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.”

Ten Reasons Sale Transactions Fail

Comicus : “Dopus; I almost had the money in my hand”  – dialogue from the movie History of the World Part I

As followers of this blog know, I am a devout fan of Mel Brooks.  I have found his

spontaneous comments on bits such as the 2000 Year Old Man both intriguing

and perceptive.  And, many contain life lessons; garlic as the ultimate weapon against

the angel of death; fear to motivate singing; dancing to avoid someone kicking you.

While I have not experienced as much as he has, I have seen more than

my share of failed sale transactions so I decided to assemble my list of the top

ten reasons sale transactions fail.

 

In reverse order they are:

  1. Waiting until next year. You believe you will always do better, show improved results and be worth more. As I write this blog, I do not think there has been a better time in my business career to sell a business. And if you wait until you have captured it all and there is no more growth left, your value fades.
  1. Forgetting it’s a process. You have to give it a chance to work. Every transaction has emotional highs and lows and entrepreneurs are loathe to wait it out. You need patience and trust in the process.
  1. Eliminating a logical buyer. With all the consolidation in our profession, my mantra is “today competitors; tomorrow colleagues.” Don’t overlook those who know your industry best.
  1. Too much focus on the past. Buyers are only interested in the past as an indicator of the future. If all you had was historical operations and it was all in cash on your balance sheet, all  anyone would pay you is the value of that cash dollar for dollar.
  1. Poor deal structure. Please let the professionals handle this. It is what you get at the end that counts; not just the price.
  1. Doing the deal yourself. You probably wouldn’t sell your own house; why do you think you can sell your business? Get a qualified, knowledgeable agent.
  1. Ignoring your warts. Perform due diligence on yourself and make sure you understand what is good and not so good about your business. Then develop a plan to address the concerns.
  1. The wrong deal team. This is the transaction of a lifetime. Surround yourself with the best.
  1. Sellers’ remorse. I have blogged about this before. You won’t sell if you do not have something to go to. Make sure you do or do not start the process

1. Unrealistic price expectations. I know; you have the most beautiful baby in the world, but when you sell your company, everything has a price and there is a professional way to understand what yours is. Please do not relegate what may be the most important decision of your life to some friend’s belief in what you should get for your business.

 

So, there you have it. I am not going to promise you will be able to sell your business for

what you want. But, if you can avoid some of these pitfalls, your chance of success will

be a whole lot higher. Good luck!

Let’s Make a Deal

“I will take what is behind door #2, Monty. (from the original Let’s Make a Deal Show with Monty Hall)

Author’s note – I am really dating myself with this quote.

A colleague and I recently had the opportunity to present a session on what we were seeing as trends in transactions in our marketplace.  We chose to use our own universe of deals – situations where we were engaged to provide some due diligence services.  We combined this with some general market information as well as some other client experience.  Our conclusions were pretty obvious – it is a great time to consider a transaction (purchase or sale.)

So, let me share just some notes and observations from our session:

      • There is a lot of “dry powder” out there – estimates are financial sponsors (like Private Equity Groups) are sitting on $1trillion; there is another $1trillion sitting on Corporate balance sheets (excluding financial institutions.)  To put this in perspective, these two amounts added together are equivalent to the 6th largest GDP in the world (just behind Brazil.)
      • Financing is available – rates are historically low and terms are very reasonable.  Consider the leverage on this “dry powder” and you have the makings of very favorable financing climate.
      • Patience hell; let’s kill something – corporations large and small are growing impatient with the “new normal.” The reason for this year’s 1 or 2% growth can be the result of which days the Holidays fall on versus last year. In that environment, it is difficult to consider yourself managing for success. It is not hard to surmise you need more sustainable growth to survive.
      • Synergy is “in” – the grueling economy over the last few years has trained owners and their management teams how to get along with less. Adding some new “bolt on” or “tuck in” acquisition does not seem as challenging as it once was.
      • “Strategics” have the edge – of the companies who engaged us, 80% were strategic buyers. That synergy combined with a deeper knowledge of the market returned this group to the more historical relationship with strategics doing more deals than financial buyers.
      • Financial sponsors may be headed to “time out” soon – the pricing is getting a bit “frothy” and making the economics work on the “buy side” to satisfy their limited investors is proving to be a bit of a challenge. That being said, it appears there is still broad interest for good deals. Obviously, for those on the “sell side,” this is nice to see
      • Why did deals work?
        • Realistic price expectations
        • Strategic fit
        • Management teams
      • Why did deals fail?
        • Seller remorse
        • Chasing revenue only – no conviction
        • Unexpected surprises

So, given the above, it is a great time to consider a transaction.  Just keep in mind that while the overall atmosphere for a deal may be more “enabling,” each deal has to stand on its own merits and deal frenzy should not replace sound analysis as a reason to buy or sell.  Good luck!