You’ve built a great business with love and care. It has grown larger than you’d ever imagined. It generates a nice profit. As a result, this has allowed you and your family to live comfortably.

Now, you’re ready to sell. You assume there’s a buyer out there. You want someone to pay you a fair price and nurture the company with the same attention you have. Most importantly, selling the business is a major part of your retirement plan.

Needless to say, buyers look at businesses differently than sellers. So to achieve the outcome you want, it’s important to think like buyers and understand how they evaluate a business.

Knowing What Buyers Want

There are many types of buyers: strategic and financial, individuals, companies and private equity funds. Despite differences, all buyers consider how much they’ll invest to acquire a business, the amount of risk they’ll bear and the potential return on their investment. To evaluate an opportunity, buyers focus on three major areas:

1. Cost and terms. What will it take to acquire the business? How much cash and how much debt? What are the deal’s terms and conditions? There’s one standout issue: the amount of cash required to make the deal. By decreasing the cash requirement and increasing the acceptable debt portion, a seller can make its company more attractive — and perhaps even increase its selling price. The biggest factor directly affecting a deal’s attractiveness is the asset base. Simply put, the more the buyer can borrow against (or for post-transaction capital), the less cash it needs upfront. As collateral, banks usually accept land, buildings, equipment, inventory and accounts receivable. Many entrepreneurs have purchased the land their business resides on and leased it to the company. An often unanticipated side effect is this structure reduces the company’s asset base. As a result, this decreases the amount of debt leverage the seller can obtain.

Another way sellers can reduce the buyer’s initial cash requirement is by accepting part of the purchase price over time. Commonly known as “seller paper,” this can do a great deal to lubricate a sale.

2. Continuity. Will the business continue to operate similarly after the sale? Much of the risk of buying a company relates to continuity. For example:

• The current owner has personal relationships with customers, distributors or vendors that the new owners may have to struggle to maintain
• The owner has special expertise that is undocumented and difficult to learn
• Key personnel aren’t committed to staying
• Offshore competition looms.

Sellers armed with solid responses to these types of continuity concerns are more likely to get their desired price. Even if you don’t want to sell your business for a few years, take steps now to ensure it can run smoothly without your personal involvement. That independence could be worth millions when you sell.

3. Growth. Are there unexploited opportunities? You may have focused your sales efforts in one geographic region, but there may be many opportunities to take the product national or international. A buyer will pay more for the business if they believe it can increase revenues substantially over one assuming the current owners have already maximized opportunities.

What Sellers Should Do

It may seem counterintuitive, but the things you may be most proud of can work against getting the best price for your company. Not many entrepreneurs like to boast their company could run just fine without them. They don’t want to seem like they’ve failed to capitalize the numerous opportunities out there as an owner. Yet these may be the very factors buyers seek, along with lower cash requirements. Contact VR Business Brokers today in understanding how to best present your company for sale.

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Article written by Giff Constable and provided courtesy of Axial

For business owners, summer often brings extra challenges like slower sales cycles and the musical chairs of employee vacations. However, summer is also a good time to unplug and take stock of where you are in your life and your business. If that process leads you to think about a sale of your business, you’re going to want to get ahead of the game in three key areas:

#1: Deal with the things that scare buyers away

There are a few big red flags that scare buyers away, especially financial buyers who play an increasing role in one’s exit options today. You will want to review your business, acknowledge where you have weaknesses, create a plan to improve what you can, and be ready to explain what you cannot.

Some common red flags include:

1. Revenue concentration: try to avoid a situation where more than 20% of your revenue is tied up in the hands of one or two customers.
2. Customer churn: High growth is attractive, but not if it comes with a really high churn rate. If your customer lifecycles are short, you’ll want to examine how you are generating leads, how you are converting leads, and ultimately how well you are delivering on your product or service promises.
3. Legal risk: Are your intellectual property rights clean? Do you have any outstanding lawsuits that can be closed off? While legal risk doesn’t always scuttle a deal, you might end up needing to accept worse escrow and indemnity terms than you’ll want. If you can’t clean these items up before you start a process, you’ll want to disclose them early on.
4. Key person risk: A lot of lower-middle-market businesses run pretty lean, but you’ll want to avoid too much dependence on any one person, especially the CEO. Now might be a good time to prioritize where you should bring in the right lieutenants and start those recruiting cycles.

In addition to those four, you’ll also want to deal with excessive debt (leverage) in the business, employee churn, and high degrees of sales cyclicality.

#2: Prep for a Fast Process

You want to preserve momentum during an sale process. Delays rarely works in the sellers’ favor because so many things can go wrong. The buyer might change their focus or strategy. You could lose a key customer or an important employee. You could miss your numbers in a key month. Any of these things might be fine in normal course of business, but sometimes it doesn’t take much to give a buyer cold feet.

Much of your preparation is simply about getting organized:

1. Get your financial books in order, and, if relevant, work with an accountant to disentangle personal finances from the business;
2. Gather your legal documents;
3. Assemble your key historical metrics (product, sales funnel, marketing funnel, etc) and market data (addressable market, competition);
4. Organize your go-forward plans (product roadmap, growth plans, etc).

More complicated is dealing with the human psychology around a deal. Do you know your own mind and are you clear about your own goals? Do you want to continue running the business? Are there showstopper terms and conditions where you simply won’t budge?

Lastly, you need to get your key shareholders on the same page. You want to put in the work to align your current co-owners and set their expectations before the deal process begins in earnest.

#3: Build Your Deal Team

Selling a business is stressful, not least because you’re likely trying to run the business at the same time. Surround yourself with advisors you trust such as an excellent attorney, tax accountant, and sell-side advisor.

It’s also worth pulling your key executives in early. They will likely need to be involved in the due diligence process, and you’re going to need them to stay focused on operational execution during all of this. An exit process is not the time to take the foot off the gas. Help them understand why you want to sell the business. Use your sell-side banker to help set their expectations on what the process will look like, and to help tamp down their fears of the unknown.

Coach your involved executives on the fact that a sale process is just that — a sales process. If they are going to be talking to the buyer, you want to make sure they have been coached on what to say. You’ll want to keep a united front.

In conclusion, while 2018 is a good year to be a seller, it’s still a good idea to take care of the above list. Go into your sales process knowing your own mind, having a clean house, and having built a great team around you.

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Article written by John Wagner, Managing Director at 1StWest Mergers and Acquisitions, and provided courtesy of Axial

Let’s say you were doing business with just one or two very large customers. Your business could, quite rightly, be categorized as overly dependent on too few sources of income. The reason is simple: Any move that those two customers made, good or bad, up or down, would cause an equal reaction in the fortunes of your company, good or bad, up or down. And if one suffered a catastrophic misfortune, so would your company. That may be stating the obvious. After all, you didn’t have to go to Harvard B school to see the importance of spreading risks like these. And that’s what most business do. They engage in transactions with any many businesses as possible, so that the negative performance or outright failure, of any one customer wouldn’t have an outsized negative impact on the provider company.

Yet as businesses scramble to make their numbers, and sales people do what sales people naturally do (book orders, any order, from anyone; all money is green) those sales are often done without respect to what percentage of your gross revenue may be concentrated into your top-volume customers. However, this customer concentration metric is especially important when you take your company to market to seek an acquirer.

IM Disclosures

Any decent Informational Memorandum (a.k.a. “deal book”) that you and your investment banker prepare to bring your company onto the market for acquisition should have a section that declares your Customer Concentration. It’s a very revealing section of the Informational Memorandum indeed, because every potential acquirer will want to review what percent of your business would cease if you lost a few of your biggest customers.

Is heavy concentration at the top of your customer list truly a terrible thing? Not always. If those top performers are predictable and pay on time, there may be no problem at all. In fact, you’d probably be surprised to see how many companies have greater than 40% of their business concentrated in just ten or twelve customers. Plus, as anyone who’s been in business for any length of time knows full well, many large customers take less effort to serve. They often have technology (like mobile scheduling tools or portals for managing digital purchasing) to smooth out delivery and payment schedules.

Rule of thumb: No one customer should represent more than 10% of your business.

Your invoicing might be simplified as well, if you can submit a superbill to a national accounting department, with a strong cash position and a seven-figure credit line. So, high-quality receivables from large buyers can be an asset, not a liability…until there is too much concentration in too few accounts. That might make an acquirer a little nervous, generating a request for more detail about the nature of the customers you are dealing with at that level. Is there a rule of thumb that acquirers look for? Indeed there is. No one customer should represent more than 10% of your business. Anything more than 10% will bring the attention of the acquirer’s due diligence team, wanting to dig into just how consistent that customer will be for years to come.

Are You Holding Your GPMs Too?

When reviewing customer concentration in the list of your biggest customers, a potential acquirer will also review the gross profit margins (GPMs) for each customer on the list. Their interest in GPMs reaches beyond mere curiosity. Here’s why: If you are heavily discounting your highest-volume buyers, expecting, as old joke goes, “to make it up on volume,” that is a source for worry. It usually indicates that you may be shipping large volumes of product at very low margins… a scenario that would potentially ding your company valuation. Maintaining GPM discipline, even among large-volume customers, is certainly a KPI of a well-run company.

If you are heavily discounting your highest-volume buyers, expecting, as old joke goes, “to make it up on volume,” that is a source for worry.

That said, if your GPMs are around the GPMs you are maintaining for your other down-list customers, this indicates you are running a disciplined operation, and that you’ve stuck to your guns when negotiating price, even with your high-volume accounts. That discipline is widely seen as a sign of a well-run business.

Before you go to market, calculate your customer concentration; it’s an instructive exercise to engage in, now or at any time, actually. Run a spreadsheet of your GPMs in the process, and compare those to the GPMs of your smallest customers to plot the spread, and see how they compare. If you are preparing to seek an acquirer, make adjustments now. Then, when you are finally ready to reveal your financials to potential acquirers, you can put them at ease that you’re well within accepted norms for customer concentration and GPMs, even for high-volume accounts.

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If you decide to sell your business to an outside acquirer, you’re going to have to decide between a financial and a strategic buyer—understanding the different motivations of these two buyers can be the key to getting a good price for your business.

A financial buyer is acquiring your future profit stream, so they will evaluate your business based on how much profit it is likely to make and how reliable that profit stream is likely to be. The more profit you can convince them your company will produce, the more they will pay for your business.

But there is a limit to how much they will pay, because financial buyers are playing the buy-low, sell-high game. They do not have a strategic rationale for buying your business. They don’t have an army of sales reps to sell your product or a network of retailers where your product could be merchandised. They are simply trying to get a return on their investors’ money, so they tend to buy small and mid-sized businesses using a combination of this investment layered on top of a pile of debt, and they want to buy your business as cheaply as possible with the hope of flipping it five or ten years down the road.

Because financial buyers are usually investors and not operators, they want you and your team to stick around, so they rarely buy all of a business. Instead, they buy a chunk and ask you to hold on to a tranche of equity to keep you committed.

A strategic buyer is a different cat—usually a larger company in your industry, they are evaluating your business based on what it is worth in their hands. They will try and estimate how much of their product or service they can sell if they added you into the mix. Because of their size, this can often lead to buyers who are willing and able to pay much more for your business.

Tom Franceski and his two partners had built DocStar up to 45 employees when they decided to shop the business to some Private Equity (PE) investors. The PE guys offered four to six times Earnings Before Interest Taxes Depreciation and Amortization (EBITDA), which Franceski deemed low for a fast-growing software company.

Franceski was then approached by a strategic acquirer called Epicor, which is a global software business with a lot of customers who could use what DocStar had built. Epicor offered DocStar around two times revenue—a much fatter multiple than the PE firms were offering.

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Article written by Giff Constable and provided courtesy of Axial

The lower middle market is getting more sophisticated when it comes to mergers and acquisitions, but both investors and owners are still making many of the classic mistakes around assessing and building value. We asked two valuation experts, Scott Hakala of ValueScope and Ken Sanginario of Corporate Value Metrics, what they’re seeing in the market today and their advice for both buyers in the current economic climate.

The biggest mistake Ken sees among business owners is chasing a financial target in an unsustainable way. “Someone tells them that they need to be at a certain EBITDA level, and then they slash costs but not in a strategic manner,” Ken said. “Owners think that they can cut costs for a year or two and have no one notice. But it doesn’t take a buyer long to get wind of what they have been doing.”

The same thing happens when a business takes on revenue that is hard to fulfill or retain. That revenue usually comes with tangible and intangible costs. When it disappears, the company is left in a deeper hole than before. If a seller is taking delayed consideration for their business, in the form of an earnout or a rollover of equity, these short-term measures can cause that future value to evaporate. “I was doing turnarounds for 15 years, and many of those situations came from companies chasing revenue or chasing EBITDA,” Ken said.

Buyers are also guilty of short-term moves that can destroy value and trigger failed expectations on both sides. “A lot of what I see is penny-wise, pound-foolish behavior,” said Scott. “The buyer squeezes R&D or sales compensation. This boosts EBITDA but the cost savings prove to be illusory. What do you do when half your sales force quits within a year?”

A lot of heroic assumptions are going into valuation models in order to reach deal-winning multiples in today’s market, but with rising interest rates and employment rates, returns may be harder to come by for both sides. Earnouts are a common tool for bridging a valuation gap and getting a deal done, but both buyers and sellers need to be careful not to make short-term moves that backfire. “We see a lot of examples where earnout issues are taken for granted by buyers assessing transaction risk and sellers taking an earnout as part of the deal,” said Scott. “Then both sides feel defrauded by the other side when it doesn’t work out.”

Both Ken and Scott encourage buyers and sellers to focus on the intangibles. For buyers, “the big buzzword today is quality-of-earnings reviews,” says Scott. “It’s usually easy to catch whether someone was running personal expenses through the business. The real issues are things like management infighting or lack of product diversity.” Once the deal is done, Scott recommends that buyers stay humble and seek to ask the right questions about the business rather than making assumptions. “There’s less room for error in the lower middle market,” he said. “One or two critical mistakes can blow up an entire firm.”

Ken encourages business owners to think about business intangibles years in advance, rather than months. “I think that most private companies can double or triple their value over a three to five year period if they directly work on their weaknesses. It takes getting to the root causes of value,” he said. “Too many owners think that value is driven by what they did last year, as opposed to what the company’s future cash stream looks like. If they plan ahead and build for the future, they will see improved multiples and their deal will close faster.”

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This article written by Danielle Fugazy and provided courtesy of Axial.net

It used to be business owners sold their companies outright to a strategic acquirer or a financial buyer or handed it down to family members. Today, many business owners are opting to take partial liquidity and stay on with the business. This option is a rather good one for business owners who may want to buy out other stakeholders or want a new partner, but aren’t ready to walk away from the business altogether.

However, taking capital and not completing exiting the company is a unique transaction—one that the business owner needs to really understand before they enter in to. Whether the business owner sells 80 percent of the business or 20 percent, it’s important for them to diligence their potential partners. Unfortunately, too frequently, business owners are so elated at the prospect of receiving capital from a financial sponsor that they don’t do the proper due diligence on their potential partner or the deal terms. Then they find themselves at a loss when they can’t get rid of the wrong financial partners without a lot of aggravation, systemic risk to the business, and an expensive outlay. The wrong agreement with the wrong partners will never allow a company to scale as intended.

Non-control and partial-control investments are like a marriage and can last anywhere from three years to upward of 10 years.  Here are some of things owners should be thinking about if they want to take an investment.

Ask the hard questions

Most financial sponsors will say they understand your industry, but the onus is on the owner to figure out if they really do. You need to talk with your potential partner, understand their background, how they obtained their industry knowledge and talk to other business owners in your industry they have invested in. You need know what their qualifications are.

“You need to ask the right questions. Owners cannot be afraid to ask the potential investor why they think they are the right fit.” says Karine Philippon, a partner focused on technology, manufacturing and distribution deals at accounting firm Mazars USA.

If they are experts in your industry they will have already acquired or invested in companies that are similar to your company. They will have successful outcomes to prove it or have partners on their team that have credible track records in the vertical.

“It’s very important that the partner have industry knowledge. The partners have to be vetted and the owners need to figure out how they will be able to leverage that knowledge and how useful it will be to them,” says Philippon.

Charlie Gifford, a senior partner with non-control private equity firm New Heritage Partners, says calling references is key. “Do your homework. Call all the references and then call people who aren’t on the reference list who may know something about your potential partner,” says Gifford.

Look for a true partner

This partner will have a seat on your or board and, in some cases, even more oversight depending on the agreement. It’s important to make sure you respect the financial partners personally. Kenneth Marks, a managing partner at High Rock Partners, an investment bank located in Raleigh, North Carolina, suggests finding out specifically who will be on the company’s board. “You want to know if the person sitting your board has the right temperament and is aligned with you and your business goals. When things go wrong, and they often do, who will be across the table? Will they solve problems or have knee-jerk reactions,” says Marks.

Good questions to ask include: do they have experience, how will they interact with you and your employees, and are they people you would feel comfortable with if you met under different circumstances?

“Like everything in life, it’s a balance between controlling the company, getting the money and having a true partner going forward,” says Philippon.

Every financial sponsor brings capital to the deal, it’s their connections, mentorship and insights that will vary and are often the most important factors. You also want to make sure your ideas align for the company moving forward so there are no surprises. Your partners should be able to help you connect to their network and propel your company forward.

“You need a partner who has the ability to identify areas in which an injection of resources can help solve a problem. You want to align with investors who can say, we have seen this before and this is how we have solved that problem or fixed this bottleneck. An investor’s prior experiences with the challenges that a business owner is facing, can help solve it or improve the situation,” says Gretchen Perkins, a partner with Huron Capital, which recently closed on a $142 million non-control private equity fund.

Think Ahead

Often times business owners wait until the last minute to have meet with potential investors and then they don’t have the time to make truly educated decisions. “Don’t let the pressure of getting liquidity drive the investment decision because you will likely wind up with less control of the company or the wrong partner because you didn’t truly think through your needs and who the right investor would be,” says Philippon.

It’s also important to understand a few things prior to the legal stage of a capital raise. Before getting far down the road, business owners should get clarity around corporate governance issues. “What types of meetings will the investor require, how often, what type of reporting, and what’s their role in the decision making process outside of being a board member,” says Marks.

Business owners also should get clarity on distributions. Many business owners are used to pulling money out of the business when convenient, but arrangements will become formalized with an investor. “Many times distributions are curtailed or managed when an investor comes on. Will these types of changes work for the business owners’ lifestyle?” says Marks.

Think about the future

If they are remaining a partial owner of the business, business owners want to protect themselves when it comes to future capital transactions. Will there be restrictions on taking additional money off the table in a future secondary sale? If the new investor wants to sell or raise more capital, who decides on the new buyer or investor and the terms? “Owners should make sure they have a clear understanding of what the exit strategy is, and they need to think about that in advance. Owners need to pay attention to the terms and conditions set forth,” says Marks.

There can be great upside to bringing on a private equity partner while retaining a stake in the business. Just remember that bringing on an investor is like getting married, but with no option for divorce. Do your due diligence and know what you are getting into.

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John McCann sold The Bolt Supply House to Lawson Products (NASDAQ: LAWS) at the end of 2017.

McCann’s strategy involved learning from the acquirers who knocked on his door. He invited would-be buyers into The Bolt Supply House and listened to what they had to say. He was not committed to selling, but instead wanted to know what they liked and what concerned them about his company.

One giant European conglomerate, for example, approached McCann about selling, but after a thorough evaluation, they backed out of a deal, worried about McCann’s central distribution system.

McCann thanked them for their time and set to work turning his distribution system into a masterpiece. Eventually, Lawson cited this as one of the many things that attracted them to The Bolt Supply House.

When it finally came time to sell, McCann commanded a premium, arguing that he had built a world-class company he knew would be a strategic gem for a lot of businesses. He ended up getting five competing offers for The Bolt Supply House and eventually sold to Lawson.

When a big sophisticated acquirer approaches you about selling, the temptation is to decline a meeting if you’re not ready to sell, but hearing what they have to say can be a great way to get some superb consulting, for free. The investment bankers and corporate development executives who lead acquisitions for big acquirers are often some of the smartest, most strategic executives in your industry and—provided you don’t get sucked into a prop deal—hearing how they view your business can be an inexpensive way to improve the value of your company.

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If your goal is to grow your business fast, you need a positive cash flow cycle or the ability to raise money at a feverish pace. Anything less and you will quickly grow yourself out of business.

A positive cash flow cycle simply means you get paid before you have to pay others. A negative cash flow cycle is the direct opposite: you have pay out before your money comes in.

A lifestyle business with good margins can often get away with a negative cash flow cycle, but a growth-oriented business can’t, and it will quickly grow itself bankrupt.

Growing Yourself Bankrupt

To illustrate, take a look at the fatal decision made by Shelley Rogers, who decided to scale a business with a negative cash flow cycle. Rogers started Admincomm Warehousing to help companies recycle their old technology. Rogers purchased old phone systems and computer monitors for pennies on the dollar and sold them to recyclers who dismantled the technology down to its raw materials and sold off the base metals.

In the beginning, Rogers had a positive cash flow cycle. Admincomm would secure the rights to a lot of old gear and invite a group of Chinese recyclers to fly to Calgary to bid on the equipment. If they liked what they saw, the recyclers would be asked to pay in full before they flew home. Then Rogers would organize a shipping container to send the materials to China and pay her suppliers 30 to 60 days later.

In a world hungry for resources, the business model worked and Rogers built a nice lifestyle company with fat margins. That’s when she became aware of the environmental impact of the companies she was selling to as they poisoned the air in the developing world burning the plastic covers off computer gear to get at the base metals it contained. Rogers decided to scale up her operation and start recycling the equipment in her home country of Canada, where she could take advantage of a government program that would send her a check if she could prove she had recycled the equipment domestically.

Her new model required an investment in an expensive recycling machine and the adoption of a new cash model. She now had to buy the gear, recycle the materials and then wait to get her money from the government.

The faster she grew, the less cash she had. Eventually, the business failed.

Rogers Rises From The Ashes With A Positive Cash Flow Model

Rogers learned from the experience and built a new company in the same industry called TopFlight Assets Services. Instead of acquiring old technology, she sold much of it on consignment, allowing her to save cash. Rogers grew TopFlight into a successful enterprise, which she sold in 2013 for six times Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) to CSI Leasing, one of the largest equipment leasing companies in the world.

Rogers got a great multiple for her business in part because of her focus on cash flow. Many owner think cash flow means their profits on a Profit & Loss Statement. While profit is important, acquirers also care deeply about cash flow—the money your business makes (or needs) to run.

The reason is simple: when an acquirer buys your business, they will likely need to finance it. If your business needs constant infusions of cash, an acquirer will have to commit more money to your business. Since investors are all about getting a return on their money, the more they have to invest in your business, the higher the return they expect, forcing them to reduce the original price they pay you.

So, whether your goal is to scale or sell for a premium (or both), having a positive cash flow cycle is a prerequisite.

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