Our New Client's Technology Has Unlimited Upside Potential

Powerful Drug Discovery Engine for a Drug Repositioning Platform. This remarkable technology is a Quantum Leap above anything prior in speeding new cures to patients and discovering new uses for existing drugs. Because our selection universe is drugs already approved for other uses, we take several years and hundreds of millions of dollars out of the Drug Discovery, Development and Delivery process. They combine Natural Language Processing, Artificial Intelligence, Network Graph Theory, Computational Biology and several predictive algorithms that can accurately identify existing approved drugs that can be used to effectively treat additional diseases.

Please review this presentation on YouTube

  

http://youtu.be/esbVpGuPGFc

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 The Growth Rate in the Sale of a Technology Company

If you are selling a rapidly growing business, especially one based on technology, using an EBITDA multiple will not provide an accurate valuation metric. This article presents an argument that these businesses should more appropriately be measured like the concept of Price to Earnings to Growth (PEG) Ratio that is used for rapidly growing public companies.

In the sale of privately held businesses there seems to be no mechanism and certainly no attempt on the part of buyers to account for the selling company's growth rate. In the public market this factor is widely recognized and is accounted for with an improvement on the PE multiple, the PEG or Price Earnings Growth multiple.

 Because there is no exact translation between EBITDA multiple (the primary valuation metric for privately held companies) and Earnings Per Share and PE multiple (the primary valuation metric for publicly traded stocks), the purpose of this article is to try to calculate an adjustment factor that can be applied against the EBITDA valuation metric in order to present a more accurate accounting for differences in growth rate for the valuation of privately held companies.

Experienced business buyers are masters of setting the rules for how they calculate the value of a business they are attempting to acquire. You may think that a 5 X multiple of EBITDA or 1 X Sales would be pretty cut and dried, but in practice it is open for creative interpretation. For example, if you just had your best year ever and your EBITDA was $2 million and the market valuation was 5 X, then you would expect a $10 million offer. Not so fast. The buyer may counter with, "That last year was an anomaly and we should normalize EBITDA performance as an average of the last three years." That average turns out to be $1.5 million and like magic your purchase offer evaporates to $7.5 million. On the flip side, if you just had your worst year at $1 million EBITDA, you can bet the buyer will use that as your metric for value.

The three owners paid themselves $100,000 each in salary, but the buyer asserts that the fair market value salary for a replacement for each senior manager is really $150,000. They apply this total $150,000 EBITDA adjustment and your valuation drops by another $750,000. If the family owns the building separately and rents it to the business for an annual rent of $200,000 when the FMV rental rate is $300,000, the resulting adjustment costs the seller another $500,000 in lost value.

Another valuation trap for a seller is that they want to hire additional sales resources to pump up their sales just prior to the sale. This is almost always a bad move. Most technology sales reps take a year or longer to ramp up to productivity. In the interim, with salary and some draw or guarantee, they actually become a drain on earnings. The buyers do not care about the explanation, they just care about the numbers and will whack you with a value downgrade.

The least understood valuation trap, however, is there seems to be no mechanism and certainly no attempt on the part of buyers to account for the selling company's growth rate. In the public market this factor is widely recognized and is accounted for with an improvement on the PE multiple, the PEG or Price Earnings Growth multiple. The rule of thumb is that if the stock is valued with a PEG of less than 1 then it is a good value and if it is over 1 it is not as good.

Because there is no exact translation between EBITDA multiple (the primary valuation metric for privately held companies) and Earnings Per Share and PE multiple (the primary valuation metric for publicly traded stocks), please allow me a measure of imprecision in my analysis. My purpose is to try to calculate an adjustment factor that can be applied against the EBITDA valuation metric in order to present a more accurate accounting for differences in growth rate for the valuation of privately held companies.

I have chosen two stocks for my analysis, Google and Facebook. The reason I choose these two is that they are widely known, very successful, in the same general market niche, and are at different stages of their growth cycle. Google sells at a PE multiple of 33.37 while Facebook sells for a PE multiple of 113.71. The PEG of Google which = PE Multiple/5 year growth rate is 33.37/16.85 for a PEG of 1.98. I actually backed into the growth rate using the readily available PE multiple and the PEG from my Fidelity account.

Facebook sells at a PE multiple of 113.71 and has a PEG ratio of 3.62 (may be some irrational exuberance here), which translates into a 5 year growth rate of 31.41%. For our comparison we should also include the average PE multiple for the S&P 500 of about 15. Let's make the assumption that on average, this assumes that these companies will grow at the growth rate of the U.S. Economy, say 3%.

So to calculate a normalized PE ratio for these two companies, we are going to create an adjustment factor by dividing the 5 year compound growth rate of Google and Facebook versus the anticipated 5 year compound growth rate of the S&P 500. For Google the 16.85% growth rate over 5 years creates a factor or 2.178 or a total of 217.8% total growth over the next 5 years. The S&P factor is 1.16. So if you divide the Google factor by the S&P factor you get 1.878. If you multiple the market PE multiple of 15 by the Google factor, the result is a PE of 28.2. Not too far off from the current PE multiple of 33.37

Facebook is a little off using this method resulting in a normalized calculated PE of 50.65 versus their current rate of 113.71. This will appropriately seek a level over time and settle into a more rational range. My point here is that the public markets absolutely account for growth rates in the value of stocks in a very significant way.

Now let's try to apply this same logic to the EBITDA multiple for valuing a privately held technology company. If the rule-of-thumb multiple for your company's valuation is 5 X EBITDA but you are growing at 10% compounded, shouldn't you receive a premium for your company. Using the logic from above we assign a 3% compound growth rate as the norm in the 5 X EBITDA metric. So the 10% grower gets a factor of 1.61 versus the norm of 1.16. Dividing the target company factor by the normalized factor results in a multiple acceleration factor of 1.39. Multiply that by the Standard 5 X EBITDA multiple and you get a valuation metric of 6.95 X EBITDA.

A little sobering news, however, you will have a real challenge convincing a financial buyer or a Private Equity Group to veer to far away from their rule of thumb multiples. You will have a better chance of moving a strategic technology company buyer with this approach.  A discounted cash flow valuation technique is superior to the rule of thumb multiple approach because it accounts for this compound growth rate in earnings. If the technique produces a higher value for the seller, the buyer will keep that valuation tool in his toolbox.

Perhaps the best way to negotiate a projected high growth rate and translate that into transaction value is with a hybrid deal structure. You might agree to a cash at close valuation of 5 X EBITDA and then create an upside kicker based on hitting your growth targets.

 So for example, your EBITDA is $2 million and your standard industry metric is 5X EBITDA. You believe that your 10% growth rate (clearly above the industry average) should provide you a premium value of 6 X.  So the value differential is $10 million versus $12 million. You set a target of a 10% compounded growth in Gross Profit over the next 4 years and you calculate an earn out payment methodology that would provide an additional $2 million in transaction value if you hit the targets. It is a contingent payment based on actual post closing performance, so if you fall short of targets you fall correspondingly short on your earn out. If you exceed target you could earn more.

Successful buyers do not remain as successful buyers if they over pay for an acquisition. Therefore, the lower the price they pay, the greater their odds of chalking up a win. This is a zero sum game in that each dollar that stays in their pocket is one less dollar in your pocket. They will utilize every tool at their disposal to convince the seller that "this is market" or this is "how every industry buyer values similar companies."  It is to your advantage to help move them toward your value expectations. That is a very hard thing to accomplish unless you have other buyers and can walk away from a low offer. Believe me, if they are looking at you, they are doing the same dance with at least a couple of others. You must match their negotiation leverage by having your own options.



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 - Revolutionsry Big Data Clinical Decision Support Analysis Engine and Database

Big Data Analysis Engine Optimizes Disease Treatment & Speeds Drug Discovery      

• Initial "Freemium" version has 15,336 registered users with the highest concentration coming from (in order) The US National Institute of Health, Harvard’s Dana Farber Cancer Research Center, Stanford Medical School, Johns Hopkins, The Mayo Clinic, M.D. Anderson, and Mt. Sinai

• Super computational AI systems biology machine has read the entire US National Library of Medicine Medline Archive, extracted all key clinical outcome data from over 200 years of research and integrated it into real time treatment optimization and new cure discovery solutions.

• Database tracks: 11,600 diseases and rates, 247,600 drugs and biological agents; 1,224 therapeutic techniques and 1,416 pharma companies for achieved successful clinical outcomes
• Commercialized Products and Services: Company solutions are productized as 1. evidence-based publications of best treatment options for patients,  2. Outcome-centric on line real time Clinical Decision Support Systems for physicians, and 3. Contract Services for new drug discovery real time drug repurposing for pharma manufacturers.

The Company's Systems Biology Machine was designed to meet the NIH "Bench to Bedside Program" goal for rapid translation of pure research into an Evidence-Based Medicine System usable in real time at the point of clinical care, and the FDA "Critical Path Initiative" goal for rapid discovery of new cures using built in CA-DDD: Computer Aided Drug Discovery and Development models.

Operationally, Company products are  web browser-accessible applications easily integrated  into all software as service solutions from leading health information/EMR Cloud providers seeking to improve patient outcomes through Personalized Medicine, evidence-targeted therapies, and side by side cost  to efficacy comparative data.  The company’s clinical outcome database is the largest in the world based solely on proven clinical efficacy and is directly integrated with Network Graph Theory algorithms for new cure discovery. Its use preempts futile path investments in the hundreds of millions of R&D dollars.  The ability of the Company's Machine to autonomously discover new cures for human disease—in 3-4 minutes of computation--has been formally demonstrated to the NSF, NIH, and FDA.  Early adopter sales have been made for each product line segment.

Our Client has engaged MidMarket Capital to locate a Strategic Buyer / Investor that could capitalize on their world class technology solution, leverage their 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.

Dropbox Link for Profile and NDA

https://dl.dropboxusercontent.com/u/12507505/%23%20140811%20%20PROFILE%20and%20NDA.pdf

 

 

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

When You Sell Your Software Company Can Have a Big Impact on Your Sale Price

When a large software company makes an acquisition in a particular niche, several other comparable acquisitions soon follow. This article discusses this market dynamic and the importance for owners of similar software companies to reevaluate their exit plans.

Our firm was engaged as a merger and acquisition advisor in 2010 to sell a Content / Document Management Software Firm. We put together a database of likely buyers in that software category and began our contact process. Fast Forward to early 2014. We have been engaged by a second Content / Document Management Firm to sell their software company. From our earlier engagement, we dusted off our database of mid-market software companies in that space and began making our phone calls.

A very interesting thing happened. 40% of these middle market software companies had been acquired by one of the large software companies. We would call one document management software company expecting the receptionist to answer by the company name in our database. Instead, we got, "Thank you for calling OpenText." Next call, instead of the expected company name, we got an EMC Company. Another call and this time, "thank you for calling Oracle." Two calls later, we reach an IBM Company.

Wow. Between mid 2010 and early 2014, there was a buying spree by the enterprise software vendors shoring up their product offering to become a much more comprehensive offering, now called ECM or enterprise content management. It was almost like a heavyweight fight - IBM punches, EMC counters, and Oracle lands a blow while OpenText dodges a punch.

For the midsized software companies in this space, these were exciting times. This rapid consolidation and active buying caused the transaction values to increase rapidly. Once the enterprise companies have added what they needed, however, the buying stops, the market returns to normal and sellers no longer command a premium price. Now the bad news. If you were a mid-sized competitor of the acquired companies, you are now competing with very large, powerful competitors. They will dwarf your company in terms of sales force size, marketing resources, brand awareness and pricing power. Their product now becomes the safe choice in a head-to -head competition with yours.

To now compete effectively will require even more skill. Your firm can continue to provide outstanding service and responsiveness. You can provide the small company customer attention that many customers require. You can be nimble and innovate with new products and features as another way to successfully compete. You often hear the stock market pundits say, "the trend is your friend" or "don't fight the trend." There is a certain wisdom to this sentiment. If you are in a software category that suddenly has become the target for the big software vendors, you may do best to exit according to the market conditions rather than your original retirement schedule.

Actually, the buying company will most likely want you to stay on board for a period of time to transfer customer relationships and intellectual property. So you can take your chips off the table today at an opportune time for rich valuation multiples and then retire a few years later. If you are younger, you can secure your family's financial future, work for the new company for a few years, gain valuable experience and then exit. Now you are ready to launch your next great idea. This time it will be far easier. You will have a large base of resources and influential contacts. Also the venture capital guys might even give you money under reasonable terms. Home Run, touch em all!

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

Business Sale Negotiations - Bridging the Valuation Gap

 Statistics show that a surprisingly low percentage of businesses for sale actually sell during their first attempt. The major reason for that is the valuation gap between the buyers and the seller. This article discusses how that gap can be breached resulting in completed business sale transactions.

In an earlier article we discussed a survey that we did with the Business Broker and the Merger and Acquisition profession. 68.9% of respondents felt that their top challenge was dealing with their seller client's valuation expectations. This is the number one reason that, as one national Investment Banking firm estimates only 10% of businesses that are for sale will actually close within 3 years of going to market. That is a 90% failure rate.

As we look to improve the performance of our practice, we looked for ways to judge the valuation expectations and reasonableness of our potential client. An M&A firm that fails to complete the sale of a client, even if they charged an up-front or monthly fees, suffers a financial loss along with their client. Those fees are not enough to cover the amount of work devoted to these projects. We determined that having clients with reasonable value expectations was a key success factor.

We explored a number of options including preparing a mock letter of intent to present to the client after analyzing his business. This mock LOI included not only transaction value, but also the amount of cash at closing, earn outs, seller notes and any other factors we felt would be components of a market buyer offer. If you can believe it, that mock LOI was generally not well received. For example, one client was a service business and had no recurring revenue contracts in place. In other words, their next year's revenues had to be sold and delivered next year. Their assets were their people and their people walked out the door every night.

Our mock LOI included a deal structure that proposed 70% of transaction value would be based on a percentage of the next four years of revenue performance as an earn out payment. Our client was adamant that this structure would be a non-starter. Fast forward 9 months and 30 buyers that had signed Confidentiality Agreements and reviewed the Memorandum withdrew from the buying process. It was only after that level of market feedback was he willing to consider the message of the market.

We decided to eliminate this approach because the effect was to put us sideways with our client early in the M&A process. The clients viewed our attempted dose of reality as not being on their side. No one likes to hear that you have an ugly baby. We found the reaction from our clients almost that pronounced.

We tried probing into our clients' rationale for their valuation expectations and we would hear such comments as, "This is how much we need in order to retire and maintain our lifestyle," or, "I heard that Acme Consulting sold for 1 X revenues," or, "We invested $3 million in developing this product, so we should get at least $4.5 million."

My unspoken reaction to these comments is that the market doesn't care what you need to retire. It doesn't care how much you invested in the product. The market does care about valuation multiples, but timing, company characteristics and circumstances are all unique and different. When our client brings us an example of IBM bought XYZ Software Company for 2 X revenues so we should get 2X revenues.

It is simply not appropriate to draw a conclusion about your value when compared to an IBM acquired company. You have revenues of $6 million and they had $300 million in revenue, were in business for 28 years, had 2,000 installed customers, were cash flowing $85 million annually and are a recognized brand name. Larger companies carry a valuation premium compared to small companies.

When I say my unspoken reaction, please refer to my success with the mock LOI discussed earlier. So now we are on to Plan C in how to deal with this valuation gap between our seller clients and the buyers that we present. Plan C turned out to be a bust also. Our clients did not respond very favorable when in response to their statement of value expectations we asked, "Are you kidding me?" or "What are you smoking?"

This issue becomes even more difficult when the business is heavily based on intellectual property such as a software or information technology firm. There is much broader interpretation by the market than for more traditional bricks and mortar firms. With the asset based businesses we can present comparables that provide us and our clients a range of possibilities. If a business is to sell outside of the usual parameters, there must be some compelling value creator like a coveted customer list, proprietary intellectual property, unusual profitability, rapid growth, significant barriers to entry, or something that is not easily duplicated.

For an information technology, computer technology, or healthcare company, comparables are helpful and are appropriate for gift and estate valuations, key man insurance, and for a starting point for a company sale. However, because the market often values these kinds of companies very generously in a competitive bid process, we recommend just that when trying to determine value in a company sale. The value is significantly impacted by the professional M&A process. In these companies where there can be broad interpretation of its value by the market it is essential to conduct the right process to unlock all of the value.

So you might be thinking, how do we handle value expectations in these technology based company situations? Now we are on to Plan D and I must admit it is a big improvement over Plan C (are you kidding)? The good news is that Plan D has the highest success rate. The bad news is that Plan D is the most difficult. We have determined that we as M&A professionals are not the right authority on our client's value, the market is.

After years of what are some of the most emotionally charged events in a business owner's life, we have determined that we must earn our credibility to fully gain his trust. If the client feels like his broker or investment banker is just trying to get him to accept the first deal so that the representative can earn his success fee, there will be no trust and probably no deal.

If the client sees his representatives bring multiple, qualified buyers to the table, present the opportunity intelligently and strategically, fight for value creation, and provide buyer feedback, that process creates credibility and trust. The client may not be totally satisfied with the value the market is communicating, but he should be totally satisfied that we have brought him the market. If we can get to that point, the likelihood of a completed transaction increases dramatically.

The client is now faced with a very difficult decision and a test of reasonableness. Can he interpret the market feedback, balance that against the potential disappointment resulting from his preconceived value expectations and complete a transaction?

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