Cashing Out – 5 Steps to a Better Deal

Many of you know I sold my agency a few years ago and in June went into semi-retirement.  As I tell people this they often pepper me with a bunch of questions on how they can get in on that game.   The most frequently asked questions I have received over the past few months are:

How do I get ready to sell my company?

What are the things I need to focus on to get the best deal possible?

Most of these tips offered below come from significant experience selling a few companies and participating in the due diligence for acquisitions or investment in numerous companies over the past fifteen years.

Why are companies acquired?
If we start our thinking by “why” companies are acquired – it is never out of the goodness of anyone’s heart – it is to fill some sort of purpose.  When we analyze the reasons for acquiring a company the steps you must take to prepare make a lot of sense.

There are essentially 2 reasons companies are acquired:

Growth & Market Share

Now is about the time that search companies will be acquired to help growth of larger digital companies or to move a well-funded mid-tier company into the top three.  The large holding companies are buying search companies for their revenue, client base or most recently, dominance in an overseas market.

I most cases, it is hard sourcing talent and building a book of case studies it is easier to just buy a local player and empower them to grow to the next level.

Competitive Advantage or Skills

This was popular a few years ago where big ad groups were buying mid-sized shops in order to have a search capability that allowed them to keep business or gain business over a key competitor.

For example, WPP bought Catalyst Online for their experience with pharmaceutical companies.  They were and are still the dominant pharma search agency and this fit in perfectly with Gray Healthcare and Ogilvy Healthworld since they have so much pharma & healthcare business. WPP bought GSI because we had the Fortune 100 clients and are the marekt leaders in enterprise and global search marketing.

Other acquisitions were around tools, Doubleclick buying Performics since they had great search tools that added that degree of technology and skills to Doubleclick’s portfolio.

Preparations & Due Diligence

In order to complete a deal you need to be able to successfully pass the painful due diligence process.  While the deal is the sexy part, the devil is in the details.  You may have the best team, tools and brand in the world but if you don’t add value to the acquiring company you will not be bought.  The following are the things you need to start thinking about NOW before you even get an inkling of a deal – the better you are prepared before the more leverage you have during and after the deal is done:.

Step 1 – Improve your Balance Sheet

The goal here is to maximize income and clearly demonstrate your future earnings potential.  The biggest suppose you will experience in the process is the valuation process.  With the exception of a killer technology that has a true competitive edge, company valuations are all done on the future value of the company based on performance today.  For example, you might be a two-person company that is on a roll winning business and on your way to be a 100 million dollar company – you will not be paid for your potential.  You will be paid for today with a glide path of potential.  If you are doing $1 million today and you can demonstrate that with the right investment and management team you could do $5 million next year etc – you will only be paid for what is realistic growth today.  IF you are really bullish about your performance you will walk right into the “earn out trap” where you will then take the risk on your potential and not the investors.

As the owner you need to understand the balance sheet and what it is telling you and most importantly, what it is telling others.

Maximize the income side of the Balance Sheet

  • Make sure current clients STAY current clients – hold on to them for dear life – if you have a bunch of short-term clients they will dig into your turnover and be concerned that you will always be cranking for new business.
  • Increase the diversity of your client base – if you are a one trick pony meaning one big client with 80% of your revenue or only have Technology or Consumer Product companies that will be a growth concern.  Try to get some diversification of the size and categories of clients.
  • Increase size and duration of the relationship & sole source – Many small agencies don’t understand the true value of an agency of record agreement.  It is s guarantee that you have the work as long as you maintain the status.  Every brand that needs search work will have to use you.  Unraveling AOR’s are hard and many companies don’t want to change vendors that is why they often have poorly managed programs.  Again, this not quite money on the bank but it is a great indicator to an investor that you have a reasonable degree of potential of defending existing, getting additional revenues from your clients.
  • Increase “Contractually Recurring Revenue” – this is money in the bank.  In most cases you can actually get a loan against this revenue.  The client has agreed in contract to a ongoing retainer or a fixed set of fees over time.  Investors like this since it is believable revenue.  If you have a bunch of accounts not under contract then that revenue can do away without anything you can do.
  • Drop low margin and/or low prestige clients – are you crazy – fire a client?  Yes, if they are a drain on resources, not paying on time and do not add either revenue or brand prestige to your company – you may need to cut them loose.  I have never had a problem firing a client that was a drain on resources.  However, even if they are small and pay their bills and are easy to work with then keep them and work with them to grow.
  • Increase the Expense to Revenue Ratio for key staff – this is a tough one –agency holding companies pretty much mandate a 3.5 to 1 ration of employee expense to revenue.  This is a big problem for search.  Due to the lack of skilled talent many agencies overpay for key talent.  For example, if you are playing that SEO stud $100k per year plus another 30% in overhead then they need to be billed out at a rate that generates $455k in revenue.  If you have 5 of those talented individuals you need to be pulling in $2.7 million in revenue to have an EtoR ratio that will be appealing to an agency group.

Reduce the expense and liabilities side of the Balance Sheet

  • Demonstrate fiscal controls & audits – if you manage your business from a shoe box or a desk drawer you are in for a surprise.  Make sure you have a bookkeeper and/or an account keeping tabs on things.  With all of the free and inexpensive accounting tools like Quickbooks online it is silly to not have good sound accounting practices – or at least in an editable format.   One of the top 5 questions you will be asked is what are your receivables? If you don’t’ know that the accounts will really be digging in and question your ability to manage a business.
  • Evaluate office space expense – This seems simple but if you have expensive space because you wanted to look bigger or wanted to work on the beach they will evaluate this.  If you have excess space consider subletting it or letting some part timers pay a discounted rate to use it for meetings.
  • Business Liabilities – If you funded your business with 20 credit cards or a personal line of credit you need to start cleaning that up.  While credit is tight now you need to start getting business credit and looking at all of that you do have.  You will have to present any liability you have related to the business – make sure you have a good handle on employee charge cards since they are hard to manage.
  • Evaluate overhead payments – any expenses – you want this side to be as clean as possible.
  • Review payment terms – This is a big one – what are the terms?  Do you have them? Do you enforce them? I have had a few F100 companies recently approach one of my investment companies wanting 90 days payment terms.  You will be lucky to get anything less than net 45 or 60 with most large companies but monitor this.  Finding a half million in labor costs can be risky and expensive if you don’t have the cash flow.

If you have an audited balance sheet that will be very helpful since it will cut out a lot of the document gathering since you will already have organized it to pass the audits.

Step 2 – Intellectual Property Protection

This is a big one and one that frustrates me that more companies don’t take the time to protect their intellectual property.  Two companies I invested in recently had key technology that was not protected.  Yes, it can be expensive but it then becomes an asset since you have rights to it.  This is critical if you are being bought due to some competitive advantage you have with technology.  For Social Media companies, most of what you do is new to the marketplace and needs to be protected.

Document Intellectual Property

  • Get Trademarks and/or Patents where applicable – these become assets that will come into play in the negotiations.  You can’t protect everything but if you have a new tool or a process or terminology get it protected.  The sooner you start the quicker you have the date you put it into play.   Ensure you have at lease protected your brand name.
  • Publish articles, manuals or books detailing methodology – you don’t have to give away the farm but using your words or process in trade is a poor mans way of some protection. If you can demonstrate you were doing something publicly that will be in your favor.  This is not in any way a substitute for proper protection but it is better than nothing.
  • Detail typical engagement methodology – this is an internal document that an attorney can review to see if there are any attributes that can be protected.  It also gives the acquiring company a lens into the process and that you have developed something tangible.

Demonstrate “Technology Advantages”

  • Proprietary technology vs. “me to” – so what – you’re a search agency and you use Google’s interface to mange it.  At that point you are just a labor force.  However, if you have some uber secret process, tool or methodology that separates you from another company you have an asset that has value beyond your revenue.
  • Key Relationships with vendors – any kind of relationship is an asset.  Overture Ambassador Program, Advisory Boards and any organizations you have board seats.  All of these a are assets to the company.  They may not factor into the final deal but they are all ways to help the acquiring company feel they are getting something that is a force to be reckoned with in the market.

Secure Current Employees & New Talent

  • Employment contracts & Non-competes –  These are critical. If key talent don’t have them now they will in the deal.  Having contracts protects your ass and assets and is a great way to demonstrate you can manage your team.  Other than company principals, it is unlikely you will be able to do non-competes.  If you are given then please review carefully and ensure that you are willing to give up your mode of income if it does not work out.
  • Equity shares – Have a detailed list of who had equity, the type and the terms. This is a great way to motivate employees.  For some, it may make sense to vest upon the deal for others they may have to wait as well.  There should not be any surprises with expectations since this will come out in the process.   Any partner or employee that has them must be disclosed and if you don’t have agreements today you must get them in place before the deal.  Once the deal is done they will be the shareholder and it is nearly impossible to get them out of the pool once the deal is done.
  • Line up key talent and tie them to the deal – if you need key talent before you can go to the next level try to tie them into the deal.  Make a note of them since you will be asked how the business can scale post deal.

Step 3 – Prepare for Due Diligence

This phase is all about proving your value and showing them the beef.  Prepare for a lot of sleepless nights, lots of paper pushing, photocopying and other nonsense.  When you are done you will feel like you are running for office or the investors have zero trust in you.  They are doing this to protect their investment just like you should do if you acquire a company.  Do not lie during this process and if you find mistakes be ready to explain them.  Now, if you told them you did $10 million in business and that was all media dollars and you only actually had net revenue of $1 million they will see that pretty easy.  I have seen that a number of times with false claims.

The good news is that if you had any problems with accounting or money management they will be fixed after this.  You will have a great set of financials and process that should be able to take to nearly any bank and get a loan f the business is healthy.

  • Gather all pertinent documents – when I did this process with GSI we ended up with ten large 3” binders full of documents.  We had to show every current contract, every invoice, purchase order and every major expense and liability.  They will want rental and lease agreements, credit card statements and any other document that shows the fiscal health of the organization.
  • Check & Recheck Financial Statements and other key documents – make sure they are right.  If you have a contact that you gave Net 30 terms and now they are on a verbal Net 60 – that needs to be updates.  In one company we thought of buying they had nearly $2 million in receivables that had not been paid but showed them as being paid.  It was a pain for them to collect that money nearly nine months after they billed the client.
  • Understand Financial Ratios – hopefully you are managing your business with sound financial data.  They will be looking at a number of financial ratios related to turnover, profitability, staff ratios etc.  They will use these to help set the valuation and earn out schedules.
  • Update and Improve your business plan – Start with the question – is it believable? Yes, I know you have the next Pets.com or Google on your hands but you also need to be realistic.  They want to know how you will grow the business once you are partners.
  • Get your stories straight with management team – review the documents with your key team.  Even if you can’t cant stand them and hope they leave post deal you need them to be a team now.  Don’t’ create lies but at least understand financial controls, client relationships, market potential and most importantly business direction.
  • Detail all assets – physical and intellectual – this is easy to understand – the more you have the more that can be valued.  Detail equipment as well as all of the IP and tools you have.
  • Conduct a detailed SWOT Analysis – this would be helpful to prove your business plan and to help them understand the landscape of the market and where you fit into it.  This is critical with social media companies since there have not been a lot of acquisitions in this area.

Step 4 – What’s in it for Me?

Understand what you want out of the deal

  • Why do you want to sell? — if you are selling for money to grow you will find that complicated. The money they are giving you is for your share of the company and they will take the revenue from that share they bought.  Don’t expect them to throw in other money to grow nor will you get anything from your reinvestment of your payment.  There is typically not a “funding” provision so understand how you will find growth.  If you want money to grow get a capital infusion not an acquisition.  If you are selling since you have problems with the business or want the advantages the new parent offer then you must understand that when you do the deal.
  • Retiring to the beach is not an option – most of the deals being done have earn out conditions.  Unless they bought a tool or other asset you are there for the duration.  If you are the face of the company or the money maker – you are the asset and you really need to start thinking about how you rope in others into that role so you can depart.
  • What is your “Control Premium” – What is the price for loss of control?  You need to think about the money you will get for the company will be worth the additional control and management structure put on you.
  • How long do you think you can work for the new owners? – this is the big one.  Sort of like the prenup question – honey of you love me you won’t think about us ending.  Yea right…  If you can find the perfect partner then great.  I know many that have stayed after the earn out but if you are not in sync you need to think about the pain point.

Seriously weigh cash vs. equity

  • You can “believe in the business” and still take cash – that is my firm belief.  In my earlier accusations I was only offered stock. When I challenged this form of payment I was told that I must not believe in the future of the company since I wanted cash.  I don’t make that mistake any more.
  • Completely understand expectations – what are they expecting from you and your company in terns of revenue, markets or other opportunities.  The more this can be made clear the fewer hassles you will have later.

Get everything in writing

  • Document all agreements – If they won’t sign it now they won’t sign it in 2 years – “Mutual Understandings” are worthless unless contracted on paper signed by both parties.  I typically make a list of my wishes and wants and go through and confirm they are all included.
  • Don’t use friends and family – for any of the paperwork unless they were an investor and part of the deal keep them separate. If uncle Jimmy is a CPA don’t use him.  If there are problems with the deal you need someone to blame and that may not set well at holiday time that he made a mistake or you lost money since he did not understand the finance of M&A.
  • Spend the money on experience – Get everything reviewed by experienced and competent Lawyers & CPAs.  Much of the due diligence expense is born by the acquiring company with their teams.  However, you need help with the finances and especially legal.  You need someone with real experience.  The lawyer we used was brilliant and was a key part of the team.  In fact, to help reduce the costs of legal fees on contracts etc. early on we gave him an equity share of the business which made him fight even harder for us in the deal.  You will also need a personal attorney to review your non-compete and other legal documents since if your business attorney is a shareholder you cannot have him review your employment agreements.

Step 5 – Prepare for Change & New Rules

Management

Taking orders from others

  • Receiving “no” for an answer – a lot! – you were the boss and now you are an employee. In many cases that is great, you get to execute and not worry about all the logistical details but it hurts a bit when you need executive approval for a $50 wireless card when a few weeks before you were approving $50k server expansions.
  • Falling into guidelines for their business – this is the one that hurts fast moving companies – we pay for talent.  If we promote a person and that job warrants a $10k bump in pay may be a problem.  I had an experience where raises were only possible 2x’s a year and any raise could not be greater than 20% of their current salary no matter if they could suddenly walk on water.
  • Understand ROI Goals and Timelines – this is the surprise you will encounter.  There is nothing like having a doubling in revenue and profit and having to hum for another business unit that is floundering.  While it is good to take one for the team you need to understand what the rules are.  Also, don’t expect a lot of exceptions for being a new acquisition – you will have to fight like the rest.

Integration & Compliance

  • Equipment & Systems – this one will drive you insane.  As you start to think about acquisition you need to factor that into any technology purchases.  It does not make sense to go buy all new servers to find the acquiring company will force you to sue something else.
  • SOX & Accounting Compliance – back to the accounting.  You will need to develop reports that roll up into the parent.  Twice this has been a full time head count just to do the integration and translation of documents.  Just wait until you have to become SOX complaint if you are acquired by a public company.  You can bank on $50k to $100k to get the needed systems and do the migrations and audits to pass the audits that will come.

While there is a lot to do, when done right it is easier and the rewards are greater.  There is much more to this but this will get you started and thinking.  If you exit strategy is acquisition then the sooner you have your ducks in a line the better you will be when that times comes.

Any other tips?

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