Selling to Private Equity: Do Your Due Diligence

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Private Equity FirmsDespite many of the challenges of the pandemic, there’s still a lot of investor money looking for solid and smart investments.  Some of that money is sitting in the pockets of private equity firms, and those firms are increasingly looking at smaller deals to fill out their portfolio of investments.  Private equity (PE) firms present an interesting opportunity to sellers and those preparing their businesses for sale should take a bit of time to understand what PEs are and how to prepare for offers they may make.

What Private Equity Can Offer

While PE has the reputation for buying underperforming companies and then re-engineering their financial, managerial, and operational structures before ruthlessly flipping them, that’s not usually the attitude they bring to smaller, Main Street businesses.

If a Main Street business offers solid growth potential and has a strong team in place, PE can accelerate that success:

  • They have access to capital as needed
  • They can utilize economies of scale (leveraging certain services they may offer to every company in their portfolio)
  • Creating strategic partnerships (this can be with other companies in the portfolio or through their own connections)

Do Your Diligence

Don’t let the term “private equity” intimidate you.  They are just people trying to find a better-than-average return on their investments.  They will definitely do their homework on your business.  But you should be doing the same to them, particularly if you are going to stay on in the business after the transaction or care what happens to your employees if you are slated to leave.

Questions to Ask

The first question you might ask is “What’s your strategy for our industry?”  Follow this up with “Why are you attracted to the industry?” and “Where do you see our business going?”  These are short questions but they should lead to long conversations, particularly if the PE has a strategy and isn’t just looking to spend their dry powder.

You can also also ask the expected questions, like:

  • Can you introduce us to new markets?  New suppliers? 
  • Can you help us develop new products/services?
  • Are there any related companies in your portfolio that we might have synergies with?

Don’t be blinded by the references they might make to how much money they have under management.  What do they bring to the table for your business and your industry?

People to Talk To

You are going to want to call their references.  For PE this would be current and former companies under management.  If they are willing to let you talk to them, you should also talk to those whose deals didn’t get to the finish line or owners who exited sooner than planned.  Also speak to members of corporate boards which the PE has ties to.  

A PE, just like your business, isn’t just a balance sheet and a profit and loss statement.  They have a culture, a way of doing things.  That way of doing things should align with your company’s culture as well.  A PE may want to buy your company outright, or they may offer you a chance to leave some skin in the game to take the company to the next level and have a second exit.  Or they may just want to make a small investment now and see how things go.  Be open to different structures and possibilities.  

Private equity groups and family offices are just one of the many qualified buyers that our brokers keep in touch with on a regular basis.  We introduce qualified buyers to our new listings each week.  If you’d like to be one of those listings, give us a call so we can see if we’re a good fit for each other.

Case Study #54: Exit on Your Terms

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Exit on Your TermsSaud Juman started PolicyMedical in his mother’s basement.  He took the mundane tasks that every hospital needed to accomplish, like the steps in disinfecting a scalpel after surgery or the proper way to mop a floor so that nobody slips and falls, and automated them using software.  From these humble beginnings Saud eventually grew the company to an exit worth over 7 times revenue.

Work the Phones

Saud had a partner early on in the business.  That partner worked on the technical side of things and Saud handled sales.  Back in the late 1990s, before the revolution the Internet would bring to every aspect of our lives, the main option available to him was smiling and dialing.  The Yellow Pages equivalent for hospitals listed every executive for each hospital.  Saud remembers 150+ call days.

The hospitals had regulatory compliance they needed to be aligned with, and once Saud was able to explain how PolicyMedical would make things easier for them, they often said yes. 

Change of Pace

About seven years after the founding, Saud’s partner wanted to move on to different opportunities.  The company was doing roughly $500k in annual revenue and they managed to negotiate an amicable buyout.  But Saud realized that with a new technical hire to replace his former co-founder, he was stuck at a lifestyle business level.  This wasn’t a bad thing, but it didn’t line up with what had inspired him to originally begin the business.  He wanted to make a significant impact in millions of patients’ lives every day, and he couldn’t do that unless he was building a high-growth, high-impact company.

The problem was, he didn’t know how to do that.  So he did the next best thing: find someone who did and asked for mentorship.

Leveling Up

Saud made a list of people in tech, healthcare specifically, who had built companies of at least $150M annual revenue.  There were only three people on the list, and he hoped that one might come to a rather casual regular networking event one weeknight in Silicon Valley (he had done research to find out that this person was often at these events).  Saud flew down there from Toronto for the event, hoping to meet him, or if not, someone who might help make an introduction to him.  His risk was rewarded when that gentleman came to the event.

While he was at first taken aback by Saud’s story, he tried to beg off, telling Saud that if he were local, he could give Saud some time.  Saud immediately responded that he would fly down any time that this person was available.  Even though this possible mentor had just sold a company and had planned to take a couple years off (and had told everyone so), Saud’s earnestness impressed him and a week later they were spending a couple days together, laying out the groundwork for the future of PolicyMedical.

In these many hours of conversation Saud found a partner, not a mentor, and after making him a formal offer of equity, they were off to the races, rebuilding the software from the ground up, and doing it in the cloud, many years before anyone knew what that was.  He also had to convince his current customer base to move to the new trend in software, which was no longer a one-time large payment followed by much smaller “maintenance” fees every year, but forever monthly payments.  

Once again Saud’s sales skills were put to use, as he had to explain that even though many of the customers would see a 3X increase in their pricing, they were still being grandfathered in at a lower rate than what was being offered in the marketplace, and if they chose to go elsewhere they were going to pay a lot more.  

Closing Time

After a successful relaunch of the software with a new partner, Saud found he had been at the helm for a total of 15 years and wasn’t having fun anymore.  We find that many people exit at this time, but Saud did something quite rare: he stayed, using sheer will power, for another three years, to get the company ready to sell or ready to hire his replacement.

In that time he:

  • Built a data room with all the reports and paperwork a buyer could dream of
  • Reviewed the status of all existing clients
  • Reaffirmed all existing contracts
  • Got audited financials

He was so prepared, in fact, that he didn’t pay his investment banker the regular retainer that is paid in order to prep the business for sale.  The business was sale-ready, and the proof was the 37 offers to buy that he received.  Many of them were far below what Saud had wanted, which was an eight or nine figure exit, equivalent to more than 7X revenue.  But instead of moping about the “low” offers, he picked the top two offers, which were close to 4X and played them off each other.

He wrote down three dealbreakers to help guide him as the process moved towards a possible final buyer:

  1. All cash (there would be no earnouts or holdbacks)
  2. Fast transition (he would be gone in under six months)
  3. Keep the engineering team (most had relocated from Brazil and were in the naturalization process, and he wanted a guarantee that would not be interrupted)

By sticking to his guns, Saud got the deal that he wanted.

Takeaways

There are so many great lessons from this case study, but we will focus on three:

  • Be in touch with what it is you want from a sale.  Saud knew that it was time to go, but he also knew he wouldn’t be happy with the sale of the company as it was, so he was willing to put in the work to get to the next level.  Have the self-awareness to know whether you can keep going or whether you have to sell now.
  • Ask for help.  Saud took seeking mentorship to a whole new level by being willing to fly from Toronto to Silicon Valley to find an industry-specific mentor.  While he ended up finding a partner instead of a mentor, the process still worked.  If you don’t know how to get to the next level, find someone who does and ask for help.
  • Have a desirable offering.  37 offers should tell you everything you need to know about how great Saud’s company was.  While those offers weren’t all at the price he wanted, the fact that so many companies were interested meant that Saud had done his homework, and if you do the same, you will have the luxury and price premium that comes with multiple buyers chasing a desirable business.

Do you think it might be time to step down from your business?  We can help you evaluate the best time and way to do that.  Give us a call!

5 Basic Value Drivers for Your Business

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5 Basic Value Drivers for Your BusinessWhen we talk to potential clients about listing their businesses with us, we speak about value drivers early in the process.  Often these value drivers are aspects of the business that have been developing over many years so they aren’t things that can be scrubbed or tweaked over a period of weeks or months to add some “curb appeal.”  The more time that you spend developing these five basic value drivers for your business now, the more you will be able to ask for that business in the future.

1. Market Position

How much of the market share does your business own?  The relevance of this number will, in part, depend on whether you are a local, regional, national, or international business.  But it will also indicate the potential for growth.  

You don’t have to be number one to be valuable.  For years Avis took advantage of being #2 in the rental car industry to drive an advertising campaign: “We Try Harder.”  

While business buyers like to see some potential to grow a market position, even if you are in the #1 spot, you’ll leave money on the table come sale time if you don’t develop some of those potential markets yourself.

2. Brand Name

As with market position, the quality of your brand name is related to the relationship of your brand to your market.  A classic example in our home market of Kansas City was the iconic “Oklahoma Joe’s” restaurants.  One of the locations was in a gas station and Anthony Bourdain famously listed it as one of the “places to eat before you die.”

Because of a business buyout between the original partners of Oklahoma Joe’s, a decision was made to change the names of the Kansas City locations to Joe’s Kansas City Bar-B-Que.  Because the brand had built a following based on the quality of their ingredients and because the new name wasn’t that different, the business continued on just as well under the new name, and for some years after people still called it “Oklahoma Joe’s” the way that people called the Willis Tower the Sears Tower.

Business buyers like to see strong, recognizable brand names with proper legal protections when necessary.  Make sure that your brand does the quality of your products and services justice.

3. Customer Lists

When it comes to customer data, there’s no such thing as “too much information.”  You should have a CRM (customer relationship manager) that collects as much information as you can about your customers.  You should also be communicating with them in a regular manner so that they are used to receiving information from you (and forwarding it to potential customers).

Business buyers are always more interested in customer lists that are current and customers that are kept in contact with regularly.  Take the time to communicate with your customers on a regular basis.

4. Barrier to Entry

Some businesses require extensive accreditation and others have high capital requirements.  But many businesses just have the regular barrier to entry: a willingness to work hard.  

If your business doesn’t have a high barrier to entry, you can deliver your service so desirable that you create a preference in the marketplace and erect a de facto barrier.  Jimmy John’s did this years ago with their “freaky fast” delivery promise.  Most people did not realize that Jimmy John’s had done this by carefully mapping their delivery areas, accounting for roads and traffic patterns, in order to be able to deliver this service.  They then raised the bar in a cutthroat industry as satisfied customers began to turn to them more often than to the competition who did not offer “freaky fast” service.

What barrier to entry can you create by excelling in an aspect of your product/service delivery?

5. Proprietary Anything

Related to barriers to entry are proprietary methods.  We are familiar with KFC’s special blend of herbs and spices and Coke’s “secret formula” but some businesses today use proprietary software or processes to catapult them into strong positions.

In addition to being popular with customers (when executed well), proprietary aspects of your business give employees a point of pride: it’s always great to work at a business that has that something extra.

Do you do something that none of your other competitors do?  If you haven’t leaned into that and communicated that to your team and customers, you’re missing a chance to drive the value of your business.

Are you unhappy with your business’s position in any one of these categories and want to improve?  We can offer advice and resources to help you do just that.  Give us a call!

Should You Have Business Interruption Insurance?

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Should You Have Business Interruption Insurance?After the early days of Covid, those businesses with physical locations which did not have business interruption insurance may have benefited from government programs which helped with payroll, for example.  Now, as some court rulings have come down and insurance policies have been modified to account for previously unheard-of events like “stay at home” orders that lasted months, it might be a good time to explore this coverage for your business.

What is Business Interruption Insurance?

In brief, business interruption insurance is income and expense replacement for a business until it can re-open.  It is perfect for retail businesses that are physically customer-facing, like restaurants, salons, and movie theaters.  It’s most often used by businesses with 100 or fewer employees and with $5M or less in annual revenue.  

Those businesses that work remotely or can easily work remotely might still consider Contingent Business Interruption insurance, which envisions your vendors being affected by interruptions, even if you are not.  This form of insurance will cover the product and service suppliers that deliver to you and sometimes even covers second-tier suppliers.  

What Triggers Payout?

Most policies envision events that render your business unable to open to the public, like:

  • Fire damage
  • Damage from wind or falling objects
  • Lightning 
  • Theft
  • Riots and vandalism

The last item, riots and vandalism, can sometimes be specifically excluded.  Additionally, riders can sometimes be added to cover losses due to suspension of utilities, flooding, earthquakes, and mudslides.  There is also coverage if the civil authority prevents people from entering your premises.

If your insurer agrees to pay, it will be during what is called the “restoration period,” which starts when the damage was incurred and ends when the property is repaired and once again accessible to the public.  Some insurers impose a 48-72 hour waiting period before the restoration period even begins.

That said, even if your policy is set to expire during a restoration period, the payouts will not be affected.

What Costs Are Covered?

There are two items insurers will consider when paying out your policy:

Net Income (what would your business have made if it had been open during the restoration period?)

Operating Expenses, including:

    1. Rent
    2. Payroll
    3. Taxes
    4. Loan payments
    5. Some general operating expenses
    6. Move to a temporary location and any equipment needed to set up there

What Does It Cost?

The three key elements of determining the price of your policy, apart from special riders, are:

  • Your Industry
  • The number of employees you have
  • Amount of coverage you want

What Happened With Covid?

Well there isn’t a single answer here.  In some cases the courts have sided with the insurers and in other cases with businesses.  For a frame of reference, one can look to 9/11.  When President Bush spoke of an “act of war” some days after the attacks, he used a word that is often specifically excluded in policies: war.  This led to a lot of wrangling in courts.

A closer analogue to the shutdowns many experienced in 2020 was the case that United Airlines filed against its insurer after 9/11: the airline wanted compensation for the fact that Reagan National Airport was closed and hence United could not operate their flights.  United lost the case in part because the building was not closed for reasons of physical damage.  

On the other side of the coin, business owners in Michigan won a case regarding Covid related to imposed curfews from the governor.  The courts agreed that this triggered the reference to “civil authority” we spoke about above.  People were prohibited from entering these businesses due to a curfew and hence insurers in this case were obliged to pay.

On top of these court cases, at least ten states have introduced legislation to retroactively include coverage for Covid in business interruption policies in their states.  If those laws pass there will certainly be court challenges from the insurers, and it may be years before it gets sorted out.

In the meantime, you might use this time period to revisit whether business interruption insurance makes sense for your business.  If there’s one enduring lesson all businesses have taken from the pandemic, it’s to prepare for the unexpected.

Need some references to companies that offer good business interruption policies?  We are happy to share some.  Give us a call!