ACQUISITION MONEY
Interest rates are still high, do buyers have money to do deals?
According to S&P Global, Private Equity firms have $2.49 trillion of what they call Dry Powder. This is money they have available to them to buy platform companies and add-ons. A large percentage of P.E. firms are focused on Small Market Businesses, companies with $10 to $50 million in revenues.
Public companies have $2.4 trillion in cash some or all of which can be used for acquisitions. These strategics buy companies focused on customers that fit with their existing product lines and will grow rapidly under their ownership.
Both types of acquirers have to prove to investors that they can make a better return that what a Treasury Bond pays. They need to put the money to work.
We always ask clients to think about the "Make or Buy question." How much money and how long would it take for someone to build your business from scratch? The answer is usually a healthy multiple of your revenue and as long as a decade. That's a good thing for selling companies. It's cheaper and quicker to buy than to build.
VALUATION -- USES, METHODS AND OWNER EMPOWERMENT
One way for owners of private companies to develop bargaining power when dealing with investors and potential buyers is to commission a valuation by an expert.
Different methods can be used for different purposes like a high value for incoming shareholders and a low one for tax purposes.
While there is flexibility on how a company is valued, it is not as freewheeling as it might seem.
The IRS requires Fair Market Valuations.* FMV is what a willing buyer with full knowledge about the company would be likely to pay (the bid) and what a willing seller with full knowledge is likely to accept (the ask).
The valuator’s job is to present a reasoned case based on data and analysis for a price range within which a credible bid will meet a credible ask.
Income makes a company valuable. Sellers give up income from future cash flows. Buyers gain future cash flows. Sound FMVs are based on measures of income. Here are three income measures that are used.
Discounted Cash Flow – This method uses real input from the company which the valuator weaves into a forecast model to present a well-constructed case for a value range. Expected future income is discounted back to today’s dollars using the current cost of capital to render Net Present Value.
Multiple of Revenue – This is a shorthand measure using current year’s revenue times a market multiple. Current market multiples can be hard to find. Using reported public company multiples is one way, also, investment banks run studies and report multiples by industry segment. Specific company information and its future prospects are overlooked in this method, which is often used in Silicon Valley for startups.
Multiple of Earnings – This is another loosey goosey method that gets thrown around in the M&A world. It uses a market multiple times a measure of current profit. The higher the profit and the bigger it is as a percentage of revenue the more the buyer is likely to pay for the company.
An effective valuator will accommodate the three methods and give relative weight to each one in determining the value range in their Valuation Report. How much weight to give one method over another is different for every company and needs to be determined with careful consideration.
Conclusion – A Valuation Empowers Private Owners
A credible Fair Market Valuation is an invaluable tool for the owner of a company. It enables good decision making and can reduce uncertainty. If a sale process is initiated it gives the seller a firm foundation from which to negotiate with buyers.
EVERYBODY LOVES DROP THROUGH
Drop Through is the amount of money that “drops through” the Income Statement from Revenue all the way to Net Income. There are a couple of important measures to look at in regard to Drop Through. Most important, though, is that Drop Through is a company owner’s best friend, especially an owner considering selling their business.
It can be expressed as the formula: Drop Through = (Net Profit / Revenue) × 100. A company with $500,000 of monthly revenue and net profit of $100,000 has a Drop Through of 20%.
A company that closes its books and produces monthly financial statements will facilitate good decision making and be easier to manage profitably.
Potential buyers track Drop Through in those statements to understand how well a company is matched to the market it serves and how successful it is competing in that market. Being able to see trends in Drop Through will increase a buyer’s understanding of the company and encourage them to bid aggressively.
COGS (Cost of Goods Sold) is the first place revenue gets reduced on its way to the bottom line. These are expenses that occur every time a product is sold or a service is delivered. They are generally out of the control of the company and similar for all competitors in a market segment.
COGS deducted from Revenue gets us to Gross Profit which is one of the first things a buyer will look at when they review financials. There are no rules on what is an acceptable Gross Profit, but generally speaking anything above 65% of Revenue is pretty good.
Operating Expenses -- compensation, marketing, sales, overhead, etc. -- are a big factor in determining Drop Through. Since every dollar above Breakeven will Drop Through many owners are tempted to try to minimize Operating Expense and juice up profit. That may work in the short term, but it may lead to lower revenue and/or operating problems in the future. Buyers will look for profit spikes that depend entirely on cost cuts and may not like what they see.
Sellers should remember that Buyers will be focused on what a company’s current Drop Through is and will spend a lot of time thinking about how they can improve it after a sale. A Seller who can talk about what they have done to manage Drop Through – what has worked and what hasn’t – will build trust and credibility with the buyer and improve the chances of a successful sale.
YOU WANT BUYERS TO SAY....
Sure, the dollars and cents are critical to getting a deal and a good price and terms. Just as important are all these “other factors” that go into making successful transactions.
Key to this is getting into the buyers’ mind and what you want the buyer to be thinking and saying. Here is a not so random sampling of “What you want buyers to say.”
We really like these folks now that we have met them.
They are really good people.
We totally trust them.
Their records are super clean and thorough.
Their customers love them.
We like and trust their broker, lawyer and accountant too!
They have been prompt and thorough in providing info when we request anything.
We don’t see any significant legal problems or potential liabilities.
They are very flexible about staying on for a reasonable period of time.
The key employees are quite competent, seem to be no problem whatsoever, and are looking forward to the acquisition.
They pay their bills on time and have no supplier problems.
They have no undesirable contractual commitments.
This is going to be such a comfortable deal to do.
As wonderful as these people are I see three terrific opportunities to increase revenue and improve the bottom line.
LET'S NOT LOSE THIS DEAL! LET'S BID AGGRESSIVELY!
DON’T LET SUCCESSION PLANNING SCARE YOU
Naming your successor is hard.
CEOs, like everyone else, don’t like to think about leaving their company but after a sale it is likely that they will. There are many reasons why that happens, not the least of which is that having been in the top spot diminishes the allure of being an employee. Especially when you have just put a lot of money in the bank.
A succession plan that identifies the key roles, including CEO, that need to be filled when a vacancy occurs, rates the current incumbents, identifies potential replacements, and authorizes training for their next position can be a huge driver of a buyer’s interest in a company and their willingness to bid aggressively.
That interest will be fueled by the knowledge that a capable team will come on board and continue the successful performance that made the company an acquisition target for the buyer in the first place.
Buyers may also be looking for qualified managers on your team who will be candidates for promotion to positions in other areas of the buying company.
In short, creating a succession plan adds intangible but very real value to a company and doing it should not be put off.
Here are some more reasons -- even if you are not about to sell your company -- that a succession plan can make your company stronger and more valuable:
· Lenders and investors will be more likely to put money into your company if they know there is a written succession plan with buy-in from the key players.
· Team members will appreciate being mentored and trained for greater responsibility.
· Identifying team members’ strengths builds confidence in the other team members and discourages micromanaging.
· The process is a healthy one and encourages loyalty of valued team members.
· It’s not a complex process and much of it is intuitive, which should make it less daunting.
Bear in mind that in the case of a sale of the company the buyer may not follow your plan and may want to put their own people or outsiders they have recruited into leadership going forward. That’s up to them. However, by formulating the plan and having it in place well before you embark on a sale you will have done what you can to advance the interests of the buyer, your team and yourself.
YES, VIRGINIA, THERE IS A THING CALLED SYNERGY!
Smart managers building their careers by building their companies through acquisition are always facing the question “Does it REALLY make sense to buy another company?’
The answer is it depends on what you are buying. The goal, of course, is synergy, aka “two plus two equals five.”
Start with revenue. The purchase of another business can bring you new customers whose spending gets added to your business. A buyer with an existing sales force that is bigger than the sellers can ramp up the top line.
In the cost of goods section of the p&l buyers can scale up the volume of purchases they make from vendors and reduce per unit direct costs for the whole company. The buyer can get a two fer. Raising revenue and reducing direct costs can add points to the gross profit percentage which gets the attention of the CFO and the CEO.
The buyer can also get the benefits of adding talented people – big hitters in sales, talented people who develop the products, and innovators who find new ways to delight customers.
Some overhead and back office costs can often be eliminated to reduce operating costs.
So, yes, there are many good reasons to buy that fast growing business whose owner is ready to turn over what they have built so that the bigger enterprise can enter a new market sector and take the acquired business to the next level. When they do it right buyers move metrics up and to the right and get a return on the money they used to make the purchase.
Fear and Greed and Talent Make the World Go Around
There is something wonderful about a truly talented salesperson. Consider John, a guy who sold magazine advertising for decades. He lived and worked through good times and bad, but whether the economy was up or down, whether his industry was expanding or contracting, it made no difference to him. "My job is really easy," he said. "The greed and fear model works. All I have to do is get out there and make calls." That model says that people will respond in a predictable way whether they are fearing loss and need to be protective or they are on a roll and want to run up their economic score. If there was trouble like a recession and John's clients were short of money to spend -- living in fear -- he pointed out to them that they actually needed to spend more on ads for several reasons: to stay top of mind among customers and prospects, to stay even or get ahead of competitors who were likely to also be short of funds, and to show the market that their company had stamina and was committed to the industry. On the flip side when markets were hot and spending was fast and free greed is the driver, get it while you can. Rack up those gains and buy the kids TWO pair of new shoes! In that environment John was a master at finding more ways for customers to spend. Like putting a belly band on each issue with the company's logo and hand delivering those issues to every attendee at the industry's biggest trade show. It's men and women like John who bring life to business. When you find one, stick with them.
INFLUENCING THE INFLUENCERS
Keynote speakers who are also bloggers, authors, columnists, broadcasters, publishers and information providers play a crucial role in business and industry. They share their expertise, insights, and experiences through keynote speeches at conferences, seminars, and events. They are experts on market trends, how to meet workplace challenges, and what innovations in business can help workers succeed. They are helping to shape the future of the next generation of industry leaders and guiding the success of the current one. They create and copyright and trademark world class content. If you are looking for a gold mine of content to re-purpose think about buying the works of keynote speakers. With one purchase you can add a library of information products that would take decades to create.
GOOD DEALS GET DONE IN THE GRAY AREA
Anyone making acquisitions – corporations, not for profits, PE or Venture funds, individuals – asks two questions:
The Investment Question: What should I buy?
The Financing Question: How do I pay for it?
The sequence in which they ask the questions provides a distinction between a financial buyer and a strategic buyer.
The financial buyer asks the financing question first. They have an amount of money designated for purchases. It is likely to be a combination of their own cash and money they can borrow from a lender they have on contract. They will only make purchases that fit their criteria. Those criteria are based on rules management, investors, and lenders have established and they have all agreed to live by. For example: a fund might have a rule that the purchase price of any acquisition cannot exceed a 6X multiple of target company EBITDA.
The strategic buyer will ask the investment question first. They look for companies that will fit their growth plan. If the target company will get them new customers and bring them incremental revenue, then they are ready to buy. They may pay for it with cash they have sitting on the balance sheet earning a low return. The management team is in place because they are supposed to earn a higher return than the money gets sitting in the bank. They are eager to buy quality companies (that may not be profitable but have potential) and put money to work to prove their worth as stewards of the organization’s assets.
This is not to say that sellers should never sell to a financial buyer and only sell to a strategic buyer. There are gray areas where good dealmakers find ways to get deals done.
A financial buyer may have invested in a large platform business, and they need to add on to it quickly to meet their plan. This time pressure may force the buyer to use their discretion and behave more like a strategic buyer to get a deal done.
A strategic may decide that they want the seller to share the risk going forward and make much of the purchase price contingent on future performance. Even though they may be offering a high valuation to the seller, the terms and the risk may make the deal less attractive. In a case like this, the seller needs to be able to persuade the buyer that their risk perception is too high.
The point is that the seller’s battle for the best deal is won or lost in the gray area where human behavior is more important than rules. This is the space where accuracy, trust, confidence and mutual comfort with the other side are what matters. When a seller and their team are clear, candid and honest in the gray area, good deals get done.
Strategy in an Age of Uncertainty
Investment and expansion drove the business cycle that just ended; we don’t know yet what will be the “new black.”
Meanwhile, you may want to find ways to strengthen the p&l and shore up the balance sheet.
Divesting assets that have been a drag on earnings may be where to start.
Consider emulating the hired coachman Barkis in Charles Dickens’ classic novel David Copperfield. Barkis was smitten and wanted to marry David’s nurse Peggotty. He told David to deliver the message that “Barkis is willin’.”
This low-key message let the other decision maker know that there was an opportunity to consider. It motivated her to think of what might come next.
Similarly, now may be the time to use an intermediary to carry the message that you are willing to talk about a non-core property that may be more valuable to another company than it is to you.
Send the message to the most likely buyer that you are willing to talk in confidence. You may find a common interest that you can both act on.
Talking is the first step, and it may lead to an outcome that enriches both sides.