Monday, July 28, 2014

The Unsolicited Offer to Buy Your Company - It Is Not a Fair Fight

If you are approached with an unsolicited offer to buy your business, be careful. Often times it is a bottom feeder looking to get a bargain and your company is one of dozens that are similarly contacted. If you become intoxicated with the thoughts of future riches, you could put your company in jeopardy. This article examines how you should manage this process.

When a company approaches you and broaches the subject of acquiring your company, it is very difficult to suppress those feelings of riches beyond your wildest dreams. Your thoughts start to move from the twelve hour work days, personnel issues, keeping your clients happy, and drift toward the tropical island with the grass hut, the perfect climate, the umbrella drinks, and the abundant leisure time. Snap out of it! Put that Champaign away and get back to
We had been engaged by a client to sell her business recently and while we were in the planning meeting, the assistant walked in with a letter from a larger industry player expressing an interest in buying her company. She was feeling pretty special until we uncovered that this same letter was sent out to 50 other companies. Buyers are looking to buy at a discount if possible. The way they do that is similar to the approach that many of those get rich quick real estate programs recommend. Go out to 50 sellers and make a low-ball offer and one of them may bite. These buyers are way better informed about the value of a company than 90% of the business owners they approach.

The odds of a deal closing in this unsolicited approach are pretty slim. In the real estate example, the home owner is not hurt by one of these approaches, because they have a good idea of the value of their home. The price offer comes in immediately and they recognize it as a low ball and send the buyer packing. For the business owner, however, valuations are not that simple. This is the start of the death spiral. I don't want to sound overly dramatic, but this rarely has a happy ending. These supposed buyers will not give you a price offer. They drain your time, resources, your focus on running your business and, your company's performance. They want to buy your business as the only bidder and get a big discount. They will kick your tires, kick your tires, and kick your tires some more.

If they finally get to an offer after months of this resource drain, it is woefully short of expectations, to the surprise or chagrin of the owner. The owner became intoxicated with their vision of riches and took their eye off the ball of running their business.

How should you handle this situation so you do not have this outcome? We suggest that you do not let an outside force determine your selling timeframe. However, we recognize that everything is for sale at the right price. That is the right starting point. Get the buyer to sign a confidentiality agreement. Provide income statement, balance sheet and your yearly budget and forecast. Determine what is that number that you would accept as your purchase price and present that to the buyer. You may put it like this, " We really were not considering selling our company, but if you want us to consider going through the due diligence process, we will need an offer of $6.5 million. If you are not prepared to give us a LOI at that level, we are not going to entertain further discussions."

A second approach would be to ask for that number and if they were willing to agree, then you would agree to begin the due diligence process. If they were not, then you were going to engage your merger and acquisition advisor and they would be welcome to participate in the process with the other buyers that were brought into the process.

A major mistake business owners make in this situation is to focus their time and attention on selling the business as opposed to running the business. This occurs in large publicly traded companies with deep management teams as well as in private companies where management is largely in the hands of a single individual. Many large companies that are in the throes of being acquired are guilty of losing focus on the day-to-day operations. In case after case these businesses suffer a significant competitive downturn. If the acquisition does not materialize, their business has suffered significant erosion in value.

For a privately held business the impact is even more acute. There simply is not enough time for the owner to wear the many hats of operating his business while embarking on a full-time job of selling his business. Going through an extended process with a buyer who only wanted to buy at a bargain can damage the small company. If you are not for sale, you must control the process. Why would you go through the incredible resource drain before you knew if the offer would be acceptable? Get a qualified letter of intent on the front end or send this buyer packing.

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

Thursday, July 17, 2014

Before You Sell Your Business, Look at it Through the Eyes of an Experienced Buyer

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

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

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


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


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


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

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

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

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

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

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

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

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

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

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

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

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

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

Sunday, June 29, 2014

While Selling Your Business - Steady as She Goes

When we first engage with a new client, we sit down with them and give them the talk. No, not the birds and the bees talk, but the talk about what they should and should not be doing while the sale process is going forward.

Our first bit of advice is to keep your eye on the ball. It sounds simple, but the business sale process is disruptive. The smaller the company with fewer management personnel, the more disruptive. We tell our clients to maintain their focus on running the business and rely on their mergers and acquisitions advisors to manage the business sale process. That being said, there are many demands placed on the owners for answering buyers' questions, conference calls, corporate visits, evaluating buyers and their offers, and negotiating.
If the disruptions cause the sales and profits of the business to fall, the buyer does not care that they fell because the owners were distracted. They only care about the bottom line performance of the business. The sale process generally runs for a period of eight months to over a year in many cases.

The original financials in the offering memorandum are often supplemented several times as each quarter passes. If you have received purchase offers based on one set of financials and those financials deteriorate, you can count on the offers being lowered across the board to reflect your company's new reality. If the downturn is sizable, it may interfere with the buyer's ability to secure financing, especially if the buyer is a private equity group.
Many owners want to juice their sales while the business is being sold to drive every last bit of value into their business sale price. They want to bring on that extra salesman or launch that big marketing campaign in order to spike their sales and profits and then get rewarded with a 5 X EBITDA bump in the business selling price. This is very expensive flawed logic on the part of the business owner. A new salesman, even an outstanding new salesman is a drain on the company profitability for 9 months to a year. That is the best case scenario. In the majority of cases the new salesman does not make the grade and is fired. His loss, however, hits the company's financials.
A marketing campaign is not always the sales driving engine the owner hopes it will be. But, for discussion sake, let's say that the campaign was well conceived and executed. The full impact of the campaign is usually delayed by six months to a year. If this occurs during the business sale process, the financials reflect the drop and the lowering of the buyers' offers will follow as surely as the next sunrise.
The cruel irony of this dynamic is that you are investing to make the business more valuable for you to sell, but instead are giving the buyers an opportunity to buy at a discount. Your investment then pays off a year after the new owner has taken over.
OK, I admit, I have painted the worst case scenario. So let's say that the salesman you hired was a real star or your marketing campaign caused sales and profits to spike in the near term. You, the business seller, now with the upper hand, go back to your buyers with a business selling price increase commensurate with the buyer reductions sited above.  The reaction you get from the buyers is not at all what you expected, however. Instead of raising their offers by your increase in EBITDA multiplied by your prior offer valuation metric, they refer to this increase as an anomaly or an outlier. Instead of rewarding you proportionately in the purchase price, they want to normalize this over the prior three years.
For clarification, let's look at the following example. Your 2011 EBITDA was $2,000,000, 2012 was $2,200,000 and 2013 was $2,400,000. You are selling your business starting in June of 2014 and you launch your successful marketing campaign that boosts your EBITDA to $3,200,000 in 2014. Your offer on the table was 5 X 2013 EBITDA or $12,000,000. You go to your buyer and say my new price is 5 X 2014 EBITDA or $16,000,000. The buyer (especially if they are a Private Equity Group or financial buyer) will say, wait just a minute, this was an anomaly and we need to normalize that over the past 4 years. So they add up all of the EBITDA numbers and divide by 4 to get a normalized EBITDA of $2.45 million. They raise their purchase offer from $12,000,000 to $12,250,000.
So you have taken on a large financial risk to invest in your business to increase your sales and profits. You beat the odds in achieving a short term bump and your buyers attempt to minimize the impact on their offer price.
On the other side of the ledger, some owners attempt to significantly cut costs during the business sales process.  We advise against this approach as well. If the market does not provide the selling price that the owners are satisfied with, they will simply not sell. If you have temporarily slashed your Research and Development or Training budget for the sale, those cuts could come back to hurt you, should you not sell your business near term.

The lesson here is steady as she goes while you are in the midst of your business selling process. A fall in profit is punished and an increase is not rewarded in proportion to the investment or the risk.
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, June 17, 2014

Listen to Interview by The Exceptional Entrepreneur

We presented/were interviewed in a Webinar entitled 10 Keys to a Successful Business Exit

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 05, 2014

Selling Your Business - Elements of a Successful Sell Side Process

I just posted a new video on YouTube that discusses the steps involved when a merger and acquisition professional engages in selling your business. We briefly describe the elements of the business sale - from signing the engagement agreement, to the blind profile and confidentiality agreement, to building the prospect data base, contacting the potential buyers, corporate calls and visits, negotiating letters of intent and finally the closing. Enjoy

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

Private Equity May Be Your Best Business Exit Strategy

I just posted a new video on YouTube that discusses when a private equity sale can be superior to a sale to a strategic buyer when you consider the "second bite of the apple" and the total terminal transaction value. Enjoy.

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, January 29, 2014

Sell Your Business from a Position of Strength

You started your venture 20 years ago "in your garage", worked several 80 hour weeks, bootstrapped your growth, look on your company with the satisfaction of an entrepreneur, and are now considering your sale.  The decision to sell is all too often a knee-jerk one rather than a proactive one -- the principal reasons are a severe health issue, owner burnout, the loss of life of a owner, general industry decline or the defection of a major customer. Often times very competent business people manage the sale of their business with less rigor than in the sale of a home. Advance preparation can ensure that you leave your business from a posture of power, not from weakness due to necessity. The purpose of this article is to discuss the ten significant elements that a business owner should take into account in their once in a lifetime opportunity to maximize the rewards from their years of effort.

Do not wait too long.  Have you ever heard, "I sold my business too early?"  Compare that with the number of times you've noticed someone declare, "I should have sold my enterprise one years ago."  Unfortunately, waiting excessively long is most likely the single prevalent factor in reducing the financial results from the sale of a closely held business.  The decline in business price normally is most significant in that final year before exiting.  The decision to sell is often times a imprudent conclusion rather than a practical decision.  An individual who spends 20 years running their business and calculating their outcomes often behaves another way in the exit from his firm.  The primary reasons for selling are events such as a significant health concern, owner frustration, the passing away of a owner, general industry erosion, or the loss of a major buyer.  Exit your business from a posture of strength, not from the necessity of decline.  Don't let that subsequent huge deal delay your sale.  You can compensate yourself for that contract you project to close with  a astutely crafted deal agreement containing contingent payments in the future if that event takes place.

Prepare yourself for years after selling.  We all create business plans both formally and informally.  We all prepare for vacations.  We plan our parties.  We need to strategize for the most important monetary event of our lives, the sale of our venture.  Normally a privately held business represents more than 80% of the business owner's net value.  Launch with your plans of how you want to enjoy the rewards of your work.  Where do you want to journey?  What pursuits have you been intending to start?  What volunteer work have you intended to do?  Where do you intend to have your home?  What job would you do if money were not an issue?  You need to emotionally determine an identity for yourself away from your company. 

Prepare your business to establish the most value in a sale.  Now that you are all enthusiastic about the fun things you'll do once you exit your business, it's now time to focus on the things that you can do to maximize the worth of your business upon sale.  This topic is adequate subject matter for an complete expose, however, we will concisely touch upon a couple of significant factors.  First, engage a skilled CPA firm to do your financials.  Buyers fear risk.  Audited or reviewed financial statements from a well thought-of accounting firm reduces the perception of risk.  Do not assume the buyer will give you credit for something that does not exist in your financials.  If you observe that a out sized fraction of your sales comes from a  a small number of clients, launch a plan immediately to reduced customer concentration.

Buyers of companies fear that when the principal exits the most important clients and vendors are at risk of leaving as well.  Start to delegate management activities without delay and pinpoint successors internally.  If you have no one that fits that description and you have adequate time, search for, hire and coach that person that would stay on for the transition and beyond.  Buyers of companies desire to hold vital people that can continue the progress of the company.

 Investigate and recognize the growth possibilities that are accessible to your business.  What additional products could I introduce to our existing client base?  What different markets could make use of our products?  What strategic alliances would help extend my business?  Capture that in a document and identify the resources required to pursue this plan.  Buyers will have their own plans, but you'll increase their perception of the value of your business through your grasp of the growth opportunities.

Maintain your focus on running the business.  A key error business owners make in selling their business is to concentrate their time and concentration on selling the business as opposed to controlling the business.  This happens in large publicly traded companies with sizable management teams as well as in private companies where management is largely in the hands of a sole principal.  Various large companies that are in the throes of being acquired are guilty of losing focus on the day-to-day management.  In case after case these businesses endure a pronounced competitive dip.  If the acquisition does not occur, their business has suffered pronounced decline in value. 

For a privately held business the effect is even more acute.  There simply is not sufficient time for the principal to wear the many hats of operating his business while embarking on a full-time job of selling his business.  The owner wants the impending sale to be absolutely confidential until the very final instant.  If the owner attempts to put up for sale the business himself, by default he has divulged that his business is for sale.  Rivals would like to have this information.  Bankers get nervous.  Employees get nervous.  Customers get nervous. Suppliers get edgy.  The owner has inadvertently created risk, a potential slump in business and a corresponding drop in the sale price of his business.

Be sure to get many potential buyers involved in your business sale.  The "typical" business sale transaction for a privately held business starts with either an unsolicited approach by a competitor or with a choice on the part of the owner to exit.  If a competitor initiates the transaction, he generally isn't interested in over compensating for your business.  In reality, just the opposite is correct. He is trying to buy your business at a discount.  Outside of yourself there is no one in a better position to understand the price of your business more than a main competitor.  He will try to keep the sales process limited to a negotiation of one.

 In our mergers and acquisitions practice the owner often contacts us after an unsolicited offer.  What we have realized is generally that unsolicited buyer is not the eventual purchaser, or if he is, the ultimate purchase price is, on average 20% higher than the first offer.  If the owner decides to exit and initiates the process, it usually begins with a interaction with a trusted advisor; accountant, lawyer, banker, or financial advisor.  Let's say that the owner is contemplating selling his business and he tells his banker.  The well- meaning banker says, "One of my other customers is also in your industry.  Why don't I provide you an introduction?"  If the introduction results in a negotiation of one, it is suspect that you will get the maximum and best the market has to offer.

Hire a Mergers and Acquisitions firm to sell my business.  You enhance your probability of maximizing your financial results while dropping the risk of business decline by hiring a firm that specializes in selling businesses.  A large public company would not even contemplate an M&A transaction without representation from a Merrill Lynch, Goldman Sachs, Solomon Brothers or other high profile investment banking firm.  Why?  With so much at stake, they realize they will do better by paying the experts. 

Companies in the $3 Million to $50 Million range fall below their radar, but there are mid market M&A firms that can provide similar services and process.  Generally when you sell your business, it is the lone time in your life that you go through that occurrence.  The purchaser of the last company we represented for sale had up to that time purchased 25 companies.  The sellers were high-quality business people, knew their stuff, but this was their initial and probably last business sale. Who had the advantage in this transaction?  By engaging a practiced M&A firm they helped balance the M&A experience scales.

Retain other specialists that have expertise in business sale dealings.  You may have a fantastic outside accountant that has done your books for years.  If he has not been involved in numerous business sales transactions, you should think about engaging a CPA firm that has the skill to direct you on significant tax and accounting matters that can literally result in differences of hundreds of thousands of dollars.  What are the tax implications of a stock purchase versus an asset purchase?  A lower offer on a stock purchase may be far superior to a higher offer on an asset purchase after the impact of taxes on your after-tax proceeds.  Is the accountant that does your financials competent to counsel you on that matter?  Would your accountant understand the best method to allocate the acquisition cost on an asset sale between hard assets, good will, employment agreements and non-compete agreements?  

 A deal attorney is very distinctive from the attorney you retain for everyday business law issues.  Remember, each element of deal makeup that is beneficial to the seller for tax or risk purposes is normally correspondingly unfavorable to the buyer, and vice versa.  Therefore the skilled team for the buyer is under directions to make an offer with the most advantageous tax and reps and warranties results for their client.  You need a professional team that can equal the buyer's team's level of experience with deal structure, legal, and tax issues.

Be realistic in your demands on sales price and provisions.  The days of irrational exuberance are over.  Strategic buyers, private equity groups, corporate buyers, and other buyers are either very smart or do not endure very long as buyers.  I dislike rules of thumb, but usually there is a limit of sales prices for similar businesses with similar growth profiles and similar financial performance.  That being said, nonetheless, there is still a range of selling prices.  So, for illustration, let's say that the sales price for a business in the XYZ line of business is a multiple of between 4 and 5.5 times EBITDA. 

Your goal and the goal of a high-quality M&A advisor is to sell your business at the top end of the range under beneficial provisions.  In order for you to sell your business beyond that range you must have a very significant competitive lead, set of intellectual assets, extraordinary expansion opportunities, or substantial barriers to entry that would rationalize a premium purchase price.  If you think about the process of detailing your car prior to  offering it for sale, a good M&A advisor will help you in that course of action for your business.  Let's say, for example, that 4 to 5.5 multiple from above was the multiple in your business and you had an EBITDA for the last fiscal year of $2.5 million.  Your gross sale proceeds possibly could range from $10 million to $13.75 million.  A skilled M&A firm with a successful practice can step you to the pinnacle of your industry's range.   The impact of reaching the peak of the sales price range vs. the low-end more than justifies the success fee you pay to your M&A professionals.

In the business selling process, reveal, reveal, reveal, and do it early.  A seemingly insignificant less important negative exposed near the beginning in the process is an inconvenience, a obstacle, or a aspect to negotiate about.  That same negative discovered during negotiations, or worse yet, during due diligence, turns into, at best, a vehicle for reexamining the validity of every slice of data to, at worse, a deal breaker.  No agreement in the world can cover every possibility if there is not a primary meeting of the minds and a trust between the two parties.  Unless you are fortunate enough to get an all cash offer without any reps and warranties, you are going to be united with your buyer for some period in the future.  Buyers strive to keep you on the hook with reps and warranties that continue for a few years, employment contracts, or non-competes that last, escrow funds, seller notes, etc.  These all fulfill a dual role to reduce the risk of future negative events.  If future significant negative events transpire, buyers tend to be punitive in their outcome with the seller.  Volunteer to divulge your company's warts near the beginning in the process.  That will foster belief and credibility and will ensure you get to keep all of the monies from your sale.

Be flexible and amenable to inventive deal structure.  Everything is a negotiation.  You may possibly have in mind that you desire a total purchase price of $13 million and all cash at close.  Maybe the market does not endorse both desires.  You may be able to get innovative in order to arrive at that purchase price goal by agreeing to carry a seller note.  If the sale procedure creates many bids and the finest one is $11.3 million cash at close.  You may counter with a 7-year seller balloon note at 8% for $3 million with $10 million cash at close.  If the buyer is a stable company, that may be a enhanced outcome than your previous goal because the best interest proceeds you can currently obtain on your investments is 4%.  Be flexible, be inventive, and use your advisors to negotiate the demanding parts and preserve your connection with the buyer.

You may possibly have spent your life's labor building your business to supply you the returns, wealth creation, and heritage that you had planned and hoped for.  You organized and were aggressive and determined in your pursuit.  You have one concluding act in your business.  Make that your closing business success.  Leave on purpose and do it from a position of power and receive the highest and best deal the market has to offer.

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