The undersigned provided strategic and financial advisory services to the Institute of Robotic Process Automation in connection with the acquisition of The IT Project Board
HIGH ROCK PARTNERS, INC.
The undersigned provided strategic and financial advisory services to the Institute of Robotic Process Automation in connection with the acquisition of The IT Project Board
HIGH ROCK PARTNERS, INC.
has been acquired by
The undersigned provided strategic and financial advisory services to CE Rental in connection with the sale to Dubin Clark & Company, Inc.
HIGH ROCK PARTNERS, INC.
Repeatedly we talk with private business owners confronted with an unexpected offer to sell their business… let’s call these “unsolicited offers”. Many times, they haven’t really thought about a succession or exit plan nor have they prepared for a deal if they so desired. Usually the owner of the company or one of their advisors (i.e. attorney or accountant) reaches-out to us for assistance.
Typical questions that we field in these discussions include –
…. and the list goes on.
Many owners focus exclusively on valuation, missing the forest for the trees. Evaluating an offer (unsolicited or otherwise) is about a combination of – – valuation AND deal structure AND timing!
Over the years, we have developed a streamlined process to help management, owners and their advisors sort through these and the other usual questions to determine a path forward. One element of that process is to quickly assess the strategic relationship of that buyer relative to our client’s business and industry… and gauge the likely value they can achieve by owning our client’s company. In other words, can the buyer likely realize significant value from our client’s company AND afford to pay at the upper-end of the valuation range? This involves answering the question: “is there a compelling strategic reason for the buyer and our client to do a deal today”? We evaluate this in connection with the recent historical and mid-term projected performance of the business.
From that last question, you see that we must first determine what is the market valuation range and have a defensible rationale for our numbers. This involves looking at the value of the company from a number of perspectives. To some degree, we are projecting what value our client’s company would command if we were to run a competitive process.
The next step involves understanding the deal structure that will work for the specific type of company being sold, thinking about both the business needs post-closing and the structure that will optimize the after-tax cash to the seller. Deal structure is usually critical to how and when the seller is paid, and how much is retained after transaction costs and taxes.
Equally important to these financial and deal topics in a transaction, is the preparedness and maturity of the operating team… these are the folks that will be with the company after the closing. So many businesses today are purchased (or NOT purchased) because of the quality and talent of the people.
I realize that I’ve just scratched the surface for this topic. My business partner, Buddy Howard, and I generated an easy to read primer called Value Levers: Increase the Value of Your Business From 3X to 7X. We wrote it for CEOs, CFOs, leaders and advisors of middle market businesses. Though we live in Raleigh, North Carolina… the concepts we speak to are relevant to most privately held middle market companies regardless of location or industry. This short book should be of value as you think about exit strategies, succession planning and being prepared for an M&A transaction.
In the process of selling a middle market private company, the buyer will eventually seek to validate the cash flow and financial information presented to them in the marketing materials; the information typically used to value the business. Once the Letter of Intent (LOI) is signed, the buyer will commence due diligence, which is a confirmatory process for ensuring the data they’ve received regarding the business to-date is accurate and correct, and to more fully understand all aspects of the company.
Traditional due diligence includes scrubbing the financial information to understand the timing and nuances of the business’ revenues, expenses, cash flow, accounting methods and practices. As part of this analysis, buyers will typically undertake a quality of earnings (QofE) analysis or assessment, usually conducted by an outside accounting firm.
Many transactions are structured as a multiple of EBITDA, which is further adjusted for the impact of any nonrecurring or nonbusiness items reported in the historical operating results of the target. Adjusted EBITDA typically serves as the foundation for buyers in building their overall valuation model and this model drives the determination of the ultimate purchase price. When transactions are based on adjusted EBITDA it is critical to assess the true baseline earnings power of the company.
Audited financial statements primarily focus on the balance sheet to ensure that the beginning balances and the ending balances of all the assets and liabilities are materially correct. This is not to imply that there is not scrutiny of the income statement by the target’s auditors, but that is generally at a much higher level than is needed to adequately understand a seller’s business model. In most cases, there can be period-to-period changes in earnings and other fluctuations that are not revealed by an audit and may be of significance to a deal. As mentioned above, business valuations and some transaction financing are predicated on a certain level of available cash flow based on the core earnings of the underlying business. Although a review of audit working papers is often a part of a QofE assessment, it is only used as a starting point for further, more forward-looking analysis.
A QofE assessment is conducted to fully understand the historical revenues, cash flow, and earnings. Although one benefit of such an assessment includes the clarification of any accounting anomalies, a thorough assessment should result in a number of other benefits, including:
The QofE assessment also seeks to validate normalization adjustments and EBITDA add-backs presented by the seller. A byproduct of the process usually includes highlighting variances or non-conformance to GAAP (generally accepted accounting practices). As insinuated by its name, the QofE report will provide insight into the quality of revenues and cash flow. Quality can be measured a number of ways and in terms of the underlying nature of these values – – such as the concentration of revenues, cash flow and accounts receivable from a few customers. Another underlying characteristic is seasonality… which is variability of revenues and cash flow based on a cycle within the fiscal year.
Even though a QofE assessment focuses on the historical performance of the selling company, its true purpose is to gain insight into the target’s future operating results and cash flows. This is seldom the focus of a traditional audit. Valuation of privately held companies is almost always based on future cash flow.
While we operate primarily as M&A advisors from Raleigh, North Carolina, in today’s US market, proactive sellers are choosing to preempt the buyer’s QofE work with their own assessment of their financial performance, and make corrections to or restatement of financial information before going to market. At a minimum, sellers are identifying areas that will likely to be of concern to a buyer, and developing a credible explanation and presentation of their issues so as to eliminate surprises. Many private companies do not have audited financial statements and use either modified cash accounting or a loose version of GAAP … thus creating predictable accounting problems when attempting to present fully GAAP compliant statements. The most common issues are we encounter with financial statements of technology, B2B service businesses, manufacturers and distributors include:
 Source: Middle Market M&A: Handbook of Investment Banking and Business Consulting; John Wiley & Sons 2012
For many North Carolina based business owners, planning an exit or retirement transition is not simply a matter of money. Many owners have spent years building their companies with a team of valued employees, and upon exit they want to assure those employees a solid future. Beyond selling your business to a strategic or financial buyer, there are other alternatives that can create financial liquidity for you as an owner AND positively impact the team and lay the foundation for your legacy and growth for those involved.
While not right for every business, one such alternative to consider is an Employee Stock Ownership Plan or an “ESOP.” An ESOP, by definition, is a qualified defined-contribution employee benefit plan that is designed specifically to invest in the shares of the business or sponsoring employer.
So what do we mean by qualified? ESOPs are “qualified” in a way where the sponsoring company and the selling shareholder(s), receive a tax benefits for selling all or a portion of the business to their employees. ESOPs are a commonly deployed corporate finance strategy that can benefit the employees as they become invested in the success of the business by effectively becoming shareholders and direct beneficiaries of the growth in value.
Some owners may feel that asking their employees to directly purchase ownership in the company is not ideal, however with ESOPs, the employees receive the ownership shares for minimal upfront direct investment. Typically shares are allocated based on the employee’s salary. Not every employee receives the same quantity of shares or rights. To mitigate management problems, voting rights can be reserved for senior management who may hold the a greater share of stock.
Another technique to share the growth in value of the company with employees uses phantom stock; which provides a mechanism to give employees an opportunity to realize the benefits of an exit without actually giving them physical shares in the business. More clearly defined, phantom stock is a contract between a corporation and the recipient, or phantom stock shareholder, that gives the recipient the right to earn a cash payment at a designated time triggered in association with a particular event such as a full or partial exit. While no actual stock is granted, the payment is to be in an amount tied to the market value of an equivalent number of shares of the corporation’s stock. The phantom stock value goes up and down as the value of the actual stock varies.
Another similar method is the use of Stock Appreciation Rights or SARs. A stock appreciation right can be a bonus payment to employees mirroring the appreciation of the company’s stock over a defined period of time. SARs incent employee loyalty and alignment as they are paid a greater sum of money as the value of the stock increases. In the case of SARs, employees do not pay the exercise price like they would with a regular stock option. Instead, they simply receive the sum of the increase in stock as cash.
Each of the two previously mentioned techniques to incentivize employees can be used in conjunction with a recapitalization of the business to create shareholder liquidity and align the long-term economic objectives of the go-forward employee base ….to continue to increase the value of the remaining portion of your ownership for an eventual full exit when the time is right.
When considering a partial or full sale of your North Carolina based business, know that there are a number of options to compensate and reward your employees for their contribution and dedication, without impacting your ability as an owner or founder to realize and monetize the full value you have created.
If you are considering selling your North Carolina based business, a key metric you must understand is EBITDA – Earnings before Interest, Taxes Depreciation and Amortization. Buyers typically derive their initial value based on a multiple of the company’s EBITDA.
Ultimately, future cash flow determines value; and EBITDA is a proxy for that cash flow. When adjusted for owner related and one-off items, this measurement of the company’s earnings can gives buyers an indicator of what the company may look like in their hands. EBITDA is important to buyers as it enables them to evaluate a company’s level of profitability without giving consideration to the capital structure and factors like tax planning and financing activities. Business owners can increase EBITDA, and provide a truer picture of the company’s earnings, by adjusting for one-time non-recurring expenses such as capital projects that were expensed, professional fees, above market owner compensation, and broader items like non-recurring components of research and development.
The process of deriving an adjusted EBITDA is called normalization and results in a recast income statement (and sometimes a recast balance sheet). There are two steps to this process. The first is adjusting the financial statements to assure compliance to GAAP (General Accepted Accounting Principles) and the second is establishing a list of add-backs. There are nuances and differences between tax accrual accounting and GAAP reporting that can have a significant impact of value, in both directions. Typical areas of concern deal with revenue recognition and year-end accruals. Understanding the adjustments to comply with GAAP usually requires a CPA that has an audit background and understands public accounting reporting.
If you are considering selling your business or pursuing an acquisition, consider partnering with an M&A advisor or investment banker that can work closely with you to prepare the business for sale and optimize the value beforehand. Experienced intermediaries will have recast financial statements and understand what types of add-backs can make a significant defensible impact on EBITDA and conversely know when to avoid adjustments that may actually jeopardize your claims of true cash flow.
Adjustments, or add-backs, have to be defensible for a buyer to accept them and use them to establish a value. In most cases, interested buyers will ask for a copy of the recast worksheet so that they can analyze the add-backs and map them to a final adjusted EBITDA number. If the numbers don’t seem plausible, you, the seller, will lose credibility, which can negatively impact value. That said, the act of recasting or adjusting your EBITDA to represent the most realistic picture of profitability under a new owner should not be a creative exercise.
With a defensible, sound adjusted EBITDA in hand, the question becomes ‘how does the buyer apply the multiple’? One of the primary factors in determining the multiple is the industry or nature of the business. For example: pure distribution companies that don’t add significant value can trade as low as three times adjusted EBITDA depending on the size of the business, whereas value-added distributors can trade much higher. Technology companies fetch much higher multiples and can oftentimes trade on revenue multiples due to the potential for high growth and high profits.
Strategic buyers tend to pay higher multiples of EBITDA because the acquisition has some synergy with their existing business and can be accretive; meaning that it can increase their earning per share. In a similar vein, a private equity group with a platform company seeking to acquire your business as an add-on, the investment is strategic in nature and may command a greater multiple than a standalone financial investment.
To maximize value in a sale transaction and move the multiple to the higher end of the range, it is important to present the true value of the company to a potential buyer – financial or strategic. To do this, explaining the strategic positioning, core capabilities, market differentiation, strength of your team, and growth opportunity of the business in a clear and succinct manner is of utmost importance. The combination of a growing a business, solid financial performance, good business practices and appropriate risk mitigation is likely to garner the optimal value.
So, remember EBITDA – the acronym that just may be the key to you maximizing the value of your company.
The priority and focus of the management of public companies is well defined: increase shareholder value. In fact, the board of directors in a public company has a fiduciary responsibility to do just that. However, the goals of private company owners vary and has a wide range of objectives. Yes, most care about increasing the value that can eventually be monetized and reducing their tax obligations; but many have parallel ambitions and motivations; social, personal and community considerations weight heavily into their decisions. For example, some businesses seek to create jobs and provide employment for their community in a region that may be economically depressed or under privileged. Some businesses are operated as a mission of Christ, seeking to evangelize and live-out the word of God and the work of the church. Others have legacy considerations and are managed as a means to provide family wealth and employment for generations to come… and the list goes on. The mix of motivations and ambitions begins to define the eventual transfer channel or succession path for future ownership, which in turn defines the parties that will likely be involved in the future of the company. The transfer channel and parties involved in that channel shape the approach in valuing the business. So to the point, owner ambitions and motives directly impact the value of a privately held business.
My chart below is meant to provide a view of the concepts mentioned above.
Let’s discuss an example. The owner of a privately held company desires to transition the business to his daughter, part of the transition being gifted with the remainder being purchased with a combination of bank debt and a seller note. In our chart, that would fall under the bubble that indicates “Fair Market Value” which is governed by an IRS set of rules. The concept of FMV has been litigated and is reasonably well defined… and most of the time tends to be on the lower end of the valuation spectrum illustrated above. So the decision to transition the business to family will likely result in a lower valuation for the business compared to the sale to a strategic buyer. Thus the ambitions of the owner directly impact the realizable value. There is no judgment nor right or wrong; the point is to illustrate the difference between value that can be monetized and the inherent value to the owner that translates into social, family or community value.
Whether in Raleigh North Carolina, where we’re located, or in another part of the US… we’ve learned to begin the process of exit or transition planning with a discussion and understanding of what’s important to owners of the company, and how their business fits into their financial and personal ambitions.
A common question we hear is “how long does it take to sell a company?”. As with many things in life, the answer is “it depends”. So what does it depend on and what are the norms? To frame my response, I’ll start with the big picture. Selling a privately held business from initial idea, through planning and preparation for the sale, through the transaction and until the seller(s) are completely off-the-hook for the post-closing commitments takes between 3 to 5 years. I know this might sound crazy-long, but give me a chance to talk you through the process. While I’ve segmented the major steps in preparing for, and selling a company… keep in mind that these topics and discussions are all interrelated. Lastly, there are out-of-the-norm examples of opportunistic sales that have taken place in a very short time and have incredibly favorable terms to the sellers. These situations have resulted in the owner(s) closing a transaction in 3-4 months and being completely out of their business (and all post-closing commitments) a year later.
Clarity of Owner Objectives – We usually start the process by trying to understand what the owner(s) of the business want and why. This understanding is much more than just maximizing the valuation of the business. It includes clarity around how much after-tax cash they desire (and need); when they want it; are there people they need to (or want to) take care of in a transition; are there social or community objectives; and how they might think about their legacy as it relates to their business. The plans and answers to these questions are rarely well defined and open a dialog with the owner(s) and a number of advisors and individuals surrounding the owner(s). The resulting discussions and planning can take a few months to a year to really get fully vetted and defined. Bringing clarity to each of these topics usually requires having a personal financial plan, a succession plan for the business and establishes the basis for what is referred to as an exit strategy or exit plan. Keep in mind that the sale of a company is only one of a number of alternatives to create shareholder liquidity, to potentially diversify personal investment, and to potentially gain access to growth capital.
Business Planning – Part of answering the questions above includes understanding the current value of the business and having a clear forward looking business plan. We find that having a compelling strategic reason to sell a company is a stronger argument for gaining interest in the business than simply “the owners are ready to retire”. Of course there’s nothing wrong with the latter reason, but it’s helpful in the sale process when selling for a business-driven need that the buyer can fulfill or help with. Examples include access to capital, buyout a partner, accelerate growth, change in competitive environment, etc… Articulating a growth strategy and valuing the company can take from 1 to 6 months, depending on the level of existing preparedness and the time management can allocate to working the process.
Transaction / Transition Readiness – An outcome of the valuation and planning process should be a realistic understanding of the enterprise value of the business and identification of the value gap that might exists between the owner’s objectives and the current market value. In our firm, we look at the Value Levers that can be managed and pulled to optimize the readiness of a company for sale and help close that valuation gap. We wrote a short book about this topic titled Value Levers: Increase the Value of Your Business from 3X to 7X. We talk about the three basic levers that management can act on to improve the value of their company and to improve transaction readiness. For those serious about starting the process and benchmarking their readiness, we have a free online tool at www.ValueLevers.net. Becoming transaction ready can take from a month to more than a year.
Sale / Transaction Process – Once the business is ready to sell, the actual transaction process usually takes from 5 to 15 months. This includes preparing materials to market the company, organizing a data room, developing a buyer list, conducting an organized auction, negotiating a letter of intent, engaging with the buyer for due diligence, negotiating definitive documents, integration planning (when appropriate), obtaining approvals and consents, and completing closing items. Financial buyers (like private equity) tend to move quickly and have shorter process times. Strategic buyers tend to have longer buying processes given integration planning, the number of individuals involved in the acquisition, and timing of corporate and regulatory approvals.
Post-Closing Commitments – The valuation and purchase price in selling a privately held company is only part of the deal. Equally important are the terms and conditions that accompany the stated value. These terms and conditions can dramatically impact the true value and realizable cash to the seller(s). In most transactions there are representations and warranties that the seller(s) make to the buyer(s). These involve many aspects of the business, how it has been historically operated, and what liabilities and claims exist at closing. In the event that these representations and warranties are proven false, the seller(s) will have to indemnify (or financially protect or reimburse) the buyer(s). This means that a seller(s) will usually have some financial risk after the sale of their business for an extended time. In addition, the sale of privately held companies often include future payments due the seller(s) as part of seller financing, an earnout, or another form of contingent consideration. Each of these means that the seller(s) is connected to their business beyond the closing for some time. Unlike the sale of a public company where the shareholders sell their shares and move on the next day, the typical post-closing financial commitments and indemnification period for privately held companies ranges from 1 to 3 years, depending on the issues/risks, the outcome of negotiations, and the market conditions at the time of sale.
Other factors that impact the timeline and eventual success of the sale process are the sophistication of the buyer and the transaction experience of your deal team (accountant, attorney and M&A advisor). If you have interest in learning more about the process and understanding the ideas better, you may find our book titled Middle Market M&A: Handbook for Investment Banking & Business Consulting helpful. As always, please feel free to reach out to me via phone or email.
“High Rock Partners was extremely helpful in developing a buyout strategy and acquiring investors for our team. They took, what seemed to us, an overwhelming impossibility and made it a reality. Kenneth and Buddy were extremely patient and spent a lot time and energy in helping us with our transaction. They broke down every piece of the complicated transaction, into easy-to-understand steps and explained the reasoning behind it in terms that we could understand. There was never a doubt that they had our best interests in mind and their efforts demonstrated their personal commitment to our team. To us, they have become more than M&A Advisors – they are trusted friends”