Recurring Revenue Commands A Premium Business Sale Price

There is no factor more powerful in driving both business selling price and the amount of transaction value you receive at closing than contractually recurring revenue. Software and IT Services companies recognize this and most are shifting to a SaaS model. This short video discusses this value creation dynamic.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To learn more about our services for technology business sellers click to visit our Web Site MidMarket Capital

Technology Business Sales - Animal Spirits Create Strategic Value

There is no more effective approach to driving up your tech company selling price than to get buying companies in a competitive bidding process. In this short video we discuss how we were able to do this for one of our information technology clients to drive her strategic value in her company sale.


Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To learn more about our services for technology business sellers click to visit our Web Site MidMarket Capital

Achieving Strategic Value in a High Tech Business Sale

In a series of short videos we discuss approaches we use to drive strategic value on behalf of our technology company business sellers. In this one we explore the technique of restating our client's financials using the pricing power of the potential acquiring company. 

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To learn more about our services for technology business sellers click to visit our Web Site MidMarket Capital

Technology Business Sales - Animal Spirits Create Strategic Value

One of our short videos where we discuss our top strategies for driving strategic value in our Technology Focused M&A practice. There is no more effective approach to driving up your tech company selling price that to get buying companies in a competitive bidding process.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To learn more about our services for technology business sellers click to visit our Web Site MidMarket Capital

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To learn more about our services for technology business sellers click to visit our Web Site MidMarket Capital

IT Services M&A Deal Announcement

Base 36, A New England Based IT Recruiting, Consulting, and Outsourcing Services Firm 

Has Been Acquired By 

Compunnel Software Group, An Information Technology Staff Augmentation Company serving Fortune 500 companies and large enterprises.

MidMarket Capital advises companies in the information technology  industry. MidMarket Capital, Inc. principal Dave Kauppi provided investment banking services to Base 36 and its principal throughout this transaction.

There was considerable buyer demand, so if you are considering your exit, the timing is favorable. Please let me know if I should contact you. Thanks for your consideration

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To find out more about our services click to visit our Web Site MidMarket Capital

In a Business Sale, the Buyer Has the Upper Hand (Part 3)

Divestopedia just published my article. https://www.divestopedia.com/2/7801/sale-process/negotiation/in-a-business-sale-the-buyer-has-the-upper-hand-part-3

Takeaway: This is part three of a three-part series that identifies the natural advantages that business buyers bring to the table before the transaction process even starts.

In parts one and two of this article series, we discussed the natural experiential advantages that a business buyer's team would bring to the table in a business sale transaction; identified buyer attacks on the transaction value during the negotiation and LOI process; and offered approaches you can use to hold your ground against this formidable opponent in regards to the working capital adjustment, benchmarks and earnouts. In this article, we continue to view this negotiation process like a fencing match; buyer thrust, seller parry.

The Due Diligence Surprise

Thrust - "We noticed that your average billing per customer is smaller than our average billing rate, we are going to have to adjust our value."

Parry - "What about the memorandum, the detailed customer lists, the monthly billing report that you reviewed prior to executing the LOI didn't you understand? Our price is firm. If you want to adjust, we are cancelling the LOI and we are back on the market."

Thrust - "We noticed that you had a spike in this particular type of revenue which is unusually profitable. We do not believe that this is sustainable and are going to have to adjust our bid to account for that."

Parry - If you analyze it correctly, last year was pretty much the norm for this type of revenue. The year prior was actually the outlier and much lower than average. Secondly, if you truly allocated corporate overhead to this income category, you would find it about the same level of profitability as our other lines of business. No adjustment is warranted."

Okay, we held our own during that round. Now it is just a formality to get the purchase agreements signed and provide our wire transfer instructions. Not yet, pick up your sword.

Unreasonable Reps and Warranties

Thrust - You receive the definitive purchase agreement from the buyer's attorney and it looks like you have to rep and warranty your first born in order to get the deal signed. All of a sudden you see escrows and holdbacks, and guarantees that were not mentioned in the LOI. Much of that is pretty standard stuff, although it will be very slanted to the benefit of the buyer.

Parry - No material changes to the deal economics allowed. "We signed the LOI and provided you a no-shop in order to allow you to perform due diligence. We were very detailed in our LOI in order to compare your bid with others that were very close. Without any legitimate finding of misinformation in the due diligence process, the economics remain the same."

As for the scary reps and warranties, holdbacks and escrows, we let our lawyers talk with their lawyers. It is almost like they have the lawyers' secret pinky handshake and they carve through this language with clarity and precision. What it usually boils down to is what is reasonable and customary in transactions that are similar to this one. If there are any remaining issues, they identify them and ask the seller and his/her advisor to work them out with the buyer. By this stage, these final points are settled constructively.

Delayed Closing Date

Thrust - "Oh, just one more thing, you are going to throw in the floor mats and the undercoating at no charge." We tell our clients to expect this because it is just the nature of the buyers. Here is how it is manifested in a business sale transaction. The closing date is set for September 30, month end. "We want to move the closing date back to October 7 so we can take a look at your month end numbers. Do you have any concerns?" No, we just want to make sure things are on track.

Parry - Not much we can do about this one but try to anticipate what they may be looking at for that final attack on value and to prepare our counter attack. This one is a little trickier, however, because in prior attacks we had the luxury of time in order to strategize and craft our response. This one is usually real time where emotions are on the jagged edge. We ask our client to prepare a response to our anticipated last minute objection and then we, as their advisors, take the first attack. We want to have the client stay above the fray and preserve their relationship for the upcoming partnership together. If that effort is not accepted and the buyer insists on an adjustment based on, "It looks like you are not tracking to hit your first year earnout target," we prepare the seller with, "You know that we put in the earnout in order to align your interests with ours going forward. I have a good deal of transaction value tied to hitting our targets and I would not have signed this agreement unless I was fully confident that I would collect every dollar of that earnout."

Stalemate

Unfortunately, in spite of my best efforts, I view a stalemate as the best outcome we can hope for once we are off the market. As you can see, the leverage totally shifts to the buyer. The price is never increased during due diligence and contract negotiation. There is pressure to even keep the business flat during this process because a good deal of the owner's attention and emotions are going to be focused on the process of selling his/her business as opposed to just running his/her business. So our process is to make it evident that there are several qualified buyers that are very close in their offers to the winning offer. If there is buyer bad behavior we can simply plug in the next best bidder. The other major strategy we employ is to recommend our client execute a very detailed-, formula- and example-driven LOI.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

Earnouts Tips and Tricks - Seller Earnouts in a Technology Business Sale

Quick Summary Explainer Video which covers the basics of this much misunderstood tool that can be quite effective in completing technology business sales.

Earnout Explainer Video

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

In a Business Sale, the Buyer Has the Upper Hand (Part 2)

Article just published in Divestopedia https://www.divestopedia.com/2/7789/sale-process/negotiation/in-a-business-sale-the-buyer-has-the-upper-hand-part-2

Takeaway: This is part two of a three-part series that identifies the natural advantages that business buyers bring to the table before the transaction process even starts.

In part one of this article series, we discussed the natural experiential advantages that a business buyer's team would bring to the table in a business sale transaction. The seller is usually embarking on their first business sale, whereas the buyer has often completed dozens of prior transactions. So, from the start, the seller is subject to a process that greatly favors the business buyer. This article will identify in the negotiation and LOI process, buyer attacks on the transaction value and approaches you can use to hold your ground against this formidable opponent. Several subtle and seemingly harmless clauses in the LOI can result in swings in actual transaction value of hundreds of thousands of dollars. It may be helpful to look at this negotiation like a fencing match; buyer thrust, seller parry.

Thrust and Parry

Thrust - a buyer getting you off the market with a loosely worded LOI that allows him/her to "interpret the terms" in his/her favor deep into the due diligence process. This is the number one seller error in the process and results in either the deal blowing up or the seller taking an unnecessary hair cut.

Parry - a seller not counter-signing the LOI until terms are defined. There are several key terms of the LOI, so we will give each one their own "Thrust" and "Parry."

Working Capital Adjustment

Thrust - A buyer-attempted treatment of working capital. Most buyers attempt initial language for working capital in the LOI that looks something like this:

Working Capital Adjustment: There shall be a typical working capital adjustment to accommodate for changes to the working capital balance, including cash, accounts receivable and accounts payable, as of the day of closing. During due diligence, the purchaser will set a working capital target by determining a normal and customary level of current assets, including a positive cash balance. There shall be sufficient working capital, including a cash balance which shall be sufficient to operate the business on an ongoing day-to-day basis and the buyer will not need to fund working capital simply to operate the business immediately after the transaction.

Parry - Not so fast, Zorro! This seems like a perfectly reasonable treatment and, unfortunately, many unsuspecting sellers will counter-sign an LOI with this language in place. The result of this is either he/she is going to get taken to the cleaners on the level the buyer decides on, deep into the due diligence process, or the seller will blow up the deal deep into the process. Neither a good result, and the sad part is that it could easily be prevented. The first rule of LOIs is to not take your company off the market with a very important term not defined up front. This language enables their team of experts to calculate their own opinion of "reasonable and customary" while you have no negotiating leverage. You have already taken your company off the market as a buyer requirement to enable due diligence with a no-shop clause.

Missing Benchmarks

The second very important mistake is that by leaving that term undefined, you have not really benchmarked the proposed transaction value against other bids. We had a client that kept a net working capital surplus far greater than what was normally required to run the business. Let's say that they kept a surplus of $400,000 when their normal monthly business expenses were $100,000. So, the level could be set as a surplus of $100,000.

Now the buyers bring in their experts and look at your last 12 months' balance sheets and proclaim that your historical level of $400,000 is what they need, then you may have just sacrificed $300,000 of transaction value. If you have one buyer that bids $3,000,000 for your company with a net working capital surplus requirement of $100,000 and you close with $400,000 surplus, $300,000 is returned to you as transaction value. This makes the total transaction value $3,300,000. If the undefined working capital surplus buyer bids $3,100,000 and calculates, after the LOI, that his requirement is $400,000, then his transaction value is short the other bid by $200,000!

This can all be prevented by the seller insisting that the LOI include a net working capital level commitment with the calculation methodology spelled out. Each buyer may have their own opinion of what that number should be, but this exercise will allow you to equalize the bids and determine which one is truly superior. Unfortunately, the buyers try to leave this vague in their LOI so that 90 days into the due diligence process, they render their buyer favorable opinion and count on the seller suffering from deal fatigue and just caving in on this meaningful loss in value. The buyers know that they do damage to your future chances if you put your company back on the market with the stigma of the previous deal blowing up during due diligence. It usually results in a market discount being applied to your company the second time around.

The 'All or Nothing' Earnout Clause

Thrust - An earnout clause with punitive "all or nothing" language. In the realm of SMBmergers and acquisitions, an earnout is a common practice and a perfectly reasonable component of a business sale transaction. It is often an effective way to bridge the valuation gap between the buyer and seller, and to align the interests of the buyer and seller for post-acquisition business performance. But like other components here, there is good earnout language and there is earnout language that is one-sided in favor of the buyer.

An example of earnout language from a buyer LOI is: The total earnout shall be paid over three years. The total possible payout amount is $1.5 million, based on growing EBITDA by 5% per year over last year's rate of $1,250,000.

The target EBITDA in year one is $1,312,500, year two is $1,378,125, and year three is $1,447,031. If the target is hit, the payout will be $500,000 for the year. If the achievement is between 85% - 99% of the target, the payout will be that percentage attainment X $500,000. If the attainment is less than 85% of the target, no earnout payment will be made.

Parry - In general, we recommend that earnouts be based on a number that cannot be easily manipulated by the buying company. So measures like net profit and EBITDA are less favorable. Here they can insert some expense items like "corporate overhead," which are out of your control. We prefer tying earnouts to measures such as total sales or gross profit margin; far more difficult to leave up to interpretation.

Next, we never recommend an "all or nothing" earnout clause. Normally, earnouts are a meaningful percentage of the overall transaction value and, if an unforeseen event takes you below their cut-off target, you have sacrificed some serious value. Our argument is that if there is a big shortfall, the percent of that shortfall in their earnout payment is enough to keep buyer and seller interests aligned post-acquisition.

If there is a downside adjustment in the earnout calculation (there always is) then we like to have the corresponding upside for surpassing target performance. In other words, if you miss your target by 10% then you only receive 90% of that year's earnout payment target. If you hit 110% of your target, your earnout payment should be 110% of that target.

We also recommend that the earnout be formula-driven and include an example calculation as shown here. The earnout total would be $1,500,000 and be paid in the first three years after the closing within 30 days of the anniversary date. The earnout would be based on thetrailing twelve months' revenues and a target to grow those revenues by 5% per year over the first three years following closing. So, the target for year one (again using the prior year end as the example) would be $5,000,000 X 1.05 = $5,250,000. For year two, another 5% growth would result in a target of $5,512,500. And for year three, another 5% growth would result in a target of $5,788,125, for a three-year total of $15,550,625. Dividing this by the total earnout payment at target ($1,500,000) results in an earnout payment of 9.06% of revenues for the first three years. The payment would be made annually within 30 days of closing of the company's books for 12, 24 and 36 months following closing.

For each year's earnout payment, the actual payout amount would be calculated by applying the payout percentage rate of 9.06% X the actual revenues. As an example, if the revenue for year three came in at $5,000,000 that would be multiplied by 9.06% and result in an earnout payment of $453,000. If the year three revenues came in at $6,000,000, the earnout payment would be $546,600.

Great, we have handled each thrust with our skillful parry. Match over, right? Keep that face protector on, the match is just heating up. Continue reading part three coming soon.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

In a Business Sale, the Buyer Has the Upper Hand (Part 1 of a 3 Part Article)

We just had this article published on Divestopedia. https://www.divestopedia.com/2/7790/sale-process/negotiation/in-a-business-sale-the-buyer-has-the-upper-hand-part-1

Unless your company is one of those must-have, breakthrough, technology companies with buyers crawling all over you, you are subject to a process that greatly favors the business buyer. This is part one of a three-part series that will identify the natural advantages that business buyers bring to the table before the transaction process even starts. Parts two and three will focus on the marketing, due diligence and contract negotiation process. I will discuss the buyer's constant attack on transaction value and approaches you can use to hold your ground against this formidable opponent.

Buyer Experience

If the buyer is a private equity group, they buy companies for a living. They will have acquired dozens of companies prior to entering the competition for your business. If it is an industry buyer, they likely have an individual or department whose sole function is to look for business acquisitions. For most business sellers, this is their first and only rodeo. What you don't know will definitely hurt you, or at least cost you.

Buyers have an experienced deal team. Do not go it alone. Hire an experienced M&A advisor to help you. Not only for the packaging and marketing of your company, but for defending the value you thought you were going to receive at closing. Make sure you get an experienced deal attorney at the contract stage to counteract the incredibly one-sided agreement that the buyer's team will present.

Buyer Choices

I know this will come as a shock, but yours is not the only business the buyer is seriously evaluating for acquisition. For private equity buyers, they generally look at about 100 companies for each one they buy. They will have several deals in the queue, along with yours, to give them plenty of options, to leverage one against the other, and to reduce emotional attachment to any one deal.

Seller Choices

The seller needs to identify several qualified buyers and process these buyers in parallel. If the seller tries to sell his/her company on his/her own, he/she can usually only process one buyer at a time in a serial process because of all his/her other duties running the company. If a buyer knows he/she is the only buyer, count on bad behavior - inability to tie him/her down on a firm offer, missed time commitments, delays, endless information requests, and on and on. If, however, you have been able to attract multiple buyers, your negotiating position is strengthened and you can offset these buyer tactics.

Buyer Controlling the Pre-LOI Negotiation

It is not uncommon to hear something like this from an experienced buyer, "Well, last year you had a spike in profitability. I am just going to use the average of the last three years as the basis for my offer." Seller response via advisor: "It makes no sense to try to negotiate at this level. We just say, 'Feel free to slice it any way that works for you. At the end of the day, if that approach makes your offer not competitive, you will eliminate yourself from the competition.'"

A buyer getting you off the market with a loosely worded LOI that allows him/her to "interpret the terms" in his/her favor deep into the due diligence process, and a seller not counter-signing the LOI until the terms are defined, are additional considerations that can swing a transaction value significantly, and will be covered, each one individually, in part two of this series.

The key here is to recognize the great disparity in the experience levels of the normal buyer team and the unaided seller. I am not saying that doing an M&A deal is rocket science, and most of our clients have the business acumen and intelligence to run that process. The problem is that, for most sellers, this will be the one and only time they will ever go through this process. Learning on-the-fly with a multi-million dollar transaction at stake, going against an experienced buyer in a zero sum game (every dollar he/she gets is a dollar you do not get), is a very costly education.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

The #1 Cause of Middle Market M&A Deal Failures

New Article just published on Divestopedia https://www.divestopedia.com/2/7767/sale-process/negotiation/the-1-cause-of-middle-market-ma-deal-failures

I believe one of the biggest reasons for M&A deals blowing up is a poorly worded letter of intent (LOI). The standard process to solicit offers from buyers in the form of an LOI includes terms and conditions that are negotiated until one winner emerges and the seller and buyer dual sign the LOI, which is non-binding. This basically gives either party an "out" should something be discovered in the due diligence process that is not to their liking or is not as presented in the initial materials. Buyers Have the Advantage of Experience

When I say poorly worded, what I really should have said is that it is worded much to the advantage of the buyer and gives them a lot of wiggle room in how the letter is interpreted and translated into the definitive purchase agreement. The best comparison I can make is a lease agreement for an apartment. It is so one-sided in favor of the landlord and protects him/her from every conceivable problem with the renter.

Business buyers are usually very experienced and the sellers are generally first-time sellers. The buyers have probably learned some important and costly lessons from past deals and vow never to let that happen again. This is often reflected in their LOI. They also count on several dynamics from the process that are in their favor. Their deal team is experienced and is at the ready to claim that "this is a standard deal practice" or "this is the calculation according to GAAP accounting rules." They count on the seller suffering from deal fatigue after the numerous conference calls, corporate visits and the arduous production of due diligence information.

When the LOI is then translated into the definitive purchase agreement by the buyer's team, any term that is open for interpretation will be interpreted in favor of the buyer and, conversely, to the detriment of the seller. The seller can try to fight each point, and usually there are several attacks on the original value detailed in the dual-signed LOI that took the seller off the market for 45-60 days. The buyer and his/her team of experts will fight each deal term from the dispassionate standpoint on one evaluating several deals simultaneously. The seller, on the other hand, is fully emotionally committed to the result of his/her life's work. He/she is at a decided negotiating disadvantage.

The unfortunate result of this process is that the seller usually caves on most items and sacrifices a significant portion of the value that he/she thought he/she would realize from the sale. More often than not, however, the seller interprets this activity by the buyer as acting in bad faith and simply blows up the deal, only to return to the market as damaged goods. The implied message when we reconnect with previous interested buyers after going into due diligence is that the buyers found some dirty laundry in the process. These previously interested buyers may jump back in, but they generally jump back in at a transaction value lower than what they were originally willing to pay. How to Even the Playing Field

How do we stop this unfortunate buyer advantage and subsequent bad behavior? The first and most important thing we can do is to convey the message that there are several interested and qualified buyers that are very close in the process. If we are doing our job properly, we will be conveying an accurate version of the reality of the deal. The message is that we have many good options, and if you try to behave badly, we will simply cut you off and reach out to our next best choices. The second thing we can do is to negotiate the wording in the LOI to be very precise and not allow room for interpretation that can attack the value and terms we originally intended.

We will show a couple examples of LOI deal points as written by the buyer (with lots of room for interpretation) and we will counter those with examples of precise language that protects the seller.

Sample Earnout Clause Within an LOI

Buyer's Proposal

The amount will be paid using the following formula:

-75% of the value will be paid at closing

-The remaining 25% will be held as retention by the BUYERs to be paid in two equal installments at the 12 month and 24 month anniversaries, based on the following formula and with the goal of retaining at least 95% of the TTM revenue. In case at the 12 and 24 month anniversaries the TTM revenue falls below 95%, the retention amount will be adjusted based on the percentage retained. For example, if 90% of the TTM revenue is retained at 12 months, the retention value will be adjusted to 90% of the original value. In case the revenue retention falls at or below 80%, the retention value will be adjusted to $0.

Seller's Counter Proposal

The amount will be paid using the following formula:

-75% of the value will be paid at closing

-The remaining 25% will be held as earnout by the BUYERs to be paid in four equal installments at the 6, 12, 18 and 24 months anniversaries, based on the following formula:

We will set a 5% per year revenue growth target for two years as a way for SELLERS to receive 100% of their earnout (categorized as "additional transaction value" for contract and tax purposes).

So, for example, the TTM revenues for the period above for purposes of this example are $2,355,000. For a 5% growth rate in year one, the resulting target is $2,415,000 for year one and $2,535,750 in year two. The combined revenue target for the two years post-acquisition is $4,950,750.

Based on a purchase price of $2,355,430, the 25% earnout would be valued at par at $588,857. We can simply back into an earnout payout rate by dividing the par value target of $588,857 by the total targeted revenues of $4.95 million.

The result is a payout rate of 11.89% of the first two years' revenue. If SELLER falls short of the target, they fall short in the payout; if they exceed the amount, they earn a payout premium.

Below are two examples of performance:

Example 1 is the combined two years' revenues total $4.50 million - the resulting two-year payout would be $535,244.

Example 2 is the combined two years' revenues total $5.50 million - the resulting two-year payout would be $654,187.

Comparison and Comments

The buyer's language contained a severe penalty if revenues dropped below 80% of prior levels, the earnout payment goes to $0. Also, they have only a penalty for falling short and no corresponding reward for exceeding expectations. The seller's counter proposal is very specific, formula-driven and uses examples. It will be very hard to misinterpret this language. The seller's language accounts for the punishment of a shortfall with the upside reward of exceeding growth projections. The principle of both proposals is the same - to protect and grow revenue, but the results for the seller are far superior with the counter proposal language.

Sample Working Capital Clause Within an LOI

Buyer's Proposal

This proposal assumes a debt free cash free (DFCF) balance sheet and a normalized level of working capital at closing.

Seller's Counter Proposal

At or around closing, the respective accounting teams will do an analysis of accounts payable and accounts receivable. The seller will retain all receivables in excess of payables plus all cash on cash equivalents. The balance sheet will be assumed by the buyer with a $0 net working capital balance.

Get the Specifics

The buyer's language is vague and a problem waiting to happen. So, for example, if the buyer's experts decide that a "normalized level of working capital" at closing is a surplus of $400,000, the value of the transaction to the seller dropped by $400,000 compared to the seller's counter proposal language. The objective in seller negotiations is to truly understand the value of the various offers before countersigning the LOI. For example, an offer for cash at closing of $4,000,000, with the seller retaining all excess net working capital when the normal level is $800,000, is superior to an offer for $4.4 million with working capital levels retained at normal levels.

These are two very important deal terms and they can move the effective transaction value by large amounts if they are allowed to be loosely worded in the letter of intent and then interpreted to the buyer's advantage in translation to the definitive purchase agreement. Why not just cut off that option with very precise and specific language in the LOI with formulas and examples prior to execution by the seller? The chances of the deal going through to closing will rise dramatically with this relatively easy-to-execute negotiation element.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

Clients Represented Software and information Technology

We got our start after working for a very fine "Generic" Merger and Acquisition Advisory firm. I do not mean this to be a dig, but just a way to describe that our former firm was industry agnostic in engaging with all types of companies. Generally they did an excellent job relying on a proven M&A process. One area that they struggled with, however, was in representing software and information technology companies. In analyzing the competitive landscape, we found this to be the case with the vast majority of lower market M&A firms and business brokers. They did not speak the language and felt uncomfortable in pursuing transaction values that were not based on rules of thumb or a multiple of EBITDA. They struggled with unlocking strategic value for their clients.

MidMarket Capital was originally founded based on our deep roots in technology in our prior business experience. Our ideal client is one that has a significant part of their company value contained in their technology and intellectual property. We have chosen to focus on representing businesses in this space and our value proposition is to drive strategic transaction value for our clients.

For buyers of technology companies, it is important that the seller's representatives "speak the language" and if you are a technology, software, information technology, or healthcare information technology company, odds are that we have represented a similar company to yours during the past fifteen years. Please see below for a list describing companies we have represented:

MidMarket Capital Clients

An IBM Cognos Partner - Performance Management, Professional Services, and Software Development Firm

A Distribution ERP Systems Software Company

Web Enabled Supply Chain Management System

eCommerce Company

Document Imaging & Management Software Company

Textbook Content Service Provider

Managed Information Security Services Company

Information Technology Consulting Company

IT Services Provider SMB

Affiliate Marketing Management Firm

Digital Communications Company

Pension Administration Software Company

CRM and Integrated Product Performance Management Software Company

Live Virtual Computer Training Company

Telecom Alliance Channel Partner

Rich Media & Interactive Marketing Software and Services Company

Wireless Electronic Monitoring Company Hardware, Software, Firmware, Software as a Service

Third-party Provider of Software for Bentley’s MicroStation

Mobile, On-Demand Data Collection, Management & Reporting

IT and telephony system design and support SMB

Publishing Management Software and Services

Network Integrity and Switch Provisioning Software Company

Advanced Networking Technology Development Contractor

ECommerce software-as-a-service (SaaS) Company

PRINT MANAGEMENT AND DISTRIBUTION COMPANY

Smart Grid Software and Engineering Company

Web Content Distribution and Compliance Management Software Company

Recreational Team Management and Group Management Portal

.Net - SaaS Based Sales Collateral Management Software and IT Services Company

Pool and Spa Service Management and Store Software Systems

Systems integrator and reseller of IT products to Federal Government clients

Mobile Field Merchandising & Data Collection Software

The BI Life Cycle Management Company - IBM/Cognos Enhancement Software Solutions

Security Solutions Value Added Distributor

A Pathology Laboratory Information Systems Company

A Cost Analysis and Control Software Company for Healthcare Facilities

An Evidence Based Patient Acuity Measurement and Nurse Staffing Systems and Services Company

A Web-Based Staffing, Scheduling and Nurse Shift Bidding Software Company

HOSPITAL INTEGRATION SOFTWARE COMPANY

Ophthalmology Information System (OIS) Company

Healthcare Revenue Cycle Management Company

Cloud-Based Vendor Neutral Archiving & PACS Software Company

Hospital Services & Software Company

Electronic Health Record and Personal Identification Wristband Company

Big Data Analysis Engine for Repositioning Drug Discovery

Smart Pharma Cap for Medication Adherence and Compliance Recording
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

Valuing Your Company for Sale - The Market Dynamics of Pricing

How much are you expecting when you sell your business? I always ask this question of our clients. The answers are as different as the businesses. "We need $5 million to give us the type of retirement we want. We have invested $2 million in the product. Our investors have put in $3 million so far. It should sell for $5 million. I heard that xyz Company got $30 million for their company." Well, my response to my clients doesn't necessarily endear me to them, but it is the truth. The market doesn't care. The market doesn'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 market looks at what the ROI is for its investment in a company. If you are fortunate enough to have a technology that can be leveraged, the market may look at the future returns of that technology in stronger hands.

For most businesses, there are benchmarks that are often used as a starting point. The most common in a merger and acquisition situation is an EBITDA multiple. That is the gold standard for privately held companies, similar to what a PE multiple is as a business valuation metric for publicly traded stocks. One of the measures that has come into vogue on Wall Street is a PEG multiple or Price Earnings Growth. It is essentially a way to attempt to quantify the difference in PE multiples between two firms in the same industry that have a much different future growth scenario.

Buyers of businesses that are privately held attempt to ignore this factor when making their purchase offers.

One small company was in an industry characterized by slow growth of about 4%, had commodity type products and consequently very thin gross margins, and had little pricing power. This company introduced a new product that was unique, had very healthy margins, retained some pricing power, and was experiencing 50% year over year growth.

The industry benchmark valuations were at 4.5 X EBITDA. The three largest players in the industry were all interested in the acquisition and each one put out an initial bid that was, surprise, about 4.5 X EBITDA. Another factor was that our client was in rapid growth mode so a good deal of their costs were front end loaded as they launched a few big box retailers during this period. The effect of this was to depress their EBITDA performance. This made these offers even more inadequate.

The result is that we have a classic valuation gap between business buyer and business seller. This is the biggest reason that many merger and acquisition transactions do not happen. The clients are terribly disappointed and suggest that these buyers "just don't get it." The buyers have experience in making several acquisitions in their space and have their business valuation metrics pretty much in stone and think our sellers are being unreasonable in their expectations. Game over, right?

Not so fast. One of the most important roles of a business broker, merger and acquisition advisor or investment banker is devise a transaction value and structure that works for both parties. We pointed out to the buyers that their traditional way of looking at these transactions is appropriate for their prior acquisitions with standard growth metrics, lack of pricing power, and commodity type products.

 We suggest to business sellers that as a small company with a few big box retailers comprising 80% of company sales with essentially one main product, that they have a great deal of small company risk. For example, if the retail buyer from xyz Big Box Retailer changes and is replaced by a buyer that has a consolidation of vendors bias, then they could lose 30% of their business with one decision. A bigger company, however, with 30 SKU's would be much harder to replace with a change in buyers.

We have established a platform with both buyer and seller to consider alternatives to their hard and fast valuation positions. Here is an example of a business sale transaction structure that could be a win for both buyer and seller:

1. $1,000,000 Cash at Close which is approximately a 4 X EBITDA multiple for the year 2007.

2. An Earn out (Additional Transaction Value) based on Seller Company's Sales Revenue beginning in year 1 and ending at the end of year 5. The earnout is at risk, but is set to net the shareholders a 6 X EBITDA multiple on 2008 projected sales (sales $6 million and EBITDA margin of 16.67% or EBITDA of $1,000,000).

This is the transaction structure we are recommending to balance a low EBITDA valuation on a company that will grow revenues by 50% next year. If they don't, then the earn out will be less. Most of the transaction value is in future performance based earn out. Our projection is that with Buyer Company cost efficiencies, Buyer Company can improve operating performance by an amount that covers the entire earn out amount and maintains or even improves Seller Company's historical margins.

Most business buyers that approach a company with an unsolicited interest in acquiring them are bottom feeders and will attempt to buy way below the market. They will attempt to draw out the process and pursue several acquisitions simultaneously hoping that one or two sellers just cave and sell out at a discount. They may start out at a decent valuation, but as they go through their due diligence process will find one issue after another that makes them reduce their offer. They often throw out the term "material adverse change" in an attempt to justify their value reducing behaviors. Some business development directors get judged or paid bonuses on how much below the original offer they can ultimately close the deal.

What is the way to combat this bad buyer behavior? The best way is to have options. Those options are multiple interested buyers. We feel very uncomfortable when we end up with only one buyer. We have taken them through the entire marketing phase and end up with only one legitimate interested buyer. You bet that buyer recognizes the issues and the likelihood of limited interest and will attempt all of the maneuvers to drive down the buying price and terms. Our negotiating position on behalf of our seller client is severely weakened and we struggle to preserve value in spite of doing this every day.

Think about how effective you will be in this single buyer scenario. We tell our prospective clients that contact us after an unsolicited offer, "When it comes to business valuation, if you have only one buyer, he is right.

Dave Kauppi is the editor of The Exit Strategist Newsletter, a Merger and Acquisition Advisor and Managing Partner of MidMarket Capital, providing business broker and investment banking services to entrepreneurs and middle market corporate clients in information technology, software, high tech, and a variety of industries. Dave graduated from The Wharton School of Business, holds a Series 63 and is a registered business broker. Dave began his Merger and Acquisition practice after a twenty-year career within the information technology industry.  Visit MidMarket Capital to learn about maximizing your selling price, valuation of intellectual property, minimizing taxes, negotiating tactics, Letters of Intent, how to select an advisor, and much more.

Grow or Sell Your Information Technology Company - A Crossroads Decision

Thinking of taking your information technology company to the next level with a major marketing campaign or by hiring additional sales resources? These are decisions that can impact your company's future. It might be time to consider the alternative of selling your business.

We are often approached by software company or information technology business owners at a crossroads of taking the company to the next level.  The decision in most cases is whether they should bring on the one or two hot shot sales people or channel development people necessary to bring the company sales to a level that will allow the company to reach critical mass. For a smaller company with sales below $5 million this can be a critical decision.

For frame of reference, prior to embarking on my merger and acquisition advisor career, I spent my prior 20 years in various sales capacities in primarily information technology and computer industry related companies from bag carrying salesman to district, regional, to national sales manager and finally Chief Marketing Officer.  So when I look at a company, it is from the sales and marketing perspective first and foremost. I am sure that if I had a public accounting background, I would look at my clients through those lenses.

So with that backdrop, let's look at what might be a typical situation. The software company is doing $3.5 million in sales, has a good group of loyal customers, produces a nice income for its owner or owners, and has a lot more potential for sales growth in the opinion of the owner. Some light bulb has been lit that suggests that they need to step this up to the next level after relying on word of mouth and the passion and energy of the owner to get to this stage.

I have spoken with more than 30, primarily technology based companies over the years that have faced this exact situation and can count on one hand the ones that had a successful outcome. The natural inclination is to bite the bullet and bring on that expensive resource and hope your staff can keep up with the big influx of orders. The reality is that in most cases the execution was a very expensive failure. Below are several factors that you should consider when you are at this crossroads:

1. The 80 20 rule of salesmen. You know this one. 80% of sales are produced by 20% of the salespeople. If you are only hiring one or two, the likelihood is that you will not get a top performer.
2. The president of the company and decision maker has no sales background so the odds of him making the right hiring decision are greatly diminished. He will not understand how to properly set milestones, judge progress, evaluate performance objectively, or coach the new hire.
3. To hire a good salesman that can handle a complex sale requires a base salary and a draw for at least 6 months that puts him in a better economic condition than he was in on his last job. So you are probably looking at $150,000 annual run rate for a decent candidate.
4. If you have not had a formalized sales effort before, you are probably lacking the sales infrastructure that your new hire is used to. Proper contact management systems, customer and prospect databases, developed collateral materials and sales presentations, sales cycle timeframes and critical milestones and developed competition feature benefit matrixes will need to be developed.
5. Current customers are most likely the early adapters, risk takers, pioneers, etc. and are not afraid of making the buying decision with a small more risky company. These early adaptors, however, are not viewed as good references for the more conservative majority that needs the security of a big company backing their product selection decision.
6. Your new hire is most likely someone that came from a bigger information technology company and may be comfortable performing in an established sales department. It is the rare salesman that can transform from that environment to developing the environment while trying to meet a sales quota. Throw on top of that the objection that he has never had to deal with before, the small company risk factor, and the odds of success diminish. Finally, this transformation from a core group of early adapters to now selling to the conservative majority elongates the sales cycle by 25% to as much as double his prior experience. If you don't fire him first, he will probably quit when his draw runs out.

With all this going against the business owner, most of them go ahead and make the hire and then I hear something like this, "Yes, we brought on a sales guy two years ago who said he had all the industry contacts and in nine months after he hadn't sold a thing and cost us a lot of money, we fired him. That really hurt the company and we have just now recovered. We won't do that again."

What are the alternatives? Certainly strategic alliances, channel partnerships, value added resellers are options, but again the success rate for these arrangements are suspect without the sales background in the executive suite.  A lower risk approach is to outsource your VP of Sales or Chief Marketing Officer function. There are a number of highly experienced and talented free lancers that you can hire on a consulting basis that can help you establish a sales and marketing infrastructure and guide you through the staffing process. That may be the best way to go.

An option that one of our clients chose when faced with the six points to consider from above was to sell his company.  This is a very difficult decision for an entrepreneur who by nature is very optimistic about the future and feels like he can clear any hurdle. This client had no sales background but was a very smart subject matter expert with an outstanding background as a former consultant with a Big 5 accounting firm. He did not make the hiring mistake, but instead went the outsourcing of VP of Sales function as step 1. When their firm wanted to make the transition from the early adapters to the conservative majority, the sales cycle slowed to a crawl. Meanwhile their technology advantage was being eroded by a well funded venture backed competitor that had struck an alliance with a big vendor.

They engaged our firm to find them a buyer, but then we encountered the valuation gap. Our business seller thought his company was worth a great deal and that he should be paid with cash at close for all the future potential his product could deliver. The buyer, on the other hand, wanted to pay based on a trailing twelve months historical perspective and if anything was paid for potential, that would be in the form of an earn out based on post acquisition sales performance.

With a well structured earn out agreement and the right buyer, our client will reach his transaction value goals. His earn out is based on future sales, but his effective sales force has been increased from one (himself) to 27 reps. His install base has been increased from 14 to 800. Every one of the buyer's current customers is a candidate for this product. The small company risk has been removed going from a little known start-up with $500 K in revenues to a well known industry player, publicly traded stock with a market cap of $2.5 billion.

He avoided the big cash drain that a bad sales person hiring decision would have created and he sold his company before a competitor dominated the market and made his technology irrelevant and of minimal value.

My professional contacts sometimes tease me and suggest that I think every company should be sold. That may be a slight exaggeration, but in many instances, a company sale is the best route. When a information technology business owner is faced with that crossroads decision of bringing on a significant sales resource that will be faced with a complex sale and the executive suite does not have the sales background, a company sale may be the best outcome.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital