I’d like to spend some time this week on a concept often misunderstood by those who do not spend a lot of time in the M&A marketplace; Private Equity. In its simplest form, it is two or more individuals investing in a full or partial ownership of a company. This can take the form of three or four friends pooling resources to buy a company. We refer to these alliances as “three people and a checkbook” and have done many successful transactions with these investors.
All profit starts as revenue. In real estate the key to value is Location, Location, Location. In business, the chant is Sales, Sales, Sales. Increasing revenues in the years leading up to sale is probably the greatest value enhancement technique. A business with growing revenues conveys so many positive aspects, including:
Buying a competitor is a significant step, but can also be lucrative. Consider this simple example: Frank has a distribution business which, based on his profitability, would normally be worth $10,000,000. However he is only receiving offers in the $8,000,000 range due to customer concentration. One customer accounts for 30 percent of revenues making buyers nervous. His competitor, who is of similar size and profitability, also has a significant customer. One way to both lessen the customer concentration, and create value, is for Frank to buy the competitor for $8,000,000. A year later, Frank goes to sell his company once again. Now, since his revenues are twice as high, his largest customer is only 15 percent of revenues. The competitor’s largest customer, now part of Frank’s business, is only 15 percent as well. If the buyer perceives these customers as less risky since they are a “smaller” part of the business, Frank has immediately increased the value of his original business by $2,000,000 (25 percent) and the competitor’s business by $2,000,000 (another 25 percent) by reducing both customer concentration risks. The $8,000,000 purchase of the competitor increased Frank’s net worth by an additional $4,000,000, a 50 percent ROI (Return on Investment) with the acquisition.
Why are you selling? Some answers to this question scare buyers and can kill your deal. The buyer knows you know more about the business, customers and industry than they do. No matter how much due diligence they conduct this will always be true. So this question plays into the buyer’s fear that you are selling because the marketplace has changed and now is the peak time for you get out, as it is all downhill from here.
Once a deal is reached with a buyer, there is typically a time period between the intent letter and actual closing, usually between 60 and 120 days depending on the industry and buyer. During this time the buyer conducts due diligence and the formal purchase documents are drafted. No matter how well you feel you are bonding with the buyer during this period, remember the deal is not done until documents are signed and the wire transfers of purchase money has crossed from their account to yours. Until these things happen, the deal is still in limbo and you are still in sales mode.
Business regulation is a fact of life. Business owners need to have a good handle on how regulation and potential legislation affects their business’ future and what is coming down the pike.
Being a business owner can provide an owner the opportunity to meet interesting people, many owners of other businesses as well. Some of these owners may become customers. From time to time, the owner then becomes a customer of his customer, an arrangement good for both businesses. However, when this occurs there is the temptation to trade products rather than follow normal billing practices and exchange of payment. This practice is typically not in an owner’s best interest for several reasons.
The typical business owner doesn’t worry about a real estate lease except when it is created or when it is time to renew. In some cases the renewal process consists of a one-page addendum signed by both parties agreeing to a new monthly rent and an extended term with other provisions carrying over from the existing lease. This quick renewal can have unintended consequences during the late stage of the business sale transaction.
The sale of your company is not about you. Well, it probably is, but that should not be the focus during the sales process. Think like the buyer; investors are looking to buy a business, an engine that generates revenues and profits separate and distinct from the value a retiring owner contributes to the business.
Many owners highlight that their business is a great place to work by pointing to their employee retention. With pride they mention the number of employees who have been with them for more than twenty years and even the occasional thirty-year pin they awarded. If the workforce is large and this long-term retention applies to a small percentage of employees while there is a strong mix of ages among the rest of the team, this is truly a feather in the owner’s cap, a strong testament to the company as a great place to work. Think like the buyer; if the team is predominately older, especially in the management ranks, the buyer sees three potential problems: