Cashing Out (web exclusive content)

High rollers may be targeting your business. Are you prepared to deal?

Drew Ermenc

November 14, 2007

It was time to sell, and Matt Prather knew it. As a founder and principal in Compass Telecom, an Atlanta company focusing on wireless infrastructure and PCS (personal communication services), he was suffering from the post-bubble telecom downturn in 2002.

Prather had founded the company with his two partners, J.C. Massey and Geoff Eggers in 1997, and had ridden a wave of prosperous growth on the "e-bubble." By its third birthday, the company had sales of $28 million in gross revenue, a 40 percent net margin rate and 16 different unsolicited offers on the table for their start-up, including a "very large" Fortune 100 company.

"We were knocking it out of the park," Prather recalls. "We had been approached in 1999 [about selling the business], but we found we wanted to do the Home Depot method and ‘do it ourselves.' Then we found ourselves in a big mess. We finally realized we needed to hire someone who could lead us through the process."

Prather and his partners chose to hire two brokers to sift through theoffers in 2000, and settled on the Fortune 100 suitor. But three weeks away from closing the deal, the buyer walked away from the table, citing concerns in the bloated telecom industry. As history would soon tell, the undisclosed company was dead on, and the tech bubble burst. By the summer of 2002, Compass – like many others in the industry – was suffering.

"Telecom went down in the tank and we followed it," Prather recalls. "We needed help in a downward trending market. We couldn't survive as a small fish anymore." Help finally came in the fourth quarter of that year, when Los Angeles-based Somera Communications made an offer to buy Compass for $10 million cash.

Finding the right time to sell a business is a challenging decision in itself, but determining the best suitor can be a monumental, time-consuming task. For Prather and partners, their story continues on a happier note, as Somera offered them the opportunity to purchase back their company only 13 months later, at a significant discount.

But for most entrepreneurs and business owners, a second chance to find that right deal is rare. Whether it's a strategic sale to a competitor or a transaction with a growing number of private equity groups, you have to do your homework if there's an itch to sell.

The increasing number of mergers and acquisitions may be enticing business owners to reevaluate their exit strategy. According to a Robert W. Baird Mergers & Acquisitions analysis report released in July, announced worldwide transactions topped $2,241 trillion in the first six months of 2007, an increase of 55.7 percent over the first half of 2006. This amount exceeds the total annual figures in 2001, 2002 and 2003.

Various factors are contributing to the overall growth in private equity investments. Despite the housing slump, the economy is still growing. There's an increase in corporate profits and cash flow. And the stock market is producing lesser returns that investors are used to, thus a shift in moneys to private equity groups, where capital fundraising is at an all-time high.

"There's a search for higher rates of return on [investors'] money," says Stuart Johnson, partner with law firm Powell Goldstein LLC and co-chair of its private equity practice team. "The place where there's been higher rates of returns on their money is private equity. Private equity groups have received a larger percentage of institutional investment over the last five to 10 years because it has higher returns. You've seen them raise larger and larger funds because their track record is good. It used to be a sleepy little part of the financial investment landscape."

Not anymore. Now a new crop of Wall Street elite, complete with the "Masters of the Universe" moniker dubbed by a business media recently enamored with this secretive group, has gobbled up high-profile companies in the past few years, including well-known brand names like Harrah's Entertainment, Chrysler and Hertz. In some cases, like Harrah's, multiple private equity groups tag team the deal to insure enough capital can be tapped for the purchase.

With a well-publicized credit crunch, reports of frenzied investors with buyer's remorse and dot-com bubble flashbacks have been hovering all summer. But it's hardly affecting the lower end of the market. Rick Cravey, a managing director in the Atlanta office of MCG Capital, a private equity group that focuses on investing in small- and medium-sized businesses, is bullish on acquiring additional companies for his portfolio, regardless of the sub-prime mortgage trickle down occurring across the country.

"I don't think it's affected our deal flow," he says. "The credit crunch has predominantly affected the bigger end of the market. And as it relates to the size transaction that we're working on – [businesses with a] sub-$250 million enterprise value or below – we're not really relying on the syndicated bank market. At the end of our market, it's still primarily and always has been sort of a club market where you find three to five banks that fill out that senior syndication. It's had a negligible effect in terms of actual deal flow."

With a few noticeable exceptions, Atlanta and the Southeast is a middle-market business community, with mostly $20 million to $500-million enterprise value companies here. Johnson believes there are Atlanta-based, middle-market businesses that are ripe for the picking.

"Most of these companies tend to be old economy-type businesses; distribution, manufacturing," he says. "Generally these types of businesses tend to be closely held private companies. The owners are aging. Typically, you might find a 60-year-old owner with a $50 million enterprise business, yet the vast majority of value is in the business itself." Johnson also has witnessed a growing number of private equity groups opening offices in Atlanta. "There's a lot of capital out there and there's a lot of opportunities for this capital to be deployed in this market."

And private equity execs like Cravey, who just opened his Atlanta office this summer, are watching and waiting for their next big deal. If a potential buyer comes knocking on your door, here are a few tips you need to know before sitting down at the bargaining table:

Understand your options

Do you have an exit strategy for your business? If so, is selling your company going to match your goals. Prather remembers watching his entrepreneurial father ride the ebbs and flows of his industry's business cycle, and grew up thinking that's all part of owning a business. "I was wrong," he says. "You get into a business so you can get out."

Write down the reasons you are interested in a financial partner. Are you looking for an injection of capital to take your business to the next level?

Or are you ready to gain liquidity, semi-retire and take only a portion of your chips off the table? Answering these questions will determine what type of transaction you want to pursue. Different deals will suit your situation, and a wide range of private equity and financial partners will offer different levels of expertise and capital.

In transactions that will involve a future business partnership, Johnson stresses the importance of chemistry within the team. "You really need to be comfortable with who your partners are," he says. "You're relying on them to help you grow and expand this business. There are others where there is a lousy match and the dynamics haven't been what people had hoped for. It's like a bad marriage."

Barry Davison purchased LMS Intellibound in 1998, and during a nine-year period, he grew the logistical staffing company's sales by more than 1,500 percent. The company became an attractive option to a number of buyers, and Davison found himself responding to solicitations for his growing company. His mind was made up as to what kind of buyer he was comfortable with selling.

"I knew I was going to go private equity," he says. "If you go with a strategic buyer, you have to open up yourself to go through the due diligence process. If it didn't work out, that's all out there. And there weren't many strategic buyers that could put the deal together that would be attractive for me."

Davison admits he was ready to get out of his business and move on to different things, and a particular deal offered by private equity group MCG Capital appeared to be right. "I was looking to diversify my risk," he says. "I had all of my eggs in one basket. With the deal, it clearly opened up the road for me to depart fully, and that was attractive to me."

Engage the experts

Davison believes the value of engaging experts' opinions is essential. "From accountants to lawyers, pick advisors that have done this," he says. "If you surround yourself with people that have done deals, you'll get a deal done,"

He argues that often times, because of the emotional capital invested in the business, owners may have excessive demands. An expert can temper those emotions. "A lot of entrepreneurs have huge egos, and if they don't have someone across the table telling them they can't do this, then they miss the window," Davison says. "They have unreasonable expectations."

Cravey agrees. "Do the best you can to educate yourself and have realistic expectations on how the process is going to work," he says. "There's a lot of work that goes into a transaction and can take awhile to get done. At least talk to others that have gone through this."

Johnson urges all business owners to invest in an expert when deciding to sell. "Hire an investment banker. The banker can help validate the value of your business and he can create a competitive situation for selling the business." A banker also will put together a market analysis including financials and operational figures and present the report to private equity groups. Often times, if the company shows potential, it will create a competition that may ultimately lead to a bidding war.

Gregg Yorkison, managing partner for CYG, an investment banking firm that works exclusively with small- and mid-sized businesses, says, "We work with the client side-by-side until the money moves. We do that because there are too many reasons for the deal to go sideways. Things always happen and we know where the potential for these things to be are. You have to get in front of the problems that come with these deals."

And planning ahead, Davison believes, will help business owners maximize their value. "If [the business owner] just sat down with professionals before they got ever got started and said, ‘ Okay, I'm not going to sell today, but maybe two years from now. Give me advice on what I need to do.'"
   
Keep your business running

"Don't get distracted," Johnson says. "[Business owners] end up talking to investment bankers and they all need information. Remember, the deal isn't done until it's done. Keep an eye on the operational aspects throughout the process and continue to operate until it's sold."

Davison had prepared for the eventual sale of the company by stepping away from the day-to-day operations, putting a heavier emphasis on his management team. "I always wanted the company to be LMS Intellibound, not Barry Davison's company. I wanted to disassociate my name as much as possible and have its culture be professional enough to stand on its own two feet. When it came time to be purchased, it was attractive as a company and not because of the owner."

Yorkison cites an example of a seller so preoccupied by the potential sale that the numbers began trending downward. The buyer took notice and lowered its offer. "The distraction alone of trying to manage the deal can hurt your business," Yorkison says. "By the start of the transaction, one or two percent of your week should be devoted to the deal. By the end, it should be up to fifty percent of your week."

Another operational hazard while negotiating a sale during is controlling the message. "The worst thing that can happen is that you're having these discussions and your employees or customers get word of it. You haven't proactively determined how they're getting that information," Johnson says. "Nine times out of 10, people take [the possibility of a sale] as a negative, and they're afraid of the result."

Balance sheet basics

"Privately held businesses have ‘stuff' on the balance sheet: country club memberships, airplanes, nice car. You need to clean all that stuff up before you start the process," Johnson says. "Private equity-based folks can discount the value of the company because you're running all these things through the business."

With selling his business as his long-term goal, Davison wanted his staffing company to be as clean as possible. "I ran it as a business, not as a personal checkbook," he says. "I was externally audited. Everything was very well documented and professional. Early on, I made the decision to make those investments knowing later that they would pay off."

Most middle-market business owners are intricately involved with their financials, and articulating your strong business points and forecasts also will help in the sale process. "You've got to have a scorecard that shows how you're running the business," Davison explains. "Do you know your competitive advantage, an advantage that [buyers] would be willing to pay more for? Keep your numbers out there all the time. If you keep your books tidy and accurate, that's worth a lot of money. We were fiscally responsible and knowledgeable and [the buyers] were very impressed. If you say you're worth X amount, you have to prove that worth. How can you be an attractive target if you don't have the information that says you're making money?"

Web exclusive - Selling Your Company 101

There are generally two kinds of buyers: strategic and private equity. Strategic buyers are companies looking to expand through acquisition and a strategic growth plan, much like what FedEx did by purchasing Kinko's in 2004. Private equity buyers, on the other hand, are looking to invest in a company with the hopes of exiting at a certain point in time to make a sizable return.

A private equity deal can be constructed in many fashions, but one of the more common choices is a complete sale of the company. "In this situation, the seller's goal is primarily to maximize value because there's not going to be involved going forward," says Stuart Johnson, a partner with law firm Powell Goldstein LLC and co-chair of its private equity practice team. "The owner must be comfortable with the deal, because once it's complete, there's no turning back. Make sure you're comfortable with the kinds of consideration you're receiving. Cash is the best. There's no way for cash to be renegotiated post-close.  If you're taking a note obligation or earn-out obligation, you need to make sure you're comfortable with how it's structured and characterized and your entitlement to that post-close."

Recapitalization deals are different in that the owner will remain a part of the company. Often times, the owner is looking for an investor to help take the business to the next stage, says Johnson, "You sell a portion of the business and you carry an interest in the business going forward. You gain liquidity and you're basically taking some of your chips off the table. The most likely reason in that situation is someone has been able to grow the business to a certain level. Either they don't want to put themselves financially risk or they don't have the operational expertise; they're sort of stuck at that level. The financial partner allows them to execute on a plan bigger than what they can do, an injection of capital. Some goes into the entrepreneurs pocket and some goes into growing into the next stage."

The financial investor usually has a solid pitch for the business owner in these transactions, Johnson. "‘You have two bites at the apple here. You take some money off and give the first time we grow this business, and then you have another opportunity and in many cases it will be bigger than the first one.' "

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