By Dirk Armbrust
Challenge: A business owner was considering selling and retiring while still wanting to secure a future for his son who worked in the business
A manufacturing business owner was introduced to The Vant Group by his attorney. The owner was approached by a private equity (PE) firm wanting to buy the business that he and his wife owned and whose son worked as a key operations manager. The timing was good for the owner and his wife, but they were concerned about their son’s future. Along with the normal stress associated with selling a business, they had multiple questions on their mind:
- Would the PE firm lay off the son after the sale?
- Would the PE firm provide an opportunity to stay and grow with the business?
- Would the sellers be “penalized” when the PE firm adjusted the price for the son’s ongoing salary?
- Was the PE firm’s offer strong enough to justify not listing the business in the open market?
We addressed the last two questions first.
We conducted a valuation assessment of the business. Our analysis indicated that the PE firm’s offer was strong but not significantly above what the seller could expect from any other buyer. We coupled this point of view with our expertise on current market conditions and salability of their particular business. (If you haven’t heard, we are in a “seller’s market”. There are many more buyers than sellers these days.)
Next, we prepped the owner with insight and “bullet points” to allow him to defend against the PE firm trying to reduce the sale price for the future salary of the son. Because the son worked in an operating role and was adding value to the business, we prepped the seller for the conversation.
Then, we addressed some of the common myths associated with the M&A space. Oftentimes, sellers worry that buyers (especially PE firms) will buy their business and then lay off a large portion of the workforce in a scorched-earth manner. This is how M&A is often portrayed in movies, but this is the exception rather than the rule. As you might imagine, this fear was front and center in this seller’s mind… especially when his son was in the employee population. However, the simple truth is that today’s buyers are looking for solid, well-run businesses. Buyers, especially institutional buyers like PE firms, would rather keep the acquired company’s infrastructure in place so that they can focus on growing the business.
Finally, we provided the seller key strategic insight on where they are today from a valuation standpoint, and what things they can do to secure a much higher sales price one to two years in the future. Based upon this deep dialogue and engagement, the sellers decided to pass on the PE firm’s offer, and focus on growing the business together (mom, dad, and son), to reach their overall goals as a family.
This case is a representative example of how The Vant Group approaches clients. There is often more to the story than just “how much can I get for my business?” (Although that is hugely important.) Things like family and succession planning issues matter. In M&A transactions, we typically serve as “quarterback” for the “deal team”. M&A advisors, attorneys, CPAs, wealth managers, and tax planners all have significant roles to play in this critical process. We ensure all the players are working together to achieve the absolute best, holistic, outcome for our clients.
Does any single customer represent more than 10% of your revenues?
From an evaluation standpoint, some prospective business buyers would consider a single customer accounting for 10-15% of a company’s sales as a major negative. Almost all prospective buyers would consider client concentration of 30% or more in just two to three customers as a big problem that would have a significant impact on salability and/or the terms and structure of a sale.
Prior to selling your business, any efforts to reduce customer concentration by diversifying your client base will be beneficial to salability, valuation and maximizing the cash received at closing. If there is a customer concentration concern, a lender may decline the loan or will likely only approve a partial loan to the buyer. This reduced loan amount also reduces the amount of upfront cash that a seller can expect to receive at closing. To address customer concentration issues, most prospective buyers will try to structure a “contingent earn-out” that is paid to the seller over time and is dependent on the future revenues or profitability derived from the company’s largest customers. If one of those customers is lost, the seller may never receive the contingent portion of the negotiated purchase price.
Here is a good article that further speaks on the topic: How business owners can mitigate the risk of customer concentration
Printing Money May Not be One of the Options for Financing a Business Transfer, but There are Options Out There.
For small to medium-sized businesses, there are several types of funding sources for financing a business transfer.
Each type is governed by the same basic factors, such as; transaction size, asset base, type of company and cash flow.
When beginning this step of the business transfer, it is good to know that delays in the financial process can be avoided early if certain precautions are taken. So before discussing a buyer’s main funding options, there are some overall matters to consider or prepare.
- Buyers should make sure to check their own credit and clean up any outlying issues.
- Personal financial statements are also important to have totally complete and ready, crossing all the “T”s and dotting all the “I”s.
A top level view and take away points for each of the main funding options
All Cash Sale
Most sellers will, of course, be favorable to an all-cash offer. It is also a given that an all-cash offer can come with a steep discount. This discount is about 40% of that of a suitable offer with financing.
Another alternative to bank financing is owner financing. Not all transactions are acceptable for institutional financing, and if an owner is not willing to discount their asking price 35-40% for an ALL Cash Sale, then owner financing might be the only other option for financing a business transfer.
The Small Business Administration (SBA) is a federal agency that will guarantee a portion of an approved loan. Financially, they only consider the EBITDA and the adjusted EBITDA. They use a strict debt coverage ratio to ensure a borrower will be able to repay the loan, pay themselves a salary and have enough left over for emergencies. Along with cash flow, the SBA looks at the buyer’s industry experience as part of their approval process. A buyer should make sure that the bankers and intermediaries they are using are familiar with this process.
An earn out is a negotiating tool that can off-set the sales price and allow a portion to be paid at a later time with specified positive revenue within a specific time period. If profits decrease, then the earn out percentage decreases. However, if the profits are higher than projected as negotiated in the terms, the earn out does not increase. The reason the earn out will stay at the same amount is because the increase is considered the result of the buyer’s efforts. Therefore, it also justified the higher price the seller was asking. By keeping to their guns, in this scenario, this option works well for both sides.
This financing is against the assets in the business or personal assets to collateralize the loan. Financial institutions often heavily discount the value of the assets to protect the bank’s risk. These loans are a great option for lines of credit and real estate loans.
To learn more about funding and financing a business transfer, a copy of Entrance – A Guide to Buying a Business by Alex Vantarakis can be purchased in paperback form or as a download at The Vant Group – Book page.
Who is Your Buyer?
Before starting the selling process, determining where your potential buyer will come from will put you ahead of the game. Know who your buyer really is.
Each business transaction is different, but there are common factors to any deal. There are certain main aspects of a buyer, each with their own list of pros and cons to consider, which typically are:
- Do they have industry (whichever type your business falls under) knowledge/experience?
- Are they a first-time buyer?
- Will they need financing?
A business broker should be able to give a preliminary idea or priority list of the most likely types of buyers. By knowing the type of buyer, the seller will have a better understanding of their needs or constraints when it is time to make or close the deal.
Broken down to the main or top-level categories, there are essentially six (6) different types of buyers. Again, what is a “pro” for one type, might be a check in the “con” bucket of another type.
Is Your Buyer the:
A usual concern for this type of buyer is whether or not they are trying to relocate or stay in their current geographical location. These are often first-time buyers, but make sure they are serious. A business transfer requires a doer, not a dreamer who is not ready to leave their current state of employment.
Competitor or Vendor
This can be the best idea or the worst idea. Though they will have knowledge of the industry, if the business transfer is not a quick process, a competitor can cause harm in the marketplace to drive down the revenue. However, due diligence should be cut markedly. Depending on their motivation, they could pay a considerable amount more than asking or their situation might not require inventory that could be on hand and therefore result in not wanting to pay top dollar.
A great option for bank financing if they can come up with the funds for securing the loan. Being that they are already invested in the business, they are of lower risk. If they are not able to come up with these funds, owner financing should be expected to be on the table. So it is fundamental to know if the business is being sold to a business minded individual.
They are always looking for a good deal but are not interested in handling the day-to-day responsibilities. If a good management team or the owner is staying on in some capacity to run the business, the deal is more likely to sell for asking price.
Keeping a business in the family can be ideal. A good rule of thumb is to use an unbiased third-party company to handle the valuation before a deal is put on the table. Family transactions can carry the added weight of emotion, so using separate attorneys and CPAs as any other business transactions is recommended. Because of familiarity, it can also lengthen the time for an accepted offer. Make sure to set clear expectations so relations are not damaged in the process.
Foreign and Public Companies
This is a very unlikely buyer for small businesses. The larger the transaction, the more viable an option this buyer type becomes. Being in contact with this type of buyer will require clear mediation to determine what each other’s requirements of the deal really are.
To learn more about how to find the right buyer for your business, pick up a copy of EXIT– A Business Owners Guide to Selling a Company, by Alex Vantarakis.
Closed Deal Case Study: Unrealistic Expectations of Business Value
Challenge: Business owner neglect led to a significant revenue decline without understanding the impact on the business value
A business owner that sold home décor contacted The Vant Group (TVG) to sell their business. The business was over 10 years old and the owner was becoming distracted by other life ventures. Due to this, they started to lose interest in the business and revenues began to decline. Eventually, it dropped to 25% of previous revenue, and the decision was made that it was time to sell. The owner’s expectations of the business value were based on the profitability of the business when it was in its prime. Unfortunately, the value of the business was now significantly less than had it sold before the decline in revenue. After understanding their current value with a valuation of the business, they chose not to market the business for sale and hold on to it.
Approach: Value is set by what the buyer is willing to pay
A year later, TVG received an email from a buyer that was looking for a type of business with very specific criteria. The profile fit the home décor business and TVG contacted the owner of the business to ask if they would be interested in talking with this buyer. Unfortunately, they had allowed revenues and profits to decline even further during that year. The buyer put in a Letter of Intent and the seller countered. The buyer was not willing to pay what the counter offer proposed as the seller was still unrealistic about the current value of the business. Many months went by and finally, the buyer decided to give another offer. There were several months of back and forth on the offer. Eventually, the seller had decided to move from Texas to another state. The seller realized that they needed to sell the business before they moved. At this point, the seller became realistic about the offer they had received. Though they had not put their business up for sale and had let their business decline, fortunately, they contacted TVG and allowed this guidance to provide an offer through the TVG connections.
Result: Closed in one month after terms were agreed upon
The seller now needed a quick sale and realized that the deal terms and purchase price offered by the buyer were their best options. The buyer and seller settled on a final purchase price, terms of the sale which included a consulting agreement and future earnings, and which inventory items would be included in the purchase. Luckily, they were able to sell their business within a few weeks of selling their residential home in Texas and make a clean break to their new state destination. Without the help of TVG, they would have never sold their business, and it would have died a slow death. Now, their original designs and home décor items have been placed in willing and capable hands. They will also be able to see the business they founded gain back the level of recognition and profitability it had once known with the goal of even greater growth.