Episode 5: Selling Your Business - Part 2

Episode Summary

Most middle market business owners plan to sell their business at some point - whether at retirement, or simply when there is an interesting opportunity to do so. But how exactly does the process of selling a business work? Is it just like selling a house, or different? Across this three part series, co-hosts Stephanie Chambliss Gaffin and Mark Gaffin walk you through the process of selling your business. In part 2 we'll define some of the jargon, narrowing the buyer universe, and ways to keep your process discrete if you aren't ready for the world to know that you are considering selling your company.

Episode Transcript

Stephanie Chambliss Gaffin : 0:00

The business owners that we talk to, are very good at selling the product that they sell, or the service that they sell. But when it comes time to sell their actual company, they find out, sometimes the hard way that it is actually a very different process. Today, we want to continue on what we talked about in our last episode, of understanding the process of selling your business. Welcome to Right in the Middle Market, a podcast about pragmatic perspectives on running, growing and selling your business. We talk about the challenges, decisions and most importantly, the actions business owners can take to create long term value in their companies. In today's episode of Right in the Middle Market, I'm pleased to be here with my co host Mark Gaffin. This is Stephanie Chambliss Gaffin, and today we're going to continue on with talking about the process of selling your business. This is what a lot of our clients find out, what a lot of small and medium sized business owners find out. This is very different than the selling that they typically do in their day to day operations of their business, that the process of selling your company has a lot of very different components, and sometimes in particular, the negotiation can be quite a bit different than what they're used to. In our last episode, part one of this series, we talked about, honestly a lot of things that you do in preparation, and those are many of the steps that we hear from business owners that they don't really think about, about all the work that you do to understand the market, think about telling the story, as we often talk about with our clients, the concept of telling the right story to the right people at the right time. And so in our last episode, we covered the importance of doing that detailed Business Review, identifying the right advisor that you're going to be working with, doing a competitive market and industry analysis, creating the marketing materials and generating what we call the investor universe or the buyer universe. You may remember that phrase from our last episode. Where we'd like to pick up today, then, okay, great. We found a bunch of people who would be good candidates to buy your company. Now what? So Mark, how do we start the process? What's the next step of going from, we've got a bunch of people who might be interested in buying a company, to what do we do with that list?

Mark Gaffin : 2:40

Well, Stephanie, I think you did a great job. In part one, kind of getting us to this point. There's a lot of concurrent work streams that need to go on to get us to this place. Again, I like how you put it out there as the right story that involves kind of doing what we call sell side due diligence, going through and making sure that it's very clear what the strengths of the company are, and that's then to the right people. That's that investor universe, right, and finding people, be the strategic buyers, financial buyers, or even hybrid type of buyers; like family offices will have elements of both. Getting those people to see that value. And this is where I take a slight departure from our example in the past, which is selling a house. I think selling a house, you're actually arriving at a price, right? There's people out there that will look at the house and they'll arrive at a price. We actually are trying to sell value here. Right, different folks would have very different concepts of what the value of this asset will be of the company will be to them going forward. And it may be an operator that's going to buy a company from another operator, but to expand it geographically, or do a number of different things that the current owner hasn't done yet. They're going to see value in that growth and that's why they're willing to pay a certain amount of money now. A financial or strategic advisor may see very different elements of value, right? It's a core capability that they don't wish to have to build, they can buy it, and then extrapolate on that very quickly.

Stephanie Chambliss Gaffin : 4:09

So when you're talking about that, you're talking about a strategic buyer. Right? So maybe we should explain take a minute and explain what we mean by a strategic buyer and a financial buyer. Right? So a strategic buyer is somebody who is another company, probably an operating company, who operates in a similar or an adjacent space, it might be somebody who is bigger than you are, it might be somebody who's the same size. In some cases, it might even be someone who's a little bit smaller, but that has a strong underlying company and wants to grow. The key with this is that it's somebody who has a strong what we might call a corporate development program, but really a strong program and interest in growing through what's called inorganic or through Mergers and Acquisitions. So they're looking to say, you know, gosh, I could grow organically, right? Which means that I'm going to build it myself, I'm going to identify new markets, new capabilities, deeper penetration, additional customers, etc. Or sometimes it is easier, faster and more economical to actually go out and buy that capability. So that's what we talked about with the strategic, right?

Mark Gaffin : 5:24

Well, and yes, that's exactly right on the strategic side of the financials, you know, kind of run a little bit of a spectrum, you have your your classic private equity folks that have developed a fund and they're going out to professionally invest the funds that they've raised into companies typically will hold them for five to seven years, as they build onto that platform. Now, this may be an add on, but, they'll buy a platform and then add on to it. So there's a number of ways why even smaller companies, may make sense to a larger private equity firm, and there's private equity firms of all different sizes. So it's really important for the advisor to have experience dealing with private equity firms of different sizes and maintain relationships with those folks, so they could actually, you know, get the get them materials in front of them, and get them queued up. So I think, if we go to, now we've got these people interested in the in the asset and you're still going to go through a bit of a funneling process, right? What we're trying to do is find through our interactions with the folks, lining up or going against what they've invested in in the past, and how their responses have been in phone calls with us as an advisor who's going to make the best, most meaningful bid going forward, right? So you're going to winnow these people down to a series of phone calls, communications. Ultimately what you don't want to do, is trample your poor client or business owner with 50 million calls from a bunch of people that may be tire kicking, and people that may be just, you know, just trying to check things out and they may not be as serious. We want to find those people that are seriously involved in the process, where this makes a lot of sense and get those people the right information, at the right time. Now, there's actually some nuance there because as you talked about strategic investors, may be someone that's actually in that is a competitor. And so we have to be very careful and discreet about the types of information released to those people. It's typically done over time, you can have a customer list which is you know, amortized, you know, where you have customer A, customer B, customer C, you don't release names early on in the process, that's way down the line with a strategic buyer. Where as a financial buyer you can be, if it's someone that's been around for a while, you can be a little bit maybe earlier with their trying to show them who some of those people are.

Stephanie Chambliss Gaffin : 7:45

I know that we sometimes call that a little bit of a dance, right? That you identify a buyer, they come back and say yes, I might be interested. You share a little bit of information, they confirm that they're still interested, you share a little more information. Right? And back and forth so that you're not sharing all of the information at once. And that's part of the way that both we're building interest with the buyer, but also that we are protecting the confidential information of a potential seller.

Mark Gaffin : 8:15

Yeah, and that's right. And I think that I would be remiss if I didn't say the way we're describing is kind of in an auction environment, when you're trying to get every people through a gated approach, right? Sometimes with smaller companies, it's not that clean. You're trying to have a bunch of people at different parts of the process. It's very important that the advisor is able to keep people interested, understand who's where in the process, keep NDA's out there, non disclosure agreements, getting them signed, making sure the right people have the deck, the next deck after you give them a teaser, and an NDA, then you're giving them a deck. Who looks like they're serious, who's actually gonna come up with an IOI that's compelling. At what point you want to let them have a data room. At what point do you actually want to sequence, the management meeting and maybe just an initial call to get a feel. Because what I found at some of these smaller companies, you can get some people on the line that the seller just immediately can kind of kick out. And you try to coach them as to why that, you know, might or might not be, give them a chance to redeem themselves. But you got it, you know, a lot of what I see a lot of times in these smaller companies, it really matters who they're selling to. They have to be someone that they can work with after the close, especially if the seller is going to be around for 6, 12, 24 months as part of a transition. Or if they want to be kept around as part of, you know, the next bite at the apple they want to roll over the buyer wants to roll over equity and stick around.

Stephanie Chambliss Gaffin : 9:42

So Alright, a couple sentences back there was a whole bunch of alphabet soup and jargon. So let me see if I can capture some of that to make sure it's really clear for our listeners who may not do this day in and day out. So one of the things you said, the first thing once we've identified that list of perspective buyers, so we're going to send out what's often called a teaser. Right? And that's kind of a one page document that summarizes again, it's anonymous, usually enough information to help a potential buyer say, yes, I'd be interested or no, I wouldn't. But usually the goal is that it's general enough that a potential buyer couldn't figure out who the seller was from that document. Then if somebody comes back, the next step is that they would sign a nondisclosure agreement, a mutual non disclosure agreement that says yes, I will keep whatever information I learned confidential, and that that's usually a prerequisite to moving to the next step. After that, you talked about the deck. So this is it's sometimes called a CIM, a confidential information memorandum, or an investor deck, it can go by a couple of different names, or some people might even just call it the book. But they're looking at what they're talking about, is something that summarizes all that work that we talked about in our last episode of what does the market look like? What are the growth prospects for this company? What are the strengths? What are what's really that investment thesis? Why would somebody be really interested in buying this company? After that, you talked about a management call. So that's one of the first calls where you have both the seller and the buyer on a call together, starting to have a conversation- learn a little bit more about the company, learn a little bit more about each other and see if this might be a good fit, as you talked about. And I think the other one you put out there was data room. And so that's something that after all of the steps we just talked about, if you have a buyer that's really interested, they're going to want to start to really dive in and understand the different- the more details about the company. So they're going to want to dig deeper into financials, you gave a good example around customer lists. There might be some things around employees, cost structure, governance structure, all of those kinds of things. In some companies might be patent. So depending what goes in that data room will be dependent on the type of company it is, and quite frankly, on the type of buyer, but the idea is this is a virtual data room, it's, you know, it's something like a ShareFile of, although there are more sophisticated platforms out there that are really designed for this purpose and can be very useful. But the idea is that it's a single repository where we start to put all of that information that a buyer can go through, and then what we start to call due diligence to decide if they want to put forth an IOI which you mentioned, an indication of interest, or a letter of intent and LOI.

Mark Gaffin : 12:51

That's right. I think that one of the things you brought up there is a sequence sometimes can be tailored to the audience. You know, to the specific investment, sometimes there's IOI's, then LOI's. And sometimes you're actually moving, you know, right to something that's a little more definitive, because you just, you have only just a couple people in the process, you're trying to get everybody, if you can to a same roughly bidding at the same time. Again, a big part of this is creating that competitive dynamic between the bidders, you want people to bring their best bids, not just price, and the highest price, but, best structure, right? The best thing that will make both for the buyer and seller to make the post close after the deal is done, make that deal viable, especially if you've got people sticking around and rolling over equity. I think one of the things that you talked about, which is important getting the story right, getting the data room right, and getting the management presentation correct, right, is all what we call sell side due diligence. And that's one of the things we do with every client that we work with on these kinds of engagements. From day one, is getting all that information ready because the last thing you want to do is have everybody kind of interested in the company and we're bogged down, trying to gather data and information, there's that certain amount of momentum. You can't you can't help but look a little bit off if you don't have some of that key information. So we coach very much on getting the key information into that data room and having it in the slides and having it ready for the first so that our our management teams look prepared and ready to anticipate the calls and questions that we see typically in these kinds of meetings.

Stephanie Chambliss Gaffin : 14:38

All right. That's a great point. Let's pause for just a moment while we hear from our sponsors for today's episode. Right in the Middle Market is brought to you by SLS Capital Advisors. SLS Capital Advisors is a boutique financial advisory firm working directly with middle market leadership to tackle critical growth opportunities including exits, mergers and acquisitions and access to capital. The principles of SLS Capital Advisors bring deep industry financial and consulting experience to firms seeking tailored strategic opportunities, including capital for major growth initiatives and alternatives for those evaluating corporate transitions and exits. SLS Capital Advisors services include managing effective exits and sales processes, involving sophisticated buyers, such as, strategic purchasers, financial buyers and operator to operator transactions. And raising capital to fund our clients growth including debt and equity elements. They also assist companies and capture growth opportunities through focused and effective organic growth in m&a programs and unlocking profit potential through business portfolio rationalization and divestiture. SLS Capital Advisors focused on delivering consultative executions for clients seeking strategic growth and capital. Find us at SLSCapitalAdvisors.com to learn more about how we can help you. Welcome back. We're here today with your co hosts, Mark and Stephanie talking about the process of selling your business. So, I'm gonna ask a question that is probably one of the most common questions that we hear from sellers, which is, shouldn't I put a price out to say that here's the price at which I'm selling my business? I do that for every other product that I sell, why wouldn't I put out a price and say, here, I'm selling my company for $10 million.

Mark Gaffin : 16:25

Again, I think that would go back to me that would kind of go back to if I was selling a house and I kind of looked around and saw what the other prices were and I kind of backed into a price. That's what I think I would do. What I want to be really careful with is there are people that would value this company significantly above what you think it's worth. Right? So if you just go out and look at multiples of EBITDA earnings before interest, taxes, depreciation and amortization, right if you go out and just get something from the country club that says this is what I think I could sell it for. That may be way too high and it's not gonna be attained. If you're a value added manufacturer trying to compare yourself to a very high tech, sass oriented company, you have to have your expectations, but I really think it's important to think in terms of valuation ranges, right? You want to have a walkaway price that you're not going to accept. And that's part of our job as advisors is to feel people out, because they'll ask us, what do they think the expectation is. And what we always try to do is keep that wiggle room there, either I'll use the floor as some guidance to make sure that look, if you're talking, you know, $8 million for this company, and I know that the owner will not take less than 12 then we could kick that person out. We'd be gentle, gentle about it, right? nice about it, but say, look, our expectation is probably in the range of, you know, six to seven to eight times EBITDA and this is the EBITDA we're working with, they're gonna know that from the teaser.

Stephanie Chambliss Gaffin : 17:57

Alright, so we've now gotten in at least one LOI in our process, again letter of intent. And this is typically non binding as is an IOI. So, this is something that usually there's, you know, a number of caveats in it a number of conditions. But now we start to have a sense of this is what a potential buyer would pay for this company, as you talked about, we also have a sense of structure. So structure is where they would pay at what you know, at what time frame, we might understand a little bit about their financing, we understand how much they're expecting the seller to rollover, right, if there's a certain amount of the sales price that they are intending to what's called hold back. So to say, gosh, you know, we want this will hold back 10% of the sales price or 15% of the sales price. And at what point that would be paid out whether that's 12 months out, or you know, maybe maybe a little sooner, maybe only little longer. So, when we talk about structure, those are the kinds of things that we're talking about in terms of the structure of the deal. So now, how do we start to move from LOI, we have an LOI, but we still haven't sold the company. So where do we go from there? What's next?

Mark Gaffin : 19:16

So I think this is where there's that balance between the IOI and the LOI. Right? So to me the most useful part of it IOI is to get people engaged to actually put something down on paper. It's one thing to have a conversation, it's another thing- put it down, give me a valuation range, give me kinds of some of the things you're looking for. And then make sure that person staying in the process and you realize that you've got that information in the data room, right? You've got that info, there's nothing that they're putting out that that you can't answer with what you have in the materials of the company. When you get to the LOI, you're really trying to drive to more specificity there. So exactly to your point, what are you thinking about on deal structure? Are you demanding that the seller stick around for two years? And that may just be a non starter. Right? So you might as well nip that in the bud. Before, you know, we get into spending a lot of money on lawyers, you know, quality of earnings and all those kinds of things, right? So you want to figure out, what's the structure of the deal you're looking for? Sometimes this is what you'd love, but what will you settle for? And same thing with the seller, I know you'd like to leave in six months, but maybe nine or 12, and we'll just specify the duties. And this will be delineated in a in a management agreement, things like that. So there's ways to use the LOI so there's less surprises. The last thing you want to do is have a bunch of stuff that oh, well, I assumed that when you're in the middle of trying to do the definitive documentation, right, that's a very expensive time to be going back and forth, back and forth with the lawyers on both sides. So that's what I think that LOI is for. We've got a structure, we can agree to that. So what are confirmatory due diligence? What are the last things that you need to see, this is where as for strategic, you'd start to take away those names, or, take away the customer A, customer B, customer C. Showing them who they are. There may be requests to actually make customer calls. You've got to deal with that on a case by case basis. How would you approach that? But you could kind of understand where a buyer may want to do that if you've got a buyer, or if you got a customer that's 30- 35% of your business. It's really important as to why that, you know, how did they feel about this? Are there any things in the documentation or contracts with a government contractor, say, for example, about change of control and contracts? So those are the things you're going to pick up in confirmatory due diligence that you just hope it's not tick the box. It's got to be done, but it's easily answered by the stuff that you already have the data room and that way you're moving to documentation without a lot of hiccups.

Stephanie Chambliss Gaffin : 21:59

I know another common question that we get is about do I have to tell my employees? And again and again, I'll go back to this concept of the dance. So early on, again, many of the clients that we work with, we work very hard to keep a process very discreet if that is the preference of the seller. And it wouldn't be until these very last stages of confirmatory due diligence where then a buyer may ask to talk with a couple of key employees. Certainly we have, you know, sometimes come up with helped the buyer and the seller work with a reason for that conversation that isn't completely transparent. Again, never want to be misleading, never want to be dishonest, but sometimes something that's a little bit more vague so that the employees wouldn't necessarily have to know until very late in the process when the seller feels pretty confident that yes, this is going to go through and now I can do a managed communication to my employees.

Mark Gaffin : 22:57

Let me touch on that really quick. I think that that's a really good point. And it's delicate. It's not that we're ever trying to be dishonest with anybody but this can be very emotional to people, they don't understand the different levels, right. And so we're going to tell people, it's a matter of kind of when, right? So there is going to be a management team that's going to be part of the thing post close. And that's going to be important for any buyer to understand and get to talk to those people at some point. We're probably not going to do up front, have a whole bunch of people running around the shop floor, in suits and ties. Of course, are not in suits and ties anymore, but you can still spot them because they've got khakis and a fleece vest on. So they're going to know its finance folks. But at the end of the day, you can disguise that a little bit by saying, look, we are taking on investors for growth. So you could kind of couch it that way. And people sometimes don't know whether that's another commercial bank providing debt financing, or if it's someone providing growth equity. And really it should be you're painting a story for your employees, which is actually right. You're trying to bring in somebody that will help invest in the growth of the company, which we actually believe. So when you get a little bit closer and it gets a little bit more traction. And these are the four or five people that are really, you know, important, you may start to talk to that very, very top level of management team or people that you're going to have their pictures probably on in your deck somewhere that are going to be brought under the tent. Those are people you're going to have to deal with, you're gonna have to deal with them either with retention bonuses or structures around that because you want them to stay. But these are also people that may do very well in rollover equity. They may do well now having actually equity stake in the deal going forward. So my experience has always been if you've got a growth company, and there's a real good reason to sell it and it's going to be a viable company post close. But actually the employers sometimes are kind of excited about the next step in the evolution of the company.

Stephanie Chambliss Gaffin : 25:06

Given that we are sitting here in Summer 2020 as we're recording this, I think it's also perhaps a good point to talk about COVID. And that, really, when when we are asked, how does the current environment with restrictions on in person meetings, restriction on travel- how does that impact the sales process? And if you think about almost everything that we've talked about, up until now, yes, probably some, meetings with management used to do those in person much sooner. Now, they may happen a little bit later. But it's really at this very end of the process. We still hear from most of our buyers, that they're not going to actually close a deal without getting to some kind of an in person meeting. But I think it's notable that really most of the things we've talked about in the process up to this point can be done quite frankly, relatively easily online via video conferencing. And so that is not necessarily a reason to forestall going through a sales process because the majority of it can be done in a virtual manner pretty effectively.

Mark Gaffin : 26:17

No, I think that's absolutely right. And I think that people are getting more and more savvy every week with the Zoom, because we're all getting a lot of reps. So even our clients, I notice have gotten better and better about being online. So I think everybody's getting better at that. I think you can do a lot, but there's really, I think there's never complete swap out for that in person, right? Especially if I'm going to say, I'm going to own this company on Monday. You're going to work for me on Monday, but this is why that's going to be a good deal, right? We're not looking to crash and burn anybody. We actually want to take this thing to the next level. This is our growth plan. That's what I want to sell to those employees. And I think that that's in everybody's interest to find out a way to do that, collectively. And I think that there's a lot of differences now, and I think the Wall Street had an article over the weekend, about people working from home that's worked for a while, what's actually going to work in the future. And I think we're all going to have to wrestle with that. I think that should be a whole nother episode is to actually what is, you know, the structure of the work environment going forward. But, you know, we get those management meetings done, we get through what we're trying to build is a sense of trust, and it's going to be trusted as part of a process. But what you're trying to do is drive to these documentation, the documentation process goes so much more smoothly. If we've really kind of addressed all the things that we were upfront. It's not trying to hide anything. We don't allow our clients to do that because it's going to get found, right? There's no sophisticated financial investor that I know of, that's not going to find something You know, whether it's state tax is not paid or something, they understand where to look. So getting out in front of it having a story, this is a corrective action, get to documentation, and then there will always be just differences that we have to whether it's working capital adjustments or things like that, we're going to have to be creative. And if we don't have alignment, we're going to go back and forth. And that's where deals can die at the last minute, because you haven't done some of the upfront work to get through that part.

Stephanie Chambliss Gaffin : 28:29

So I think that's a great point to pause for today. This has been hopefully really interesting for our listeners to talk about, how do you go from, we've identified a number of potential buyers, to now really winnowing it down to one or maybe a couple that you're actually negotiating with. I think we'll come back for a third part of this series to be able to talk about the actual negotiations and closing and maybe then we'll start to lead in a little bit to what happens post close as well. This is Stephanie Chambliss Gaffin and you've been listening to Right in the Middle Market, a podcast about running, growing and selling your middle market business. We'd love to hear your comments about today's episode or ideas for topics you'd most like to hear in the future. Send me a message on LinkedIn or drop me an email at podcast@gaffingroup.com. Until next time, be well and be inspired.