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
