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.

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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.

The Zen Art of Cooperative Negotiation

/in /by Don Ross

zen-negotiationThe common image of an M&A negotiation between a buyer and a seller is that of a rugby scrum: two masses of interlocked muscled bodies scheming and bulldozing their collective strengths in opposing directions in an effort to secure the prize without compromise and ultimately yield one winner and one loser.

In contrast, what I call the “Zen Art of Cooperative Negotiation” is a playing field where the players (the principals and their attorney, M&A broker, and other advisors and stakeholders) become more collaborative and the outcome rewards everyone. The goal is win-win. There are no losers.

Below is a list of strategies that support a cooperative negotiation of business acquisitions, mergers, sales and other business transactions.

  1. Patience. Find a tempo that both can live with. A relaxed, easy swing usually gets more distance and greater accuracy. Set a realistic time frame checklist that keeps everyone on task but allows flexibility.
  2. Accept the personalities that are in the negotiation. Suspend judgment, keeping in mind that the end game is a successful transaction, not a personality contest.
  3. Share your objectives and listen. If you know what your end games are, you can be more mindful of the elements that will get you there. A “give and take” philosophy preserves self respect and encourages cooperation.
  4. Don’t burn bridges. Visualize the negotiation process as a cross country hike, not a tip toe through a minefield. You will encounter obstructions on the journey but with time and effort, most can be resolved. . . .but only if you leave the door open.
  5. Concentrate with your mind and stay loose with your spirit. A clear headed approach tempered with occasional humor can alleviate the stress and tension and optimize performance.
  6. Be honest. Full disclosure is always the best policy, and that applies equally to what you don’t know.

You can connect with Don Ross at 707-778-0210 or donross@exitstrategiesgroup.com.

Using Retention Bonuses to Enable an M&A Transaction

/in , /by Al Statz

Assurance of business continuity is essential to most business acquisitions, and for small to mid-size companies, this often translates to retaining key employees. This blog looks at using a simple tool, called a stay bonus or retention bonus, to keep your key people on board through a sale or merger of your company.

Bonuses are commonly used in business to reward employees for performance, such as hitting a sales target, implementing a new system, or boosting manufacturing productivity. Bonuses can also be used to incentivize a key employee to stay with your company for a specified period of time after a sale or merger.

How much are we talking about here?

sbimageStay bonus amounts are customarily based on the key person’s annual compensation, determined in accordance with the risk and effect of losing them. According to Mercer’s Survey of M&A Retention and Transaction Programs, median stay bonuses paid by U.S. companies range from 25 to 95 percent of base salary depending on the position (see graphic). The way we see this at Exit Strategies is that the stay bonus amount has to be personally meaningful to the key employee. In many of our deals this number is half to two-thirds of a person’s annual compensation.

But isn’t retention a buyer’s concern?

Remember that what gives your business value is the expectation of future earnings, adjusted for risk. As you reduce risk for buyers, your business value and probable selling price go up. From a buyer perspective, the cost of acquiring a business is more than just the purchase price. Other line items on their investment ledger include, for example, legal and professional transaction fees, loan fees and other closing costs, working capital injection (if you retain cash or AR) and any extra compensation paid to employees to ensure their continued employment and performance.

Stay bonuses can come from either side of the table—the seller or the company acquiring—or both. When retention bonuses are paid out of your proceeds, buyers can afford to pay a higher purchase price. So, in the end, it really doesn’t matter which side the bonus comes from.

When is the bonus offered?

Stay bonus agreements (a.k.a. stay-put agreements) are usually offered to (negotiated with) key employees when the owner is preparing to sell the company. Actual timing normally varies by employee and circumstances. Someone who you don’t identify as key to your company’s future may be offered a financial incentive during due diligence to ensure their participation in the short-term post-sale integration process. Integration bonuses are typically offered to CFOs, controllers or IT specialists.

Offering a stay bonus early on arises when an employee is critical to future performance and would be difficult to replace (e.g. a top design engineer or salesperson). Or when you need to involve them in the selling process. It may be compensation for the extra work involved. A third situation is when the employee is aware that you plan to sell the company, and you need them to stay put. When employees become aware that their employer is for sale, they understandably get nervous and may begin seeking alternative employment or become more open to offers of employment. When competitors find out that a company is for sale, key employees are likely to be approached and offered signing bonuses to jump ship. You can mitigate that risk by putting a retention bonus in place early on.

When is a stay bonus paid?

Stay bonuses should be paid out a specified number of months AFTER your deal has closed, not before and not at closing. Remember, you need them to stay on with the new owner. Most retention incentive bonuses are payable within 3 to 12 months after a deal closes. For key-employees who are critical to long-term success, it may be 24 to 36 months. Stay bonus agreements can also have an acceleration provision where they become payable if employment is terminated by the buyer.

How much should I budget for this?

The budget for stay bonuses will depend on several facts and circumstances. It’s a wide range in practice, and in many cases its zero. As a general rule, the larger the company, the smaller this budget is relative to the sale price. Unfortunately for small service businesses with few employees, it can be a significant percentage of the sale price. Some sellers elect to pay bonuses to loyal employees simply to acknowledge their contribution to the company’s goodwill value—unrelated to retention.

Stay Bonus Limitations

Clearly stay bonuses have limitations as a long term retention tool. Ultimately the buyer will need to provide rewarding work, a desirable culture, competitive compensation, growth opportunities and strong leadership. They do however enable transactions by reducing business risk during the critical months before and after an acquisition or merger. And of course there are other forms of financial incentives that can be used to align the interests of owners and employees, such as stock options, stock appreciation rights and phantom stock —a subject for another day.

In closing; retaining key staff affects the overall success of most M&A deals. Key employees drive customer retention, product and service quality levels, and in some cases business survival. Bonusing key employees to facilitate a business sale, merger or acquisition isn’t always necessary, but should always be considered when developing your exit strategy.

California-based Exit Strategies Groiup has been helping company owners plan for and exit their businesses successfully since 2002. Stay bonuses are just one tool in the M&A toolkit. If you have questions or are considering selling your company, Email Al Statz or call him at 707-781-8580 for a confidential consultation.

Can You Sell a Contracting Business to a Buyer Without a License?

/in , /by Adam Wiskind

Solar Installers, General Contractors, Electricians and Plumbers in California have something in common when it comes to selling their businesses. All of these businesses require a Contractors State Licensing Board (CSLB) license to operate. This can be an additional burden to the process of transitioning a business to a new owner. What if a potential buyer doesn’t have the necessary licenses? The easiest solution to this issue is to target investors that already have the Licenses needed to operate the business but this obviously limits the pool of potential buyers.

It is possible to sell a contracting business to an individual without a CSLB license but it requires some negotiation, trust and planning between the seller and buyer. To maintain their Contractor’s License a contracting business must employ or associate with a “Qualifying Individual” or “Qualifier”. A Qualifier has demonstrated knowledge and experience in the construction industry and can either be a Responsible Managing Officer (RMO) or a Responsible Managing Employee (RME) of the company.

An RMO/RME is according to California Law permanently employed by the applicant and is actively engaged in the operation of the applicant’s contracting business for at least 32 hours or 80 percent of the total hours per week such business is in operation, whichever is less. An RMO and RME may have different duties within the company but their responsibilities and liabilities with respect to the license are the same.

A contracting business can be sold to a buyer without a contractor’s license as long as the Qualifying Individual for the company is willing to continue to be employed by the business until the buyer is able to obtain the necessary licenses or hire a new Qualifying Individual. Under this approach managerial control will inherently be divided as the Seller’s Qualifying Individual will want to maintain close oversight of the contracting work being performed. Typically these situations are transitional because the new business owner will want to obtain the necessary licenses themselves or hire their own Qualifying Individual.

Exit Strategies Group has sold many California contracting businesses; some to investors who did not have the necessary CSLB licenses prior to the sale/acquisition transaction. With legal consultation, careful planning and development of trust between parties we help our clients to navigate this obstacle and successfully exit their contracting businesses.

Please contact Adam Wiskind at (707) 781-8744 or awiskind@exitstrategiesgroup.com about selling a Solar Installation Company, Construction Company or any other company requiring a California Contractor’s License.