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September 23, 2014

How To Get a Big Company Multiple For a Small Business

Big public companies trade at a significant premium over small businesses in the same industry. Investors perceive big, sophisticated companies as a safer bet than small, owner-dependent companies and therefore place a premium on the value of big businesses.

Let’s take a look at the professional services industry. Although most consultancies are a small collection of experts, there are also a handful of big publicly traded professional services firms. Omnicom (NYSE:OMC) is a massive marketing services company with a market capitalization of around $18 billion. For all of 2013, Omnicom reported pre-tax income of $1.66 billion, meaning they are trading at around 11 times pre-tax income.

Over at www.SellabilityScore.com, we ask smaller business owners (our typical user has between $1 million and $20 million in sales) if they have received an offer to buy their business, and if so, the multiple of their pre-tax profit the offer represents. When we look at the professional services segment, we find the average multiple over the last two years was 3.81—almost three times lower than Omnicom.

When we isolate professional services companies with at least $3 million in revenue, the multiple being offered goes up to 4.97 times pre-tax profit, but it is still less than half of Omnicom’s 11 times.

And in case you thought this phenomenon was unique to the marketing services vertical, take a look at the IT services giant Accenture (NYSE:ACN). Accenture reported pre-tax income of $4.3 billion in 2013 and currently has a market capitalization of more than $52 billion, meaning they are trading around 12 times pre-tax profit, which is more than double the price we see being offered to smaller professional services firms.

How To Get a Big Company Multiple For Your Business

So how do you get a public company-like multiple for your business? One approach is to look for a strategic buyer. Unlike a financial buyer that is looking for a relatively safe return on their capital invested (which is the reason investors place a premium on big, stable companies trading on the stock market), a strategic buyer will value your company on how buying you will impact them.

Let’s imagine you have a grommet business predictably churning out $500,000 in pre-tax profit. These days, a financial buyer may pay you around 4 or 5 times earnings – in this case, roughly $2.5 million – if you can make the case your profits are likely to continue well into the future.

Now let’s imagine that a company that sells a billion dollars worth of widgets starts sniffing around your grommet business. They think that if they integrate your grommets into their widgets, they can sell 10% more widgets next year.

Therefore, your little grommet business could add $100 million dollars of revenue for the widget maker next year – and that’s just year one after the acquisition. Imagine what your business could be worth in their hands if they continued to sell more widgets each year because of the addition of your company.

The widget maker is not going to pay you $100 million for your business, but there is somewhere between the $2.5 million a financial buyer will pay and the $100 million in sales that the widget maker stands to gain next year that is both a good deal for you and for the widget maker.

Premium multiples get paid to big companies and also to the little ones that can figure out how to make a big company even bigger.

June 11, 2014

Is now really the “perfect” time to sell a business?

Yesterday the Dow Jones Industrial Average flirted with 17,000 points.

Last month, GF Data reported “Middle Market multiples jump in Q1” as private equity buyers and their amnesic bankers jacked up offers on mid-market companies.

Knight Frank recently reported the cost of a London flat is up 7.5% over the same time last year; and similar trends can be seen in many real estate markets around the world.

Internet stocks are fetching multiples of their revenue again.

It seems everywhere you look, valuations are up. All this froth could lead a business owner to say that now is the perfect time to sell.

Maybe.

But most owners who sell will have to do something with the money, which usually means buying into an equally inflated asset class.

Let’s imagine you own a business throwing off $2 million of Earnings Before Interest Taxes Depreciation and Ammortization (EBITDA). Given how frothy the market is, you decide to sell when a Private Equity Group – pockets lined with cheap money from the bank –offers you 6 times earnings.

You win the lottery and walk with $12 million before expenses and taxes. Now you have to decide what to do with your money.

Buy stocks? Well, the Dow has more than doubled since 2008 and could be cut in half again. Maybe you decide to play it safe and put your money into a vacation home in Phoenix. While homes are still cheap there, the average price of $190,000 in April 2014 was up 75% since May 2011.

Would you want to put all your eggs into a real estate market that has almost doubled in the last three years?

Instead of real estate, maybe you decide to buy some technology stocks like Salesforce.com, which is trading at almost eight times revenue.

Missing the market

Now let’s imagine you wait. You ride it over the top, and the market for privately held businesses tanks. Financing dries up. The Dow drops to 11,000 (still more than 50% higher than it was in 2009) and the best offer you can squeak out is four times EBITDA, or $8 million.

Are you a loser?

Maybe, but you get to invest your $8 million (less after closing costs) into a stock market at 11,000 points, which means if the market climbs back up to 17,000 – a 55 % increase – then your $8 million goes to $12.4M – half a million more than if you had sold at the top.

The problem with timing the sale of a privately held business is that the owner(s) still needs to do something with the money.

So, is now really the perfect time to sell? Or is it perhaps better to wait until your internal operations and metrics are sound and then sell when you’re ready, regardless of what is happening with external markets – because whatever market you sell into, you will have to buy into the same market conditions.

February 13, 2014

Instinctive leadership vs. The CBO

Are there elements of your own personality within your company’s brand?

If you’re like most owners, your company’s brand evolves naturally from who you are as a person. Phil Knight ran a 4:10 mile before he started Blue Ribbon Sports, the company that would go on to become NIKE. It is therefore no surprise that the NIKE brand celebrates competitiveness as one of its core attributes.

Herb Kelleher is himself a colorful personality so it is no surprise that Southwest Airlines includes “fun” as one of its brand attributes and allows flight attendants to sing the in-flight announcements to the tune of Call Me, Maybe.

My friend Ted Matthews, the author of Brand: It ain’t the logo calls this “instinctive leadership.” You don’t need to tell an employee of an entrepreneurial company how to act; they can see what the company stands for whenever you’re in the building.

You don’t need to bore employees with posters displaying the words Trust, Integrity, and Team Work. Those values are nothing more than words emblazoned on half the boardrooms of America. They mean nothing to a group of jaded employees. Instead, your people will know how to act based on how you react to specific situations.

They’ll know to treat subordinates with respect when you acknowledge and thank the waiter at lunch.

They’ll know your company values vulnerability when you offer a personal story of your own shortcomings.

They’ll know teamwork is important when you personally roll up your sleeves and help out when the team is in a pinch.

Most of the founders I know get this, and they do a great job of being “instinctive” leaders. The challenge comes when you have grown your company beyond just a handful of employees. When they no longer see you day –to-day, you have to make the shift to what Ted calls a Chief Brand Officer (CBO).

The role of the CBO

The role of the CBO is to codify your brand into a document – Ted calls it a Brand Foundation – that allows people to understand what you stand for. The Brand Foundation worksheet in the back of Ted’s book encourages you to answer the following questions:
• Why do you exist as a company?
• Where are you going and how will you know when you are there?
• What do you believe in?
• How do you act?
• What is your voice?
• How do you make a difference?

Once this is written down and shared with employees, the CBO’s job is to constantly remind employees of the foundations of the brand. Ted has found that one of the most powerful ways to make brand attributes stick and spread is through storytelling.

It is one thing to say “we believe in having fun.” It is another for Herb Kelleher to stand up at a companywide meeting and acknowledge the flight attendant who gave the funniest safety announcement of the year.

It is one thing for Phil Knight to say “NIKE’s brand stands for competitiveness.” It is quite another for Knight to send an email to all staff congratulating a junior employee on qualifying for The Boston Marathon.

Once you have the brand foundation, it is the storytelling that makes it stick.

If you haven’t read Ted’s book, do it now. I’m onto my third reading and I learn something new with each pass. I’ve also asked Ted to join us in Las Vegas at Built to Sell: The Workshop so you can build your own brand foundation with the help and guidance of the branding guru himself. Ted just agreed yesterday to come to the Vegas workshop, so I’ve decided to extend the registration deadline for a few days to allow those of you who haven’t yet met Ted Matthews and heard him speak, to make the decision to come. Sign up here.

February 05, 2014

5 dirty tricks buyers use to acquire your company for less than it’s worth

There’s a school in Chicago that teaches buy-side finance people how to acquire companies on the cheap. They have a steady stream of private equity firm partners lining up to learn how to fleece business owners out of their company.

I’m not sure why a school for buy-side mercenaries bugs me so much, but it does.

In the public markets, disclosure rules mean that buyers and sellers have the same information about an investment thesis. The market is liquid and you can buy something for pretty much what the market says it’s worth.

In the private markets, buyers and sellers have imperfect information. The waters are murky—which leaves virgin sellers susceptible to being taken advantage of. Here’s a smattering of the typical sleazy techniques buyers learn in school:

The Inflated Working Capital Calculation

The Con: The buyer surprises you with a generous offer but intentionally omits their proposed working capital calculation or leaves it vague. After you agree to an offer price, the buyer proposes a punitive working capital calculation, forcing you to leave more of your money in the company the day you hand them the keys.

The Result: Your after-tax proceeds from the sale of your business are lower than if you had accepted one of the other offers with a more favorable working capital calculation.

The Defense: Have a buyer spell out their proposal for calculating working capital before you agree to a Letter of Intent.

The Proprietary Deal

The Con: The buyer woos you into signing an exclusive deal to acquire your company before you create a competitive market for your deal.

The Result: You lose negotiating leverage and ultimately get a lower price for your business.

The Defense: Do not sign an exclusivity agreement until you’ve shopped your company to a shortlist of strategic buyers.

The Bait & Switch

The Con: The buyer agrees to purchase your business for X price. At the end of the due diligence period, when you’re emotionally drained and committed to a sale, she drops the agreed-to price.

I once asked a veteran corporate lawyer how common Bait & Switch tactics are in mid-market M&A. Over a 20+ year career, he had never worked on a company sale where the original offer was not discounted in some way before the deal closed.

The Result: You sell your business for a price lower than originally agreed.

The Defense: Assume the buyer’s price will drop 15% during due diligence; so only accept a Letter of Intent if you could live with selling for 85% of the offer at the LOI stage.

The 100% Vendor Take-back

The Con: The buyer agrees to your price but insists you finance all or most of the sale. Most buyers ask the seller to finance a minority portion of the deal, but asking a seller to finance all of it is the equivalent of walking into a Starbucks, reaching into the till, grabbing a wad of cash, and using the store’s money to “buy” yourself a coffee.

The Result: If you end up financing most of the sale of your company, the buyer has little or no skin in the game, which means they will walk (leaving you as the proud new owner of your company again) at the first sign of trouble.

The Defense: try to get at least 50% of your proceeds in cash so the buyer has something to lose if they can’t make a go of your business.

The Earn-out

The Con: The buyer agrees to a valuation for your business that includes a portion of your proceeds “at risk” in an earn-out. If you don’t hit your goals, the earn-out vanishes.

The Result: Your proceeds from a sale can be less than if you had accepted a lower all-cash offer.

The Defense: Expect an earn-out, but treat it as gravy. Only sell if you’d still be happy with the deal if the earn-out never materialized.

This is just a smattering of the dirty tricks used by the highly trained mercenaries on the other side of what will be your negotiating table. We’ll pick this conversation up in a few weeks at Built to Sell: The Workshop where I’ll take you through my eight laws for negotiating the sale of your business. See you in Vegas.

January 27, 2014

Planning to exit in 5 -10 years? Here are 10 things to do right now.

You may have been surprised to see Stanislas Wawrinka beat Rafael Nadal to win the Australian Open last weekend. After all, Nadal was the clear favorite, having won all 26 combined sets in their 12 previous matches.

But Nadal’s lower back started to seize up in the first set, and Wawrinka was prepared to take full advantage. In fact, Wawrinka has been preparing for his moment in the sun since he was fifteen years old, when his parents pulled him out of school so he could focus on his tennis career. He turned pro back in 2002 and ever since then has been preparing for his shot at winning a Grand Slam.

Will you be prepared for your moment in the sun?

As a business owner, you too need to be prepared when opportunity strikes. The two most common reasons owners sell their business are:

• Getting approached with an unsolicited offer; and
• Having a health scare (e.g., heart attack, stroke, etc.) that lands them in the hospital.
In either case, you’re not in control of the timing, but you are in control of how prepared you’ll be when opportunity (or necessity) strikes.

Whether you want to sell in five or ten years, here’s my list of 10 things to do right now to get your business ready to sell:

1. Make sure your customer contracts include a “survivor clause,” stipulating that the obligations of the contract “survive” the change of ownership of your company. That way, your customers can’t use the sale of your company to wiggle out of their commitments to your business.

2. Cultivate a group of a dozen “referenceable” customers that an acquirer could interview. When you sell, the buyer will want to speak with your customers; so you need a group of people – customers who are also friends – that would be willing to say good things about your company. In particular, the acquirer will be looking for assurance that the customer will keep buying after you leave, so make sure your referenceable customers are loyal not just to you but also to your business.

3. Start tracking your Net Promoter Score (NPS). Increasingly, acquirers (both “strategics” and Private Equity Groups) have standardized on NPS as a way to predict the future of their portfolio companies.

4. Write a “teaser.” A teaser is an anonymous letter an M&A professional uses to solicit interest from an acquirer to buy your company. Writing your teaser now will crystallize the important attributes of your company and ensure you focus on the right metrics in the coming years. Your teaser should cover the Who, What, Where When and Why of your business:

• Who: describe why your management team is a winner.
• What: describe what you sell and why customers choose you.
• Where: where are you located and what is the potential to expand geographically?
• When: how long have you been in business?
• Why: What are the strategic reasons someone would want to buy your company? Do you have a niche? Is your product a world-beater?

Carry your teaser around with you and update it constantly. Keep making decisions for your business now through the lens of how the results of your decisions would be perceived by a potential acquirer down the road

5. Identify 10 companies with a strategic reason to buy your business. Once you have a short list of potential buyers, study their M&A activity. What do they buy? What do they list as the strategic reasons for their acquisition in their media releases? Who are their lead corporate development executives?

6. Do business with your short list. Once you have a short list of potential acquirers, try to do business with as many of them as you can. Companies buy companies they know; so if you can find a way to work with a potential acquirer (either as a partner, supplier or customer) it’s a chance for them to become familiar with your company.

7. Professionalize your bookkeeping – there’s nothing that freaks a buyer out more quickly than sloppy books.

8. Protect your gross margin. Oftentimes, when leading up to being listed for sale, businesses grow by chasing low-margin business. You tell yourself you need top-line growth, but when an acquirer sees your growth has come at the expense of your gross margin, she will question your pricing authority and assume your journey to the bottom of the commoditization heap has begun.

9. Stop doing the selling. If you’re the rainmaker, nobody will buy your business without a soul-crushing earn out. Keep in mind that sales people take time to train and to hit their stride. Depending on your industry, it may take them a year or even two to start cranking out deals, so now is the time to hire and train them – not six months before you want out.

10. Register for “Built to Sell – The Workshop” that takes place February 28 – March 2. We’ll spend a few days together maximizing the sellability and value of your business. We’ll talk about how to attract a strategic buyer without telling them you’re for sale. I’ll reveal publicly for the first time the eleven subscription business models I’ve been researching for my new book due out in 2015, and we’ll go through my eight laws for negotiating the sale of your business in the face of a mercenary buyer – any one of which could make (or save) you six or seven figures. I’ll explain the three most common mistakes owners make in selling their business and how to avoid each pitfall. Early registration closes this Friday. Do it now!

Photo: GETTY IMAGES

January 20, 2014

3.6 or 6.1 times earnings — which offer would you prefer?

We’ve just done some analysis with the data from the users of The Sellability Score since we launched back in 2012, and we’ve discovered companies that are “Built to Sell” get offers that are 71% higher than average:

Background On The Survey

After writing the book Built to Sell, I hired a team of researchers and we developed a scoring system that allows readers to understand the “sellability” of their business. You can complete a forty-question survey and you’ll see how you performed on the eight key drivers of sellability.

We license this and other tools to Sellability Score Advisors (people like accountants and M&A professionals) who invite their contacts to complete the survey and get their score. During the survey, we ask respondents if they have received an offer to buy their business, and if so, the multiple of their pre-tax profits the offer represents.

The Sellability Premium

We recently stuffed 6955 of our completed questionnaires over the last year or so into a mathematical model and churned out some interesting statistics, the most thought provoking of which is this:

Those businesses with a Sellability Score of at least 80 out of a possible 100 get offers that are 71% richer than the average business.

We call this 71% delta between the average business and a Built to Sell business “The Sellability Premium”. Take, for example, two companies each creating a million dollars in pre-tax profit. Business A has a Sellability Score of 65 and Business B has a Sellability Score of 82.

When we did the survey, the average multiple offered all businesses was 3.55 times pre-tax profit. Therefore, business A, according to our data, is likely to attract an offer of $3.55 million dollars ($1,000,000 x 3.55).

Business B is also generating a million dollars of pre-tax profit but they’ve been doing the hard – often unsexy – work of building to sell. With a Sellability Score of 82, Business B is predicted to get a 71% premium over the average business, thereby fetching something closer to $6.1 million ($1,000,000 x 6.1).

Yes, building to sell does make your business safer and more enjoyable to run, but it also makes it a whole lot more valuable when it is time to sell.

One final thought: if you’re planning to attend the Built to Sell workshop in Las Vegas from Feb 28 to March 2, we’ll invite you to get your score from one of our advisors prior to attending the event. That way, you can bring your report to the event and we can discuss your score together during our one-on-one. There are still a few spots available for the workshop and you can lock in your early bird discount of $600 by registering before January 31st.

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