Leveraged Recapitalization

April 21st, 2009

In a leveraged recapitalization a the company being sold takes a loan for the majority of the purchase price, the new owners put in some equity capital, and the existing owners retain an equity stake.  For example, a company valued at $10,000,000 might be recapitalized as follows:

Existing owners equity capital: 1,000,000

New owners’ equity capital:       1,500,000

Bank Loan:                                7,500,000

Total Capital:                           10,000,000

The existing owners retain 40% of the equity in the company but pocket 9,000,000 in cash (less transaction costs and taxes of course).  The owners then grow the business and exit by selling (usually in 3 to 5 years).

There are of course issues with this deal structure, such as the ability of the business to repay the loan from cash flow, maintaining adequate capital to grow the business, how well existing owners and new owners can work together, the skills that each party brings to the table, and how major decisions are made.  An owner who wants to take money off the table, however, can take a lot of money out of the business while maintaining significant upside potential and gaining a new partner that brings skill and capital to the table.

Selling Part of Closely Held Company

April 12th, 2009

I just returned from a meeting where a company owner discussed selling 60% of his company to a Private Equity Group.  At first glance this seems like a bad strategy.  The owner gives up control, and 60% of the profits.  It is difficult to protect your interests as a minority partner in a closely held business.  The new owners can force changes in strategy, operations, etc. and yet the existing owner is still tied to the business.  So, why would any owner take an offer in which another entity acquires a controlling interest in a business?

There are a variety of advantages to the existing owner in this deal structure.  First, the Private Equity Group that is acquiring the controlling interest is interested in growing the business and exiting in three to five years.  They have a track record of successfully growing businesses by bringing additional financing and expertise.  If the existing owner retains 40% and sells in three years he can share in that growth.  The owner interests will be protected both by the purchase and sale agreement and by the fact that the PEG wants the owner to be motivated and grow the business.

This deal offers the owner, who has the majority of his net worth tied up in the business, the ability to take some chips off of the table and diversify to reduce his risks.  It does so, in a way that allows the money that comes out to be treated largely as a capital gain for tax purposes.  So, the potential upside may outweigh the dangers of being a minority shareholder in a closely held corporation

Don’t Bother Trying to Sell Your Business in this Economy

January 15th, 2009

Well, not so fast.  Selling just about anything in this difficult economy is tougher than it was a few short moths ago, and selling whole businesses is no exception.  But among the gloom, deals are still happening.  Here’s a little of what we’re seeing:

Buyers with Cash

Many if not most business acquisition involves some amount of bank financing.  And, ot understate by a lot, banks have put a damper on lending.  But not all deals involve bank financing.  Buyers with cash are still buying.  The more cash a buyer has available for the acquisition, the more likely the deal will get done.

Seller Financing

Understandably, sellers don’t like to take back paper.  Equally understandably, buyers love to buy with seller provided financing.  The reality today is that more sellers have to provide more financing to make deals happen.  Of course sellers don’t want to hear this.  But there are some good reasons to take back paper, not the least of which is doing so will make the deal more likely to close.

Our advice:  Be more open to taking more of the purchase price over time.  But at the same time, try to get more security on the loan that you are, in essence making.  Try for a personal guarantee (the bank certainly would insist on a guarantee).  Also, try for specific collateral like a rental property or other tangible property the buyer can use to secure the loan.  The more collateral the more motivated the buyer will be to make the business work (and keep his property from being forfeited).


The last thing a seller wants to hear is that his business is worth less than he thinks it is.  Here’s the bucket of cold water:  Valuations have come down with the economy.  Buyers are looking for a return on their investment that is in proportion to the perceived risk.  Perceived risk is higher now for just about any business than it was before the economy went south.  Most venerable public companies are selling for big discounts as compared to what they were selling for 6 or 8 months ago.  So buyers expect smaller privately held firms to sell for lower prices as well.

Couple this with the fact that most buyers out there, at least those capable of making a deal, are largely cash buyers.  Cash buyers rightly feel that they are entitled to a better price because they have cash and can spare you the uncertainties and overall unpleasantness of waiting for a yes from a bank that may never come.

On the Bright Side…

Lots of would be business sellers have decided to hold off on selling until the economy improves.  Now with the smartest economists in the country disagreeing on the whether the economy will get worse or better of the next couple years, we’re not even going to venture our opinion as to whether waiting makes sense.  We can say that the competition is lighter because so many would be sellers are holding back for now.

I think we’ll stay with the advice on the article in this blog When is the right time to sell? that argues “don’t bother trying to time the market”.  Sell when it makes sense to you for other reasons than timing.

Business Mistakes

October 14th, 2008

We have created a new website about business mistakes.  The site contains excerpts from Gary Schine’s book 101 Small Business Mistakes, Myths, and Misconceptions. Please take this opportunity to learn from the mistakes of others instead of making them yourself.

Why a foreign buyer won’t buy your business just because the dollar is weak

June 16th, 2008

We get a lot of calls from business owners who say that a broker has told them that foreign buyers are willing to buy their businesses for truly astounding prices. These alleged “buyers” are usually located in Europe or Asia and just dying to buy American businesses.

Here’s the flaw in the logic. Usually when a buyer purchases a business they continue to operate it in the same way that it had been operated. That means that if your business generates profits in dollars now, it will continue to generate profits in dollars after the sale – the same cheap dollars. When those profits are converted back into Euros or Yen, the exchange rate that worked for them during the purchase reduces their return. So, unless the buyer is betting that the dollar will soon rebound a cheap dollar doesn’t help raise their rate of return.

Next time I’ll talk about other reasons that an overseas buyer might purchase a U.S. firm and how those scenarios affect the price.

Costs that are Often Overlooked in the Costs to Create Methodology

March 26th, 2008

Often when a buyer is purchasing a business to get into a new geographic area or expand his product offerings, the buyer uses the cost to create or a buy versus build methodology to evaluate the price that the buyer should pay. The cost to create methodology is explained in detail on our Guide To Selling a Business website, so I won’t repeat it here, but I’d like to point out a pitfall in the methodology.

Unlike in a previous post, where I discussed the problem of the buy vs. build methodology producing a value that is too low because the probability of failure is underestimated, I want to talk about a problem with the buy vs. build methodology that results in overpayment for the acquired company.

Often a buyer will calculate the value of an acquisition by just totaling up the costs that would be incurred to create the new product and/or services or to expand into the new geographic area. Then, they assume that they are done with the valuation.

However, there are a number of costs associated with acquiring a business that you need to put into the equation:

Acquisition Costs

There is a cost to acquire the target company. These costs may include fees and commissions to business brokers, attorneys, can accountants. Costs of taking physical inventory. Due diligence can also be expensive to perform.

Opportunity Costs of Acquisition

An acquisition takes time of senior management, which may be better used for other purposes.

Potential Failure to Close

No closing is ever assured. You may decide that there was misrepresentation as you perform due diligence or the owner may decide to keep the company for reasons that have nothing to do with the deal.

Integration Costs

There are potential expenses related to integrating two companies. For example, you will probably rename one of the companies to have a single brand. Doing so requires marketing, printing, and communication expense. You may also want to standardize on a single pension, health insurance, or other benefit plan, a single accounting system, and so on. To do so you may incur legal, accounting, or IT costs.

You may also need to integrate your products and services with those of the acquired company. This is especially true when acquiring software companies. Seamlessly integrating software packages that were not designed to work together can be extremely difficult.

Being Stuck with Past Decisions

When you start something on your own, you can tailor your decisions to your target market and/or to the needs of your existing customers. In acquiring a company you need to accept the decisions that they have made in the past or pay to undo them.

So, if you are the president of a software company and your VP of business development comes to you and says “We think it would take $10 million to develop an ERP package, but I’ve identified three ERP companies that we could probably buy for $8,000,000″ you need to determine the costs of acquisition that are discussed above and add them to the price. You may find that the $2,000,000 savings disappears when you’re done.

Three New Websites

March 18th, 2008

We have added three new websites to our growing family of mergers and acquisitions websites. The first stie, our Business Broker Locator which allows you to locate a business broker based on the location, size, industry and other specific characteristics of your company. The second site, Ownership Transitions showcases services available to either buy or sell a business, at either an affordable hourly rate or at a fixed fee. The third site, is a companion to our Guide To Selling a Business. This site, a Guide to Buying a Business is written from a buyer’s perspective and has a plethora of information on how to purchase a company.

More About Comparables

March 6th, 2008

In my last real post I talked about some of the problems with using comparables, namely that there is not enough information in most datasets to determine how comparable the data really is. It’s a bit like trying to value an orange by knowing the price of 30 small round fruits.

Comparable values often can give you a range of multiples that is so broad as to be meaningless. In a comparables report that I ran for Mfg. – Fabricated Metal Products with sales between $1,500,000 and $2,500,000 I got an average cash flow multiplier of 3.21, and the median was 3.52. “Great,” you say, “so my metal fabrication business with cash flow of $1,000,000 is worth about $3,333,000.” “Not so fast,” I reply, “the range of multiples in the report was from 0.16 to 5.27, so your business is worth between $160,000 and $5,270,000 – quite a range.”

Further complicating the use of multiples is that unlike in real estate deals where comparables are often used, in small to mid-sized business transactions the deal is seldom all cash. When a comparable is reported it may not be clear what the true value of seller provided notes, earn-outs, restricted stock, contingent payments, and so on really is.

There is, however, one big advantage to using comparables. Comparables represent real world transactions. So, if you are going to use comparables, how do you go about doing so in a way that minimizes the problems that we’ve discussed? The answer has two pieces. First, use comparables as only one method of valuing your business among several. Second, select a good source of multiples data. The best source is a business broker that can use past transactions of his own as a source of data. The broker will be aware of how the deal was structured and how similar your business is to the comparable. If you don’t have access to an experienced professional to help with the valuation, http://bizcomps.com has data that is more comprehensive than most. For example, the data includes a field for the percentage of the deal paid in cash at closing. Alternatively, if you’re considering selling perhaps it makes sense to talk to a broker. You can use our website (shameless promotion here) http://businessbrokerlocator.com to get up to four proposals from pre-screened business brokers. Ask them how they’ll help you determine an appropriate asking price.

New Book and WebSite

February 21st, 2008

I was working on doing another post about comparables, but something got in the way…

Gary Schine and I have Written a new book “Guide to Selling a Business” and created a website, based on the book. The website can be found at GuideToSellingABusiness.com The book and site are meant to be a complete guide to selling a small to mid-sized company, whether you choose to do it yourself, or hire an intermediary. As always, any feedback is welcome.

The problems with using comparables as a valuation methodology

February 9th, 2008

One method of valuing a business is to use comparables. In the world of small businesses, this is often a mistake. Let’s look at some of the reasons why.

I ran a report from a prominent data provider (who now offers free valuations based solely on these comparables) at the request of a buyer who was purchasing non-emergency medical transportation companies. Let’s look at some of the issues with the report. To begin with, although the data provider was a reasonably large player and the database contains about 17,000 transactions no category narrow enough to match what my buyer was interested in, so we ended up using a category titled “Services – Local Passenger Transportation.” We got a result based on 34 sales over a 5 year period, a period that included wide fluctuations not just in the market for small businesses but also in things like the price of gasoline that had disproportionate impact on this industry.

The average Cash Flow Multiplier was about 2.4, the median was 1.9. So, could my client conclude that a seller who was asking 1.5 times EBITDA was a bargain and one who was asking for 3 times EBITDA was asking top dollar? Not really. If we look at the descriptions and limit ourselves to transactions that had occurred within the last year, we find only 2 transactions are left, not enough to base any real conclusions on. Their multiples of cash flow were 2.47X and 3.64X.

What is more important than what we know about these companies is what we don’t know. In this report we have no idea how strong the balance sheets of each company was and medical transportation is a capital intensive business. Even if we had the balance sheet, there are many things that can affect the numbers on that balance sheet making two balance sheets hard to compare without an in depth analysis. For example, choosing a different method of depreciation can materially affect the value of the balance sheet.

There are also things that are never reflected on a financial statement. A business in a rural area will sell for less then one near a major city. A business that is growing is more attractive than one that is not. Unless you know a lot about the businesses being compared you can’t decide how relevant the information is.

Most business comparable reports don’t contain enough data to allow a reasonable assessment of true value. It’s like trying to assign a value to a house based only on the square footage, the number of bedrooms, the number of bathrooms, and the fact that it is in Los Angeles. To get real value you would need to know what shape the house was in, what neighborhood, etc. Anybody who tries to value a home on the basis of broad averages would be laughed at. Unfortunately, businesses that are even harder to value fairly based on comparables are often valued in just that way.

In the next post I’ll talk more about the problems with using comparables to value a small to mid-size business and the one after that I’ll talk about where they can be useful.