To summarize: If your situation calls for formal valuation, get a good CVA on the case.

If you want to find out what your company will likely sell for, reference this chapter and save a few bucks.

8 Financing Options

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M&A is all about where the money comes from. If there is money to fund the deal, we go. If there is no money, we

dont. Not much more complicated than that.

Financing options vary significantly depending upon the size of the transaction. To simplify, here are three typical scenarios based on a range of deal sizes: Under $5 million: Deals under $5 million can usually be funded through local banks using an SBA guarantee to collateralize the loan. The program we use most often is the SBAs 7A program. Without getting too specific, a buyer can typically buy a company using the following percentage breakdown: `` 30 percent buyer equity (Cash paid at settlement) `` 60 percent bank financing `` 10 percent seller financing (a.k.a. Seller Note) Note: The SBA likes the owner to keep some skin in the game. This is typically achieved by having the seller

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hold a seller note which is in second position behind the banks primary loan or senior loan. A word of caution: In order for a transaction to qualify for an SBA loan, the company must have a track record of producing enough cash flow to provide a reasonable income for the buyer after servicing the proposed loan. This needs to be confirmed using the past three years federal tax returns for the business. The bank will usually accept recast items (refer back to calculating EBITDA in Chapter 6). However, they are not interested in unrecognized revenue or other inappropriate accounting games. If the companys financial records do not pass muster for an SBA loan, there are few other options for funding the transaction beyond seller financing. The issue is collateral. Banks look to protect their interest with collateral and loans to businesses of this size are almost always Asset Backed Loans or ABL. There are rarely enough hard assets in a transaction to provide sufficient collateral for an ABL since much of the price will be goodwill. In an SBA loan scenario, the government provides the lender a guarantee of 75 percent of the loan amount (this amount has been as high as 90% in recent years) as an incentive for the bank to make the loan despite the insufficient asset coverage. In simple terms, if the loan goes belly up, the bank eats 25 percent of the loss and the government eats 75 percent. Without

this guarantee, the banks are generally not interested in these types of transactions. Over $15 million: Deals over $15 million are large enough to attract cash flow lenders (GE Capital, Citibank, etc.). These lenders will consider the deal based on its merit and the quality of the management team involved. If they believe that the cash flow forecast is sufficiently robust, they may lend on the deal regardless of the collateralize-able assets involved. Assets are always a plus as they provide collateral for the lender, but cash flow is king. Note: This cash flow lending market has been significantly curtailed since the market melt-down of 2008. Over $5 million and under $15 million: Deals in this space are difficult to finance via traditional banks. The SBA is not an option at this level as the 7A loan program is currently capped at $5 million. These deals, while significant to those involved, are too small for the big cash flow lenders. Deals between $5 and $15 million can take any number of forms. If the buyer is a strategic buyer, there is a fair chance that the deal will involve a significant amount of cash (cash the buyer already has on hand) and/or stock in the acquiring company. If the business is sold to a nonstrategic buyer, the buyer will use as much leverage as possible to complete the transaction. Expect the buyer to fund 30 percent of the transaction with their own equity.

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After that, there should be some bank financing available, but only to the extent that there are assets to collateralize the loan. The remaining balance of the purchase price will typically involve a seller note, an earn-out, or the seller retaining a percentage of the company. It is difficult to predict whether or not your company will attract a strategic buyer. You need to have something special that is currently annoying one of your larger competitors, useful to a large company, or just waiting for more development money to take it to its fruition. A more likely scenario is that your business will sell to a financial buyer. These people are professional buyers and seemingly always buying. In planning, you should assume that your company is

know that all-cash deals are rare when a financial buyer is involved. This comes as a shock to many people and is the reason many people I know have ignored credible offers in the past. The common quote: I told them I wanted all cash. If your neighbor says she sold her company to a private equity group for cash, she is probably taking a bit of poetic license. She got cash, for surejust not 100 percent. This is not necessarily a bad thing if you understand the game. Lets look at the private equity gamewhat I described earlier as The New Exit.

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going to be sold to a financial buyer, either an individual or a private equity group. Recall that financial buyers will ultimately base their purchase decision upon their ability to earn an acceptable rate of return. The price a financial buyer will pay has been addressed in Chapter 6. Whats important here is how they pay it. It is extremely important to keep in mind that the buyers ability to get financing is directly related to your companys historical ability to generate cash. If your company does not have a good track record with consistent, positive cash flow, financing (regardless of the vehicle) will be a challenge for the buyer. It is also important to

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LEVERAGED RECAPITALIZATION A.K.A. THE NEW EXIT

A formal definition: A leveraged recapitalization (recap) is a financial transaction (typically with a private equity group or PEG) that provides liquidity to existing shareholders while reconfiguring the capital structure of the companys balance sheet. In my words: A recap is the means by which baby boomers can gracefully exit their business, taking chips off the table, and transitioning out on their own terms. (Note: This type of transaction will typically be limited to businesses that earn at least $1 million in EBITDA. Exceptions may apply for exceptional businesses).

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A RECAP IS THE NEW EXIT.

This New Exit is actually not an exit in the traditional sense. It is a process that appeals to many of my baby boomer clients. It appeals to them because they are not ready to retire cold turkey. They are not ready to let the stock market define their money-making ability completely. They still have ideas for the business and things they wish to accomplish on a professional level. That being said, they are realists and know that they only have a finite amount of time on this earth. They are open to the concept of reducing their involvement in the business somewhat and taking some of their equity out at the same time. They would not mind having someone else worry about the day-to-day as long as they were able to still play a meaningful role. Many business owners approaching retirement have an outright fear that selling the business will leave them with nothing to do and that their active lifestyle will be replaced by a slow decline to the end of their productive life. A recap should not be viewed as a sale. It should be viewed as a recapitalization of the company (which is what it is). Your equity (or most of it) will be replaced by a private equity groups equity and your motivation to exit will be replaced by their motivation to grow. A recap can be a very positive thing for your employees,

your customers, and your legacy. At a time when you are starting to slow down, the business will get an injection of enthusiasm and money. The evolution of private equity has enabled business owners to reap legitimate financial rewards on transactions between $5 and $15 million that would not have been available ten years ago given the funding constraints discussed at the beginning of this chapter. Middle Market Private Equity Groups (PEGs) have effectively addressed the unique funding challenges of deals in this price range. We have over 700 PEGs in our database. This is a serious buying force, and those who understand and welcome this force will probably do very well. Lets look at the financial rewards of a recap. How can you sell a $10 million company for $15 million? You need to take two bites of the same apple. Let me explain. Lets assume your company is valued at $10 million and you sell it to a PEG using a recap transaction structure. I am going to ignore taxes in the following illustration. (Long-term capital gains taxes are currently 15 percent.) Here is what your deal might look like: `` You get $7 million in cash at settlement ($4 million of the buyers equity, $3 million borrowed from a bank); `` You hold a $1 million seller note (five-year note at 6

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percent interest); `` You roll $2 million of the purchase price as equity in the recapitalized company. You now have $7.0 million (pre-tax) in your pocket. Invest it well and enjoy it. You now get over $200 thousand a year in note payments for five years. You own 33 percent of the recapitalized company (they put up $4 million of equity, you put in $2 million) and you now get to run the business using their checkbook. This is not a typo; you will still be running the company for some period of time unless you have already developed the business to run without you. The only thing exiting the business at settlement is a big check representing 70 percent of the value of the business which is now in your personal bank account. Lets assume the business doubles in size over the next five years and sells to a larger company for $20 million. The company has paid off the bank debt and the note due to you out of operating cash flow and is sold debt free. You own 33 percent of the company and will receive 33 percent of the net proceeds, roughly $7 million. So how did you do? `` $7 million at sale #1 `` $1 million in note payments (ignoring interest) `` $7 million at sale #2

`` $15 million in total People look at this structure cynically. I hear arguments like: If Im going to run the company, I am going to own it. Thats fine. However, there are other things to consider. In the above mentioned scenario the owner may not have to stay actively involved for more than a transition period (especially if they have groomed their heir apparent). The better the management team, the less they are needed. I have had owners remain involved from between three months to three years. There is also the issue of estate planning. In the above mentioned scenario, there is peace of mind for the family. If the seller were to die in year two after settlement, his wife/heirs would continue to collect a note payment and continue to own 33 percent of the company without having to run it. Let me say that againwithout having to run it. There is nothing pretty about a widow or a group of inexperienced children burdened with having to run or sell a company that they know little about. In the recap scenario, they will have none of those worries and are also financially secure given the $7 million received at the first sale. Do not underestimate the implications of this paragraph. These points reflect the true beauty of selling the com-

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pany to a private equity group. Too often, I see situations where the owner can no longer perform at top speed due to health issues. A leveraged recapitalization allows an owner to lock in what they have earned, take chips off the table, and protect their loved ones against a potentially difficult situation. the dark side of a recap. If you have run your company like a small business, you will note a significant change after the transaction. Like any financial institution, the PEG will require financial reporting to assure them that their investment and the companys assets are being well managed and protected. Expect to have to provide audited financial statements, conduct monthly closings, and attend quarterly reviews. All of the above will be completely irrelevant if your product (your business) and your people deliver. If you run a sloppy operation and your organization has grown lazy, they will need to change, and they will probably not like it. A highly performing business acquired by a private equity group will feel little change. The most notable change should be a renewed desire to invest intelligently and to grow. Ive never seen an effective workforce (I have seen many, union and non-union) who didnt appreciate new business and recognize that their job was safer for it. Before we move too far ahead, lets also take a look at

My advice to business owners considering a recap is to take a hard look at the pros and cons with those closest to them. The pros tend to far outweigh the cons. The biggest argument business owners offer in objection to a recap is that they will, for the first time in a long time, have to report to someone on performance. (This will likely be a board controlled by the private equity group.) This is a weak argument. The vast majority of the people in the world count themselves lucky to have someone to report to at all. If youre good, the board wont bother you. If they do bother you, it will be to provide more resources to support your good work. If youre not, they have purchased the right to ask questions and expect results in line with what they thought they were buying. My last comment on this concept of The New Exit is that there is a personality fit to consider. I believe that the PEG you select to work with must be a good fit for your companys culture and for you personally. If your company is sufficiently qualified to be considered by one PEG, there are ten others that would look at you as well. Take some time to meet the people who run the PEG and see who will sit on your board. Ask to speak with other business owners who have sold to them and get their input. The worthy PEGs have solid track records and are happy to have you speak with business owners

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with whom they have been through similar transactions. These conversations will surely put you at ease if you are dealing with the right group. If not, look for another one that feels right. Ask each PEG specifically what their plans are for the company after the transaction and what role they would like you to play. They usually have a clear plan and they tend to stick with that plan unless you guide them in another direction. If you are worried about them laying off people, ask them. A recap is a transaction between two parties that will have an ongoing relationship. Set clear expectations early and make sure they do the same.

ther cant, or it is costly for them to do so. Here are the issues by profession: Accountant: This is the one advisor you speak to at least once per year. They know a lot about your business and your personal life. How often do you ask their advice on exit planning? Most people do not ask their accountant for advice in this area, and there is little incentive for an accountant to bring up the subject. Heres why: If you sell, they will probably lose you as a client (at least as a business client). Human nature and the desire for self-sustainment predicts that they ignore the subject. In your accountants defense, and assuming you are profitable, you can probably amass a larger fortune by running the company for another year, pocketing another years profits, and then selling it for a similar multiple next year. No argument. Unless you tell them: 1) You want out, or 2) Something is coming that you cant or dont want to handle, they will probably not bring the subject up. Attorney: Most attorneys know enough about M&A to discuss options with you. How many of you call your attorney and really ask for advice on planning issues? I only call mine when I have a problem. I have never called him and asked him to spend a few billable hours with me just pondering the future. I dont like spending money with my attorney any more than anyone else, and I like

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YOUR TEAMAND THE ADVISOR VOID

The following fact may not have occurred to you thus far: Some people do not want you to sell your company and will advise you against it. These people may be some of the same people who are currently in the best position to help you properly plan for the sale. However, their normal cycle of interaction with you, as well as the nature of their own self-interest, may keep them from bringing up the idea of selling as an option. I call this The Advisor Void. The fact is, none of your advisors are going to tell you what I am telling you in this book. The reality is they ei-

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the guy. Thus, your attorney will not tell you whats in this book because you dont give them a chance. Banker: A good banker will have seen a few deals in his or her time and can provide some guidance on the matter. However, you probably dont ask because youre afraid. You are afraid that they will pull your lines of credit if they get a sniff you are thinking of selling. Understandable, but not helpful in terms of exit planning.

$12 million to it via wire transfer from a settlement. Nice. M&A Advisor: I put the M&A Advisor last on the list since nobody knows who we are or what we do. The fact that privately held deals are not disclosed adds to that problem. Unless someones friend sells a business through us or we know one of their other advisors, they will not necessarily know we exist. All of the above come together to create a situation where highly talented business owners approach the largest financial transaction of their life with little or no idea of what to expect.

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already set up at least three rounds of golf (fishing, bowling, etc.) with you and different M&A Advisors. The only reason she hasnt done so is out of ignorance. Lets assess: `` You are already her client; management; `` Your biggest asset is likely your business. Wealth advisors are the most likely to benefit in the long term if you sell your company. Their odds of investing the proceeds of the sale increase dramatically if they play a role in the sale itself. There are wealth advisors who actually get this. I know a select few who do. The ones that do are the ones who have taken a relatively small account (say $250 thousand) and added a smooth

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Wealth Advisor: Your wealth advisor should have

`` She gets paid (in many cases) based on assets under

FILLING THE VOID

The only person who can fill this void is you. You are the one who needs to create your transition team. I cant tell you how many times I have been kept behind Door Number 1, the attorney behind Door Number 2, and the accountant behind Door Number 3. Certain owners, who like to keep things close to the vest, want to work with their advisors in isolation and arrive at their own, independent decisions. Not smart unless you have done this before. If youre five to ten years away from a possible transaction I suggest you start developing your team of professionals now. One way to begin is simply to get the above-mentioned advisors together for a review meeting at least once a

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year. I call this the Board of Advisors meeting.

we would also like to keep certain benefits like our car, etc. running through the company. The important part about this process is that all of these different advisors, with different disciplines and expertise, are all able to see your goals through their own lens. They can subsequently interface with each other on your behalf without any confusion regarding your desired outcome. Peer pressure plays a powerful role here. It is rare that

THE BOARD OF ADVISORS MEETING

Schedule a working lunch with your key advisors once per year. At the start of the meeting, you should be the first person to give a presentation. Clearly articulate your medium and long term goals, both personal and financial. Send the participants an outline of your goals before the meeting. Bullet points will work. Open the meeting with a statement like this:

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tion.

As you all know, Mary and I have a goal to be able to retire in five years. Ideally, we want our son, Bob, to take over the business. However, he may have other plans. As a fall back, we would like to have the business optimally positioned for sale two years before we want to retire (allowing for transition time). If we sell to the outside, we want top dollar, and the proceeds will go into trust for our children and their childrens educaIf Bob takes over, we would like him to be able to buy us out in the most tax effective way possible and we are willing to finance the transaction. We dont need much cash from the deal as we have done well over the years. We do want to have health insurance that covers us after the sale, and

an advisor is forced to perform in front of other advisors from other disciplines. It is usually just the advisor and the business owner, speaking in isolation. The last thing your accountant wants to do is to appear unprepared or clueless in front of an attorney, a banker, and an M&A professional who may know more about the subject than they do. A rising tide lifts all boats. These advisors will come prepared to offer suggestions and solutions. Once you have finished with your opening statements, give each advisor thirty minutes to talk about their interaction with your company in a pseudo Board of Directors meeting. Your banker can talk about suggestions he has to make your debt more efficient and what type of financial performance (defined in terms of financial ratios) will be required to support a new debt structure. Your attorney should provide an annual update on issues like buy-sell agreements, corporate minutes, etc.

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Let your accountants show what they have done to minimize your taxes. Your wealth advisors can provide guidance on both business and personal cash management and review the discussion with your personal financial goals in mind. An M&A advisor should be on hand to update the team on the value of the business in the current market, trends to consider, and to make sure all parties are in a position to respond to an unsolicited offer if one comes in. Caution: You need to control them. Certain advisors are

and follow through on that. Some things are worth more than a few billable hours. A powerful referral can provide positive income impact for years. A nice touch is to bring in five or six of your business owner friends to meet your advisor team at a social event (cocktail party). At the party, tell the guests what youre doing in terms of planning and how pleased you are with these folks and how it might be good for them to consider the same. (The advisors may actually hug you.) Caution your friends against assembling a team of strangers. Tell them, Why not use this group, they already work well together! Make your advisors work, but endear them to you, and they will get you through the bumps down the road. Everyone has a need to feel appreciated. Go out there and make your team feel special. I highly recommend starting this process at least five years in advance of a possible transition so that you can do some serious planning.

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snobs. An attorney might look down on an accountant. An accountant might look down on a banker. And, everybody looks down on the M&A advisor. One thing you can do up front is to make sure that each advisor understands your expectations and that they treat each other as equal professionals and members of a team. Dont let one party be pompous. If theyre not team players, replace them. By the way, this should be an annual freebiea cost of having you as a client. Lunch is on you, but their time is on them. In helping you achieve your goals, there is billable work for everyone in the room somewhere down the road. The more creative they are and the more ideas they generate, the more opportunity they have to generate worthwhile billable hours in the future. As an incentive to participate in this process, be sure to grease them. Promise them an unbelievable referral

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TRANSACTION TIME
While the hours spent at the Board of Advisors Meeting might be free, time spent on a live transaction will not. Lets consider the costs you should expect from each party and what specific roles they should play in completing a transaction:

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Accountant: Your accountants role will usually be limited to supporting your due diligence requirements, calculating net proceeds, and advising on tax matters. Attorney: Your attorney will get heavily involved once a letter of intent has been submitted by a buyer. I have seen attorneys fees range from $5 thousand to $75 thousand on transactions which would seem on the surface to be similar and comparable. While its true that complications like patents, intellectual property, pending lawsuits, and warranty claims can account for much of the variation from deal to deal, a primary expense driver is often the competence of the attorney. One ineffective or inexperienced attorney (on either side) will drive review time on both sides. The single best person to control your attorney costs is your attorney. Banker: Your banker is not going to charge you for

you an inseparable part of their sphere of influence and they will be sure to repay the favor. One more comment, banking is a relationship business. If you have developed a productive relationship with your banker and they move banks (like most do), move with them. They will appreciate the loyalty. You rarely need money when times are good. Make sure they remember who has stuck by them in their time of need when you show up with an ugly balance sheet and need money. M&A Advisor: M&A advisors exist to help people buy and sell companies, (In this book, we are just focusing on sell-side M&A advisors.) and they derive the majority of their income from success fees. However, most experienced M&A advisors require a retainer during the process. A word of caution regarding M&A advisor fees. Retainer fees charged by a reputable firm are not to be confused with paying an excessive amount up-front to a questionable firm. Check with your attorney and your accountant to find out who the most effective M&A people are in your industry and your area. Ignore the five hundred faxes and mailers you get per year and rely instead on referrals from people you trust. I suggest hiring an M&A firm on an open-ended con-

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hourly activity, but she plays a key role in funding a possible transaction. If you dont have a relationship with your banker, you should get one. This person will be very important in helping the buyer get money when it is hard to find. Start sharing information about your business with your banker (good, bad, and ugly) on a regular basis and bring them into the fold as a trusted advisor. Ask their opinion on key situations and try to get them as much business as possible refer them to friends and make them successful in any way you can. This makes

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tract that can be canceled by either party upon written notice. Pay them for their time to write the book (probably worth $2,500 to $5,000 if done well) and give them some retainer money along the way. Be wary of people willing to sell your business on a 100 percent contingency basis. It seems counterproductive to have someone working on your behalf so heavily compensated for their ability to get you to accept an offer. What happens if the offer is not a good one? Keep the relationship professional and let them feed

9 Hire Help or Do-it-Yourself (DIY)?

If help were free, I assume you would take it. Thus, cost is a primary driver in the decision to hire help. Lets look at your options and the related costs. I will start with the hire help options and then address the DIY scenario.

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their families while working on your windfall. Paying somebody even a modest retainer creates an obligation on their part. Any retainers you pay should be credited against success fees otherwise due at settlement when the deal is done.

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HIRING HELP: WHOS OUT THERE?

Investment Bankers: These are probably the most capable people in the field. Investment bankers are typically very well educated and will have lots of experience either personally or via other people at their firm. Their overhead structure is usually significant given the level of talented people they employee. They will typically limit their engagements to clients with at least $3 million in EBITDA, but most of their clients will be larger. Their fee structure will probably include a sizeable, up-front fee ($50 thousand+) and a sizeable monthly retainer. Their success fee (the part of the deal they will keep as commission) will be based on a Lehman formula.

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