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

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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.

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.

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.

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.

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?

Stay 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.