Archive for the ‘Miscellaneous’ Category

The Experience Factor

Thursday, January 17th, 2008

The folly of going with a single buyer


“When a man with experience meets a man with money, the man with experience walks away with some money and man with the money walks away with some experience” – Anonymous 

Recently an insurance company executive approached us about selling her company. She had an offer from a national insurance company, let’s call it “XYZ Company”, and wanted to see if we could bring in a buyer to pay more for her company. We have seen many instances where a buyer, typically someone in the same industry, makes an offer on a local company and ends up paying a substantially lower value for the company than what a proper business sale would enable. The best advice we could give her was to retain our company to represent her and conduct a confidential M&A Process to maximize her take home.

This buyer, a sharp lady, is a great insurance executive but, as is the case with most business owners, has no experience selling companies. The national insurance company on the other hand, has done many acquisitions in the past and has a seasoned team working on this transaction. Without representation from a competent M&A specialist, here is what this business owner will likely go through:

v  XYZ starts the process off with a basic, generic, non-binding LOI with an offer well below or at the low end of the business’s value

v  Seller may ask for more money and the XYZ Company may accede depending on their acquisition strategy and how tough its negotiators are.

v  Once the seller thinks she has got fair value for her company, XYZ embarks on an exhaustive due diligence process. XYZ company’s attorneys, accountants, acquisition experts start their inquisition into the seller’s company affairs.

v  The owner gets busy with collecting tons of paperwork, preparing many diligence reports, answering questions and starts losing focus on the business

v  XYZ starts finding several small and big things that are wrong with the company’s financials, sales pipeline, future projections, leases, etc.

v  XYZ puts out an updated LOI which is lower than the initial offer because of all the things that they uncovered in the due diligence process.

v  The terms in the updated LOI are complex, payments delayed, tied to future performance, and generally structured in a way that is not advantageous to the seller

v  By this point in time, the seller has spent countless hours of precious personal time and has also spent several tens of thousands of dollars in attorney fees reviewing the contracts and other legal documents.

v  The process also takes its toll on the business. With the seller’s eye off the ball, the business starts to suffer. Employees get nervous and productivity drops. In some cases, key employees or key customers may leave. XYZ Company’s continued due diligence finds signs of deteriorating business and asks for further accommodations from the seller.

v  If the seller realizes she has been had or if she becomes emotional about the process, she will pull the plug, cut her losses, and go back to rebuilding the company for a sale later. But more often than not, the seller is tired, anxious, stressed out, under time pressure to make the transaction, and eager to move on. Faced with the compelling arguments from XYZ Company’s experts, the seller decides to take the lowball deal and moves on.

The seller could avoid this with one simple step – Start M&A process with a competent set of advisors and let them work with multiple buyers. The M&A process will enable all potential buyers, including the one that started off the process, to compete for the business. The buyer who sees the most value in the business will likely win and provide the seller with the best value as well as favorable terms. A win-win deal for all parties involved.

At our firm, we have routinely done deals where the final take away was 20% to 40% higher than what the seller would have netted had he/she gone with the first offer.

Double Lehman Explained

Friday, February 23rd, 2007

How M&A intermediaries get compensated

Almost every seller wants to know what our fee structure is before deciding to put a business on sale. Some of our larger clients are immediately familiar with the Double Lehman structure we use but some others have never heard of this fee structure before. Some of the larger companies have heard of the “Lehman Formula” but not the “Double Lehman”. First a brief history of “Lehman Formula”: Lehman Formula is a compensation formula developed by Lehman Brothers many decades back for investment banking services and is structured is as follows:

–       5% of the first million dollars involved in the transaction

–       4% of the second million

–       3% of the third million

–       2% of the fourth million

–       1% of everything thereafter

This formula suggests that a seller would pay an intermediary a fee of $150 thousand on the first $5 million of transaction value. Thereafter, the formula calls for an additional 1% of any value in excess of $5 million. According to the Lehman Formula, a transaction value of $100 million would generate a transaction fee of $1.1 million, or 1.1% of value. Over the last few decades, as inflation changed the size of the deals and as the complexity of the deals grew, this fee structure has evolved. In modern investment banking transactions, this fee structure is somewhat modified and goes along with upfront fees, retainers, hourly fee and other fee to compensate for the expenses in the transaction.  

For large deals, especially the ones in hundreds of millions of dollars, the Lehman Formula provides large fees and there are several national M&A firms such as Goldman Sachs, Merrill Lynch who compete to win these deals. These deals are highly customized and compensation for the M&A specialists is tailored per the objective of the deal.

On the other end of the transaction sizes, business brokers typically charge 12% of the transaction proceeds for business under $500,000 and 10% of the transaction proceeds for businesses over $500,000. Mid market M&A specialists have a challenge in the sense that the work of finding qualified buyers and closing smaller deals can be as or more difficult than for larger deals. Working at the compensation level implied by Lehman is untenable given the complexity and work required of these small deals. However, charging clients at 10% level as business brokers charge can be detrimental to the interest of the client selling his/her multi-million dollar business. Double Lehman is the compensation structure designed by M&A specialists to solve this problem. Double Lehman is a variation on the Lehman Formula to bridge the gap between the very small (less than $1 million) and very large (greater than $100 million) deals.

Under Double Lehman, the M&A specialist fee is structured is as follows:

–       10% of the first million dollars involved in the transaction

–       8% of the second million

–       6% of the third million

–       4% of the fourth million

–       2% of everything thereafter

The Double Lehman provides for a transaction fee of $300,000 of the first $5 million of the transaction value. The fee on a $20 million deal would be $600,000 (3% of value).

Bottom Line: The Double Lehman is a convenient way to begin discussions regarding M&A specialist compensation for selling mid-market companies. The formula provides a structured means of discussing fees and facilitating agreement between sellers and intermediaries. For smaller deals, this fee structure is significantly superior to what business brokers charge. For larger deals (greater than $10 million), the fee structure is more likely to be a combination of upfront fee and success fee and every deal is negotiated. The seller and the M&A specialist can work together to create win-win deals.                        


Monday, January 22nd, 2007

Welcome to the blog of Chakradher (Chak) Reddy, Chief Dealmaker, Elite Mergers & Acquisitions.