maximizing exit value - basil peters€¦ · maximizing exit value • there are several ways to...
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Maximizing Exit ValuegAngel Capital Associationg pAnnual Summit Workshop
April 15, 2009
Basil Peters
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Outline of Part 2
• When can you sell?y
• Developing an Exit Strategy
• Maximizing Value
• Planning for a Successful Exit• Planning for a Successful Exit
• The Exit Timeline
• Summary
• Workshop on Exit Valuations
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Simple Model of a Companyp p y
Entrepreneurs InvestorsEntrepreneursSweat Equity
InvestorsCapital
Company CapitalCompany Capital Gains
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Two Types of Exitsyp
• There are basically two types of exits:y yp1. Going public (an IPO or RTO)2 Being acquired (an M&A transaction)2. Being acquired (an M&A transaction)
• Today, there is effectively no IPO market
• This workshop will focus on M&A exits
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When Can You Sell?When Can You Sell?
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Common Misunderstandingg
• A common misunderstanding about M&A gexits is that you have to grow the company to be profitablep
• Or grow it to be larger than $X millions of revenuerevenue
• The real threshold is to ‘prove the business model’
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What it Means to Prove the Model
• In a recurring revenue business, for gexample, you have a spreadsheet that clearly shows actual results for:y1. Revenue per customer2. Gross margin per customerg p3. Customer lifetime (or churn)4. Cost of customer acquisition4. Cost of customer acquisition
• In other words, how much is a customer th d h t d th t t i ?worth and what do they cost to acquire?
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Proven Model and Value
• Some businesses have slightly different g ymetrics to prove the model
• But when you prove the model you can build• But when you prove the model you can build a credible projection that shows if:1 N dd d $X illi f it l1. New owners added $X millions of capital,2. The business would have Y customers 3. And be worth $Z millions
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That’s When You Can Sell
• There are often additional factors like competitors and market changes
• But the important threshold to determine• But the important threshold to determine when you can sell is when you have proven the modelthe model
• That’s when you can have a reasonable ynegotiation on value
• And sell the business• And sell the business
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It’s Often The Optimum Timep
• As soon as you prove the model is often the y pbest time to sell
• Always best to sell on an upward trend• Always best to sell on an upward trend
• Sell on the promise not the realityp y
• Often when you can get the best price
• Very often ‘stuff happens’
• Most entrepreneurs ‘ride it over the top’• Most entrepreneurs ride it over the top
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Developing an p gExit Strategygy
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Developing an Exit Strategyp g gy
• The most important element in the business pplan
• Every company has an exit strategy• Every company has an exit strategy
• Even if nobody realizes ity
• Even if it’s a lifestyle business without investorsinvestors
• It affects many daily business decisionsy y
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The Exit Is Just Another Process
• Whether it’s a financing, product g pdevelopment, marketing or sales goal
• The chances of success increase• The chances of success increase dramatically if you have a good plan
• Your exit strategy is the plan for your business – the entire business
• Your plan should start at the end (the goal)
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The Important Elementsp
• An Exit Strategy could be as simple as:gy p
• “Our exit strategy is to [sell the company] in about years for around $ millionabout __ years for around $ __ million.
• We plan to execute the exit by engaging a p y g g g[mid market M&A advisor] by _[date]_.”
• Or it could be an IPO or RTO and I bank• Or it could be an IPO or RTO and I-bank
• Formally check alignment at least annuallyy g y
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Maximizing ValueMaximizing Value
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You Can Often Get 50% More
• When the exit is designed and executed wellg
• It is often possible to increase the exit valuation by 50 to 100%valuation by 50 to 100%
• This is especially true of early exitsp y y
• Where the market is much less efficient
• And valuation is driven by futures rather than the past five years of actual financialsy
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Building Shareholder Value
Founding = 10% Equal Tactics & Strategy = 40% Exit Strategy & Execution = 50%
80
90
100
But Mentorsadd much
hi h l t
Exit strategy, find buyer,structure, negotiateand close transactionlu
e
60
70
Mentors assistcompany during
periods of growth
higher value at inflection points
olde
r Va
30
40
50
Develop productand make the
first sale
p g
A well designed d t d itS
hare
ho
10
20
30
Founders startcompany
and executed exit can create as
much value as all of the other work
S
0of the other work.
Time
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Maximizing Exit Valueg
• There are several ways to maximize the yfinal selling price:1. Structural value increase1. Structural value increase2. Illuminating strategic value3 C it li i I ffi i t M k t3. Capitalizing on Inefficient Markets4. Maintaining multiple bidders5. Sales and negotiating skill
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Structural Value Increase
• Often small tweaks in the corporate pstructure can increase the final selling price by 10 to 15%y– These can be balance sheet changes– Asset vs share sales– Asset vs. share sales– Financing mechanisms like sub debt– Tax innovations
• Opportunities are almost endless but canOpportunities are almost endless but can often add $ millions
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Illuminating Strategic Valueg g
• Identifying strategic value often creates the y g glargest fundamental increase in selling price
• It’s not actually creating strategic value it• It s not actually creating strategic value, it usually has to be there already
• But it very often has to be illuminated for the potential buyers (often very challenging)y ( y g g)
• This can often be the most valuable contribution from the M&A professionalcontribution from the M&A professional
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Capitalizing on Inefficient Marketsp g
• Markets for selling a business, especially for g p yunder $100 million, are very inefficient:– Information is difficult to accessInformation is difficult to access– There are a small number of buyers
Th k t i illi id– The market is illiquid– Often very few for sale (like yours)
• All of which can be big advantages for the sellerseller
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Always Have Multiple Biddersy p
• There are two important reasons that every p yexit transaction should always have multiple bidders:1. To improve the probability of closing2 To maximize the price2. To maximize the price
• Optimum number is 3 near the end
• Also a practical maximum
• Usually creates the biggest increase in price
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Selling and Negotiating Skillg g g
• There is no question that some sales people q p pare just better – often much better
• I hate to admit it but I get ‘sold’ all the time• I hate to admit it - but I get sold all the time
• Selling a company is just like any other sale g p y j y– but bigger and more complex
• A really outstanding M&A advisor or• A really outstanding M&A advisor or business broker can increase the final price by 50% or moreby 50% or more
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Planning for a gSuccessful Exit
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Planning and Executiong
• When the exit process is well planned and p pprofessionally executed:– The exit date, andThe exit date, and– Exit valuation
• Are both reasonably predictable
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Steps to Completing an Exitp p g• The basic steps to completing an exit are:
1 B ild li t li ti it t t1. Build alignment on a realistic exit strategy2. Engage the best professionals3. Clean up the corporate structure4. Prepare for due diligence5. Do a secondary sale (in some cases)6. Optimize the financial results7. Build the sales funnel8. Manage the auction9. Negotiate and close
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Check the AlignmentCheck the Alignment
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Check The Alignmentg
• It’s surprising how often there is a mis-p galignment between key stakeholders on the exit strategygy
• The only way to check is to get a ‘signoff’ on a written exit strategya written exit strategy
• Usually takes at least one offsite planning y gretreat to build full alignment
• Even after check alignment annually• Even after, check alignment annually
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The Agreement With Entrepreneursg p
Today, many believe that the fundamental agreement between investors and entrepreneurs is:1. The investors invest their money as equity2. The entrepreneurs all work together to
i th l f th it dincrease the value of the equity, and3. Provide the investors, and themselves,
liq iditliquidity.
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Building Shareholder ValueCompleting the
Founding = 10% Equal Tactics & Strategy = 40% Exit Strategy & Execution = 50%
Completing the sale creates as much value as all of the other
80
90
100
But Mentorsadd much
hi h l t
Exit strategy, find buyer,structure, negotiateand close t tilu
e
work.
60
70
Mentors assistcompany during
i d f th
higher value at inflection points
transaction
olde
r Va
30
40
50
Develop productand make the
first sale
periods of growth
Sha
reho
Investors get 100% of their money back on
10
20
30
Founders startcompany
S their money back on the sale, so 50%
vesting on the sale is fair and optimizes
0
Time
fair and optimizes alignment.
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Most Fair Vesting Formulag• Assuming that was the fundamental
agreement,
• and that 50% of the value is often createdand that 50% of the value is often created at the exit,
• Then reverse vest:• Then reverse vest:– 50% of the shares daily over a three year
period andperiod, and– The other 50% when there is a ‘sale’ of the
company. y– All vesting for senior employees accelerates
on a sale of the company.
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First Exit Strategy, Then Financegy,
• This doesn’t happen most of the timepp
• But the right way to build a company is
• Determine the type of business
• Build alignment on the exit strategy• Build alignment on the exit strategy
• THEN develop the financing plang
• And then start to contact investors
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Check Financial DNA Before
E t i lEntrepreneurialDNA Resulting Corporate
DNA is a Hybrid of
In estors’
DNA is a Hybrid ofEntrepreneurs’ and Investors’ DNA
Combined with
Investors’DNA
Check the compatibility firstCheck the compatibility first
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E P f i lEngage Professionals
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Role of the Professionals
• The most important jobs of the M&A advisor p jor business broker are to:1. Protect the CEO and rest of the team1. Protect the CEO and rest of the team2. Add the experience and strategy3 B th b d3. Be the bad guy4. Maximize the price and terms
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The CEO Should Not Lead
• There are several reasons the CEO should not lead the exit:– CEO is needed to maximize the numbersCEO is needed to maximize the numbers– CEO rarely has the depth of experience
A d i ft fli t d– And is often conflicted– Usually cares too much– Should not be the bad guy
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Every Deal Needs A Bad Guyy y
• M&A transactions are usually funy
• They always involve big money
• The job of both sides is to get the best price
• At some point in almost every transaction• At some point in almost every transaction, things will get tense – and often much worse
• Every transaction needs a bad guy – a very good bad guy (who is not the CEO)g g y ( )
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Failure is Quite Common
• One of the secrets of the M&A business is that M&A professionals often fail to complete a transactionp
• There are no statistics on this and the professionals never talk about itprofessionals never talk about it
• I have been asking companies for yearsg y
• The fault often lies with the company but the cause is the same communicationcause is the same - communication
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Professionals Should Be Local
• Executing an exit is an intimate processg p
• Done right, often requires weekly meetings with the CEO for many months or a yearwith the CEO for many months - or a year
• Companies often engage professionals who p g g pare thousands of miles away
• In my opinion that rarely makes sense for• In my opinion, that rarely makes sense for under $100 million transactions
• And often results in a failure to complete
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M&A Advisory Feesy
• It’s surprisingly difficult to get accurate p g y ginformation on what professionals charge
• High quality M&A advisory fees are usually:• High quality M&A advisory fees are usually:
• Work fee of about $50,000 plus ap
• Success fee of approximately:1 6 t 10% f d $10 illi t ti1. 6 to 10% for under $10 million transactions2. 4 to 6% for $10 to 30 million sales3 2 t 4% f $30 t $100 illi3. 2 to 4% for $30 to $100 million
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Legal and Accounting Feesg g
• Legal and accounting fees vary widely g g y ydepending on the complexity, not the size
• For a simple clean transaction legals might• For a simple, clean transaction legals might only be $50,000
• But for a complex deal can easily be$1 million or more
• Accounting costs can be a few thousand to over $100 000 if audits haven’t been doneover $100,000 if audits haven t been done
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Cl U th St tClean Up the Structure d P fand Prepare for
Due DiligenceDue Diligence
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Clean Up The Structurep
• In almost every exit I have seeny
• There are structural defects that need to be cleaned up before the exit can completecleaned up before the exit can complete
• Many are built into the default corporate y pstructure by statute
• Well intentioned minority shareholder rights• Well intentioned minority shareholder rights can cause big problems
• Fix these before contacting buyers
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Pre-Exit Structural Elements
• 51% shareholder vote required to sell the qcompany
• Not the standard statutory terms!• Not the standard statutory terms!
• Clear and well understood share allocation
• Employment agreements
• Protection of corporate interest agreements
• IP ‘cleanly’ owned by the company• IP cleanly owned by the company
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Prepare for Due Diligence Earlyp g y
• Exits require a lot of manpower from the q pcompany and the professionals
• The worst thing is to lose momentum during• The worst thing is to lose momentum during the latter stages on a due diligence issue
• Strongly recommend the due diligence be complete and online early in the processy
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Secondary Salesy
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Do a Secondary Saley
• A secondary sale is where new investors ybuy founders’ and early investors’ shares
• A secondary share sale can be almost• A secondary share sale can be almost ‘magical’ in finalizing alignment and solving structural defectsstructural defects
• Usually considered impossible a decade yago
• Today secondary are much easier to do• Today, secondary are much easier to do
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Successful Secondary Salesy
• But secondaries can be done, if:– The price is reasonable, and
There is a clear exit strategy and a– There is a clear exit strategy, and a– Good team in place to execute the exit
• For example, the ParaSun case study in the workshopp
• In that case, the buyers were angels and other accredited investors (about a dozen)other accredited investors (about a dozen)
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D li th B tDeliver the Best NumbersNumbers
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Plan to Over-Achieve
• To get the best price for the businessg p
• There should always be multiple bidders
• And a professional ‘auction’ process
• To maximize the price the team should do• To maximize the price, the team should do everything possible to deliver results that are better than the projectionsare better than the projections
• An important reason the CEO shouldn’t lead
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Th E it Ti li dThe Exit Timeline and T lli th TTelling the Team
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Often the Biggest Questiongg
• Many times in exits I have been involved ywith,
• The question that seems most important to• The question that seems most important to the team and the board is
• Not “How much can we get?”
• It is “How soon can we complete a• It is How soon can we complete a transaction?”
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How Long It Usually Takesg y
• The short answer is usually 6 to 18 monthsy
• From the time you engage the M&A professionalsprofessionals
• Until the cash is in the bank
• But it can often take considerably longer if the company isn’t ready or if the structurethe company isn t ready, or if the structure needs to be cleaned up, or if the financials need improvementneed improvement
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When To Tell The Team
• Many CEOs have difficulty determining y y gwhen they should tell the rest of the team that the company is for salep y
• Some worry that it will create anxiety
• Others think it is ‘none of their business’
• Most of the time the internal grapevine is so• Most of the time the internal grapevine is so efficient that they already know
• Best practice is to tell everyone early
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Timing is importantg p
• Most common mistake is to ride it over the top – it’s human nature
• Best time to sell is when everything is going• Best time to sell is when everything is going really well
• That’s when you will usually get the highest price, even if the business can grow furtherg
• The difficult thing is to start the process a couple of years before the growth peakscouple of years before the growth peaks
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Before You Start Sellingg
• About a third of the work includes:1. Building alignment around exit strategy2 Financial history and projections2. Financial history and projections3. Selling document (like a business plan)4. Cleaning up the corporate structure5. Preparing the due diligenceg g
• Usually takes 1 to 5 months
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Building The Sales Funnelg
• The second phase includes:p1. Searching for prospects that match2. Develop tactics on strategic valuep g3. Initial contacts to 50 - 1004. Responding to 10 - 20 interested4. Responding to 10 20 interested5. Starting due diligence with 5 - 86 To get to a stable short list of 36. To get to a stable short list of 3
• Usually takes 2 to 6 months
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The Bidding Processg
• The third phase is the most exciting and p gmost intense
• Ideally three buyers will be in due diligence• Ideally three buyers will be in due diligence
• And actively negotiating, simultaneouslyy g g y
• The CEO will become the limiting factor even if the M&A advisor is doing welleven if the M&A advisor is doing well
• Usually takes 2 to 4 monthsy
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Negotiating and ClosingNegotiating and Closing
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Negotiating and Closingg g g
• Even after there is a binding term sheet and gpossibly a deposit
• It can take months for the M&A advisor• It can take months for the M&A advisor, lawyers, accountants and board to complete the fine points of the definitive agreementthe fine points of the definitive agreement
• And obtain all of the approvals from boards, shareholders and regulators
• This final phase is usually 1 to 3 months• This final phase is usually 1 to 3 months
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Reps and Warrantiesp
• A lawyer friend says more M&A transactions y yfail on reps and warranties than price and terms
• Basically a personal guarantee from the CEO and other major shareholdersCEO and other major shareholders
• To protect the buyers against future y gliabilities or misrepresentations
• Start coaching the team early in the process• Start coaching the team early in the process
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Summaryy
• Angels can provide enough capital for most g p g pmodern companies
• The rules on exits have changed• The rules on exits have changed
• Most exits are under $20 million
• Small M&A activity is still doing well
• Angels and entrepreneurs will usually have better returns with an early exity
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For More on Exits
E l E it i h d B k• www.Early-Exits.com in hardcover or eBook
• www.AngelBlog.net for new articles and updatesp
B ilP t f P P i t d• www.BasilPeters.com for PowerPoints and videos