Photography By Shannon Drawe
Out of the blue comes a phone call from a reputable company targeting your business for an acquisition or merger. You are flattered and you are intrigued. You decide the time could be right to sell, but are you prepared to respond to an unsolicited buyer?
For David Dodson, Senior Vice President & Wealth Regional Director at BB&T, the answer is, “Don’t pretend the call didn’t happen.” Dodson was a speaker at Texas CEO’s Enlightened Speaker Series event in Houston, and he said he sees too many entrepreneurs begin to plan after the sale of their business, but that entrepreneurs need to begin with the end in mind. “They begin the process of planning retirement once they see the transfer wire,” said Dodson. “They come in after their transaction and say they just sold their company and want to start planning the future.” For Dodson, that’s backwards.
Planning The Wedding vs. Planning The Marriage
Dodson put a focus on planning in his comments by quoting Zig Ziglar, who said, “People spend more time in planning the wedding than they do in planning the marriage.” The point being, the owner needs to put in a good deal of thought about what he wants the outcome of the deal to be, in terms of lifestyle, before responding to any offer or starting the process.
Dodson provided an example of working the numbers backward to determine what the cash out would need to be for an owner to maintain a current lifestyle. If monthly personal expenses are $20,000, that’s $240,000 per year, pre-tax. Then add in a 20 percent tax rate and the number goes to $300,000 per year to continue that lifestyle in retirement. Next comes how large the portfolio needs to be to generate $300,000 a year. Dodson recommends using a withdrawal rate of 4 percent per year. “The 4 percent rule says if you take 4 percent or less out of the portfolio throughout retirement, that portfolio will be durable and able to handle market corrections and cost-of-living increases,” noted Dodson. To get to $20,000 per month after taxes, the amount in the portfolio needs to be $7.5 million. Beach house or mountain home? Add more.
Pre-exit planning and execution is the “marriage” in the Zig Ziglar quote and comes before the phone call from a potential buyer. Dodson recommends taking one to five years to get ready by working on personal financials, because there are a lot of issues to consider. What is the family legacy? Capital for kids and grandkids? Family foundation?
Dodson contends there are two reasons people don’t do pre-exit planning. The first is a lack of knowledge of how significant income and estate tax are to the sale of a business. The second reason is that, too often, owners get too far into a transaction and have accepted a letter of intent (LOI) before stopping to plan. But at that point too much of the toothpaste is out of the tube. “You can’t put the toothpaste back in — once you’ve met some of the metrics, you’ve eliminated the ability to use certain planning tools in your exit,” observed Dodson.
When The Phone Does Ring
With a great deal of investor capital in the hands of private equity firms and the need to get that capital invested, the likelihood of receiving a call is fairly high.
Matt Register, Managing Director at investment banking firm Corporate Finance Associates (CFA), has a simple view: “I have never seen an unsolicited offer come in at maximum value,” he said. “Your deal never gets worse with additional bidders.” Register regularly hears from owners who receive unsolicited offers for their companies. When that happens, Register recommends owners be prepared to answer two questions:
- What does the post-transaction future look like? Owners need to decide if they want a retirement where they completely leave the business; continue to be part of the company with a more limited role; or, take out some cash now and lower the operating risk with a new equity partner.
- What’s your number? “You’re now exchanging the golden goose that has fed your family and provided cash flow for all the expenses in your life for a pile of money,” Register said. “How big does it need to be to handle everything you’re trying to accomplish, post-transaction?”
Who’s On The Other End Of The Line?
Libby Covington, a Principal at the private equity firm CapStreet Group, said owners must address four issues when the call comes in: financial goals, personal goals, long term vision for the company and control. Covington observed, “Those decisions will determine the type of structure of your deal.”
Covington detailed several types of structure options. “The first type of deal is a 100 percent buyout,” she said. In this scenario, owners give up control and leave the business, typically taking a lower multiple. That’s because all the capital is paid right away. The total buyout is more likely to be done with a strategic buyer — a company that wants to tuck in a new acquisition as part of its growth strategy.
The second is the area where CapStreet spends most of its time: a majority recapitalization. In this structure, the private equity firm buys a controlling position of 51 percent or more. Along with taking a controlling interest, the private equity firm adds their expertise and invests in the company’s growth. “They are your partners and they will help you run the business,” said Covington. “Because of the use of debt, you can probably make more money on your second exit than you did on your first exit.”
The third option is a minority piece of equity, or growth equity capital. Covington said this tends to be more of a passive investor who offers some advice, but is not as involved as a majority partner.
Finally, there’s mezzanine debt, which will add to the debt load but comes with no loss of ownership. “With mezzanine debt, you keep complete control, and you’re not diluting any of your equity,” said Covington.
With the exception of the 100 percent buyout, owners will be working with their investor partners for five to seven years. “You want think about the people and if they are a fit and if you can partner with them,” noted Covington. “It’s not always the highest offer that’s the best if you feel like you can’t work with those people.”
Coming Up With That Number — The Valuation & The Multiple
David Walther does due diligence — he does diligence for sellers that want to be prepared by running the process on themselves, and he does it for buyers that need to come up with a valuation. Walther is a director of transaction advisory services at RSM.
Walther has seen a shift in the market of due diligence services by accounting firms. Ten years ago, Walther saw only the buy side going through the process. “These days, the sellers, more often than not, are doing their own diligence to be prepared, and they let the buyer review that work,” he said.
For those who are selling, Walther sees three key values in getting the due diligence done prior to starting a transaction. The first is that clean deals close faster, and it’s easier to negotiate the purchase price.
Second is maximizing the value. With a 9- to 10-time multiple in an industry, a $50,000 EBITDA adjustment increases the purchase price.
Lastly, sellers never want the buyer to control the deal. “By laying out the information in a favorable way to the seller, you can bring up issues beforehand to prevent the buyer from using any of those issues as leverage in the final stages of a transaction,” said Walther.
Finally, he reminded attendees, “Once the LOI is signed and the purchase price determined, there is very little room to renegotiate. At this point, it’s all now the buyer’s leverage.”
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