Business Buyers are Savvy Shoppers

The business sale process is a complex battle for leverage. A seller wants to invite many qualified buyers to the table and position his company to produce strategic value. The experienced professional business buyer has his own arsenal of tools to move the balance of power in his favor. This article examines how Private Equity Groups approach the process and try to stack the odds in their favor.

We preach to our business seller clients the benefits of testing the markets and inviting many qualified buyers to participate in the process. The ultimate goal is to get two or more buyers that recognize the tremendous synergies that the combined companies could realize and produce offers that are not based on a financial multiple, but on a strategic value premium. A financial multiple would be a purchase value something like 4 X EBITDA (basically cash flow) or 70% of annual revenue. 

What would produce strategic value? The good news is that this can be created in a number of different ways.  The evil "Wall Street stereotype" is to eliminate duplicate functions and save a tremendous amount in payroll expenses. I am not a big fan of this as the reason for doing an M&A deal. Somehow tearing something apart does not represent any particular management imagination or skill. Identifying ways to build value by creating the sum of the parts that far exceeds the inputs is real visionary management. 

This strategic value can be created by acquiring a complementary product line that can be added to a strong sales and distribution network.  Acquisition targets can provide superior systems, business models, product technology, and  management talent that can be leveraged by the new combined company to produce revenues and profits that far exceed the two separate companies. 

This sounds easy on paper and makes a lot of sense, but the truth is that most acquisitions fall short of expectations because, integrating all the systems, personnel, culture, locations, customers, etc. is complex. This makes buyers cautious. When buyers get cautious, they revert back to the conservative financial multiple which basically provides a safety net to their investment if the post acquisition synergies are not realized.

We subscribe to a private equity group database which helps us identify likely buyers of our sellers based on searching their investing criteria and identifying their portfolio companies. A surprising discovery I made is that in this particular universe of the largest 3500 private equity groups, they owned a combined 46,000 companies. If you wanted to draw any conclusions about business buyer behavior, this would be your group of target subjects.

First conclusion is these guys want to win. Sure it's money, but it is the game and the competition and thrill of the conquest that also drives these serial business acquirers. They think they are the smartest guys in the room (hey check their educational, and job history background) and on paper  they may just be. But you only need to have one failed $20 million acquisition to instill some real rigor and financial conservatism into your process.  They want to stack the deck to put as much as they can in their favor to make these investments winners.

The first thing they do is look for Warren Buffet type businesses. You know the ones that have a durable competitive advantage, positive cash flow, steady growth rate, loyal customers…… They want to draft Payton Manning coming out of Tennessee - Great start.

The next tenant of their success formula is to take advantage of the large company valuation premium. This is how it works. Their first acquisition into a market space is generally a bigger company, say $25 million in revenue. Let's say that this valve and pump company sells for a 6.1 X EBITDA multiple. They then attempt to make a series of tuck-in acquisitions of a $5 million valve company here and a $4 million pump company there. These smaller companies command a smaller valuation multiple than the large company, say 4 X EBITDA. The day the acquisition is completed, the PEG has already won because the acquired company is now valued at the higher EBITDA multiple of its new parent. They make a series of these investments, grow the company organically as well for 7 years and then sell their $150 million in revenue company to a strategic buyer at an EBITDA multiple of 7.8 X.

These sophisticated buyers are very disciplined in their acquisition process and very seldom stray from the strict EBITDA multiple offer.  In order to stick to that discipline, they have to look at a lot of deals. We normally ask our buyers that have signed NDA's and looked at our client, and then withdrew, why they dropped out. We get a lot of different answers, but the top answer is that they were in another deal and would not be able to process both at the same time. Most of these firms invite 50 - 100 potential acquisitions into the top of the funnel for each one that they complete.

So, what they are doing is creating the counterbalance of the leverage we are trying to create by getting lots of potential buyers involved.  They have multiple options, so if the price gets too high, they go for easier prey. If the sellers are difficult, they move on. If the financial reporting is shaky and unclear they find a company where it is transparent.

Please don't let me give you the impression that this process is totally by the numbers. There are great companies that will command a premium, but just like buying a luxury automobile, they are still shopping.

 


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

We are Representing a new Business for Sale Opportunity - IT Managed Services Provider

ACQUISITION OPPORTUNITY - Managed IT Services Provider SMB

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

2015 Revenue Proj: $2.3 MM   2015 EBITDA Proj: $561K

·         Recurring Revenue Business Model: 90% of company's revenues are generated from managed services and Web Hosting contracts. Currently over 200 Cloud Services Clients.

·         Diversified Customer Base: With 345 clients, no single customer represents more than 9% of annual revenue, and the top 5 customers represented 27% of sales in 2014. Their customer base is also well diversified across several industries - transportation,  non-profits, engineering,  professional services, hospitality,  healthcare and insurance

·         Growth in Revenues and in Profitability: The Company has achieved a 9.8% compound sales growth while steadily increasing EBITDA margins.

If you would like more information, please click this Drop Box link to print the Profile / Confidentiality Agreement.

Click Here for the Profile/Confidentiality Agreement

COMPANY DESCRIPTION

The Company provides one of the most comprehensive managed service offerings in the New England market. They provide an economical service with the ability to proactively monitor over 1,000 items on a server. The Company charges a flat fixed monthly fee, while most competitors charge for remedial or proactive services. Some of the Company’s managed IT service features include: server & desktop management,  patch management,  Help Desk, onsite support,  network  & security management, business continuity,  and 24 x 7 proactive monitoring.

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

Acquisition Opportunity - IT Recruiting, Consulting, and Outsourcing Services Firm New England

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

Est. 2015 Revenue: $ 8.7 MM      Est. 2015 EBITDA: $ 1.064 MM

• Superior Name and Reputation: For over 12 years, Company has provided effective IT consulting and recruiting solutions to a wide range of industries. Based on its depth of internal technical talent Company excels in fulfilling complex IT positions with high quality consultants.
• Low Employee Turnover: The culture of keeping each employee trained and exposed to the latest technology and trends has proven to encourage employee morale and support the Company’s continued success and growth.
• Strong Client Relationship: Company is proud of its strong ties to clients as evidenced by the extremely high rate of repeat business. Key customers and consultants have transacted with the Company for many years. Many engagements are multi-year placements.

If you would like more information, please click on the dropbox link and complete and return the attached Confidentiality Agreement (page2).

  

Click Here for Profile/Confidentiality Agreement

COMPANY DESCRIPTION

The Company differentiates itself on many fronts, including its excellent operating history (99% placement success rate), consistent high-quality IT consulting and staffing services, extreme responsiveness to client needs, a strong ethical reputation, loyal customers and consultants, a highly-experienced, educated and loyal staff, and the ability to work with a wide range of industries. The Company also continuously seeks to increase its capabilities by understanding the direction of the market; increasing its competiveness in the marketplace. 

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

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