Do investment bankers, M&A advisors and business brokers actually add value? If so, how?

/in , /by Al Statz

Financially savvy company owners, such as private equity groups and diversified public companies, clearly see the value that M&A advisors add, since virtually all of them hire one to run a professional sale process when selling a company in their portfolio — even when they know who the buyers are and which one is likely will pay the highest price.

On the other hand, most entrepreneurs only sell their company once. As a first time seller, they haven’t experienced the value that a capable M&A advisor adds, which puts them at a disadvantage. Fortunately a survey of business sellers by Fairfield University professor Dr. Michael McDonald¹ provides credible evidence that intermediaries add value and explains how. I’ve summarized some of the survey’s findings here.

Professor McDonald surveyed 85 business owners located across the U.S. who sold their companies with the help of investment bankers² for between $10 million and $250 million during the 2011 to 2016 period.

All 85 sellers answered YES to the question of whether their investment banker added value.  As to where they added value, McDonald asked the owners to rate the value and relative importance of 8 services that such intermediaries provide:

  1. Identifying and finding the buyer
  2. Managing the M&A process and strategy
  3. Adding credibility to the seller
  4. Enabling management to focus on running the company during the sale process
  5. Educating and coaching the owners
  6. Negotiating the transaction
  7. Preparing the company for sale
  8. Structuring the transaction

All eight of these services added value according to the owners surveyed.  They said the most valuable services were, “managing the M&A process & strategy”, “structuring the transaction”, and “educating and coaching the owner”.

Importantly, the least valuable service was “identifying and finding the buyer”.  Simply introducing a buyer to a seller is not the primary value that intermediaries bring to the table (though clearly that is still a valuable part of the M&A process).

While this survey focused on $10-250 million deals, its findings hold true for smaller companies as well. If anything, the value that an experienced intermediary brings to owners of smaller businesses is even greater. These owners usually have even fewer internal resources to draw upon and are even more consumed with running their companies than their middle-market counterparts. Partnering with a quality business broker makes even more sense.

¹ I’m using the terms investment banker, M&A advisor, business broker, deal maker and transaction intermediary more or less interchangeably here. Firms that handle only $25 million plus deals usually refer to themselves as investment banks. Firms that mostly sell main street businesses for under $2 million usually call themselves business brokers.  Exit Strategies mostly operates in the $2-50 million price range, and we’ve settled on calling ourselves M&A advisors. Some firms like ours prefer the term “boutique investment bank”, particularly if they serve a few niche industries. When hiring an intermediary, regardless of what they call themselves, it is important to have a good understanding of their knowledge and experience, and the level of service they provide.

² Download the full survey results: The_Value_of_Middle_Market_Investment_Bankers

For more information on Exit Strategies’ full-service sell-side M&A services or to discuss a current need, confidentially, you can reach Al Statz in our Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Increase Business Value with Recurring Revenue

/in , /by Exit Strategies

Businesses with a higher percentage of recurring revenue generally sell for higher prices. Recurring revenue business models are highly sought after by strategic and private equity buyers because they are perceived as less risky. Future revenue is more predictable and requires less ongoing sales effort and reinvestment.

Companies like Salesforce.com pioneered recurring revenue in the software world, creating the Software as a Service (or SaaS) model. SaaS turned the traditional software licensing model on its head. Not surprisingly, acquirers of software companies reward sellers who’ve built a low-risk subscription model that looks to them like an annuity stream.

Companies in all industries can increase value with a recurring revenue model. Property management companies sell for more than real estate brokerages, for example, because they have long-term management agreements with landlords and leases with tenants that produce steady monthly revenue. Staffing companies, which place temporary workers with employers and produce annuity-like monthly revenue, sell for more than project based recruiting firms. Distributors who sell primarily proprietary products to OEMs sell for higher multiples than distributors who primarily sell commodities to end-users because high switching costs make customer relationships last much longer.

What percentage of your company’s revenue is recurring? 

Almost any business can find at least one recurring revenue opportunity. A license-based software company for example can add an annual support  program. Almost every boutique wineries has a wine club that automatically ships wines to customers on a monthly or quarterly basis. Restaurants can create loyalty programs that encourage customers to return on a regular basis.

Whether you are planning to exit soon or years from now, we encourage you to consider the immediate cash flow and future valuation benefit of recurring revenue.

Contact us for more information on increasing the predictability of your business revenue to increase enterprise value.

Case Study: How One Entrepreneur’s Advisors Enabled a Successful Estate Transfer

/in , /by Bob Altieri

I recently had a client who wanted to transfer his medical distribution company to his son and retire with peace of mind — a common occurrence these days. Dad and his CPA requested an opinion of Fair Market Value to set the price for a transfer of stock. After I appraised the company (S corp.) stock at $2.0 million, Dad and Son asked me how to finance the transaction. Dad was reluctant to carry a long-term loan for his son — also a common occurrence! Here’s how a team of advisors helped the client make this happen …

The lenders that I approached wanted Son to inject a minimum of $500K (25% of the deal price). This turned out to be a lot more than the son had available. One creative lender suggested that Dad finance the sale for a short time until Son had paid down 25% of the principal on Dad’s note, then return to him for an SBA loan.

The lender proposed 3 seller notes totaling $2 million: Note1 for $500k (25% of the purchase price) for two years, fully amortized; Note2 for $750k with interest-only payments, due in 2 years; and Note3 also interest-only and due in 4 years. The plan was that as soon as Note1 was paid off, the lender would take out Note2 to Dad with a $750k 10-year term loan. Then, after that bank loan was seasoned for 2 years, the lender would lend the remaining $750k to take out Dad’s Note3. The result: Son can acquire the business with no money down, Dad can be completely paid off in 4 years, and Son will have the flexibility of a long-term loan.

When Dad and Son were ready to finalize their agreement, they called a meeting with me and their attorney and CPA. I discovered one significant problem. Under a stock sale, Son’s expected salary and distributions, after taxes, were not quite sufficient to cover his debt service (principal and interest payments) and living expenses in the first two years.  During the meeting, I suggested doing an asset sale-purchase instead of the planned stock deal. In an asset purchase, the Son’s net after-tax cash flow would be substantially increased by the stepped up basis of fixed assets and intangibles. After providing rough calculations, Dad and Son received definitive tax advice from their CPA.

Cash Flow Benefits

Let’s look at an example of the difference in cash flow in an asset sale versus a stock sale.  Assume a $2,000,000 price in both cases, with inventory and fixed assets as shown in the table below, as well as price allocations to covenant not-to-compete and goodwill under an asset sale.

Asset Sale – Buyer Stock Sale – Buyer
Inventory $400,000 (not deductible) $400,000 (not deductible)
Fixed Assets $100,000 (new basis) $25,000 (existing basis)
Covenant not-to compete $50,000 na
Goodwill $1,450,000 na
Buyer’s total deductions against income $1,600,000 $25,000
Depreciation of Fixed Assets $20,000 / year, 5 yrs* $5,000 /year, 5 yrs*
CNTC & goodwill combined $100,000 / year, 15 yrs $0
Total deductions, years 1-5 $120,000 $5,000

*Assume all fixed assets have 5-year depreciation

With an extra $115,000 per year in deductions, and assuming a combined state and federal tax rate of 40%, the Son’s after tax cash flow in an asset purchase would be $46,000 more. Under this structure, the Son’s cash flow would be sufficient to support the debt and enable the ownership transfer.

Dad and Son are now almost a year into their transition. Son is faithfully paying down Note1, the business is doing well, and Dad and Son are happy.

The first moral of this story is that business succession planning and estate planning are team sports, where entrepreneurs need a team of experts to guide them. No single professional is qualified to advise on the range of succession and estate issues that arise.

The planning process often begins with an appraisal of the business and real estate assets, so that tax, financial and legal professionals, lenders, insurers and other team members understand the assets to be transferred. The second moral is that when a business is part of an estate transfer, as in this case, selecting a business appraiser with experience in structuring and financing business sale transactions can be a big advantage!

For further information or to discuss a current need, contact Bob Altieri at ESGI.

Employ a Recurring Revenue Model to Increase the Value of Your Business

/in /by Adam Wiskind

Businesses with recurring revenue are generally more attractive and more valuable to buyers.

Recurring revenue, simply stated, is the portion of a company’s revenue that is highly likely to continue in the future. An effective recurring revenue model creates a “stickier” relationship between the provider of a product or service and the consumer. Those businesses don’t have to spend as much time and money acquiring new customers.

Effective recurring revenue business models:

  1. Consumable -The original recurring revenue business was pioneered by Gillette. Entice consumers to use your inexpensive razors and then perpetually sell them expensive razor blades. Computer printers and coffee makers like Keurig has followed suit achieving substantial profit margins on consumables like printer cartridges and coffee containers.
  2. Subscription – A subscription is a contract to provide a product or service over a period of time, typically annually. Customers are charged for the service or content over the course of the period. Magazine subscriptions and software subscriptions (often called SaaS) fall into this category. There are also many services like janitorial businesses and equipment maintenance businesses that do or could use this model.
  3. Transaction – Credit card companies that take a percentage of every transaction that they originate invented this type of recurring revenue model. However, over the last few years the “sharing economy” has popularized this approach with other successful companies like Uber and AirBnB. These companies charge a small transaction fee to match sellers with buyers.
  4. Rental – Finally, a customer that borrows an asset, such as an apartment, a car, or a tool commits to a recurring charge as long as they continue to borrow the asset. This creates a recurring model as well. Data storage companies and many cloud services such as Drop Box utilize this model.

Why recurring revenue models are attractive to buyers:

  1. Predictability – Businesses that employ a recurring revenue business model, rarely miss monthly or quarterly forecasts because the forecasting models are more accurate. At the beginning of the period, the business starts with a base to grow from rather than beginning from zero. Owners and potential buyers are thus rarely surprised by major fluctuations in results. This predictability has many downstream benefits.
  2. Expense management – Predictability means business owners can manage their expenses more precisely relative to their revenue. One of the challenges with lumpy revenue models is that until the quarter or the year is over, you don’t know how you did. Which means it is difficult to ramp up or down expenses smoothly to match revenues.
  3. Scalability – Recurring revenue model businesses tend to be easier to scale because they produce predictable cash flow to invest in growth. Also, to be successful at generating recurring revenue a business must produce a product or service of consistent quality. Typically, once a product or service has been standardized it is easier to scale the business.

These unique investment benefits make businesses with recurring revenue more valuable than other businesses in the same industry.

With a bit of creativity and planning, many business owners can apply one of the above models to create a recurring revenue stream for their company. If you have questions about recurring revenue business models or are considering an exit, please contact Exit Strategies for a confidential consultation.

Early-Stage Tech Company Exits

/in , /by Exit Strategies

You’ve built a world-class software solution, delivered to customers as a SaaS application or web service.  You’ve recruited a team and created intellectual property. Customer retention is strong and the buzz is growing in your vertical market. Each new customer acquisition represents incremental recurring revenue that falls directly to your bottom line – and the company is closing in on cash flow positive territory.

Could this be the right time to sell the company?

You may be thinking, I’ve barely scratched the surface of the company’s income potential. Why sell at this juncture? The key is that you’ve built the engine for future financial returns. Perhaps a strategic acquirer with more marketing muscle or an existing customer base can turbo charge sales and edge out the competition better than you can on your own.  Or perhaps you’re a serial entrepreneur who’s strength is starting companies, and you’re ready for a new challenge. There could be any number of reasons why selling at this stage makes sense.

When implementing an exit strategy, early stage companies must select the right strategic M&A partner. Start-ups that are short on track record and long on vision and promise represent a unique species in the M&A market. Investment banking firms typically charge hefty fees, and prefer working with larger, later-stage clients.  On the other end of the spectrum, business brokers are generally unaccustomed to working with IP-focused technology clients.  If you’re caught in this under-served market niche, Exit Strategies Group can help. We focus on lower middle market clients, and have the skills and experience to value, package, market, and sell early-stage companies successfully.

One of your first questions will likely be, “what’s my tech start-up worth?”

Factors Affecting Small Tech Company Valuation

  1. Annual revenues and revenue growth rate
  2. How revenues are obtained (licensing fees vs subscription)
  3. Profitability
  4. Customer retention
  5. Strength of management team, and post-acquisition longevity
  6. Growth of the underlying industry
  7. Intellectual property
  8. Technology leadership
  9. Market share
  10. Viral adoption

In 2016, there were several noteworthy deals in the public markets.  While these public company transactions do not reflect how an early-stage privately-held tech company will be valued, it’s interesting to note the relative multiples of these deals:

Seller Buyer Revenues Transaction Rev. Multiple
LinkedIn Microsoft $2B $26.2B 13.1
Demandware Salesforce $2.37M $2.8B 11.8
NetSuite Oracle $7.41M $9.3B 12.6
Yahoo! Verizon $4.96B $5B 1.0

Is it surprising that Yahoo! sold at a 1x revenue multiple while the others sold for at least 11x?  LinkedIn, Demandware, and NetSuite all have growing revenues, defensible IP, in growing market segments. Yahoo! does not.

saasevtorev

Source: Software Equity Group | 2015 Annual Software Industry Financial Report

On average, larger companies (in terms of annual revenue) command higher price/revenue multiples. Price/revenue multiples for small early-stage companies typically range from 1X to 3X (with outliers as low as 0.5X or as high as 10X).

When planning your exit, it’s beneficial to understand the broad range of valuation multiples and influencing factors. The underlying value drivers hold true for all size deals. Consider the valuation factors listed above, and make sure your company is firing on all cylinders.

If you have a $1-50 million revenue early stage software or tech business and you’re planning or considering an exit, please contact one of Exit Strategies’ California-based advisors for a free confidential consultation.

Ten Exit Planning Benefits

/in /by Al Statz

Someone’s sitting in the shade today because someone planted a tree a long time ago. — Warren Buffett

Few would argue that a successful retirement takes more planning for a business owner than it does for other people.

Whether you intend to transfer your business to family, management or a third party, an exit plan is usually intended to produce a more successful exit and retirement. Here at Exit Strategies, an “Exit Plan” (or succession plan) means analyzing your business and planning how and when to exit ownership and employment, while maximizing value, reducing risk, and preserving wealth.

Ten Exit Planning Benefits

  1. Clarifies your best transfer option and timing
  2. Identifies value and marketability gaps
  3. Increases shareholder value
  4. Positions the company to attract more and better buyers
  5. Ensures business continuity
  6. More seamless leadership transfer
  7. Increases cash proceeds
  8. Minimizes taxes
  9. Minimizes financial risk
  10. Prevents costly mistakes

On a personal level, an exit plan re-energizes you and gives your work greater purpose. It clears and settles your mind, focuses your attention, and reduces your stress and anxiety.

In Exit Strategies’ experience, business owners rarely have the time or expertise to tackle this on their own. This is where we come in. To start with, we’ll objectively analyze your business and help you increase its value and marketability if gaps exist. We’ll coordinate with your tax, legal and estate planning advisors. Then, when the time is right for you and your family to sell, you’ll be ready, and the outcome will be successful. Ideally, we’ll start working together two, three or even five years before you’re ready to sell. The earlier we get involved the more impact we can have.

For more information on our exit planning services, and the approximate costs, timeframes and the typical return investment involved, Email or call Al Statz at alstatz@exitstrategiesgroup.com or 707-781-8580. Our discussion will remain confidential.

Exit Strategies Sells Aldetec, Inc. to Private Equity Backed Strategic Buyer

/in , /by Jim Leonhard

Sacramento, California – Exit Strategies is pleased to announce the acquisition of microwave electronics manufacturer Aldetec, Inc. by U.S. Technologies, a portfolio company of Cornerstone Capital Holdings.

aldetec_logo

Sold To:

ust_logo

Aldetec, Inc. designs and manufactures integrated microwave assemblies and RF amplifiers for the commercial, military and space flight industry sectors. US Technologies (UST), of Fair Lawn, New Jersey, provides quality electronics design, manufacturing, engineering, testing, repair and refurbishment services, from complete finished units down to the component level. Cornerstone Capital Holdings, which owns UST, is a private investment firm that seeks to acquire niche manufacturing and industrial service companies with enterprise value ranging from $5 to $50 million.

Exit Strategies (ESGI) represented the sellers on an exclusive basis in this transaction. In the course of our sale engagement, we prepared a business valuation, composed the offering memorandum, marketed the company confidentially, negotiated on behalf of our client, managed the sale process and advised the sellers throughout the transaction. Deal terms are of course confidential.

For further information or for advice and representation in the sale, merger or acquisition of a company, contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com.

About Exit Strategies

Exit Strategies Group, Inc. is a respected lower middle-market mergers and acquisitions advisory and business valuation firm based in California. ESGI brings M&A experience, proven processes and meticulous attention to detail to help private business owners sell, merge and acquire companies, as well as partner with private equity groups to grow and maximize value in an eventual exit. Our advisors have more than 100 years of combined experience in business merger and acquisition transactions in a variety of industries including sophisticated electronics manufacturing.

Don’t Forget the Net Investment Income Tax when Selling a Business

/in , /by Al Statz

The Net Investment Income Tax, which our friends at the IRS put into effect in 2013, takes an extra toll on business owners who sell their businesses; and for that matter, on most higher income taxpayers and any moderate income taxpayer whose income increases suddenly in a given tax year.

What is the Net Investment Income Tax?

The Net Investment Income Tax (“NIIT”) is a 3.8 percent federal tax on certain income of individuals, estates and trusts whose modified adjusted gross income or “MAGI” exceeds certain threshold amounts. Common forms of investment income are interest, dividends, capital gains and passive business activities such as rental income or income derived from royalties. Generally, wages and income from an operating business are NOT considered net investment income.

For individuals, the MAGI threshold is $250,000 (married filing jointly) and $200,000 for single filers. Taxpayers with MAGI over the threshold are taxed at a flat rate of 3.8 percent on all net investment income, in addition to other taxes!

When you sell a business of any significant value, NIIT will likely affect your tax liability in the tax year(s) in which you receive payment. Individuals report (and pay) net investment income tax on IRS Form 1040; while estates and trusts use Form 1041.

So, what should business owners do?

If you are considering the sale of a business or business interest, it is important that you fully understand the tax implications of a sale beforehand. There are strategies that you can use to minimize your tax liability if you take action early enough and/or structure the sale in certain ways. Contact your tax advisor to estimate your tax liability and find out what can be done to maximize your after-tax proceeds.

 

Exit Strategies are not tax professionals, and we do not provide tax advice. However, tax issues arise in nearly all of our exit planning, valuation and M&A brokerage engagements, so we are well aware of them. If you are looking for an experienced CPA or tax advisor to analyze the various federal and state tax issues related to a business transaction and recommend appropriate tax minimization strategies, we can recommend one or two. Feel free to Email Al Statz or call him at 707-781-8580 for help.

Selling an Ecommerce Business in the Lower Middle Market

/in , /by Exit Strategies

With continuing growth in consumer online spending and many high-profile public acquisitions this year, it seems like a great time to sell your online retail business. But things are never quite as simple as they appear.

Over the past few months, several impressive acquisitions have been announced in the public markets. Walmart has purchased Jet.com at a jaw dropping $3.3 billion; a move that is presumably Walmart’s effort to narrow Amazon’s ever-increasing dominance. Consumer brands company, Unilever, acquired Dollar Shave Club earlier this year, another massive $1 billion deal. And the Unilever acquisition machine is still hungry, rumored to be purchasing Jessica Alba’s The Honest Company, also for $1 billion.

Other well-known emerging ecommerce companies have raised impressive sums of money, suggesting incredible valuations. Take Ipsy for example, which raised $100 million in 2015 for their subscription-based make up service.

The above examples all have one or more of the following characteristics in common: Strong intellectual property, unique business model, extreme differentiation, and larger than life CEOs.

Most online stores do not have a Hollywood-famous CEO or an R&D budget to reinvent the consumer shopping experience. How do these companies create acquisition value? In the lower middle market, we often explore exit strategies with CEOs of ecommerce companies; in the process, we’ve discovered two differing models that are both attractive to prospective buyers in their own unique ways.

On one hand, there are many niche-oriented “efficient online stores” – where a majority of sales are generated through channels, and where most products are drop-shipped directly to customers. These companies have narrow, unique product lines – simple enough to manage with a basic ecommerce platform. Such an ecommerce business requires few employees, little or no office space, and virtually no inventory. An online business with these characteristics, and $1 – $2 million in revenues, can be attractive to individual and financial buyers.

On the other hand, many “mature ecommerce businesses” reached an inflection point – where it became mandatory to invest heavily in underlying platforms and technologies, to make difficult decisions about sales channels (and related margins), and to bear the overhead of specialized marketing staff and warehousing. When revenues exceed $5 million with consistent growth and profitability, such online retailers can become attractive to strategic buyers.

Online businesses have become far more competitive and challenging in today’s business landscape. Large players like Amazon increasingly sell virtually every product category, breaking through the old fortress walls of niche-based differentiation. Large players are investing billions in technologies – such as Chatbots and drone delivery – simultaneously creating simplicity for consumers and barriers to entry for smaller online retailers.

It’s always important to consider your exit strategy, while focusing on growth and fundamentals. Are you building an efficient online store or a mature ecommerce business? These strategic decisions prepare your company for eventual exit, and create appeal for the right kind of buyer when the time comes.

Why is That Information Needed?!?

/in , /by Exit Strategies

When we begin a business valuation project the first thing we do is provide an extensive document request list. A week or two into the analysis, we send a customized questionnaire to help us understand the business in appropriate depth. Our questions are designed to understand the facts and circumstances of your business well enough to develop a reliable opinion of value. To the extent we can, we try to streamline and tailor our requests so as not to overwhelm the client.

Most clients trust that we have a method to our madness and dutifully respond to each request and question. Sometimes however we get comments like: You asked for that before! Why do you need that? What does that have to do with value? So and so didn’t ask for that.

It’s an investigation, not an interrogation.

A key fact in most privately held businesses is that owners run personal expenses through the business. We ask about these for several reasons. For starters, a buyer would want to know the core expenses and cash flow of the business; they aren’t usually interested in paying for your kid’s health and auto insurance and cell phone bill. Second, when we add these expenses back, it increases the value of the business. Lastly, and very often overlooked, when owners evaluate post-exit income they often use flawed inputs to forecast income needs.

Case in Point:

On a recent exit plan an owner told me he thought his business was expensing $30,000 in perquisites annually. After we investigated, the actual amount turned out to be closer to $80,000. And that’s pre-tax. To replace that $80,000 after he exits the business, he would need around $120,000 in pre-tax income. That’s a $90,000 annual difference from his guesstimate. Inflation adjust for a 25-year retirement plan, and it produces a very large spending shortfall – or a big change in lifestyle. Isn’t that worth discovering today rather than when you run out of money 5 or 10 years into retirement?

And, no, we are not IRS agents!

This example illustrates why we ask a lot of questions. There are many more areas of your business that we need to investigate. Short-circuiting the valuation process only compromises the result and leads to poor decisions. A reasonably thorough analysis by a qualified valuation expert on the other hand produces a result that can be relied upon to make the best decisions for you, your shareholders and your family.