Cautionary Tale #7: Excess Inventory Blocks a Sale

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Excess InventoryWe all make mistakes in business. Sometimes it costs us money immediately, other times in the long term. In the worst cases, all the way through and including the sale of your business. Particularly when an owner is ready to sell and is in the mindset of “cashing out”.

Not that long ago, we were working with a Main Street interior design/contracting business with $800k in annual revenues. The total owner benefit was $300,000. He had $1.8M in real estate and $1.5M of inventory tied up with the valuation of the business. The problem was, not only was that 4 years of inventory… But more than $1M of that inventory was a particular type of natural stone that the owner loved and had “gotten a deal on” some years ago. But never really moved.

When we asked him about it, he responded by saying he “wanted more display options” and that “it would sell eventually.”

While the latter might be true, it may be across an unacceptable time horizon for the buyer. The display options statement was a smokescreen to avoid dealing with the embarrassment of a bad call. The reality was as the years continued on, this type of stone would only be more out of style with current trends, making it even more difficult to move. He was right that it would give “more display options,” but the reality was the obsolete inventory in the display made new stuff look that much better!

There were a few options here:

  • Liquidation of the outdated stock wholesale in a one-time event. This would result in some tax-loss harvesting benefits for the current owner and could be easily demonstrated as a one-time write-off for a potential buyer. This would also serve as a useful “cautionary tale” about operating that particular kind of business.
  • Drastically mark down the pricing to make it attractive for buyers. This could lead to more cash on hand for the current owner as well as demonstrate that at a certain price the inventory can move.
  • Exclude the obsolete inventory from the business. If the current owner really believes the inventory will move, then he can strike up a deal with the buyer in which the stone would be sold on a consignment basis over a fixed period of time.

It’s no failure to make mistakes in business. The real failure is in not admitting those mistakes or dealing with them so they don’t cost you yet again. In this case, it could obstruct an exit.

Don’t be that type of owner. Own your mistakes so that you can move on to what you’d like to do next.

Case Study #33: The Acquirer Gets Acquired

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Long before the general public knew what Amazon Web Services was, and that it provided the backbone for entities ranging from Netflix to the CIA, Glenn Grant was building G2 Tech Group.

G2 Tech Group was leading the industry in migrating services to the cloud, where Amazon Web Services lives. While it’s true that many times pioneers get slaughtered and later settlers prosper, if the pioneer seeks an exit at the right time, he/she can enjoy the fruits of all that hard labor.

Managed Service Provider

While Glenn had started the firm as a traditional break/fix IT firm, over time it became a managed service provider (MSP). His MSP offered managed devops (maintaining tools for developers) and got ahead of the industry in two ways:

  • Introducing Amazon Web Services to clients long before it was standard practice.
  • Creating a subscription model of recurring revenue. The services he offered gave clients an insurance policy “just in case” but also was proactive in offering assistance and tutelage in using these tools.

At one point Glenn was directly and indirectly managing thirty employees. He wanted to use his market position to start acquiring smaller firms and take a more powerful role in the industry. But as he started to do his own research into a possible exit, he saw that there was actually a chance for a strategic acquisition, not just a financial one. Potential buyers were discussing multiples of revenue instead of EBITDA. With money out there chasing a functioning business like his, he decided to pivot from acquiring smaller firms to being acquired himself.

Selling Sooner Rather than Later

Acquirer Gets AcquiredHe was ahead of the curve and was well-built, so he could have easily coasted for a few years and banked the profits. But Glenn knew that while business moves fast, tech businesses move even faster. Worse, if he didn’t sell, one of his competitors might, and then instead of the competitor he knew, he’d be dealing with an 800 pound gorilla that might be able to simply outspend him.

When the time came for Letters of Intent, all three of them came from Private Equity Groups.

While Glenn had heard horror stories of what PEGs can sometimes do with Mid Market businesses, he did his own homework. He took the time to get to know the partners of the PEGs who were competing for a deal with him. And he asked to speak to fellow entrepreneurs in the portfolios of those firms. They could tell him first hand how the transaction went and whether promises were kept after acquisition.

Second Bite of the Apple

Because Glenn had started working with Amazon so early, the firm was a “trusted partner” with Amazon. This gave G2 Tech Group even more leverage in a potential sale.

Glenn saw the value of these first acquisitions in his space defining what the industry would look like in future. So he didn’t want to just ride off into the sunset, but wanted to have an impact in the evolution of his company. As such, in the transaction he was able to take a significant amount of money off the table, but he also was given the chance to invest some funds into the new entity (enough to keep it “interesting,” he noted). He was now in a position to give it a push while he was at the height of his subject matter expertise (and since he still had the desire to push on). He stayed on for two more years with the new company and did indeed enjoy a “second bite of the apple” with a subsequent exit from that firm.

There are as many ways to structure business exits as there are businesses. If you possess the drive and energy of someone like Glenn, we can help you structure your exit to be something similar. Give us a call today.

Anxiety before Closing is Normal

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AnxietyOne of our brokers was recently asked to be part of a panel at a conference. The panel topic was about experiences in selling a business and in preparatory slides she saw a focus on the stress, emotion, and anxiety that came with a business sale.

Being a rather no-nonsense type herself, she thought it was too focused on the emotional side of the transaction, until a timely email from her to the buyer and seller (and the responses) reminded her this is indeed something that both buyers and sellers deal with during a transaction. Rather than run away from it, it’s important to discuss it openly.

Delayed Closing

While the two attorneys involved in this deal seemed dedicated to trading punches regarding deal points, both buyer and seller remained amiable and engaged with each other. They took the delay in closing with stride, but even the delayed date seemed optimistic. To add to the regular challenges of taking over a business, the new owners would be moving to Kansas City from out of state.

In response to our broker’s asking about how both parties were feeling, the seller noted that there were still many unknowns. But they were continuing to take one step at a time and were excited to get to the closing date. They were looking forward to introducing the buyer to their whole team.

The buyer responded similarly, noting that a great part of his peace of mind in the transaction lay in the team he had surrounded himself to shepherd this deal to closing. His accountant, his attorney (who we had introduced him to), and other mentors were making sure that all the relevant questions were being asked and we, as the broker, were ensuring that those questions got answered.

Stay Calm and Carry On

During diligence, a lot of “why” questions can come up: “Why did you spend on this?” “What possessed you to do that?”

It’s important not to get emotional or assume the worst. Realize that diligence isn’t a “necessary evil” but rather a “necessary good” (even though many days it doesn’t feel that way!)

Often, the questions answered during this period of diligence lead to long and interesting discussions about the business and operations. The overall philosophy about the company (and life) could not have come up over a perusal of income statements and tax returns. Indeed, this is going to be a significant event in your life, so you should take the time to enjoy the journey and feel all the feelings. But don’t get lost in those feelings to the detriment of the transaction. Assume the best, have a constant and diligent attitude about the questions you ask (and that are posed to you) and move towards a successful transaction.

Cautionary Tale #6: Accounting Woes

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Accounting WoesWhenever we discuss commonalities in successful transactions, inevitably “clean books” will be one of the first three things mentioned. Numbers don’t just matter for your valuation, or for tax purposes, or just to track where the money has gone: without clean books, a buyer can’t know whether he/she is looking at a solid business.

Here are three examples of people who came to work with us who didn’t accept that basic premise:

Bad Books, Buyer Balks

We had a seller who was looking to sell a car wash, but had inconsistent and sloppy books. The buyer understood this and was willing to wait as the books got cleaned up. For some reason, the seller had been using a tax attorney to do the accounting. $20,000 and some months later, the seller had clean books and was square with the IRS. But in the process, the buyer had long since flown the coop because of the time lag and lack of responsiveness from the seller. To compound his woes, the previous accountant/attorney was suing him for non-payment of previous bills.

Don’t put yourself into this situation. Startup owners do it all the time by handing a shoe box of receipts to their new accountant/bookkeeper. Don’t do that. Start on the right foot from the start.

Full Disclosure Matters

In another situation similar to the one above, a seller was not as responsive as she could have been with her books, and the buyer started to get uncomfortable. At some point, it came out that there had been a $180,000 bad debt write-off from an old account. The situation was completely explainable as a one-time occurrence that shouldn’t affect the value of the business, but the seller had already been slow in responding. The buyer saw this disclosure as only the first in what might be more shocking disclosures, even though the reality was that this was the only real accounting issue to discuss.

The seller had created an atmosphere of concern and doubt, so it didn’t take much more to dissolve that confidence entirely. Always show and tell all the warts of your business to your broker. We’ve seen them all, and one thing we can say for sure; when you lead with honesty, you create and foster trust with your buyer.

Lying to the IRS

Another time we had a seller with a business that took in $2.2M in annual gross revenues, which led to $400,000 of declared owner benefit. But the owner also took $200,000 of unreported cash for himself, which was obviously not declared to the Internal Revenue Service. When we told him that he couldn’t get what he was asking for for the business since the books didn’t back the narrative, he insisted that we list the business anyway. “I’ll get audited if I go back and fix it now, anyway,” he said. While that has happened in certain circumstances, we told him that this wouldn’t be attractive to buyers.

Unsurprisingly, he got precisely zero offers, for the simple reason that potential buyers thought, “if he’s willing to lie to the IRS, which will run over your grandmother to collect what it’s owed, what else is he willing to lie about… to me?”

Honesty is the best policy. It is one of those lifelong bits of wisdom our mothers taught us long ago.

We all make mistakes – if you haven’t been straightforward with your books in the past, there very well may be ways to fix them and prepare your business for a successful sale.  Call us and let us connect you with people who can help you do precisely that.