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After selling my logistics company in 2012 and my e-commerce company in early 2014, I've had some time to reflect in how differently each sold. My notes from both sales created the list of seven things every entrepreneur must cover well before selling your business.
First, I want to give you a short summary of the two sales I went through over the last few years. I elected to sell my logistics company myself and avoided private equity (PE) firms, investment bankers, and business brokers. Simply by posting my business online and getting the word out within my 20 year old transportation Rolodex, the best outcome was right down the hall as I ended up selling it to my terminal manager. The negotiations were clean and concise and lasted less than a week, only one business attorney was involved, papers were signed and the deal was done. From start to finish, the sale was complete in less than 90 days. The second time around, I hired an investment banker, put months into a CIM (confidential information memorandum) document, worked on a list a mile long of potential buyers - from PE firms to fortune 500 companies, and did multiple dog & pony shows in front of interested buyers. In the end, we got a handful of non-binding bids that all ended in disappointment for various reasons. One year later, I sold out my shares to my minority business partner. Each of these experiences produced a plethora of new found knowledge in an area I thought I knew pretty well through a few of my past experiences, books I've read, and colleagues I knew in the M&A arena. Let's just say I had no idea! I am grateful for both experiences, what I learned, and my desire to share them with other entrepreneurs. With the startling number of start-ups sprouting up everyday, it is critical to have the end in mind. The "end" is an exit strategy under your terms and within the parameters you set that triggers the start of an exit. It is healthy to think through possible exits once your business is financially stable and has a strong operational foundation. The following are seven things you must get in order and optimally presented before putting your business up for sale. Knowing this simple outline will help you set up your company for securing the best multiple of EBITDA to all potential buyers that show interest in your business. #1: Your Financial Statements must be in order from day one. As an entrepreneur, you do not want any holes in your historical financials. Get with your CPA or Controller and put together the following critical financial statements:
#2: Estimate the Value of Your Business Assets. It’s essential to list and price all physical assets of your business, including furnishings, fixtures, equipment and inventory. In my simple transaction, this was done down to every piece of furniture, computers, and office supplies. With the overwhelming approach in my e-commerce business, this was overlooked by both sides and became a mess a few months after we closed. Tangible Assets – The worth of these items is important for buyers who require you to provide a complete asset list, including purchase prices and fair market values. The worth of these assets is also very important in determining whether or not you should liquidate these assets before the sale. #3: Prepare Your Statement of Seller’s Discretionary Earnings. Work with your accountant or bookkeeper to "recast" or "stabilize" your business income statement into what’s interchangeably called a statement of owner’s cash flow or a statement of seller’s discretionary earnings (SDE). Public companies and middle market businesses are valued as a multiple of EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization. However, smaller businesses are valued as a multiple of Seller's Discretionary Earnings (SDE), which can be defined as EBITDA + Owner's Compensation AND owner perks (bonuses, company car, and other special perks the owner did for her or himself. Therefore, SDE is typically the net income (or net loss) on the company tax return + interest expense + depreciation expense + amortization expense + the current owner's salary + owner perks. #4: Estimate the Earnings Multiple That’s Likely to Apply When Pricing Your Business. Most owners receive somewhere between one and four times the annual SDE of their business, with the multiple pegged to the attractiveness of the business being purchased. Go into this with defined expectations of what you are wanting to see regarding the SDE multiple. #5: Do the Math to Arrive at an Early Estimate of Your Purchase Price. Based on how attractive your business appears in key areas that most affect its future success under new ownership, you can multiply your annual SDE by your estimated earnings multiplier to arrive at a preliminary estimation of your business purchase price. #6: Price Check! After arriving at your estimated purchase price, conduct the following research: 1) Search every online businesses for sale marketplace to research similar listings and sales in your business category, market area, and price range.; 2) Gain insights into selling prices of comparable businesses.; 3) Work with your sales agent (investment banker, broker/consultant, or adviser) to see how your pricing lines up with the prices of comparable businesses that have sold over the last 24 months. Look for trends - both up and down. #7: Research. Research. Research. You simply cannot do enough research before and during the process of getting your business ready to sell. Whoever you partner with the assist in the sale or you decide to put it on the market yourself, it is critical that you do your homework so none of the many wool blankets that are out there get pulled over your head! Good investment bankers will shoot straight but are very good at dampering your expectations, throwing out multiples that are sometimes in left field, and discounting parts of your business or intellectual property that might increase your multiple significantly. Research other business like yours and determine: who the buyers were and where they came from (industry, PE's, etc.), what multiple range over the last 24 months, and who else is for sale that might create a blind-side competition. Looking back, my simple and somewhat naive approach with selling my logistics company ended up being the best approach in a lot of ways. From being much less stressful to hitting my target sale price. However, the second time around I learned a lot in a much bigger arena. Have fun through the process and stay engaged. It just might be a life changing event that opens many new doors to choose from! Good luck. Scott E McGlon is the President of McGlon Properties, LLC and the author of many blog post on MP Blog. He has been a serial entrepreneur, investor, and president of many successful start-ups since 1998.
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by: Scott E. McGlon
From company owners to inexperienced deal analysts, many confuse EBITDA with cash flow. Clearly understanding the distinction between the two is critical whether you are a start-up, angel investor, or an established business looking to expand via acquisition or other means. When leveraged buy-outs (LBO) gained popular ground in the 80's and early 90's, EBITDA became the primary metric of choice to determine how much a company could potentially take on (the foundation of qualifying an LBO). Since then, EBITDA has gained even more prominence since it is one of the baselines used to get to a starting-point valuation as a multiple of EBITDA. The multiple used usually is determined by industry and based on the current M&A supply & demand of the company being evaluated. A key point is that the EBITDA metric is not uniformly defined under GAAP standards thus allowing many ways companies can calculate and, in some cases, manipulate EBITDA. This variance in how companies define EBITDA leads to inequalities and sometimes confusion regarding the true cash-generating abilities of a business. Depending on third-parties that look at EBITDA as one of their main metrics and the confidence level it creates, differences in EBITDA calculation usually lead to additional questions or more stringent due diligence. The key take-away's to understanding EBITDA is the fact that it does not take into account the following:
If a company wants to grow, defend its market position, and remain viable & profitable, the monthly cash needed to finance the above obligations carries prominent importance. There are three main costs that are not usually found in company's stated EBITDA which lead to overstated cash flows. These are underestimating or accelerating depreciation, working capital adjustments to fuel growth, and week to week capital expenditures (capex). Depreciation - The over or underestimation of capital expenses for asset-heavy companies such as the trucking industry (over 30 years industry experience) is one of the oldest tricks in the book and can grossly skew available cash flow. Adding back all depreciation for a company without leaving an allowance for capex will overestimate the available cash flow significantly. However, not adding back any depreciation can underestimate the cash flow. This is especially true if a company uses accelerated depreciation to reduce its tax burden. In most of these cases, the companies are profitable and carry little to no debt, Simply put, there have been a lot of cases over the years of companies manipulating depreciation schedules to inflate EBITDA. This is a true indication of a company that is not being true to their actual capex allowance needs. Working Capital Adjustments - Most companies need to invest profits back into the company just to keep their growth objectives moving forward and to stay ahead of competition. EBITDA does not account for changes in working capital and the cash required to run the daily operating activities or the fluctuations associated with it. Ignoring working capital requirements assumes that a business gets paid before it sells its products or services - e-commerce companies for example. However, very few traditional companies operate this way. Most businesses provide a service and get paid in net 30 (industry average). Ideally, a business collects in advance for its services, pays off its due payables within terms or earlier, and uses its profits to reinvest into additional raw material inventory, products, or even staff. Capital Expenditures (capex) - What assets or equipment is fundamentally required to operate? This is a critical question for understanding a company's capex month-to-month requirements. Certain industries like transportation, heavy/industrial manufacturing, and oil & gas all require heavy, ongoing investment in equipment just to operate. Most EBITDA calculations do not take into account capex. Line items within a chart of accounts balance sheet will show the significant investments in plant and equipment required to operate. EBITDA can get artificially inflated when companies capitalize operating expenses and allow them to be depreciated over time, thus decreasing operating expenses. The closer you can get to fully understanding true capex, the more you can rely on EBITDA as a dependable metric. In closing, the EBITDA metric has received a bad reputation in recent years (post Internet bubble) but this should only be taken with entities using it in improper ways. Just as a steering wheel is great for navigating an automobile, the same method is ineffective in steering your horse! How you define EBITDA might be different than a featured company does. Bottom line, it shouldn't be used as the main metric in evaluating corporate profitability. Like any other metric you use in evaluating a business, EBITDA is only a single indicator. Depending on the company's accounting methodology, EBITDA could be construed as vague, unclear, and/or a great metric to hide the true financial story. The people that make up the business, the processes they have to execute, the market share it has, and the products they sell are all key indicators that must be defined thoroughly when making a business decision on any company. Scott E McGlon is the President of McGlon Properties, LLC and the author of many blog post on MP Blog. He has been a serial entrepreneur, investor, and president of many successful start-ups since 1998. by Scott E McGlon
If you really want to be proactively positioned with potential investors, you must be able to answer what I call "the critical ten". These questions remove any doubt in potential investors minds that you, as a founder of a start-up, have what it takes to get your start-up to a self-sustaining business. Over the past few years, "boiler plate" answers, "canned" presentations, and flying start-up lingo and buzz-words are in almost every executive summary, business plan, and/or start-up presentations to seed, angels, or VC's. If you get nothing out of this blog entry, take the following with you: show sincere passion and be yourself. There is nothing more unappealing than listening to a young founder going over-the-top to try impress the investor(s). My simple advice to every start-up is to be upfront, honest, and straight-forward with the answers to the following questions:
Relax! Being cool under pressure defines confidence with an audience that knows it well. Understanding these questions and presenting the right answers will determine the level of success you achieve with any investor that you get in front of. Now, go get'em! Scott E McGlon is the President of McGlon Properties, LLC and the author of many blog post on MP Blog. He has been a serial entrepreneur, investor, and president of many successful start-ups since 1998. by David S. Rose
Let's start by understanding that because we are talking about something called "Convertible Debt", it means that whatever it is will start out as one thing, and potentially convert (or "change") into something else. In this case, what the investor receives in exchange for his or her cash starts out as debt, and potentially converts into equity. Debt is a fancy word for a "loan". That is, I lend you money, and you agree to pay back the money that I loaned you at some known point in the future, along with a specific additional amount of money (called "interest") which is your payment to me for having been willing to loan you money in the first place. Equity is a fancy word for "ownership". That is, I give you money and you give me part ownership of the company. Because I'm now an owner right alongside you, you don't ever have to pay back the money to me (remember, it wasn't a loan), and even if the company goes broke you still won't owe me a penny. HOWEVER, also because I'm now an owner right alongside you, I get my share of any increase in value that ever happens with the company. The difference here is that debt results in a fixed payback regardless of whether good things or bad things happen to the company, while equity results in completely variable payback from $0 (if the company goes under) to potentially billions of dollars (if the company ends up being worth a lot of money.) The key functional aspect of these two very different things is that if I'm putting, say $100,000 into your company as debt, the only thing we need to discuss is the interest rate that you'll pay me for using my money until you pay it back. But if I'm putting it in as equity, then we need to decide what percentage of the company's ownership I will end up with in exchange for my investment. To figure that out, we use the following math equation: [Amount I'm Investing] ÷ [Company Value] = [Percent Ownership] Therefore, since we can calculate any one of the three terms if we know the remaining two, and we already know how much I'm investing (remember, we said $100,000), in order to figure out what my ownership percentage will be after the investment, you and I need to agree on a way to figure out what the company valuation is (or will be) at the time I purchase my shares of stock. So, if I were just going to buy stock in your company today, we would agree on a valuation today, I'd give you the money today, you'd give me the appropriate percentage of the company's stock, and we'd be all set. But that's NOT what we're doing. Instead, I'm loaning you the money today (for which, as you'll recall, there is no need to set a valuation on the company). HOWEVER, since I really don't want only my money back plus a little interest (heck, I can get that just by putting my money in a bank account, instead of into a very risky startup), we agree that at some point in the future I will be able to convert my loan into the equivalent of cash, and use that money to buy stock in the company. But because that conversion is going to be happening at some point in the future, while I'm giving you the money today, we need to figure out a few things today,before I am willing to give you the money. Specifically, we need to decide (a) when in the future the debt will convert to equity, and (b) how we will decide the valuation of the company at that point in the future. The answer to both turns out to be the same thing: we will wait until a richer, more experienced investor comes around and agrees to buy equity in the company. At that point we will convert the debt into equity (a) and we will use as the valuation whatever that other investor is using (b). However, the fact is that I was willing to invest in your company at a time when that other big shot investor was not, and you used my investment to make the company a lot more valuable (and therefore got a high valuation from the other investor) so it doesn't seem fair that I should bear the early stage risk, but get the same reward as a later stage investor, right? We solve this problem by agreeing that I will get a discount (typically anywhere from 10% to 30%) to whatever the other investor sets the valuation at...which is why we call this a Discounted Convertible Note. But you know what? Although that sounds fair, it really isn't (or at least serious investors don't think it is.) That's because the more successful you are at using my original money to increase the value of the company, the higher the valuation the next guy will have to pay...and pretty soon the little discount I'm getting doesn't seem so fair after all! For instance, if that same big shot investor would have valued your company in the early days at, say $1 million, but is eventually willing to invest in you at a valuation of, say, $5 million, that means you were able to increase the company's value 500% using my original seed money. But if my convertible note says that it will convert at only a 20% discount to that $5 million, for example (which, if you do the math, is $4 million), I would seem to have made a very, very bad deal! Why? Because I end up paying for your stock based on a $4 million valuation, instead of the $1 million it was worth in its early days when i was willing to make my risky investment! No fair! So how do we solve this problem? What we do is say "OK, because I'm investing early, I'll get the 20% discount on whatever valuation the next guy gives you...BUT just to be sure that things don't get crazy, we will also say that regardless of whatever crazy valuation HE is willing to give you, in no case will the valuation at which MY debt converts ever be higher than, say, $1 million." That figure is known as the "cap", because it establishes the highest price at which my debt can ever convert to equity. And that is why we call this form of investment (which these days is used by most angel investors) a Discounted Convertible Note with a Cap. About the author: David S. Rose, Entrepreneur, Investor, Mentor - serial entrepreneur and active angel investor, based in New York. As an inveterate startup guy, I've founded half a dozen companies since my first at age 10, and as ‘super angel’ technology investor, I have funded over 80 others. I am the founder and CEO of Gust, the entrepreneurial finance industry's infrastructure platform; founder and Chairman Emeritus of New York Angels, one of the leading angel groups on the East Coast; Managing Principal of Rose Tech Ventures, an early-stage ‘super angel’ fund specializing in Internet-based business; Partner in True Global Ventures (an international super-angel venture capital fund) and Chairman of Egret Capital Partners, a middle market private equity firm. |
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AuthorScott E McGlon is the President of McGlon Properties, LLC and the author of many blog posts on MP Blog. He has been a serial entrepreneur, entrepreneur-in-residence, investor, and president/CEO of many successful start-ups since 1998. “Success is walking from failure to failure with no loss of enthusiasm." - Winston Churchill "The few who actually
go out and take extraordinary initiatives are the envy of the majority who sit back and just observe." “The LORD makes firm the steps of the one who delights in Him; though he may stumble, he will not fall, for the LORD upholds him with His hand.” - Psalm 37:23-24
“Keep away from people who try to belittle your ambitions. Small people always do that, but the really great people make you feel that you, too, can become great.” "It is more important in what you become than what you achieve. What are you going to become in pursuit of what you want?" - John Marsh, Marsh Collective
“Work harder on yourself than you do on your job" - Jim Rohn
"The secret to success is very simple: EVERYDAY if you do quality work, take initiative, act on innovative thoughts, and are assertive in your actions all backed by faith, the dividends will consistently flow your way." - SEM
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