Buy Out Values – Hail the Willing Buyer

“How the hell did he come up with that number?” – quote from a new client reacting to his partner’s price to be bought out.

Almost every week, I get the chance to see a number of potential transactions among partners — mostly negotiating buying each other’s shares or debating what value to use in a buy-sell agreement. All different types of markets with the operative words being “fair value.” So I have been in the middle of this before and I have a solution that I have used, but it involves some education and “faith” by both parties if it is going to work. Let me explain.

Fair market value is used in a somewhat cavalier fashion in these type of deals but there is little focus on the key aspects of the definition of this term which is a value based on what a knowledgeable, willing and unpressured buyer would probably pay to a knowledgeable, willing and unpressured seller. Valuation experts use common tools to arrive at a number or range, but in the end, most importantly, you need a “willing buyer.” So what is the problem?

When you go to sell your business, the willing buyer may be a financial sponsor of some type (hedge fund, private equity, venture capital, etc.) or even your competitor or someone who wants to get into that market (often called a strategic buyer). Most of these willing buyers have another way to measure the results of their transaction. For example, I had a client sell a significant division of his company to a strategic for about 15 times earnings. This was a great deal for him, but the purchaser was public, selling at 25 times earnings; and my client’s ongoing $10 million in earnings increased the buyer’s market value by $250 million. Not bad. However, this does not translate into the private company market of “willing buyers.”

Using this example, if my client wanted to sell to his partner who wanted to continue to run this business for a long time and not sell, that partner would have to fork over all earnings (at current levels) for 15 years before he would see a plug nickel. What willing buyer is going to do that? Yet, it is a problem I confront quite often. So in this case, the “willing buyer” will only offer something a bit more reasonable from a pure cash-on-cash recovery basis – say 3 to 5 years. Many buy / sells I see have a price of 3 to 5 times EBITDA which gets you to the same place.

So I often suggest that the offer be based on projected cash flow for a 3 to 5 year period. I also suggest that a provision be added such that if the company is sold in say a 5 year period, there is some form of “claw back” – that the previous owners are paid in part as if they still owned some shares (all negotiated). The alternative is to wait for that outside purchaser to come along and prolong an important exit event. So while fair market value is a sacred term, please remember when in comes to partners, it is governed by the provisions of the “willing buyer.”

Madagascar – Where Being an Entrepreneur is a Way of Life

“Necessity is the mother of invention.” – old English proverb

My wife and I recently visited Madagascar. It is a beautiful country with unbelievable landscapes, great people and of course lemurs. As I am prone to do, I saw this world through my own “colored” glasses and personally believe there are more entrepreneurs there than anyplace I have ever been. Now before you think I may have stayed in the sun too long or had too many THB’s (Three Horses Beers), please bear with me.

I am not sure about the official unemployment rate, but we spoke to dozens of people from all walks of life while we were there. Except for one, all were what we would call in the US, independent contractors. They were paid when they worked (office and factory workers, those in tourism, etc.) and not paid when they didn’t. So to survive, almost everyone has their own “business” – from performing some type of service to raising crops to clothing boutiques. Every town we visited had a plethora (thank you Three Amigos) of vendors selling everything from food to clothing to kindling wood. So I contrast this with what I see here every day and realize there are two big differences.

First, Madagascar is very poor so there are no “friends and family” to help support you as you go off to develop some new product or service. They need their venture just to survive; to pay the rent or barter to get food for their family. They are the ultimate risk takers – figuring out what they need to do to make it through the day – they are not living comfortably at home (or with friends) writing code for what hopefully will be the next killer app.

Second, they are unbelievably resourceful. Now I meet smart startup founders every day and they certainly know how to deal with limited resources. In fact, when I hold sessions and ask participants to describe an entrepreneur, one of the most common responses is they know how to get the most done with the least. But there, this concept is taken to a different level. There is little money and scarce natural resources, yet we visited “businesses” that:

  • Made aluminum pots (the same my Mom used for pasta) out of 100% recycled aluminum. They used everything from old building siding to car parts. By the way – no kilns for heat; just charcoal and the molds were formed out of silica sand.
  • Created inlaid wood pieces from recycled wood. Here the key tool was a saw; the body of which was constructed from car parts and the saw blades from the steel found in recycled steel belted radial tires.
  • Produced miniature model bicycles from 100% recycled bike parts – everything from hand brake cable to old tire spokes.

So now perhaps you can see what I admired about the entrepreneurial spirit there. Necessity for them is the mother of invention – both the need to survive and the need to make the most from what is available. Perhaps this “way of life” will inspire you to work even harder to make your venture a success because as tough as you think it may be, you are probably not as burdened as the entrepreneurs of Madagascar.