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Mid-Management: Dreams of Owning a Business

Have you always dreamt of owning your own business? What about having your boss’ job? If you are in management and in a privately owned company, it might be possible for you to be the boss and the owner one day. However, many mid-level managers do not know how to accomplish their dream of owning a company that currently employs them. The good news is that your dream can become a reality.

One of the challenges of transitioning from an employee to a business owner is thinking like a business owner. As an employee, your manager/owner provides guidance, and often you may not question the guidance. As a business owner, you make all the decisions, set goals, and create a plan that will drive the future of the company. Then, you will be the one that has to drive and financially fund the vision. Yes, you will develop mentors around you, but as a business owner, you are the one that benefits and suffers from the positive and negative outcomes of your decisions.  

While you may work long hours currently, be prepared for a more immense workload and additional hours. Employees have a work schedule, and business owners that operate the company do not have work schedules. You are on call 24/7, and it is hard to get away from the business as you always carry that burden with you. Vacations are interrupted and weekends are often spent at the business. However, if you are in a place in your life where you can dedicate the required time, mentally and physically, to the business, the long term pay-off, whether it be financial or time freedom, can be significant.

Interview your owner and shadow him/her if possible. Ask the company owner for insight into their day. Understand the stresses that the business owner deals with daily. Some of the stresses will be confidential, such as employee issues or financial issues, so anticipate that your receiving limited insight.

 

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Then commit to making your dream a reality. Ask the business owner their exit strategy. Some owners may be open to a slow exit where you can purchase the company over a few years, or they may want a clean exit where you have the option to purchase the company immediately and the current owner walks away after a short handover period. Having an introductory conversation about your interest in purchasing the company is going to be important. Once you understand the business owner's personal goals regarding their exit, it will allow you to structure a deal to achieve both parties' goals.

It is important to prepare your financing so you know how much you can afford. This knowledge is key to structuring an offer. The business owner will need to share the information around the business' performance for a bank to underwrite an acquisition. The company's current banker might be a good starting point. After your conversation with the business owner, ask if they would be open to making an introduction to the company’s banker. The banker understands the business and risk as they have underwritten the business previously. Their goal would be to underwrite the business to incorporate the new ownership. 

Be patient and ask for help when needed. Purchasing any business can be an emotional process. If you have never been through the process previously, you may need to seek help from your advisers or hire an experienced buyer side M&A advisor. There are many resources available to you to help with the purchase.

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Why the Best Buyer May Not Be the Highest Bidder

Taking your business to market is a very challenging yet rewarding process. Receiving feedback from potential buyers enables you to learn both what specifically attracts buyers to your company and what your business is generally worth. Throughout the process, a valuable lesson learned will be the importance of weighing all potential offers, rather than strictly accepting the highest offer.

Consider the likelihood that the buyer can finance the proposed offer

Having multiple Letters of Intent (LOIs) to compare against each other is a great problem for a seller to have. Each offer is unique and presents different solutions to finance the proposed transaction. However, an LOI is not binding and simply moves you into an exclusive relationship with a buyer for a set period (typically 60-90 days). Deciding to enter an exclusive relationship with this one buyer can affect your perceived value with other serious buyers, should you have to reopen dialogue if the agreed upon LOI does not ultimately close the deal.

A major component in valuing an LOI is the legitimacy of the offer. One buyer may come in and submit an offer that is a percentage higher than that of other buyers. If you agree, spend time working with the buyer, and ultimately learn that the buyer does not have the funds necessary to pay the intended price, you have lost valuable time on market and there is no guarantee the landscape will be the same upon return to market. For example, other buyers that extended an LOI may have moved on, eliminating them as a potential buyer for your company. Effectively, each seller must determine the authenticity of an offer in respect to the time it will need, the resources that must be committed, and the effect it will have on relationships with other buyers.

Deal structures can be valued in many ways

A second characteristic to consider is the structure of the deal. Four broad levers that buyers have in structuring an offer are cash, equity, debt and earnouts. The percentage makeup of each component is a huge aspect of the offer. For example, a seller who values cash upfront may value a $10 million all-cash offer more than a $12 million offer that is split between 50% cash and 50% earnouts based off estimated financial performance post transaction. An earnout structure would be less appealing to that seller due to the uncertainty of achieving the targeted earnout performance and/or the potential for litigation in the period between transaction-close and the earnout’s expiration.

 

Ready to explore your exit and growth options?

 

Compatibility with your potential partner

Unless you fully exit your company and receive a full-cash offer, another topic to consider is determining how well the buyer aligns with you and your company. While not always the case, some buyers may state that proposed deals are contingent upon the owner remaining on full time after the sale because they value the owner’s role for a successful transition of ownership. For any deal in which this is the case, you would also need to reflect on whether you are willing to transition from being the manager to being managed.

A buyer’s compatibility with your company also matters when your payout is contingent upon earnouts or a retained equity position. As mentioned in the previous section, funding for the sale can include earnouts. An earnout is a post-closing purchase price payment that is contingent upon the acquired company meeting negotiated performance goals post closing. If your company’s performance post acquisition does not pan out as expected, the earnout expectations may not be met and you would not receive the compensation which was expected at the close of the deal.

Alternatively, if the seller retains an equity position in the company post sale, then there may be a benefit to accepting an offer from a buyer that is not the highest bidder: if that buyer brings a strategic relationship that grows the value of the retained equity position. Oftentimes this strategic relationship manifests itself in operating synergies allowing for expense reductions, new revenue growth opportunities, or additional management expertise.

Financing strength, deal structure, and compatibility are three of many attributes in addition to the final price that must be considered when selling your company. Ultimately, in a process that is so complex and intense, choosing which offer to accept is not quite as simple as accepting the highest offer.

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Leading Positive Change After an Acquisition

Though every business will go through changes as it evolves, being acquired by a business is perhaps the one that can be the most stressful for its employees. There can be much uncertainty for a company that is acquired. If not handled properly, the buyer can lose some of their people (along with their customer relationships, institutional knowledge, etc.) that made the company successful. Managing the change positively during this tumultuous time can reduce a mass exodus after a sale is completed.

Key employees may be worried about whether their jobs will be intact after an acquisition. Perhaps they feel their role won't be needed, or the buyer will want to use their people to perform their functions. At the same time, the buyer may be worried that these key employees will leave. Leaders and other influencers within organizations set the tone for a company's culture, innovation, and strategic initiatives. Losing them reduces the value of the company they are acquiring.

One key to reducing uncertainty for the acquired company’s employees is first to create readiness for change. People will resist change unless they are ready for it. On the other hand, when they are open to change, employees are more likely to accept everything that comes with it. These employees will be an essential part of the transitional period after the acquisition. Getting their buy-in will pave the way for creating a stronger company in the future.

 

Ready to explore your exit and growth options?

 

In their book Developing Management Skills, Whetten and Cameron suggest four ways to create readiness when leading positive change:

Benchmark best practice and compare current performance to the highest performance

Within the context of an acquisition, it's possible (likely even) that each of the involved organizations can perform certain functions better than the other. This may be one of the catalysts behind the acquisition. In that respect, synergies can be experienced when buyers and sellers learn each other’s best practices and implement improvements. Improvements can mean doing things better, faster and/or cheaper.

Institute symbolic events to signal the positive change

Symbolism can have a significant impact. The authors indicate that to be "successful in leading positive change, you must signal the end of the old way of doing things and the beginning of a new way of doing things." This can be accomplished in a variety of ways and can be elaborate or more reserved.

Create a new language that illustrates the positive change

Changing the way people talk about the change that is occurring is vital. If negativity abounds, positivity must replace that language. Taking the time to reframe things with a positive outlook can impact how employees view change.

Overcome resistance

People are typically against change because of the unknown. Finding common ground and having people participate in the change helps. Converting resistors is especially important because they have a way of influencing the rest of the team. Proactively identify the employees most likely to undermine the change and help them get on board first. They will, in turn, help persuade other employees.

Helping people understand the importance/urgency of the change that is happening through the acquisition will increase the likelihood they will stay and help ensure a smoother transition of ownership. The key is conveying that the company's employees are an essential part of the company's success going forward and preparing them for the change they will experience.

 Benchmark International Buyer Profiles

Want to be the first to know when new opportunities come to market that fit your acquisition criteria? Create a buyer profile today. While you're there, be sure to check out all the resources we've created specifically for buyers, including opportunities, on-demand webinars, buyer events, and our latest edition of The Mark magazine.

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Buyer Comfort

Buyers tend to assuage their discomfort with deal structure.  When negotiating with buyers, it is prudent for the seller, guided by a seasoned M&A Advisor, to consider what the underlying issue is, discomfort, instead of addressing the result of that discomfort, a specific deal structure. Huh, you say? Let me dive a bit deeper.

Buyers of businesses use deal structural devices to cure many issues or concerns. Let's take a second to illustrate the most typical elements of a structured deal. While the following encompasses the most common deal structures, it is, by no means comprehensive.

Cash at the closing table is obvious and needs no further illustration. A seller note or seller financing is also fairly simple. The seller essentially serves as a lender to the buyer. The attorneys draft a promissory note, perhaps a stock pledge agreement and incorporate them and potentially other documents in the definitive agreements. The buyer pays off the principal of the note and interest over the course of a few years.  Seller notes don't tend to be contingent upon anything other than the solvency of the entity backing the note. They are deferred. Rollover equity, often known as Seller Rollover, Rollover or simply Roll, occurs when the seller maintains a position in either the existing business or Newco. In some circumstances, a seller may sell 80% of the shares in his or her company while in another, that seller may sell 100% of the shares in her business and simultaneously reinvest what amounts to 20% of the proceeds in Newco. This is generally a cashless exercise. It is critical for the seller to engage seasoned advisors to assist in structuring the rollover in the most tax-efficient manner. The final typical structural element of a deal is an Earnout. Where the seller note isn't contingent upon performance, an earnout is. Earnouts pay out a prescribed dollar amount over time as certain agreed upon and defined metrics are achieved. While these tend to be quantitative metrics like EBITDA and Revenue, they can also be tied to qualitative measures like maintaining key customers or employees or integrating technology. In addition, earnouts can be tied to maintenance or growth.   

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As I hinted at earlier, buyers use these structures to cure their apprehension. What is behind that discomfort or apprehension? Many things but at the heart of most of those is the oft-cited, yet misunderstood concept, risk. Risk, in a business context, is the chance for an unanticipated outcome. Risk can be specific to a business, to an industry, to geography or more global. Risk isn't inherently bad, thus the risk/reward model, but it needs to be accounted for in decision making. Buyers, in their initial diligence, aim to understand the underlying risks and determine their tolerance for said risks. When structuring an offer, they seek to allocate and incorporate those risks.   

Some buyers seek out businesses that are very easy for them to understand, have very predictable financial performance and robust operational teams.  Those types of businesses, if proper controls are also present, will garner simple offers with a high percentage of the deal in the form of cash. This is a low-risk deal. A business with more volatile performance introduces incremental risk. A buyer may still be interested in the business but may shift cash at close to an earnout. If the business is growing rapidly, but that growth hasn't been consolidated in the buyer's eyes, that earnout may be linked to the growth of earnings or revenue. Perhaps the buyer will apply a three-year average to EBITDA to incorporate the volatility into the valuation.  If the seller wants to be paid on the recent growth, a buyer may use an earnout to bridge the valuation gap. A buyer willing to pay 5x EBITDA in an all-cash deal may pay 8x or more if allowed to incorporate structure, thereby mitigating their risk.

If the seller is adamant that he or she won't accept an earnout, it behooves an M&A advisor to dig deeper into where the actual buyer's discomfort lies.  Rather than fighting the earnout, might it be a better strategy to uncover the underlying issue and solving that? The earnout is the solution, not the problem. Why might a buyer incorporate an earnout? There are several possible reasons; 1. Earns reduce the cash required to close the deal.  2. They create alignment between buyer and seller post-close, thereby ensuring the seller continues to act like an owner even when he longer is an owner. 3. They confirm their diligence. Can these concerns be addressed in other ways? Of course, they can. If the earnout is moved to a seller note, no additional cash at close is required of the buyer to fund the deal. Both two and three can be addressed through a seller roll. If the buyer wants to ensure the seller acts like an owner, make him an owner. Rollover allocates some of the risks to the seller in both an earnout and rollover equity. Perhaps an employment contract signed by key employees would provide the buyer some comfort? Many deals incorporate an options pool, Management Incentive Program (MIP) or Profits Interest as additional ways to create alignment post-close. 

The central idea is this. Rather than focusing all of your attention on the proposed structure of a deal, attempt to think through the concerns the buyer is trying to sooth with that deal structure. Solving for the actual underlying problem rather than the buyer's proposed solution may lead to better outcomes for both parties.

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What is included in the M&A due diligence?

The due diligence process is one of the final steps in an M&A transaction where the potential buyer does its obligation to best confirm and verify the seller's company data and relevant information. This information typically includes but not limited to: financials, IT, operations, legal & compliance, insurance, corporate bylaws, contracts, customers, among other important information. Typically, the due diligence process follows the execution of a letter of intent (LOI), a non-binding document outlining the intent of both parties to commit to the transaction.

Once the LOI has been executed, the buyer will request a list of items to be shared by the seller with the intention of disclosing the selling company’s key details that could uncover risk buyer. As mentioned before, items can range all the way from financials to operations to insurance to contracts, among others. In cases where the seller owns the real estate, additional documents pertaining to the real estate, such as: deeds, mortgages, tax documents, owners’ insurance, etc. will need to be provided. Given today’s advancements in technology, once the due diligence request list has been sent to the seller, the team leading the deal will proceed to open what we call in the M&A world a “virtual data room” or a “data room.” These two terms are referred to as online portals that hold and store the information requested by the buyer with high levels of security only available for certain parties, including: buyer, seller, M&A attorneys, CPAs, advisors, among others. The data room allows activity within the room to be tracked and archived so there is a file of the information exchange after closing should any issues arise.

Once the due diligence starts, it is highly recommended for the buyer to hold, at the very least, weekly meetings or calls with the seller to discuss outstanding items or any questions that may have arisen from the process. As the due diligence process progresses, the buyer will become more familiar with the seller’s company. For an instance, should the buyer find any items that may play against the seller in the due diligence process, the buyer may use this to lower the valuation of the business which may ultimately result in a lower offer price.

In addition, this process can result as a discovery of potential opportunity to better structure the deal, find real synergies among parties, review any benefits and challenges for potential system integrations, and any associated risks that may arise from the result of this potential acquisition. 

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Buyside Perspective

As stated on Benchmark International’s website, our perspective makes us different. We strive to help clients reach their maximum value for the sale of their business. To accomplish that goal, it’s important to also have good buyside perspective.

Buyers look at companies differently than sellers and some advisors. Certainly, a company’s financials are a common barometer for both sides to gage a company’s performance and success. And cultural fit is a must. Beyond those metrics; however, buyers prioritize characteristics to mitigate investment risk. These characteristics include, scalability, stability, resiliency, and the ability to grow.

Scalability is about a company’s ability to accommodate growth – to behave as a larger entity. Some acquisitions result in smaller companies becoming part of much larger organizations. The new structure sometimes brings new processes, systems, and reporting requirements. These changes in scale can introduce risk if personnel lack the bandwidth, appetite, skills, or resources to ramp up. Buyers seek assurance that the team is adaptable and capable of scaling.

Many investors also seek stability. The project-based business with wild swings in revenues or heavy seasonality, for example, presents significant challenges in performance, planning, and execution. For most investors, consistency is vital and this is often tied to a company’s revenue model. This is a key reason why buyers prefer recurring revenue models. For industrial services businesses, long-term or preventive maintenance contracts provide recurring revenue. Many equipment manufacturers have transitioned to providing a service rather than hardware. For example, some compressor manufacturers retain the physical asset and provide an “air as a service” guarantee for a monthly fee. And software companies achieve this by transitioning to a subscription, or software as a service (SaaS) model. Together with a “sticky” customer base – high switching costs or risk – these all provide a level of revenue stability that might otherwise be absent.

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