Wednesday, December 08, 2010

Selecting a Merger and Acquisition Advisor for the Sale of Your Business - The Request for Proposal

In my prior business experience in the information technology industry, it was a very common practice for potential buyers to submit a Request for Proposal in order to make a purchase decision. After several years as a Merger and Acquisition advisor, I finally got an RFP. A light bulb went off. This is the most important "purchase decision" a business owner will ever make, and yet the process of selecting an advisor in a multi million dollar transaction is generally less diligent than the purchase of a $200,000 software product.

I gave this a great deal of thought and came to a conclusion. These business owners are very smart and accomplished people, but they generally will only sell one business in their lifetime. They knew how to evaluate every other product or service relating to their business because they had made those purchase decisions multiple times over the years. It occurred to me that they did not have the experience to know the right questions to ask in order to objectively evaluate one M&A firm against another. Their instincts are generally pretty good, so in the selection process we normally go through, they bring in the 3 or 4 firms for presentations, check a few references and make a decision on a gut reaction.

The purpose of this article is to provide those business sellers that possess great instincts an additional tool to objectively compare Merger and Acquisition advisors by asking the right questions. Below is a sample RFP that should be helpful in your selection process:

Request For Proposal for the Merger and Acquisition Advisor
Sell Side Engagement for XYZ COMPANY, INC.


XYZ is an IT Services firm consisting of 3 divisions. The first provides contract maintenance and break fix maintenance for mid range systems and network components. The second division is an IBM Business Partner for mid-sized systems combined with consulting and professional services. Division 3 is a used equipment brokerage service. The company has been in business since 1995 and does about $25 million in revenue.

Approximate 2005 Revenues - $25 Million

Responding Company Name

Brief Company Description

Years in Business

Primary Contact Name for this Engagement

Phone Number
Email address
Company Address
Company Web Site

1. In the past 24 months what transactions have you completed?
Company Name Nature of Engagement Industry Description of Client
XYZ Company Sell Side Engagement Healthcare information technology

2. How many Investment Bankers work for your Firm?

3. Who would be working as the lead on my engagement? Please include Bio.
a. Include any professional designations i.e. Series 7, CBI
b. Include any industry associations i.e. IBBA, local business broker chapter M&A Source, etc.

4. Is your firm known for a particular industry niche? Transaction niche? Please describe.

5. What steps do you take to insure the confidentiality of the sale process?

6. Please Send a sample of your deliverables:
a. Blind Profile
b. Confidentiality Agreement or NDA
c. The Book, Memorandum or Executive Summary
d. If you do a mailing - typical contents

7. Describe your process of marketing your sell side engagement with a typical timeline from start to finish: i.e. day 1 sign engagement agreement, 1 Week submit first target database for approval, Week 2 submit draft of Profile/NDA for approval.............Confidentiality Agreements Signed, Executive Summary is completed, etc.

8. Describe the Marketing Process - is it posted on Internet Sites, emails, mailing campaign, direct telephone calls, etc

9. What is the profile of the "A Target" buyers for my company? Briefly describe.

10. If you have any client reference letters from the past 24 months, please include 2 or 3 in your package.

11. As one of our final selection criteria, will we be able to speak to references?

12. Detail your fees.
a. Up-front payments
b. Monthly fees
c. Minimum Cash at Close
d. Expenses
e. Other
f. In lieu of this, please submit your agreement with the fees as they would be set for this sell side engagement.

13. What is your philosophy on putting a price tag on my company?

14. Describe your process of keeping your client informed on the progress of the sale.
g. What reports do you submit to the client? Include samples please.
h. How often are reports submitted?

15. How will I know that I am getting the best price and terms if your firm represents my company for sale?

16. Does your contract call for exclusivity?

17. If I don't think you are doing a good job, what options do I have?

18. What about a "tail" on the agreement? If your firm is fired, what prospects carry a tail for fees to your firm? How long is the tail?

19. Please explain why your firm is the best fit for our sale engagement.

20. What are your thoughts about valuations for our company/industry.

21. What would your firm do in to advise us on improving on our transaction value?

The RFP responses are due by May 24. If you have any questions please email them to Please note that this is highly confidential and my employees are not to be made aware that we are considering the sale of our 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

Thursday, October 28, 2010


Selling your business is the most important business transaction you will ever make. Mistakes in this process can greatly erode your transaction proceeds. Do not spend twenty years of your toil and skill building your business like a pro only to exit like an amateur. Below are ten common mistakes to avoid:

1. Selling because of an unsolicited offer to buy - One of the most common reasons owners tell us they sold their business was they got an offer from a competitor. If they previously were not considering this business sale, the owner has probably not taken some important personal and business steps to exit on his terms. The business may have some easily correctable issues that could detract from its value. The owner may not have prepared for an identity and lifestyle to replace the void caused by his separation from his company. If you are prepared, you are more likely to exit on your own terms.

2. Poor books and records - Business owners wear many hats. Sometimes they become so focused on running the business that they are lax in financial record keeping. A buyer is going to do a comprehensive look into your financial records. If they are done poorly, the buyer loses confidence in what he is buying and his perception of risk increases. If he finds some negative surprises late in the process, the purchase price adjustments can be harsh. The transaction value is often attacked well beyond the economic impact of the surprise. Get a good accountant to do your books.

3. Going it alone - The business owner may be the foremost expert in his business, but it is likely that his business sale will be a once in a lifetime occurrence. Mistakes at this juncture have a huge impact. Do you understand the difference in after tax proceeds between an asset sale and a stock sale? Your everyday bookkeeper may not, but a tax accountant surely does. Is your business attorney familiar with business sales legal work? Would he advise you properly on Reps and Warranties that will be in the purchase agreement? Your buyer's team will have this experience. Your team should match that experience or it will cost you way more than their fees.

4. Skeletons in the closet - If your company has any, the due diligence process will surely reveal them. Before your firm is turned inside out and the buyer spends thousands in this process and before the other interested buyers are put on hold - reveal that problem up-front. We sold a company that had an outstanding CFO. In the first meeting with us, he told us of his company's under funded pension liability. We were able to bring the appropriate legal and actuarial resources to the table and give the buyer and his advisors plenty of notice to get their arms around the issue. If this had come up late in the process, the buyer might have blown up the deal or attacked transaction value for an amount far in excess of the potential liability.

5. Letting the word out - Confidentiality in the business sale process is crucial. If your competitors find out, they can cause a lot of damage to your customers and prospects. It can be a big drain on employee morale and productivity. Your suppliers and bankers get nervous. Nothing good happens when the word gets out that your company is for sale.

6. Poor Contracts - Here we mean the day-to-day contracts that are in place with employees, customers, contractors, and suppliers. Do your employees have non-competes, for example? If your company has intellectual property, do you have very clear ownership rights defined in your employee and contractor agreements. If not, you could be looking at meaningful escrow holdbacks post closing. Are your customer agreements assignable without consent? If they are not, customers could cancel post transaction. Your buyer will make you pay for this one way or another.

7. Bad employee behavior - You need to make sure you have agreements in place so that employees cannot hold you hostage on a pending transaction. Key employees are key to transaction value. If you suspect there are issues, you may want to implement stay on bonuses. If you have a bad actor, firing him or her during a transaction could cause issues. You may want to be pre-emptive with your buyer and minimize any damage your employee might cause.

8. No understanding of your company's value - Business valuations are complex. A good business broker or M & A advisor that has experience in your industry is your best bet. Business valuation firms are great for business valuations for gift and estate tax situations, divorce, etc. They tend to be very conservative and their results could vary significantly from your results from three strategic buyers in a battle to acquire your firm. When it comes to selling your company, let the competitive market provide a value.

9. Getting into an auction of one - This is a silly visual, but imagine a big auction hall at Sotheby's occupied by an auctioneer and one guy with an auction paddle. "Do I hear $5 million? Anybody $5.5 million?' The guy is sitting on his paddle. Pretty silly, right? And yet we hear countless stories about a competitor coming in with an unsolicited offer and after a little light negotiating the owner sells. Another common story is the owner tells his banker, lawyer, or accountant that he is considering selling. His well-meaning professional says, "I have another client that is in your business. I will introduce you." The next thing you know the business is sold. Believe me, these folks are buying your business at a big discount. That's not silly at all!

10. Giving away value in negotiations and due diligence - When selling your business, your objective is to get the best terms and conditions. I know this is a shocker, but the buyer is trying to pay as little as possible and he is trying to get contractual terms favorable to him. These goals are not compatible with yours. The buyer is going to fight hard on issues like total price, cash at close, earn outs, seller notes, reps and warranties, escrow and holdbacks, post closing adjustments, etc. If you get into a meet in the middle compromise negotiation, before you know it, your Big Mac is a Junior Cheeseburger. Due diligence has a dual purpose. The first is obviously to insure that the buyer knows exactly what he is paying for. The second is to attack transaction value with adjustments. Of course this happens after their LOI has sent the other bidders away for 30 to 60 days of exclusivity. If you don't have a good team of advisors, this can get expensive

As my dad used to say, there is no replacement for experience. Another saying is that when a man with money and no experience meets a man with experience, the man with the experience walks away with the money and the man with the money walks away with some experience. Keep this in mind when contemplating the sale of your business. It will likely be your first and only experience. Avoid these mistakes and make that experience a profitable one.

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

Monday, July 19, 2010

Thursday, June 24, 2010

Business Buyers are Valuation Experts

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

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

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


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


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


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

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

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

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

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

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

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

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

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

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

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

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

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

Monday, June 21, 2010

Bridging the Valuation Gap between Business Seller and Business Buyer

Statistics show that a surprisingly low percentage of businesses for sale actually sell during their first attempt. The major reason for that is the valuation gap between the buyers and the seller. This post discusses how that gap can be breached resulting in completed business sale transactions.

In an earlier article we discussed a survey that we did with the Business Broker and the Merger and Acquisition profession. 68.9% of respondents felt that their top challenge was dealing with their seller client's valuation expectations. This is the number one reason that, as one national Investment Banking firm estimates only 10% of businesses that are for sale will actually close within 3 years of going to market. That is a 90% failure rate.

As we look to improve the performance of our practice, we looked for ways to judge the valuation expectations and reasonableness of our potential client. A Mergers and Acquisitions firm that fails to complete the sale of a client, even if they charged an up-front or monthly fees, suffers a financial loss along with their client. Those fees are not enough to cover the amount of work devoted to these projects. We determined that having clients with reasonable value expectations was a key success factor.

We explored a number of options including preparing a mock letter of intent to present to the client after analyzing his business. This mock LOI included not only transaction value, but also the amount of cash at closing, earn outs, seller notes and any other factors we felt would be components of a market buyer offer. If you can believe it, that mock LOI was generally not well received. For example, one client was a service business and had no recurring revenue contracts in place. In other words, their next year's revenues had to be sold and delivered next year. Their assets were their people and their people walked out the door every night.

Our mock LOI included a deal structure that proposed 70% of transaction value would be based on a percentage of the next four years of revenue performance as an earn out payment. Our client was adamant that this structure would be a non-starter. Fast forward 9 months and 30 buyers that had signed Confidentiality Agreements and reviewed the Memorandum withdrew from the buying process. It was only after that level of market feedback was he willing to consider the message of the market.

We decided to eliminate this approach because the effect was to put us sideways with our client early in the Mergers and Acquisitions process. The clients viewed our attempted dose of reality as not being on their side. No one likes to hear that you have an ugly baby. We found the reaction from our clients almost that pronounced.

We tried probing into our clients' rationale for their valuation expectations and we would hear such comments as, "This is how much we need in order to retire and maintain our lifestyle," or, "I heard that Acme Consulting sold for 1 X revenues," or, "We invested $3 million in developing this product, so we should get at least $4.5 million."

My unspoken reaction to these comments is that the market doesn't care what you need to retire. It doesn't care how much you invested in the product. The market does care about valuation multiples, but timing, company characteristics and circumstances are all unique and different, when our client brings us an example of IBM bought XYZ Software Company for 2 X revenues so we should get 2X revenues.

It is simply not appropriate to draw a conclusion about your value when compared to an IBM acquired company. You have revenues of $6 million and they had $300 million in revenue, were in business for 28 years, had 2,000 installed customers, were cash flowing $85 million annually and are a recognized brand name. Larger companies carry a valuation premium compared to small companies.

When I say my unspoken reaction, please refer to my success with the mock LOI discussed earlier. So now we are on to Plan C in how to deal with this valuation gap between our seller clients and the buyers that we present. Plan C turned out to be a bust also. Our clients did not respond very favorable when in response to their statement of value expectations we asked, "Are you kidding me?" or "What are you smoking?"

This issue becomes even more difficult when the business is heavily based on intellectual property such as a software or information technology firm. There is much broader interpretation by the market than for more traditional bricks and mortar firms. With the asset based businesses we can present comparables that provide us and our clients a range of possibilities. If a business is to sell outside of the usual parameters, there must be some compelling value creator like a coveted customer list, proprietary intellectual property, unusual profitability, rapid growth, significant barriers to entry, or something that is not easily duplicated.

For an information technology, computer technology, or healthcare company, comparables are helpful and are appropriate for gift and estate valuations, key man insurance, and for a starting point for a company sale. However, because the market often values these kinds of companies very generously in a competitive bid process, we recommend just that when trying to determine value in a company sale. The value is significantly impacted by the professional Mergers and Acquisitions process. In these companies where there can be broad interpretation of its value by the market it is essential to conduct the right process to unlock all of the value.

So you might be thinking, how do we handle value expectations in these technology based company situations? Now we are on to Plan D and I must admit it is a big improvement over Plan C (are you kidding)? The good news is that Plan D has the highest success rate. The bad news is that Plan D is the most difficult. We have determined that we as Mergers and Acquisitions professionals are not the right authority on our client's value, the market is.

After years of what are some of the most emotionally charged events in a business owner's life, we have determined that we must earn our credibility to fully gain his trust. If the client feels like his broker or investment banker is just trying to get him to accept the first deal so that the representative can earn his success fee, there will be no trust and probably no deal.

If the client sees his representatives bring multiple, qualified buyers to the table, present the opportunity intelligently and strategically, fight for value creation, and provide buyer feedback, that process creates credibility and trust. The client may not be totally satisfied with the value the market is communicating, but he should be totally satisfied that we have brought him the market. If we can get to that point, the likelihood of a completed transaction increases dramatically.

The client is now faced with a very difficult decision and a test of reasonableness. Can he interpret the market feedback, balance that against the potential disappointment resulting from his preconceived value expectations and complete a transaction?

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

Saturday, June 05, 2010

The Importance of Reasonableness When Selling Your Business

Sometimes business owners are their own worst enemies in the sale of their business. this post explores the importance of reasonableness for a business seller.

We recently completed a survey of a broad cross section of business brokers and merger and acquisition professionals. One of the questions we posed was, “What is the biggest challenge you face in your practice?” We gave them eight choices including lack of financing, sell side deal flow, not enough buyers, etc. We asked our professionals to pick their top three. The top answer was Seller Value Expectations with a 68.9% response rate. The next closest answer was sell side deal flow at 55.3%. Why is this the biggest challenge that our industry faces? To me this translates into a great deal of wasted effort on the part of our buyers, our seller clients, and our profession.

This is further exacerbated by the business sellers that expect a full business sale engagement with no monthly fees and the only payment in the form of a contingent success fee. A true professional M&A engagement includes preparation of blind profiles, confidentiality agreements, memorandum authoring, preparing a database of buyers, buyer contact, conference calls, buyer visits and negotiations. A typical business sale takes between 4-12 months and often involves from 500-1,000 hours of Investment Banker work.

Because deal flow is the second largest problem that the industry faces, many business brokers and merger and acquisition professionals will agree to this success fee only seller demand. I believe it was Rockefeller that said, “If it seems too good to be true, it probably is.” One of the large industry players estimates that the average business sale closing ratio is less than 10%. This is so important that I am going to say it again. The business sale closing ratio is less than 10%. It fails 90% of the time.

Let's look at the natural result of this dynamic. The business broker, if he is doing it the right way, is going through this very labor intensive process to contact buyers, get confidentiality agreements signed and bring qualified buyers to the table. Here is what typically happens. The owner is getting all of this work for free, has unreasonable value expectations and since he is not paying any fees, has no sense of urgency. The broker could bring in legitimate market offers that are fair and the owner says, “That is not nearly enough, you are doing fine, just keep going.”

Well it doesn't take a business broker too many situations like this before something has to change. The first thing that usually changes is that he now refuses to take on any engagements without an up-front payment or a monthly consulting fee to offset some of his costs in this low closing environment. What happens over the next year is that his deal flow totally dries up, because he is competing with those professionals that are still willing to operate with only a contingent success fee.
The next question is how do those brokers that operate on a contingency basis stay in business?

The simple answer is that they can no longer afford to perform a true M&A process. They take on a large number of clients and try to sell their business through newspaper ads, industry publication ads, email blasts to private equity groups, email blasts to other brokers and the favorite - putting the business on several business for sale Web Sites.

All of these approaches, with the exception of contacting private equity firms (about 1 % of businesses for sale meet their rigorous buying criteria) invite individual buyers, not corporate buyers. Individual buyers are looking to buy a job and to the extent that business sellers have inflated value expectations, these buyers have equally deflated valuation expectations. It looks something like this. Do you have the $XXX minimum needed for the cash at closing? No but I have investors. These investors never show up.

The individual's analysis follows this logic. Well, at the height of my career, I was making $150,000, so I am going to have to get at least that out of the business each year. Also, because this is high risk, the equity I put in will command a 25% return, and I have to cover the 75% of transaction value debt at 10%. So, by my calculation I can afford a price of 60% of what the true market value of the business is.

This gap is almost never bridged between business seller and individual buyer. And yet the approach most of the business broker profession is forced to take based on the unreasonable expectations of the sellers invites this dynamic. This is often hugely damaging to the seller's business. No matter how much he tries to focus on running his business, this stream of bargain hunters is a big drain. The business often suffers a significant drop in performance during this period, and like an overpriced home, often becomes stale in the process.

As the owner of a Main Street Business - bar, restaurant, salon, convenience store, gas station, etc. the economics and the likely universe of buyers really dictate this approach. Just be prepared for this process and at least have your non-paid broker screen out the totally unqualified buyers.

For owners of B2B type businesses and larger businesses, your buyer will not be an individual, but rather a corporation or a private equity group. Let's focus here on the corporate buyer. If the potential buyer is under $50 - $100 million in revenue, the M&A contact is usually the president. If the company is larger, it usually will have the initial deal vetting completed by the head of strategy, business development or mergers and acquisitions. Those people are not visiting business for sale Web Sites or searching the business opportunities section of the newspaper.

The business owner's first reasonableness hurdle is whether he/she recognizes that to reach these corporate buyers is a very difficult and labor intensive process and a firm that specializes in reaching these targeted buyers is the right choice to hire. These professionals normally require either an up-front fee or a monthly fee in addition to the contingent success fee.

Well, you did it. You interviewed several firms, checked references, felt comfortable with their process and felt confident with them as you partner for the next 6-9 months. Your M&A firm takes you to the market and gets several companies interested. You arrange multiple conference calls and corporate visits and then the subject of value comes into focus. This is where deals usually break down. There is a natural valuation gap between buyer and seller and the challenge becomes how to bridge that gap with both valuation and deal structure. The seller's reasonableness will be put to the test as he tries to balance his emotions with the ultimate arbiter of value, the marketplace. But that is the subject of a future post.

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, May 26, 2010

Achieving Strategic Value in the Sale of an Information Technology Company

One of the most challenging aspects of selling an information technology 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 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 .Net. 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. Next, 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, May 12, 2010

This ticks me off. Some web sites are taking my articles and generating gibberish. What is the purpose of this? See example. content

Wednesday, April 28, 2010

Selling Your Business - Why Use a Business Broker

Perhaps the most important business transaction you will ever pursue is the sale of your business. Many business owners attempt to do it themselves and when asked if they got a good deal, many respond with "I think so," or "I got my asking price," or "I really don't know," or "It was a disaster." Often times these very capable business people approach the sale of their business with less formality than in the sale of a home. The purpose of this post is to answer the questions - Why would I use a business broker and what am I getting for the fees I will pay?

1. Confidentiality. If an owner tries to sell his own business, that process alone reveals to the world that his business is for sale. Employees, customers, suppliers, and bankers all get nervous and competitors get predatory. The business broker protects the identity of the company he represents for sale with a process designed to contact only owner approved buyers with a blind profile – a document describing the company without revealing its identity. In order for the buyer to gain access to any sensitive information he must sign a confidentiality agreement. That generally eliminates the tire kickers and deters behaviors detrimental to the seller’s business

2. Business Continuity. Selling a business is a full time job. The business owner is already performing multiple functions instrumental to the success of his business. By taking on the load of selling his business, many of those essential functions will get less attention, sometimes causing irreparable damage to the business. The owner must maintain focus on running his business at its full potential while it is being sold.

3. Time to Close. Since the business broker’s function is to sell the business, he has a much better chance of closing a transaction faster than the owner. The faster the sale, the lower the risk of business erosion, customer defection, employee problems and predatory competition.

4. Large Universe of Buyers. Business brokers subscribe to databases of businesses that enable them to screen for buyers that are in a certain SIC Code and have revenues that would support the potential acquisition. In addition they maintain databases of high net worth individual buyers and have access to private equity groups databases that outline their buying criteria.

5. Marketing. A business broker can help present the business in its best light to maximize selling price. He understands how to recast financials to recognize the EBITDA potential post acquisition. Higher EBITDA = higher selling price. He understands the key value drivers for buyers and can help the owner identify changes that translate into enhanced selling price.

6. Valuation Knowledge. The value of a business is far more difficult to ascertain than the value of a house. Every business is unique and has hundreds of variables that effect value. Business brokers have access to business transaction databases, but those should be used as guidelines or reference points. The best way for a business owner to truly feel comfortable that he got the best deal is to have several financially viable parties bidding for his business. An industry database may indicate the value of your business based on certain valuation multiples, but the market provides the real answer. An industry database, for example, can not put a value to a particular buyer on a key customer relationship or a proprietary technology. Most business owners that act as their own business broker get only one buyer involved – either another business that approaches him with an unsolicited offer or a referral from his banker, accountant, or outside attorney. Just look at the additional billion plus dollars of value created for MCI shareholders because of the competitive bidding between Verison and Quest Communications.

7. Balance of Experience. Most corporate buyers have acquired multiple businesses while sellers usually have only one sale. In one situation we represented a first-time seller being pursued by a buyer with 26 previous acquisitions. Buyers want the lowest price and the most favorable terms. The inexperienced seller will be negotiating in the dark. To every term and condition in the buyer’s favor the buyer will respond with, “that is standard practice” or “that is the market” or “this is how we did it in ten other deals.” By engaging a business broker the seller has an advocate with a similar experience base to help preserve the seller’s transaction value and structure.

8. Maximize the Value of Seller’s Outside Professionals. Business brokers can save the seller significantly on professional hourly fees by managing several important functions leading up to contract. His compensation is usually comprised of a reasonable monthly fee plus a success fee that is a percentage of the transaction value. The business broker and seller negotiate with the buyer the business terms of the transaction (sale price, down payment, seller financing, etc.) prior to turning the purchase agreement over to outside counsel for legal review. In the absence of the business broker that sometimes-exhaustive negotiation process would default to the outside attorney. It is not his area of expertise and could result in significant hourly fees.

9. Maintain Buyer – Seller Relationship. The sale of a business is an emotional process and can become contentious. The business broker acts as a buffer between the buyer and seller. This not only improves the likelihood of the transaction closing, but helps preserve a healthy buyer – seller relationship post closing. Often buyers want sellers to have a portion of their transaction value contingent on the successful performance of the company post closing. Buyer and seller need to be on the same team after closing.

Our experiences with businesses that engaged our firm as a result of an unsolicited offer from a buyer have been quite instructive. The eventual selling price averaged over 20% higher than the first offer. In no case was the business sold at the initial price. To conclude, the business broker helps reduce the risk of business erosion with improved confidentiality while allowing the owner to focus on running the business. The business broker led sale helps maximize sales proceeds by involving a large universe of buyers in a competitive bidding process. Finally, the business broker can improve the likelihood that the sale closes by buffering buyer – seller negotiations and by balancing the experience scales.

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, March 27, 2010

Selling Your Software Company - Market Timing is Critical

When a large software company makes an acquisition in a particular niche, several other comparable acquisitions soon follow. This post discusses this market dynamic and the importance for owners of similar software companies to reevaluate their exit plans.

Our firm was engaged as a merger and acquisition advisor in 2007 to sell a Content / Document Management Software Firm. We put together a database of likely buyers in that software category and began our contact process. Fast Forward to early 2010. We have been engaged by a second Content / Document Management Firm to sell their software company. From our earlier engagement, we dusted off our database of mid-market software companies in that space and began making our phone calls.

A very interesting thing happened. 40% of these middle market software companies had been acquired by one of the large software companies. We would call one document management software company expecting the receptionist to answer by the company name in our database. Instead, we got, "Thank you for calling OpenText." Next call, instead of the expected company name, we got an EMC Company. Another call and this time, "thank you for calling Oracle." Two calls later, we reach an IBM Company.

Wow. Between mid 2007 and early 2010, there was a buying spree by the enterprise software vendors shoring up their product offering to become a much more comprehensive offering, now called ECM or enterprise content management. It was almost like a heavyweight fight - IBM punches, EMC counters, and Oracle lands a blow while OpenText dodges a punch.

For the midsized software companies in this space, these were exciting times. This rapid consolidation and active buying caused the transaction values to increase rapidly. Once the enterprise companies have added what they needed, however, the buying stops, the market returns to normal and sellers no longer command a premium price.

Now the bad news. If you were a mid-sized competitor of the acquired companies, you are now competing with very large, powerful competitors. They will dwarf your company in terms of sales force size, marketing resources, brand awareness and pricing power. Their product now becomes the safe choice in a head-to -head competition with yours.

To now compete effectively will require even more skill. Your firm can continue to provide outstanding service and responsiveness. You can provide the small company customer attention that many customers require. You can be nimble and innovate with new products and features as another way to successfully compete.

You often hear the stock market pundits say, “the trend is your friend" or "don't fight the trend." There is a certain wisdom to this sentiment. If you are in a software category that suddenly has become the target for the big software vendors, you may do best to exit according to the market conditions rather than your original retirement schedule.

Actually, the buying company will most likely want you to stay on board for a period of time to transfer customer relationships and intellectual property. So you can take your chips off the table today at an opportune time for rich valuation multiples and then retire a few years later.

If you are younger, you can secure your family's financial future, work for the new company for a few years, gain valuable experience and then exit. Now you are ready to launch your next great idea. This time it will be far easier. You will have a large base of resources and influential contacts. Also the venture capital guys might even give you money under reasonable terms. Home Run, touch em all!

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

Wednesday, March 17, 2010

Elements of a Successful Sell-Side Engagement

Our Latest Presentation -  Welcome to our brief presentation on the MidMarket Capital Selling Process – Elements of a Successful Sell-Side Engagement. We believe there are several desired results from a successful process including completing the sale in the shortest amount of time, minimizing the demands on the company executive team, maximizing the price and terms for the owners, and finding the right buyers that will serve both current employees and acquired customers while preserving the legacy of quality the owners have built.

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, March 09, 2010

Survey Results - Information Technology Merger & Acquisition Trends from MidMarket Capital

We surveyed CEO’s and Directors of Mergers and Acquisitions over a broad cross section of software, Healthcare IT, IT services, and Information Technology. We were pleasantly surprised by the robust growth projections and level of optimism from these Information Technology Executives. Below are the results from this brief survey:

After a very difficult 2009, the executives surveyed were surprisingly upbeat, with 32% of respondents believing that their business will grow by more than 20% over last year. 57.7% of those surveyed are either actively seeking acquisitions or would make an acquisition if the right opportunity were available. With customer acquisition one of the greatest challenges for IT companies, not surprisingly, the most important acquisition criteria was to acquire customers at 26% of respondents. 19% would use an acquisition to enter a new market.

The top three growth categories, according to the respondents were projected to be Mobility/Smart Phone Apps, Healthcare/Electronic Medical Records, and SaaS/Web Based Apps. The hottest areas in terms of potential acquisitions were SaaS/Web Based Apps, at 22% and Healthcare/Electronic Medical Records at 20% of respondents. It sure looks like these IT executives are confident that their sector will be one of the engines to drive this economy into recovery.

To view the complete survey results visit

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 01, 2010

Selling Your Company – Finding the Right Buyers

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

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

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

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

As we conversed further, my radar started buzzing loudly. This guy was getting ready to provide a low ball offer and was trying to sell me on all the reasons why I should go back to our client and pitch his offer. I politely listened to his well practiced approach for a little while longer. Then he came up with the statement that I just could not let go. He said that last year’s revenues were an unusual upward spike and “I am just going to use 2008’s revenues as my basis for my offer. Well, I just could not let that one go. I asked him how he would have made an offer if last year was unusually bad, but the prior five years were strong. He would not respond, but of course, the answer was that he would have made his offer based on the new trend.

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

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

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

But I digress. Let’s get back to our client. The good news is that we had 6 other industry buyers that we had contacted and they were looking for acquisitions that were based on acquiring new customers or adding another product offering, or leveraging their sales force or install base. In other words, their buyer motivation was not to buy a company with a low-ball offer.

The only way we can encourage buyers to make fair offers is to conduct an outbound marketing campaign to industry buyers that have strategic reasons for making acquisitions. If we can get several involved, then the buyer that comes in and says that he is going to base his offer on 2008 performance, is easily eliminated from consideration. If a business seller is only going to attract these inbound, bargain seeker buyers from Web Sites, he/she will only be getting low ball offers and wasting a lot of time.

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