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

Experience Trumps Smarts in the Sale of Your Information Technology Company

 People who start software and information technology companies are generally very smart people. When it comes to representing yourself in the sale of your business, the key issue is not smarts, but experience. The purpose of this article is to highlight the intelligence versus experience issue and give examples where experience trumps intelligence.

  

The greater the complexity of the task, the more the advantage goes to the one who has prior experience with that task. Ask anyone who has sold their business and they will tell you it is a surprisingly complex undertaking.

Some very well-known examples were the experiences of the great author, George Plimpton as he stepped into the boxing ring against Joe Louis, put on the goalie pads for the Boston Bruins or barked out signals as the quarterback for the Detroit Lions in a pre-season football game.

These experiences resulted in some great reading. The competitive outcome for the inexperienced combatant, however, was not a happy ending. Curious George was totally outmatched. Admittedly, I had earlier written self-serving articles and Blog posts on the benefits of business seller representation by a Merger and Acquisition Advisor or Business Broker. There are hundreds of similar articles out there from our competitors. The message is pretty much the same:

1. They know the market and the valuations.

2. They have an active database of identified buyers.

3. By representing yourself, you alert the market, your customers, your competitors, and your employees that you are for sale.

4. Running a business is a full-time job. Selling a business is also a full-time job.

5. A business owner normally conducts a serial process (one buyer at a time) which dramatically reduces his market feedback and negotiating position.

6. It is complex, you may only sell one business in your lifetime and the buyers are much more experienced than the sellers.

I really want to dissect point number 6 because I don't believe most business owners fully embrace either the complexity or the consequences of the disparity in experience. First of all, as a generalization, successful business owners are really smart people and have solved myriad complex problems over the years to make their businesses prosper. To many of them, selling their business is just another of those complex problems that they have routinely solved to their advantage. Well, I am a pretty smart guy (my kids might differ), but if my doctor presented me with my lab test results from my physical and asked me to prescribe my treatment, I would refer him to a mental health professional. The point here is not my intelligence, but my level of experience.

Joe Louis spent 10,000 hours perfecting his craft under extreme conditions of competition and pressure. George Plimpton worked in a gym for a couple of weeks with a boxing trainer. If you asked Joe Louis to write a Pulitzer Prize winning novel, you might have to duck a right cross. Both Joe Louis and George Plimpton were geniuses at their craft. They were inexperienced in other areas and were at a distinct disadvantage when trying to compete in another field against the experts in that field.

As I retrieve my third golf ball from the water hazard, I rationalize to myself, "Well at least Tiger Woods can't run an HP 12C present value calculator like I can. Knowing Tiger Woods, he actually probably can.

Let me try another example of the value of experience to illustrate my point. Have you ever tried mounting a new door? The first time I did it, it took me several hours - getting the special hole drill for the knob and internal mechanism, measuring for hinges, chiseling the slots for the hinges, propping the door and securing it for mounting, etc. Each one of these steps was something new to me and I wasn't very good at any of them. By my third door mounting, I was starting to become pretty competent. For a business owner, your business sale is your first door. By the way, that is one very important door.

Now let's look at the buyers. The first category is the Private Equity Investor. They buy businesses for a living. Ask an average PEG (Private Equity Group) how many deals they look at for every one they actually acquire. They will tell you it is well over 200 different companies. Most of these 200 are dismissed at the start of the process with the teaser or blind profile. They can judge whether the target meets their broad criteria of revenue, EBITDA, profit margins, industry segment, and others.

Many businesses pass their initial screen and they enter the excruciating process of conference calls, detailed data requests on customers, vendors, gross profit by product/customer/vendor, sales by product/customer, top ten customers, top 10 suppliers, percentage of business in the top ten, and on-and on. Many more companies are eliminated in this process. We then proceed to the indication of interest letter (broad statement of the economics of their proposed deal) followed by corporate visits. Once through that process, the surviving targets get additional data requests and follow-up questions. This is not always a one-way elimination. Sometimes the PEG IOI letter is not high enough to make the seller's cut and they will be eliminated from the process.

  

The home stretch is submitting a Letter of Intent with a much tighter presentation of the final deal value and structure. This is a competitive process and the seller winnows the suitors down to 1 finalist through back and forth negotiations. Once the highest and best LOI is countersigned by the seller, there is an exclusive period for due diligence. Often the deal blows up in due diligence when a material issue is uncovered and the buyer attempts to alter their original offer in response to this new data. Often times the seller will simply blow up the deal. So the process starts all over.

The point here is that these Private Equity Groups have vast experience, not only in closing deals, but vast experience with every stage of the deal process. So for every deal completed they originally look at 200 teasers that result in the execution of 50 confidentiality agreements and the review of 50 memoranda. 20 of those deals warrant a conference call with the owners and follow up questions. 8 companies survive that process and result in 8 indications of interest letters and 5 corporate visits. 3 companies survive to due diligence and 1 makes it to the finish line. This is a continual moving pipeline of deep deal experience.

As a business owner, by the time you connect with a PEG, they have pretty much seen every twist and turn a deal can take. Their approach resembles an apartment owner's rental agreement - tremendously one-sided in their favor. For a PEG, a deal that blows up in the eleventh hour becomes an expensive lesson learned and war story. For a business owner, it can dramatically negatively impact their future business performance.

Wait, you say. I am a software company with the next big thing. My buyer is not a private equity group, but one of the strategic buyers - IBM, Google, Facebook, Adobe, and Microsoft (pick your giant). Let me give you a humbling dose of reality. We have represented some world class technology companies and just getting one of these blue chippers to take a look at them is a monumental task. The primary objective of the M&A department of the giants is to protect the mother ship. They want to prevent entrepreneurs from getting into any potential legal claim on the Blue Chip's intellectual property.

Therefore they institute a screening process designed to surround the company with a corporate moat around the castle. That moat has different names at each company. At one it is called the "Opportunity Management System". At another it is the "Partnership Management Department".

Here is how it works. The individuals in this department are very hard to find and very seldom answer their phone. You are directed to a Website and are required to fill out an exhaustive 16 page submission form. You are then issued a submission number. You then go into the black hole and may be reviewed by a junior level screener that does not have the breadth of experience to judge a Twitter versus a Pets.com.

It gets worse. Every day 100 more "Opportunities" get submitted and piled on top of your number. The only way to get attention is from the Division Manager who owns the functional area where your product fits. Convince him to go rescue your number and to get your form to a senior opportunity manager to process and vet the idea.

Just like with the PEGs, this is a relentless process of deal flow for these company buyers. Sellers in this environment are on their heels right from the start and struggle to garner any negotiating leverage. If your technology is strong enough to be rescued for a more comprehensive look, the guys on the other side of the table are the heavyweight champions of M&A deals. They have seen it all.

Not to minimize the first 5 benefits identified earlier in this article, but balancing the experience of the buyer's team with the experience of the seller's team is critical to enhance, protect and preserve the value of your transaction.

In its purest form, a letter of intent is a document designed to define the economic parameters of a transaction that, pending completion of due diligence, will be memorialized in a definitive purchase agreement and a deal closing. In its practical use, a letter of intent is like an apartment renter's agreement with every subtle advantage benefitting the author of the document. An inexperienced seller will agree to a seemingly innocuous clause about working capital adjusted at closing according to GAAP accounting rules. If you are the seller of a software company with annual software licenses or prepaid maintenance contracts, that could be a $ million mistake. It is a rare attorney that would ever catch that. Well, not actually. They are all representing the experienced buyers.

  

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

Financial Advisors – It's Time for Some Difficult Discussions with Your Business Owner Clients

If this recent market meltdown has taught us anything it is to make sure you are diversified over several investments and asset classes. Would you recommend that a client put 80% or more of their assets into a single investment? Of course not, but a large percentage of your clients actually have that level of concentration. Your clients that are business owners likely have 80% or more of their family's net worth tied up in their business. On top of that, privately held businesses are illiquid assets often requiring one to two years to sell. So for your baby boomer business owner clients, it is time to have some tough discussions. It is time to move your financial advisory practice beyond the scope of a provider of financial products to an advisor on family wealth maximization solutions.

Business owners are typically not proactive when it comes to exit planning or succession planning in their business because it forces them to embrace their own mortality. Well, they just need to get over it. If an owner has a sudden debilitating health issue or unexpectedly dies, instead of getting full value for the company, his estate can sell it out of bankruptcy two years later for ten cents on the dollar. This is a punishing financial result for the lack of appropriate planning.

Statistics on Business Exits

• According to Federal Reserve's Survey of Consumer Finances, in 2001, 50,000 businesses changed hands. That number rose to 350,000 in 2005 and is projected to increase to 1,000,000 by 20015. Some estimates place the value of businesses transitioning to new leadership over the next ten years at $10 TRILLION. The Price Waterhouse Trendsetter Barometer Survey shows that nearly 65% of CEO's plan to retire within ten years or less: 
• 42% within 5 years.  51% of those plan on selling to another company while 18% plan on a transition to family members and another 14% plan on a management buyout.

·         Only 22% have done a great deal of succession planning and another 26% have done some. But 24% have done little, and 19%, virtually none.  9% did not report.

·         Only 39% percent of CEO's have a likely successor in mind, but less than two-thirds of them say that person is ready to take control today. 

But among those planning to sell their business, far fewer have explored the following opportunities:

·         Only 36% have planned how to increase after-tax proceeds;

·         Only 35% have developed an investment strategy to protect and manage their monetized wealth

Questions You Should Be Asking of Your Business Owner Clients

In your role of providing a holistic approach to maximizing your client's wealth, you should be asking these questions:

       What are your plans for your business when you retire?

·         Do you have children that you want to take over the business?

·         Have you determined how you are going to transfer the ownership?

·         Do you know how much your company is worth?

·         What % of your family's net worth is in your business?

·         In your business life, what keeps you up at night?

·         If you were hit by a bus tomorrow, God forbid, what would happen to
your business?

In your role of trusted advisor, you simply must ask these difficult questions and guide your client in exploring options and planning for his eventual exit. Before he just assumes that the  torch will be carried by the next generation, make sure that the next generation even wants to run the business.  Imagine the loss in value that would have occurred if the real estate billionaire from the western suburbs of Chicago had turned his empire over to his son who simply wanted to produce plays.

Are his heirs even capable of running the business?  Has he held on to the reins so tightly that the kids involved in the business have not been able to develop their decision-making or leadership skills?  Do they command company respect because of their personal strength and skills or are they grudgingly granted respect because they are the child of the owner?  If that is the case, the odds are not good for them taking over when he retires.

The business owner must make some difficult decisions when he or she decides it is time to retire. Why did he create this business?  Was it to keep this business in the family for generations or was it to provide for his family for generations?  If the desire and the capability of the children are not evident and the company is large enough, it may be the right decision to first get outside board members actively involved as step one.  Step two would be to hire professional management to run the business. A second alternative is to sell the company while he is still running it and it can command its highest value. If he has children that want to remain in the business for the immediate future, incorporate that into the sale agreement with employment contracts.
Another way to ask your client to think of it is, while I am running the business, the best ROI is to keep the bulk of my net worth invested in this company.  If I am no longer running the company what is the best risk reward profile for my net worth?  Would my heirs be better off if the business was sold and the value converted to financial assets?

Many financial advisors feel uncomfortable having these types of discussions with their clients. Because of the business owner's reluctance to plan for his business exit, you should actively get out in front of the process with your client. This decision and how it is executed will be the single most impactful event in your client's financial future. You can take on the quarterback position in assembling a multidisciplinary team that can include:

The Financial Advisor – Coordinate all the pieces for a holistic wealth maximization plan

Attorney – Create the necessary documents, wills, trusts, family LLC's, corporate structure, etc.

Estate Planner – work with financial advisor and attorney to create the properly documented estate roadmap

CPA/Tax Advisor – review corporate structure, analyze after tax proceeds comparison of various transaction structures, create tax deferral and tax avoidance strategies

Investment Banker/Merger and Acquisition Advisor – Analyze the business, create value creation strategies, position the company for sale, and create a soft auction of multiple buyers to maximize selling price and terms.

As your business owner clients approach retirement, you need to help them with investment decisions that employ sound diversification and liquidity strategies. Their business is generally the largest, most illiquid, and most risky investment in their total wealth portfolio. Their successful business exit should be executed with the same diligence, knowledge, experience and skill that you regularly apply to their other asset class decisions.

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

New Engagement HealthCare Technology Company

 We just engaged with the company below to locate buyers/investors for their healthcare technology company.

Smart Pharma Reminder and Monitoring System to improve Medication Adherence

·        4 Billion prescriptions filled annually in the US - non-adherence results in $300 Billion Cost to healthcare system

·        Catalyst for outcome-based healthcare delivery

·        Device protected by a granted US Patent + one pending

·        Inexpensive device ($3 per unit in volume cost) is programmed by the prescribing pharmacist

·        Device records patient use of medication for HIPPA compliant Web reporting allowing additional care giver interventions and sale of adherence data to insurers, Pharma companies

·        Recipients of 3 NIH SBIR Grants to prove the technology & study the impact on patient adherence

·        Competitive solutions are expensive and complex - requiring set up by the patient or care giver

According to published research, only about 50% of prescribed medication is taken as scheduled.  This issue leads to problems with patient health outcomes, and it adds almost $300B to the annual cost of healthcare when diseases aren’t controlled effectively and unnecessary complications lead to hospital and nursing home admissions. 

Company's solution to the problem of medication adherence is the @CAP which is unique from any product on the market because it is automatically programmed, wirelessly in the pharmacy as part of the regular work flow in filling a prescription.  Of course it provides the visual and audible reminders to help the patients remember to take their medication, but it doesn’t require any programming by the patient. Medicare part D’s Medication Therapy Management (MTM) program allows for the cost of this product to be covered at the pharmacy for patients that qualify. The @CAP is also priced to be disposable or reused. Additionally, @cap and related products record and report adherence in real time, giving interested parties patient-level data in real-world settings to understand drug usage, and treatment outcomes, and influence behavior change.

Company's product benefits the entire value chain in delivering an improvement in outcome-based healthcare.  The patient increases adherence thus reducing the likelihood of adverse conditions requiring additional medical care. Their care givers can utilize the system's information to provide additional interventions.  The pharmacies, pharmacy benefit managers and manufacturers all benefit from increased consumption/sales. The insurance companies benefit from increased adherence resulting in far fewer expensive medical issues, hospital admissions, emergency room visits and other treatments. Finally, fewer preventable medical procedures reduce the strain on the entire healthcare system.

Our Client has engaged MidMarket Capital to locate a Strategic Buyer that could capitalize on their industry leading solution, leverage their patents and intellectual property and scale into a very large and receptive market space.

We are exclusively representing this Company to your firm as part of an offering to a select group of qualified investors. MMC specializes in mergers, acquisitions, financing and divestitures of privately held middle market businesses. No reproduction, in whole or part of this Confidential Acquisition/Investment Profile may be made without prior written permission of MMC.
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