target company in our buy side engagement agreement.
For example, our agreement might read, " The purpose of this agreement is to set forth the terms and conditions under which MidMarket Capital, Inc. ("MMC") agrees to advise Acme Machine Tool and/or its owners, shareholders and affiliates (collectively, "Clients") as consultant, and the sole and exclusive finder, in an effort to locate acquisition targets, described as machine tool manufacturers for the medical device industry with revenues between $20 million and $100 million, and effect the purchase or merger of the identified acquisition target’s business."
If we get interest, but a healthy dose of skepticism from the target company owner we are contacting, we often send him our buy side engagement agreement with the identity and specific contractual terms blacked out. We leave enough of the signature visible so that they can see that it is a real contract, but cannot determine the identity of the client. This generally works to at least begin a dialogue and move to the next step.
Selling a business is not easy and your choice of the firm that you use to represent you can be the difference between a successful outcome and a big waste of time surrounded by a lot of frustration. My hope is that a lot of business owners read this article and reject this unfortunate business process. As I tell our associates, "What a client sees before the sale is what they can expect after the sale." The sale here is selling the business owner on engaging the Merger and Acquisition Advisory firm. Do you really think a firm that approaches clients with this lack of integrity deserves to get 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, January 20, 2009
10 Signs That it is Time to Sell the Family Business
Watch this 7 minute video on some warning signs that indicate it is time to sell the family business. http://www.youtube.com/watch?v=x3T8xYJL678
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
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 02, 2009
Sell Your Business – 10 Keys to a Successful Exit
This 8 minute video explores the 10 things business owners should do in advance of selling their companies.
http://www.youtube.com/watch?v=R6xdTkDrUyU
Please provide any feedback on how effective this medium is in helping communicate our message. Thanks,
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
http://www.youtube.com/watch?v=R6xdTkDrUyU
Please provide any feedback on how effective this medium is in helping communicate our message. Thanks,
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
How You Sell Your Business Will Determine Its Selling Price
This YouTube Video is an 8 minute slide video on the wide differences in business selling price that result from different owner approaches to selling. Liquidation value is at the very low end and Strategic Buyers in a soft auction Merger and Acquisition Process will result in the highest selling price.
http://www.youtube.com/watch?v=PZ479pMCaq0
Please provide any feedback on the effectiveness of this approach to communicating our message. Thanks,
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
http://www.youtube.com/watch?v=PZ479pMCaq0
Please provide any feedback on the effectiveness of this approach to communicating our message. Thanks,
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
Ten Key Factors in Maximizing Your Business Selling Price
I am scaring myself with my tech wizardy. Check out our video slide presentation on YouTube
http://www.youtube.com/watch?v=SZ5VHmSh9Xg
I would appreciate any feedback on how effective this medium is in communicating our message.
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
http://www.youtube.com/watch?v=SZ5VHmSh9Xg
I would appreciate any feedback on how effective this medium is in communicating our message.
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
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