Archive for February, 2007

How To Maximize The Value Of Your Business

Friday, February 23rd, 2007

Looking At Your Business From An Acquirer’s Viewpoint

You are contemplating on selling your business and want to understand how best to maximize the value of your business. You might have heard from your industry contacts that some businesses similar to yours sold for 3 times EBITDA and some others sold for 6 times EBITDA. This variation could mean a difference of several million dollars in take-home! What makes this variation possible? How can you get the best value for your business?

The purpose of this article is to help you look at your business as an acquirer might in valuing your company. The more attractive you can make your business to the acquirer, the better chance that you will get a higher value for your business. Your M&A advisor will also play a big role in the valuation and we will cover this in a different article.

Here is a list of key vectors acquirers use in evaluating business:

1.      Strategic Fit: Strategic fit occurs when some aspects of your business (products, services, distribution channels, location, etc.) are worth a lot more to another player in the industry than it is to you. When a strategic fit is established, the acquirer sees what you offer on a post acquisition basis and may be willing to offer much more than the going market multiples for the business. Give careful consideration to who the strategic acquirers may be. This is one area where a knowledgeable M&A advisor can be of great help to you. 2.      Cash Flow: After strategic fit, cash flow is the single largest value driver for most businesses. Think of ways to improve your EBITDA on a sustainable basis. Acquirers are suspicious of short term jumps in cash flow. So, be careful not to delay hiring or equipment purchases beyond what you believe is reasonable. Once an acquirer starts doubting your credibility and sees risk in the deal, the due diligence increases and the acquirer will make changes to valuation to adjust for the risk.3.      Management Depth: Keep in mind that acquirers are buying the business that they hope will be functional and growing after the sale. It is tough for the acquirer to place high value on your business if you are the sole decision maker in the company and the business depends largely on your skill set. Developing your staff so that they can run the business when you are gone can pay big dividends when it is time to sell. If you are concerned about your employees leaving once you are gone, it may be good idea to consider employment contracts, stock grants and other incentives that give them a reason to stay long term. If possible, start work on staff related issues at least a year before you plan on starting the sales process.

4.      Customer Diversity: Acquirers are nervous about businesses where a high percentage of business comes from a handful of customers. Ideally, no single customer should contribute to more than 10% of your revenues or profits. The best solution for this problem is to diversify the customer base. If that is not feasible, be prepared to accept part of the transaction price paid as earn-outs or plan on supporting the acquirer in an advisory role to ensure customer continuity.

5.      Recurring Revenue Stream: Acquirers love predictable and low risk revenue streams. Any long term contracts, annual service/licensing fees, and other recurring revenue streams make business more desirable and fetch a higher price in the marketplace. In service oriented business, converting predictable customer support calls into recurring revenue stream can turn a business liability into an asset.

6.      Desirable Products & Services That Are Difficult To Copy: Acquirers place higher value on a business with unique products, services, or distribution systems than a business whose offerings are considered generic. Think of ways in which your product/service is unique and why it should be valuable to an acquirer.  Having an edge and having the ability to communicate the edge can do wonders to your business’s valuation.

7.      Barriers To Entry: With so much competition all around you, why is your business difficult to copy? Why will the acquirer be able to have as much success with the business as you had? Is it because of intellectual property (patents, copyrights), regulation (permits, zoning), difficult to get contracts (you are one of the two or three qualified vendors at each of your major accounts), or something else? What is unique about your business? Having good answers to these questions indicates that there are barriers to entering your business and these barriers make your businesses more valuable than your competitor with similar cash flow.

8.      Pending Upsides: You believe you are about to come up with a compelling new product or make major inroads into a premier customer. You also believe that these developments can double your business next year and do not want your company to be undervalued based on current financials. Delaying the sale has other consequences that make it unattractive for you to wait. So, what do you do? A good forecast backed up by management presentations with examples on why the company would achieve the forecasts is extremely powerful. However, keep in mind that any forecasts that do not materialize as planned during the sales process can have substantial negative impact on the sales price. Having a good understanding of your product/sales pipeline and having the ability to communicate it with your M&A advisor can help structure a deal where part of the sales price can be paid in earn-out to capture some of the upside.

9.      Industry Exposure: Perceived industry leadership is an intangible that can enhance your company valuation. Keep a record of newspaper stories, articles in trade magazines, mentions on local TV or any other mention of your company in print or any other media. Your business is more valuable, if your company is perceived as being a leader in the industry and sought after for its expertise. Asking your employees to write articles and keeping in touch with local and industry reporters not only enhances your valuation in the long term but also helps drive your business and image in the community.

10.  Strategic Plan: A written strategic growth plan that clearly documents the areas the company can grow can be an asset to acquirer. Length of the document is not as important as the content. A well written 2 or 3 page growth plan is sufficient. Acquirers will also find useful prior year plans that show the history of your ventures – along with their failures and successes.

11.  Record Keeping: To many acquirers, high quality book keeping reduces risk and also says a lot about how the business was run. Having a set of clean, easily auditable books inspires confidence and helps during the due diligence and negotiation process.

12.  Accentuate The Positive: Every business has its chinks and it is very important for the seller to identify these negatives and proactively offer solutions for turning the negatives into positives. It is important sellers take steps to put out any bad news on he table early and dealing with it than letting it come back and haunt them during the negotiating process.

The most important takeaway from this article should be that while EBITDA matters, EBITDA is not everything. Improvement along the key vectors mentioned above will give your M&A advisor a considerable upper hand during the negotiation process. If the EBITDA of your business is $1 million, a difference in a multiple of 3 and 6 would mean a difference of $3M in pre-tax earnings. Not bad for doing a little bit of homework!

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.