Wednesday, December 20, 2017

Private Equity Groups Can Recognize Strategic Value in a Tech Company Acquisition



Latest Article Published on Divestopedia

Takeaway: There has been a surge in acquisition interest in technology-related companies from private equity. This article examines the change in approach that was required in order for them to compete with strategic buyers.



The majority of our sell-side M&A engagements are in representing software, information technology, healthcare technology and other tech firms where a good deal of their value may not be reflected in their financial statements alone. Owners of these types of companies want to receive value in excess of the standard EBITDA multiple based on owning intellectual property that could be leveraged by a larger company with greater distribution capabilities.
I must admit that, in my earlier years, my perception of private equity groups (PEGs) as being very 'by the book' in terms of company valuation discouraged me from marketing to them as aggressively as I typically approached a strategic buyer. I always felt that my strategic positioning fell on deaf ears and they just wanted to see the numbers.

PEGs Are Changing the Way They Look at Tech Companies

There has definitely been a shift in the approach that PEGs are taking to evaluating, bidding on and ultimately buying tech companies. PEGs are already formidable bidders because of their deep pockets and financing capabilities. Now that they are matching or exceeding the bids of strategic industry players, they are winning more deals in the technology space. So the availability of funds risk is largely removed for the anxious seller who may receive a similar valuation from a strategic industry buyer, but questions whether the PEG can come up with the cash.

Tech Deals Provide Growth Opportunities for Private Equity Buyers

The interest of private equity groups in technology companies recognizes that there is tremendous potential for growth. In the old days, PEGs would negotiate and attempt to paint all their acquisitions with the EBITDA multiple brush. This is a totally inadequate valuation methodology when comparing a slow growing bricks-and-mortar company to a rapidly growing digital company. In fact, Wall Street has developed an improvement on the PE multiple with the PEG multiple. It stands for the price/earnings/growth multiple, and attempts to quantify the value of rapid growth into the valuation metric. It helps explain why a rapidly growing company like Facebook or Google sells for a higher PE multiple than a more mature, slow and steady grower like Xerox or Walgreens.

PEGs Are Involving Their Platform Companies in Tech Acquisitions

Another subtle shift in the PEGs' behavior is that they are involving their tech platform companies in the acquisition very early in the process. In the past, this involvement was more behind the scenes and more of a division of functions. The attitude of the PEG was that they are the experts on acquiring businesses and their platform company was the provider of operational excellence.
I suspect that after numerous deal losses at the hands of the strategic industry buyers, the PEGs had to become more like an industry buyer by involving their subject matter experts from their technology platform company. This has had an amazing impact on the sellers. Having someone that understands your company and its potential is much more pleasing than defending every nickel of your transaction value to a financial buyer.

Growth Opportunity Is Supplanting Financial Engineering

By involving the technology platform early in the process the emphasis has changed from one of financial engineering and cutting to one of leveraging assets and synergy. This new approach is looking for the combination of strategic assets to achieve 1+1=3. By expanding their vision, PEGs are recognizing the value potential created by cross-selling to each other's client base, improving time to market on an important upgrade, an improved customer acquisition model that could be employed by the larger parent company or adding the new capability to their current offering and making it more powerful than their major competitor's offering. The financial rigor and discipline will still be there with the PEGs' involvement, but that is no longer the sole focus in the negotiations.

A Change in Acquisition Approach Was Needed

So the new and improved PEG approach to acquiring small tech companies was necessary because they were not winning enough deals. The win percentage has gone up considerably because they are shifting their focus to growth potential and recognizing that they will have to pay for some of that potential. In our last two deals for Managed Services Providers (one in 2016 and one in 2017), the winning bidder was a PEG with an MSP as a platform company.
In a recent deal, a PEG was the winner in a competitive bid against some other PEGs and several strategic buyers. The successful PEG put their tech company CEO front and center on the deal discussions, conference calls and corporate visits with the sellers. The sellers felt understood and valued for what they had created. The buyer recognized that their small target had some valuable intellectual property, not in their technology, but in their business model. Their approach to landing new accounts was very effective and superior to the approach of the buyer. The buyer felt they would benefit by implementing this superior new account sales approach. They won the bid because they fostered this understanding and mutual feelings of respect.



Make a Little More Room for a Higher Bid

Private equity groups have a secret weapon that should enable them to be more competitive in these deals that previously were won by the strategic buyers. It is called the large company premium versus the small company discount.
Their model is to originally acquire a platform company with a value of $30 million. For this example, let's say that the baseline EBITDA valuation is 8 X. Now they go out and seek ad-ons that may be in the $3-$8 million dollar range. Those sized companies will generally sell at a discounted EBITDA multiple compared to the large company multiple. In this example, let's say that is a 5.5 X multiple. Here is where their magic happens. By virtue of acquiring the smaller company and adding it to the larger company, its EBITDA now is valued at the much higher multiple of the larger company. So if the selling company had an EBITDA of $1 million and were valued prior to the acquisition at 5.5 X, the value is $5.5 million. On the day of closing, that company (as a part of the bigger company) adds $1 million X 8 for a value of $8 million. $2.5 million in value was created out of thin air.
So he next time you are in heavy negotiations with a PEG, remember they have a built-in upside and a little more room to come up with some additional strategic value.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Tuesday, December 12, 2017

Available for Acquisition - Website AI Lead Capture Chat Agent



Click Here to get Profile and Confidentiality Agreement


·         An Automated Chat Agent: that uses a form of artificial intelligence (Natural Language Processing) to respond to text input from a visitor and behave like a real live (human) chat agent on a website.
·         Operates Autonomously 24x7: engaging with website visitors, capturing their contact information and main questions and sending that information to the business for follow-up.
·         Current Install Base: 180 users through: 1 major white label partner, 3 small partners, and 7 direct end-users
·         Technology Has Proven to Increase Lead Capture: for a number of industry verticals by a factor of 2-10x.
·         Rapid Set-Up: Allows basic version of automated agent running in less than15 minutes for general businesses and several vertical markets companies (company developed templates available)
·         Chat Highly Effective at Engaging Website Visitors: and it is a rapidly growing market with 52 million websites already using live chat.  However, small-medium businesses do not typically have the manpower or resources to man live chat 24x7 so an effective automated service is highly attractive for these businesses. 
·         Focus on Lead Generation: focus on lead generation for small-medium businesses.  Greater than 95% of a website’s visitors do not engage with the business – this is the main problem we’re solving.  We’ve setup our system to engage a website visitor more effectively than live chat or simple pop-ups so that we can capture more leads for that business.
·         Simple and non-technical:  Other AI agent solutions are complex and require a higher level of technical sophistication to setup, deploy, and maintain the agent.  Our solution is simple, easy, and does not require special technical or marketing skills.  You don’t need PhD’s to setup and maintain the system or professional copywriters to script the agent.  We’ve taken the guesswork out.  It’s turnkey.

·         Modular Technology Platform: The way we have created our tech platform we have a type of technical ‘shell’ that lets us plug-in to more advanced AI/NLP systems. We currently have our own NLP.  However, as 3rd party specialty NLP providers become more sophisticated those capabilities can be added to the system. It is setup to add these providers (like Watson, Rasa.ai, etc.). A strategic acquirer gets the benefit of having something that is ready to deploy now and also a technical architecture that is a foundation to build upon if they choose.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Wednesday, June 7, 2017

Company Acquisition Opportunity - Indexed Universal Life Marketing & Presentation Software for Insurance Agents and Financial Advisors


2016 Revenue: $514 K  2017 Proj Revenue: $850 K


 MidMarket Capital, a Mergers and Acquisitions Firm, is representing the Client described below for sale:

Growing Market for the Company’s Services: Main product is an illustration software for Indexed Universal Life. IUL’s emerging popularity with insurance agents and financial advisors, along with retirement savings wealth trends in general, support strong momentum for Company's market opportunity.

Proprietary Financial Product Development:  Company  occupies a very unique viewpoint in the retirement savings industry, has hundreds of agent and carrier contacts, and understands the underlying actuarial and marketing aspects of insurance-oriented savings products. All materials and product names are copyrighted.


Track Record/Proven Product Acceptance: Company has increased its year-over-year sales to one of the largest IMOs in the industry since inception, and now has other IMOs participating, as well as other market participants interested. Great growth potential with expanded marketing resources.


Click Here to eSign the Confidentiality Agreement for Client # 61151

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Friday, May 19, 2017

Company Acquisition Opportunity Publisher of Medical and Scientific Illustrations - Expansive Digital Assets



 The Company is a research and development publishing company specializing in high-quality medical and scientific illustrations, and educational products. Since its founding in 1998, the company has built a library of digital anatomical, pathological, and physiological illustrations and the text copies related to them. They are the most consistent in the industry with a consistent look across media.

Trademarks and copyrights: The Company earns royalty fees from previous promotional and medical publications. The Company retains the copyright for each new product it develops and currently maintains a library of approximately 150 copyrights.

Expansive Visual Assets: Since its founding in 1998, the Company has amassed a catalog of over 1,000 multi-layered illustrations that covers the majority of medical conditions and muscular and skeletal ailments providing a comprehensive portfolio of medical and pharmaceutical education materials to be used in a variety of publishing mediums.

Leveraging High Quality Assets: The multi-layered illustrations can be deployed digitally for an enhanced learning experience, capitalizing on the growth of on-line education and professional training.





Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Wednesday, May 17, 2017

Company Sale - Rapidly Growing MSP Southeast Michigan




2016 Revenue: $2.8 MM     2017 Proj Rev : $4.1 MM

The Company offers data, voice, and interconnect services as well as managed services, premise and cloud phone systems, and cloud services. The Company provides IT Support such as technical helpdesk support, computer support, and consulting to small and medium-sized businesses. Company's Managed Service Plan ensures proactive care, round-the-clock maintenance, and live (24x7x365) help desk support. In 2016, revenue was derived from hardware and software sales (41%), recurring revenue (service agreements and circuit commissions) (40%), and break/fix and ad hoc services (18%).

Company differentiates itself from the competition on many fronts including: a proprietary process for evaluating and solving technology needs; a comprehensive approach based on years of experience with and a market-leading position in both data and voice technologies; and a full suite of services ranging from infrastructure to cloud services, which is unparalleled in the Company’s market segment.


Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Tuesday, May 16, 2017

New Client Acquisition Opportunity - MSP with Life Sciences focus

2016 Revenue: $4.5 MM                               2016 EBITDA: $596 K



 Click Here to eSign the NDA

Founded in 1995 and headquartered in Massachusetts, Company provides strategic IT consulting in information technology, qualified cloud offerings and managed services, including managing regulated, qualified and non-qualified environments. Having worked with numerous products requiring regulatory oversight Company understands the distinct needs of the Life Science industry. We can provide a layer of comfort to the CIO or CFO in an environment where you might not have enough coverage for those critical or legacy applications and still be able to maintain all of the regulatory requirements that your company absolutely requires. Company is recognized as a leading provider of regulated systems management services with a focus on providing IT operating and application systems support. We can assume complete responsibility of the IT environment for companies who decide to outsource their IT or quality auditing needs. Company uses principles supported and taught in the Project Management Institute, and our Good Systems Practice® Managed Service approach provides the customer with much more flexibility than a traditional staff augmentation. 







Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Thursday, April 27, 2017

It Is Time To Sell Your Business Watch for These Danger Signs





Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Tuesday, April 4, 2017

10 Keys to Maximizing Your Company's Selling Price





Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Tuesday, March 28, 2017

How You Sell Your Business Will Determine Its Selling Price





Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Thursday, March 23, 2017

When to Sell Your Company to A Private Equity Group



Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

Thursday, December 22, 2016

Business Sellers Could Learn from this Seventeen Year Old Shark Tank Winner



Shark Tank Deal Wunderkind
The critical moment of many Shark Tank deals is when one of the Sharks asks, "How did you get to that valuation?'  I can't believe how often the contestants eliminate themselves with a poor answer to that question that stops their deal process almost before it begins.  Answers such as : We have invested $2 million in the product, so our valuation should be at least $2 million, or Our investors have put in $3 million so far. It should be valued at $5 million, or, I heard that xyz Company got $30 million for their company. So based on that our company should be worth $10 million."  Well, ask any Shark. This is not how they look at the value. The Sharks and the market in general don't care how much it cost you to develop the product or how much your investors have in or how much you need to retire or how much you think it is worth.

The Sharks look at what the ROI is for their investment in a company. So when the Sharks asked the seventeen year old how he arrived at his valuation he promptly responded with, our sales during this period were X$ and if your project that for a full year, they would total Y$. Our profit margins are at Z%, so if you project that forward, our annual cash flows would be XYZ$. At a cash flow multiple of 5 X, that gets you to our valuation. After a moment of stunned silence, one of the Sharks said, you have to be one of the smartest seventeen year-olds out there. I agree. This kid knew his stuff and he was prepared and he blew away the Sharks who have seen hundreds of contestants absolutely fumble this most basic of investor questions. Nice job, young man.

It is hard to criticize this very bright young man, but I am going to Bill Belichick him. The Patriots just won 27 - 3 and Belichick lists his three things the team could have done better. I only have one, and it is a minor nit, but could be important to him in the future. Most of the Sharks agreed that his was a fair valuation based on his multiple of cash flow analysis. One of the deficiencies of this approach, especially for very rapidly growing firms and earlier stage firms, is that the company growth rate is not accounted for in the cash flow multiple valuation approach. Why do some companies like Facebook and Google sell for much higher Price Earnings multiples than the average S&P stock? The answer is that these companies have a far higher earnings growth rate and that has been translated into a higher PE multiple. In fact, many investor professionals are now basing investing decisions on the PE growth multiple which does, in fact, incorporate the company's growth rate into the valuation equation.

So even though the Sharks agreed that his was a fair valuation, remember the car buyer never pays list price, so they will be trying to bid that price down by selling the value of having the Shark involved (which is quite valuable, by the way). Our seventeen year old wunderkind could have planted a preemptive thought when presenting his valuation with something like, "So our valuation is 5 X annual earnings, but that value does not even account for the fact that our sales have been growing by 8% month over month."

My assistant coach just passed me a note. What about the phenomenon for start-ups and emerging companies that their expenses are temporarily much higher due to the front loading of development and marketing expenses? If you look at the multiple of cash flow model, the entrepreneur is actually punished from a valuation perspective because of their growth expenditures if they are selling their company or seeking investors during this hyper growth phase.


So remember, buyers will try to come up with reasons why they should not pay you asking price for your company and you need to be able to counter with equally compelling reasons why they should. Maybe the Sharks should pay the seventeen year old entrepreneur a premium based on how much they might learn from this budding superstar entrepreneur.


Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Wednesday, December 21, 2016

Shark Tank Star - Magnet Lady's Superior Negotiation Techniques

Beating the Sharks at Their Own Game

On the 12-16-16 Episode of Shark Tank presentation by the mother from Seattle, Washington, who has designed removable and reusable magnet stickers for hanging art, I witnessed a bit of deal making art from the contestant. First, she was passionate, confident, and likeable; always a great platform to establish in negotiations. Secondly, she was well-prepared and could easily articulate her prior financial performance. Third, she came in with a very impressive record of prior success on QVC. Too many contestants come in with a "save me" attitude that is not effective.  Magnet Lady focused on growth and what she and a Shark could accomplish.  She was precise in her ask (what she would use the funds for) and her valuation expectations. 

All of this was impressive, but where she earned a grade of A was on her deal creativity and execution under fire. First, Lori was trying to pressure her into a single bid, which is a technique many of the Sharks have tried to use. They try to elicit a single bid auction with the implied threat of the Shark walking away if their initial offer is not accepted immediately. In our Mergers and Acquisitions practice, we find this to be the single biggest mistake that entrepreneurs and business sellers make. They often jump at an unsolicited offer or non-contested offer that ends up being far lower than what a competitive market process would produce. Magnet Lady deftly and respectfully kept the doors open with a comment to the effect that once we were partners, you would not want me to make any rash decisions. This allowed her to receive additional offers from the other Sharks. This resulted in a substantial improvement in her valuation.

So now she has Lori who has been leveraged up by other offers and she knows that buyers hate this. Magnet Lady believes that Lori is her best partner going forward, but her initial offer is one half of what Magnet Lady originally asked for. She also knows that Lori will probably not just raise her bid directly in a bidding war type of auction. So Magnet Lady counters with a very creative structure that commits Lori to her original bid for a valuation at the closing of the deal, with a contingent performance Kicker. If that performance measure is reached then Magnet Lady will receive her originally proposed valuation.


This would have been an excellent strategy with several days and an experienced advisor to help her craft her counter proposal. But the fact that she did it in real time under intense pressure from skilled deal makers is quite remarkable. She knows with Lori's help, hitting her targets will be a slam dunk. So she soothes Lori's ego by not forcing her original ask, but artfully gets there with a slightly different structure. Plus, she has again reinforced her confidence in her venture by putting her skin in the game and not asking for the entire value up front.  Buyers love this. Done deal.  When your magnet days are over, maybe you will be "attracted" to a career as a deal maker. See what I did there?

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Tuesday, December 20, 2016

Shark Tank Presentation Critique - The Culinary Ninja



Our Shark Tank Contestant
As a mergers and acquisitions advisor, I find the Shark Tank show fascinating like a football coach would, watching next week's opponent's game film. The show distills what is often a 6 to 8 month process down to a very intense eight minute vignette of the deal. Prior to the Shark's grilling, the contestants prepare their investment business case (the equivalent of the offering memorandum) and market their opportunity to the show's producers to earn the right to pitch the Sharks.
The culinary ninja with his Paleo Ice Age Meals had an attractive product in a hot area with lots of potential. He used a little showmanship and delivered his pitch as a poem after presenting his ask at a company valuation of $10 million, with limited current sales.  Every one of the Sharks was turned off and several delivered a poem response that conveyed the message that his valuation was off the charts high and how can he possibly justify that. He had essentially lost them and tried to recover with his very recent development of a potential partnership with Cross Fit. That information was interesting to the Sharks, but he had already lost them.
With the caveat that I was not standing up there in the glare of the bright lights with 5 seasoned deal- makers in attack mode, I am going to deliver some arm chair quarterbacking. In our business, we are often approached by companies with great potential or the best technology, who just need the buyer with the brand, the customer base, and the resources to take the product to the next level.  Where the reality gap comes in is that they want to be paid for all of this future performance with a lofty valuation not supported by current financial metrics and they want it all in cash at closing. That is what the Ice Age Meals guy did and he got justifiably bloodied by the Sharks.
How could he have changed his outcome, gotten his investor partner, while creating the possibility that his valuation would be realized? Well, he could have withdrawn his deal and waited until he closed the partnership with Cross Fit, and then come back later with the same valuation expectations. That is not a good idea because getting this audience with the Sharks is too important to pass up and may never return. The approach of this arm chair quarterback would have been to preface his value expectations by first presenting the Cross Fit potential partnership . Next he should have acknowledged that it was not a sure thing so he was willing to do a deal with a significantly lower valuation at deal closing with a contingent future valuation based on post closing performance.
So his valuation proposal would be comprised of both value and structure. For example, he may ask for a closing valuation of $250,000 for a 10% ownership stake. The second component would be a potential $750,000 additional valuation which could be based on 6%, 5%, and 4% respectively of sales during the next three years of operations. So if sales were $3 million, $4 million and $5 million during the next 3 years, he would capture $180 K, $200 K, and $200 K of additional contingent transaction value. In the mergers and acquisition world, this contingent transaction value is referred to as an earnout.
Buyers are more than willing to pay for potential once that potential is realized and they love it when the Seller shares in the risk and puts their money where their mouth is. By using this approach the Paleo ninja would not have immediately turned off the Sharks and been dismissed as an unrealistic seller. He would have been viewed as a more resourceful partner and someone willing to work with the buyers.  Here is the sad part of blowing this opportunity. The deal with Cross Fit has a lot of hurdles to clear before any money changes hands. The odds are against a fledgling start-up trying to do business with a much larger established company. The biggest reason is that a great deal of buyer resources are expended in order to roll out a partnership and they do not want to risk that their new partner goes out of business and wastes the investment and potentially damages their brand.
An investment from a Shark is a self-fulfilling prophesy. The little company will survive and thrive. Taking this information of the Shark's investment back to Cross Fit immediately removes the largest impediment to getting the partnership deal closed. The odds of the partnership deal improve dramatically which in turn improves the future sales potential for the Paleo meals resulting in realizing the full potential of the contingent portion of the transaction value.
It is a shame a deal did not get done with a potentially very good product with some serious upside potential. A small tweak in deal structure could have resulted in a much more accepting deal environment between the Paleo ninja and the Sharks. Investors and business buyers set up evaluation gates that the target must pass through. Don't allow them to eliminate you early by not passing the reasonable seller gate. 



Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Tuesday, December 13, 2016

Business Sale Negotiations - Base the Letter of Intent on Your Industry's Valuation Metrics





Unless you are one of the rare companies that is viewed as a valuable strategic acquisition by a company with highly valued stock as their currency,  your selling price is going to closely approximate your industry's valuation metrics. For an eCommerce Website it could be a multiple of annual net profit, for a IT managed services provider it is a multiple of MRR (monthly recurring revenue), and for a distributor of medical supplies it is a multiple of EBITDA.

So for this example we will use the IT Managed Services Provider. We got a great deal of buyer interest and had multiple buyers involved. We started taking bids and negotiating letters of intent. Because we know that the due diligence process can stretch out (sometimes as a buyer's way to make late inning price adjustments - an unfortunate practice known as Re-Trading) we wanted to provide a price adjustment mechanism that was fair to both buyer and seller. Normally because the process favors the buyer, the price can only go down between LOI execution and closing, but almost never up (if you don't believe me, read on and you will see how true that is). We wanted to accomplish two things with our approach; 1 encourage the buyers to complete the process in a reasonable period of time and 2 provide for both price increases and decreases with a performance measurement that would be based on the prior 12 months to the month of closing.

As we started getting our offers, our counter offers converted the purchase price into a multiple of EBITDA and then incorporated language that would base the final purchase price on the actual EBITDA for the prior 12 months to closing. The language looked like this:

BUYER will pay SELLER purchase price of $4,350,000 (four million three hundred fifty thousand US dollars) for 100% of debt-free assets of the company, goodwill, non-compete and non-solicit agreements. For illustration purposes, the valuation is based on 4.35 times EBITDA of the trailing 12 months (TTM) to the month prior to the execution of this letter, as provided by the business broker. At the present time and using available information, the TTM EBITDA from October 2014 to end of September 2015 is calculated to be approximately $1,000,000. The purchase price at closing will be based on an EBITDA multiple of 4.35 X the actual EBITDA for the 12 month period preceding the month of closing.

Again, the main purpose of this language is to level the playing field between buyer and seller.  Normally the buyers deluge the seller with voluminous data requests and in smaller privately held companies it is usually the owner that is in charge of responding. Often the performance of the business suffers and the buyers then make their adjustment to purchase price based on that downturn. If you do not formalize and document the corresponding upside for the seller, should the business performance improve, the buyers never raise their price. They have had you off the market for 6 months and it is par for them to play brinksmanship and threaten to walk on the deal rather than raise their price. You box them into a corner with this language by proactively documenting what you know they will do already. Once documented, it is pretty hard to argue that you shouldn't be provided the same protections. It is the same principal as a mutual non disclosure agreement.

So in a competitive bidding situation, we get the best terms and conditions from our buyers including the variable purchase price calculation at closing and fixing the amount and the formula for calculating the net working capital level.  We hammer out a couple of additional details including the calculation of the earnout, with the ultimate winner and we dual sign the letter of intent. As promised, the due diligence is exhaustive with the private equity group buyer. They assign a junior analyst to be the coordinator and another analyst to focus on populating the data room.  They already own a platform in this industry and involve that company's CEO in our weekly status call. As the months pass, yes months, the seller's performance continues to improve and we are sending monthly financial updates. It is becoming evident to all involved that the purchase price is going up. Remember what I said earlier - for the buyer the price almost never goes up.

Four months into the process the buyer produces a "term sheet" which basically fixes the purchase price to the original place holder level and overrides several key points that we had earlier negotiated in a competitive bid process. Our client was very upset and we pointed out to the buyer that we were not going to accept new terms after we were off the market for four months and that they had agreed to these terms in a competitive situation. I even sent them our email threads of our hard fought negotiations as a reminder. I also sent them our deal comparison work sheet to show all of the other bids that we received (I blanked out the identities of the other buyers, of course). Because of our extreme negative reaction they did not press on getting any agreement on the term sheet.

So we returned to the due diligence process and the PEG hires a human resources consulting firm, adding to the due diligence burden and often duplicating requests already completed. They also hired an "independent third party" CPA firm to go over our clients information and produce a quality of earnings report but not before yet another exhaustive round of data gathering, again much of it duplicated. We received a detailed report with several attacks on EBITDA and value but a couple of the highlights were, "To recruit and maintain quality employees, the Company may have to step up its contribution to the cost of health insurance and also add to the benefits package. The costs of such upgrades could easily run $50K-$100K per year."  This was completely speculative and not backed by any facts including our requested quote from their insurance carrier to move 8 employees to the new plan. We also pointed out that retroactively applying anticipated future adjustments to historical EBITDA was a real stretch on industry practices.

Another gem in the report was "The company will need to add resources in the administrative function at a cost that might be estimated on the low side at perhaps $100 K annually." This is after we have already discussed eliminating the seller's CFO with the platform company at a savings of $50,000.  

Another Quality of Earnings Report Finding "The relatively low margin on product sales combined with the fact that they are generally not recurring except over multi-year replacement and upgrade cycles means that the product component of the business should be valued using a separate, lower multiple of revenue and/or earnings than the service revenue, which is recurring." Well, first, the division of product revenue was clearly stated in all materials the PEG  had when negotiating their offer.  The offer against 11 other qualified bidders was a single EBITDA multiple. Again, the bid was set in a competitive process and did not include any dual multiple component.

All in all they presented $332,000 in EBITDA Adjustments as their starting point to reopen the price negotiations almost 5 months into the process. We refuted every one of their attempted non supported and arbitrary adjustments.

As nerves were frayed and the deal is on the edge of blowing up, I get an email from one of the partners at the PEG. 'Thanks for the note Dave, clearly we are just going to keep talking past each other if we focus on EBITDA. I think we can agree to disagree. (for clarity this won’t change the approach to employees, they will still be offered our company's benefit package at closing).

MRR is clearly the value driver of this and all MSP businesses." He claimed that the information they were provided and were using for their LOI showed a different revenue breakdown between product sales and monthly recurring revenue than what the seller was currently doing. "That issue notwithstanding the average TTM MRR at that time was 239k and the purchase price in our signed term sheet was $4.35M or 18.2x MRR. The average TTM MMR has indeed grown since April (by 7.2%), applying an 18.2x multiple to that MRR $256k brings you to $4.66M, we are willing to round up to $4.7M. That represents a $250k increase in enterprise value since the term sheet was signed."

Well the actual measurement that the LOI called for was based on 4.35 X the latest TTM EBITDA of $1.2 M that puts the value at $5.22 M.

At this point the PEG counted on our guys giving in and taking  their deal but there had been so much erosion of good will that our sellers walked away. This was a very expensive outcome for all involved. My take away from this is first, I am really angry at this unfortunate practice of "re-trading" that some PEG's use as their acquisition model. Wikipedia, the free encyclopedia, defines A Re-trade[1] as the practice of renegotiating the purchase price of real property by the buyer after initially agreeing to purchase at a higher price. Typically this occurs after the buyer gets the property under contract and during the period that it is performing due diligence. The buyer may raise a due diligence issue and demand a purchase price adjustment to a lower re-trade price. The seller can be left in a bad situation where it must either accept the lower price or lose the sale and re-market the property.


It occurs to me that had the buyer set their purchase price to the metric that was most important to them in setting value, they would have made sure to completely understand what the MRR in this case was prior to negotiating a LOI. If the due diligence process showed an unexpected surprise or variance in MRR they would have been protected. Also the seller would have accepted any legitimate price adjustment because the rules were clearly spelled out. They instead bid on a multiple of EBITDA and despite their best efforts to carve it up in due diligence could not find one defensible legitimate adjustment.  When the price went against them and they attempted to change the metric to give them the answer they wanted, they destroyed the seller's trust and killed the deal.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value