Deal Points: Getting to the Finish Line

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Getting to the Finish LineIn any business transaction, there are going to be key deal points that are deal breakers for the buyer or the seller. As brokers, we’re going to represent our client to the best of our ability. We also have one eye on the greater picture, the deal itself. And sometimes, we can come up with creative solutions to get a deal to the finish line and make both parties happy.

Real Estate

Sometimes a seller wants to include the real estate of a business along with the sale. But if it’s bundled together, it becomes too much for the buyer to take on. Sometimes the financing won’t cover it. Sometimes because the cash flow isn’t there. Owners will sometimes not pay themselves rent on the property and thus create an unattractive proposition to buyers who don’t have the luxury of owning the building the property is housed in.

A win/win solution can be to carve the real estate out of the deal and make the seller a landlord. In this way, the buyer doesn’t have to deal with the cost of the real estate. And the seller is incentivized to make sure the buyer succeeds so he gets additional cash flow via the tenancy.

Royalty

We’ve discussed the risks of an earnout on numerous occasions.  Sometimes a seller who isn’t happy with this option can ask for a royalty on a specific product or in a specific division of the company. The principle of the earnout is the same: money later instead of at the time of closing.  

This can be a win for a seller who doesn’t want to go down a  traditional seller financing route (for whatever reason) and for the buyer who can see that the seller believes in the product/company enough to defer compensation and base it on performance.

Assets

Over the years, the seller may have acquired assets that are either superfluous to the business (additional trucks that are simply being kept as “spares”) or not part of the buyer’s vision for the company. The seller doesn’t have to “take a loss” on these assets. He/she can simply carve them out of the transaction and sell them separately. The buyer wins by not paying for assets that he/she doesn’t feel the business needs going forward.

Spinoff

Sometimes a buyer might only be interested in a particular part of the business. This could be the fastest growing segment of the business. Or it might feature a method or technology that he/she is particularly interested in. This presents an opportunity to spin off that part of the company either as an entity owned solely by the seller or in some kind of partnership (allowing the buyer to fully buy out the seller at some point.)  This can allow the seller to take some money off the table and/or use some of those proceeds to package up the rest of the business for sale on its own.

There are many bespoke possibilities to get to the finish line of a transaction. But you can’t get there if you’re overly focused on “winning” a deal point and ignore its role in the transaction as a whole. That’s where we can (and do) help. Want to know more? Give us a call!

Covid Questions from Banks, Part I

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Covid Questions from Banks, Part IWe are still watching deals happen during this unique year in our history. What we’ve begun to notice more and more is that banks are asking more questions. With an overall feeling of caution in the air, an industry already known for its caution in “normal” times has become even more cautious.

We wanted to share some of the questions banks are asking our clients as they pursue traditional financing.

Strategic Questions

How has the business been affected by Covid-19?
This doesn’t just concern finances, but the status of your lease, the state of your employees, and the general state of your industry (this includes general forecasting on the future). There will be more specific questions to follow, but this is an “executive summary” answer.

Did the business shut down? If so, for how long, and why?
Obviously, a bank will be happy to see a simple “No” here, but well-answered “Yes” and “Why” responses are also helpful.

Did the seller pivot and does the buyer have to change anything about the operations or model in the near future?
This is the asterisk that banks are going to put on your older financials. They want to know what things look like now that you’ve made adjustments (if you did) and what the buyer will have to do (if anything) in the months ahead.

Are there growth opportunities because of the crisis?
While there is much doom and gloom in some parts of the market, those in transportation and manufacturing have had banner years. Some pivots have also yielded great results for businesses.

PPP/EIDL Questions

Did the business receive a PPP loan or an EIDL loan?
This is fairly obvious and part of the financial snapshot of the company anyway.

Does the business expect the PPP loan to be forgiven?
Well, this is slightly more complicated as it’s not entirely in the hands of the seller. We’ve written about this already, but we expect more clarity in the months ahead to assist sellers in answering this question.

Will the PPP loan be paid off by the seller prior to the sale of the company?
This hasn’t been a deal breaker, but if it’s a yes, it has seemed to have provided some comfort to the banks. Understandably, if a seller is hoping for loan forgiveness, they might choose to wait rather than pay off a loan that would have been forgiven, especially if it’s a large amount.

Supply Chain Questions

Has your production or supply chain been disrupted? Please explain in the context of pre-Covid vs. post-Covid.
One unexpected side effect of the sudden demand for Plexiglas is that it’s doubled and tripled in price. Businesses that you wouldn’t immediately think had anything to do with that material on a day-to-day basis are seeing the price of it go through the roof. There can be delays measured in weeks to obtain Plexiglas at the new price.

How does this affect margins?
In the Plexiglas example above, obviously without a severe (and understandable) change in price to the customer, margins are going to get chewed up. This will need to be explained across every product/service in your business.

Projections

The big question: What are your detailed projections for the next 2-3 years?
We’re seeing banks ask for forensic level detail here as we’ve never seen before: they want month by month breakdowns. We know that these are educated guesses at best, but this is what we’re seeing creep into diligence at this moment.

We don’t want to overwhelm you with all of the questions, so we’ll save more for a future article on this subject. In the meantime, if you don’t want to deal with the bank on your own, give us a call. We’re happy to help!

Know Your Broker: A Day in the Life

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Know Your Broker: A Day in the LifeNot everyone has a good sense of what we Kansas City brokers “do” in getting our buyers and sellers to a successful conclusion. Yes, they know we have to send a lot of emails and make a lot of phone calls. But what else? In this article we’ll give you a bit of a look at a hypothetical “day in the life” of one of Kansas City business brokers.

Finding and Qualifying Buyers

Each broker has his/her unique network of buyers that has been cultivated over the years. The best brokers will have also taken the time to qualify those buyers by making sure they aren’t just lookers or tire-kickers. We make sure that our buyer list is as qualified as possible, so that no one wastes their time. We may keep that buyer network “in the loop” through emails, forecasts, or even blogs like this one. 

We want to stay top of mind for those looking for businesses for sale in Kansas and Missouri (we are also active throughout the Midwest). So when we get a new business listing that we like, we send it out to our network. We get new listings all the time, so these touch points happen regularly. On any given  day we might be communicating with this network or bringing it up in discussions in our ongoing networking and other meetings in the community.

First Steps

Once buyers display genuine interest in a particular business due to an abstract we’ve provided (confidentiality is important so we don’t get too detailed), we will then get a non-disclosure/confidentiality agreement from them. This allows them to get the information they need in order to make a serious decision to move forward. We want the buyer to meet with and interview the seller as soon as possible to determine if the business is the right fit for the buyer.

If there is interest, it is important to move to an  Offer to Purchase to solidify their position ahead of other potential buyers. In this phase we get the seller to disclose high-level detail and not getting too deep into the weeds with specific and detailed questions. That’s the thing to do during due diligence.  

Diligence

After an acceptance of an offer, emails and phone calls really get rolling. We will arrange for the buyer and seller to meet and facilitate information gathering necessary for diligence and deal financing. At this stage we wear different hats, depending on the email, phone call, or conversation:

  • Mentor: Many clients are first time buyers or sellers and really don’t know how the process works. We have to tell/show them. 
  • Coach: Just as there are certain exercises and drills that sports players have to do in order to get to game day, there are certain documents and legal issues that need to be addressed prior to closing day. We gently prod, but sometimes have to be less gentle when people are zoning out/procrastinating.
  • Professional: Some clients will need help with issues like tax planning, obtaining financing, or negotiating real estate. We have seasoned professional contacts that we can refer people to.
  • Friend: We will often field a panicked phone call or respond to a troubling email with empathy. Many of us have owned businesses before and we know that seller remorse is real (and how to deal with it). Again, each broker brings his/her own particular personality to the table to deal with specific situations.

Every broker will tell you that on any given day we’re wearing at least one of these hats at any moment.

Closing

There are various parties that will sometimes do their best (or maybe their worst?) to derail transactions. They may do this consciously or unconsciously, but whatever their mentality, it’s our job to mitigate their destructiveness.

Our role is to clearly and professionally deal with roadblocks, obstacles, and any other challenges that can keep these two parties, buyer and seller, from walking away happy in a transaction, both getting (mostly) what they wanted. Our brokers’ secret weapon is experience. This is not the first time we’ve dealt with these challenges and we have plenty of stories to tell about unbelievable last-minute problems that nearly sunk great deals. But we dealt with them in a timely manner, with patience, and as noted above, with empathy. We are closing deals on any given day and preventing them from going astray.

As you can see, our days can vary, but there’s a consistent theme: helping our clients get to a successful finish. We happen to be good at that. If you want to learn more, give us a call!

Case Study #40: A Covid and Due Diligence Casualty

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Case Study #40: A Covid and Due Diligence CasualtyAna Chaud started Garden Bar some years ago in Portland as a fast casual restaurant which featured salads only. While such chains as Chopped and Sweetgreen existed on the East Coast, nothing comparable existed in Portland, and Ana pioneered the market.

While Ana had some background in nutrition, she had no restaurant experience. She partnered with someone who had fine dining experience and in the first year they did well. They brought in $500,000 in top line revenue, doubling that in the second year. They had a “clustering” strategy similar to Starbucks, in which a commissary location supplied all the produce for a group of stores.

Funding

The very first store was completely self-funded by Anna, and the second store was covered by a small SBA loan and some funds from friends and family. This type of business needed to scale to really make great margins (not just to achieve economics of scale in purchasing, but in sales). To add four more stores, Anna took $500,000 in funding from eight investors, yielding them 20% in equity.

To add more stores and inject more working capital, Ana went to another set of angel investors and raised $1.1M in the form of a convertible note. At this point, Ana made a mistake in her due diligence. She allowed one of the investors to draw up the note and didn’t hire someone to represent her interests. If she had, she might have seen one of the terms that would have given her pause: if the company was acquired prior to the note converting, the investors would get a 2.5X return on the original investment.

The Acquisition Clause Became Important

As Ana grew Garden Bar, it became a very attractive acquisition opportunity for a company who had a similar concept in Seattle. And they were looking to become a regional player in the Pacific Northwest. She wasn’t aware of this prior to getting an extension on the convertible note, with no change to the return clause she had missed. Three months after that acquisition, she was looking at an LOI.

While the note holders had liquidation preference in a sale, the preferred shareholders, the original investors that funded stores 3-6, had to approve the increased payout to the convertible note holders. You might guess they were not too keen to do so. That said, everyone who had invested in Ana and Garden Bar up to that point were angel investors, people generally more interested in helping entrepreneurs get up and running, rather than a high rate of return. Everyone put their heads together to negotiate, and Anna gave up all her immediate upside to make sure that all the investors were at least made whole. And then they would profit via an earnout mechanism over a couple years.

It might have been an improbable happy ending if it weren’t for the arrival of COVID-19. In Portland, this meant an extreme lockdown. While the first part of the transaction had closed and her investors had been mostly made whole, Ana’s earnout is now at best in jeopardy, and in the worst case, completely gone. Only time will tell.

Key Takeaways:

  • Get help with due diligence.  If you’re going to need investors, get representation. Have a professional with your interests in mind look over any document that gives away equity or indebts you or the company.
  • Accept risk. At one point, Ana had personally guaranteed almost all the leases for the stores, simply because she was still considered “risky” for the banks, despite being able to show strong cash flow.
  • Remember that earnouts are never a sure thing. While we’ve discussed the risks of an earnout in ordinary situations, COVID-19 has added one more possibility into the mix.