Some Food for Thought

 

What will cause buyers to stop the presses, put pencils down and say enough is enough? It’s not unusual for different buyers to have different sets of deal killers. We’re not only looking at the perception of risk, but the actual risk. There are things that could potentially kill a deal, but they are not going to impact the value of the company. We emphasize early in a sales process of identifying and evaluating a broad group of buyers where the right type of buyer doesn’t uncover a deal killer that kills the entire case.

Private equity groups, strategics and investors all have different appetites and tolerances when it comes to risk. For instance, a strategic buyer may not be as agitated about your customer concentration because they have a long roster of customers so there’s less risk as an enterprise. A larger strategic may be more willing to take a bit more risk through a higher valuation. A platform company of a PEG may have a healthy risk appetite as it has the platform to lean back on and spread risk across the enterprise. Occasionally, we parent shop by playing ‘mom against dad’ – the PEG against the platform company – when one says no and the other says yes.

It really comes down to how your business aligns to each type of buyer your case engages. It greatly impacts the sale process and it’s why it’s incredibly important to build a process where we have a diverse mix of buyer profiles and a broad slate of offers from financial, strategic and some individuals. There’s going to be different multiples or overall valuations. We’re positioning your business towards buyers who have businesses doing something similar or adjacent to yours. There will be immediate synergies for the right buyer to capitalize on. And the right buyer will be willing to pay a higher multiple than any traditional buyer.

“I Found One!” Many sellers think they hit the jackpot and don’t have to pay for a represented deal. A well-run process is the best way to increase the value of your business as we’re engaging many sellers and buyers day in and day out. When you have a reputation for leading a good business, your inbox is probably full of buyers trying to score an off-market deal. Buyers love to get off-market deals because there’s no competition. The reason they do that is very important – they know you likely have no clue how important a deal structure is.

The easiest part of any business case is finding a buyer. The hardest part is certainty to close on a deal structure that’s mutually beneficial. No competition means a less favorable valuation from the seller’s perspective or a less favorable structure potentially as well. How much of a hit might you take? In our experience it’s been 25 to 35%. You really want to take a half million-dollar haircut on your life’s work? God love ya’ sir!

“As seller you’re not giving up anything and the buyer’s not giving you anything. It’s a mutually beneficial arrangement where the buyer gives you fair value and the seller turns over a cash-flowing asset. Everyone holds up their heads!” – Scott Spector

Auctions. We’re not necessarily fans of an auction because of how many times a case can run off the rails. If you’ve been with us a while, you understand how important integrity and relationships are to us. We’re not interested in being KKR. We’re known as being process experts to our PE network and they understand and appreciate we’re going to create competitive friction. Where the deal makes sense to the right buyer, the friction usually brings the top deals, valuations and structure to the top thus rewarding the seller. Our clients understand linking up with us ensures the transition from life’s work to a transferable asset commanding the best possible price and a congruent deal structure for both parties.

A Represented Case. Consider this, buyers have to invest hundreds of thousands and sometimes millions of dollars into due diligence. Oftentimes a represented deal from an M&A advisor or an investment bank signals a seller is serious. As advisors, we invest countless months in educating our clients, so a represented case is a serious case. Whether you choose to work with JSP or an investment banker, we have a higher probability of closing than others. On the buy side, especially for PE firms, the financial investment and the opportunity cost of a failed deal is huge. PEGs are going to great lengths to ensure your business is how it is represented.

Show Me the Money. In the LMM (lower middle market), the heart and soul of a private equity strategy is to establish a platform and then make add-on acquisitions. The platform may pay upwards of 8 to 10X for a $5MM EBITDA business. Pay close attention here – the gold is to then capitalize on multiple arbitrages* making several acquisitions at 4 to 5 times earnings where they buy $1MM EBITDA businesses. Once the add-ons are integrated that $1MM cash flow is now worth 10X, so they capture the delta between the two multiples between the acquisition and what the platform is worth. Read that again! Bring it full circle and executing the strategy allows the PEG to have a higher risk appetite in these transactions.

To Earn Out or Not. Sometimes a sellers business plateaus or there’s been incremental ups and downs and the timing to sell now isn’t the best decision. Buyers are looking towards the future of the enterprise not just past performance. The unicorn is selling your business on a multi-year uptick and not the peak. One buyer may pay a higher multiple with a history of growth. Another buyer may pay a higher multiple with signs of growth with a contracted backlog or favorably trending ARR (annual recurring revenue) validating that growth. These businesses will receive a higher multiple than a business absent those characteristics.

For example, if prevailing multiples in a particular industry are 6X and you have a firm that’s growing very fast compared to your peers in that industry, then you may realize a 7X, 8X or possibly even 10X. It’s not the only mechanism as there’s other mechanisms as well at play. Sometimes we run into a scenario where they don’t stretch the multiple keeping the multiple the same, but there’ll be some type of earnout. The buyer will say, “sure Mr. Seller I believe you’re going to grow, but I’ll pay you when I see it.” Seller beware…

The buyer will propose a similar mechanism for the seller to reap the benefit of the anticipated growth once it’s achieved. If it’s achieved the seller would earn more than if they were paid up front as the buyer is estimating the potential growth. That’s the gamble in this case as the buyer is only paying for incremental growth if and when it actually materializes. It reminds me of the first TopGun movie running the debriefs, “that’s quite a gamble with a $30MM aircraft lieutenant.” Taking on an earn out as a transition depends on the actual specifics of how it’s structured; another reason why it’s important to have a good M&A advisor and legal advice through the process.

Many founders and sellers grow some amazing businesses, and it’s likely their largest and most important financial asset. Most business owners don’t speak textbook language of valuations and don’t speak the language of buyers with caps and baskets and other jargon. One of our most important roles is to serve as translator between the universe of buyers – private equity, strategics and investors – and founder. Not only are you selling your life’s work, you must oversee your team operating the business during the process. One eye on the ball and one eye towards the future – it’s a very difficult task! These bullets are just a handful of high-value elements to consider in selling your life’s work.

*Multiple arbitrages in private equity refers to the strategy of increasing a company’s value by acquiring it at lower earnings multiple and then selling it at a higher multiple, often without making operational improvements. This approach allows private equity firms to profit from the differences in how various buyers value companies based on their earnings potential.