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Wednesday, April 26, 2017

Lesson #264: Financing Mergers & Acquisitions

Posted By: George Deeb - 4/26/2017

We have previously talked about How to Set Your Mergers & Acquisitions Goals .  But, once those goals have been set, and targets hav...



We have previously talked about How to Set Your Mergers & Acquisitions Goals.  But, once those goals have been set, and targets have been identified, how exactly do you fund those transactions?  As you will read, financing M&A activity is very different than funding stand-alone growth with venture capital, as the investors are largely very different--mostly banks, private equity firms and family offices, instead of venture capital firms.  This post will help you better learn your M&A financing options.

EQUITY ONLY--NO CASH NEEDED

M&A activity doesn't always mean that cash needs to trade hands.  Sometimes you can implement a merger by basically using your equity as a currency, and negotiating a pro rata stake in the combined company.  For example, if you have two equal sized businesses both valued at about the same valuation stand-alone,  you can merge the companies together and your original shareholders would own 50% of Newco and the other company's shareholders would own the other 50% of Newco.  If they are not the same size, use a metric like relative revenues or relative EBITDA and set the relative ownership that way (e.g., if one business generates 75% of the combined profits day one, they could own 75% of the combined equity in Newco).

CASH ON HAND OR COMPANY PROFITS

If cash is needed, maybe your business has cash on its balance sheet or it is generating material profits, and you can fund your M&A activity that way, with no outside capital.  Since companies are typically valued as a multiple of EBITDA,  you may need to save up a few years of profits, in order to afford the other company you are trying to buy, if they are the same size as you.

SELLER NOTES

The easiest way to finance an M&A transaction is to have the seller agree to not take all of their cash up front.  As an example, maybe you pay them 80% at closing, and  you pay them 20% in a seller note a year or two down the road.  Any seller that has confidence in their business, should be willing to agree to at least a small amount of seller note to help you afford the upfront transaction.

SELLER EQUITY

In many scenarios, having the seller involved with the future of Newco can be very helpful.  Maybe you don't know their industry very well?  Or, they bring some specific skillset to the table, and they would enjoy keeping part ownership and future involvement in "their baby".  That helps them to get some upfront liquidity by selling a large portion of their ownership, but at the same time, let's them participate in the long term growth that is created, as a minority shareholder.  So, as an example, if you give the seller a 10% stake in Newco, you only need to fund the 90% of the company's valuation upfront.

BANKS & SBA BACKED LOANS

Banks are often the first call for funding M&A.  But, with banks, there are several hurdles you need to get through.  They need to like the industry, the team, the historical cash flow trends, the underlying assets of the business they can secure, the financial covenants, etc.  And, the more cash flow you have as a combined company, the higher odds a bank with lend to  you.  There are some banks that will lend to companies as small as $500K of cash flow, but the vast majority don't really get excited until you are generating $2-$3MM in cash flow.  So, look for targets that can help you get to that threshold, to simplify your M&A fund raising efforts.  And, keep in mind, bank finance will be the most senior loan in your capitalization table, and banks will need to be repaid within a couple years (and will be senior to any other note holders, including the seller note above).  So, plan accordingly.

In addition, the banks are often conduits to loans backed by the Small Business Association, where they will lend up to 90% of the transaction.  But, the price is steep with the mandatory personal guarantees that will be required, putting you personally on the hook for any defaults by the company.  Personal guarantees can often be avoided in typical bank loans for companies generating enough annual cash flow, so only go down the SBA-backed road if it is your only option.

PRIVATE EQUITY FIRMS

The lion's share of the capital needed for M&A will most likely come from private equity firms or family offices, likes these linked examples in Chicago.  There is a shortage of really good companies for sale, and these investment companies are more than willing to back good teams building good ideas, assuming the combined company is generating a lot of cash flow (which they can take to the banks and finance a portion of the deal with debt, to reduce their equity investment need).  Again, because they are looking to the banks for help, they too will bias companies with over $2-$3MM of combined cash flow (although many will look at deals smaller than this, if only investing equity).  Before you reach out to PE firms, make sure to research if they like to invest in deals within your industry and revenue stage on their websites.

EXAMPLE DEAL

So, let's put this all together in an example deal.  Let's say you found an ecommerce company to buy, that is generating $2MM in cash flow.  Assuming that company is growing 20% a year, it could be worth 5x cash flow, or $10MM.  You think it is important to keep the founder involved, and you are willing to have him take a 10% stake in Newco, so you really only need to finance $9MM to buy the 90% stake.  That could be funded $3MM by a private equity firm, $3MM by a bank and $3MM by a seller note (if amenable to the seller).  And, the private equity firm would most likely want you to have some "skin in the game", so maybe their portion is split $300K from you and $2.7MM from them.  Ninety days and lots of negotiations later, you should be ready to close.  This is an example only, as the multiples, amounts and percentages can vary substantially by deal, company, growth rate and industry.

Hopefully, you are now ready to put on your M&A hats, and get that transaction funded.  But, don't forget about all the potential M&A pitfalls along the way, as we have discussed in the past.  At all times, buyer beware, and exercise conservative caution throughout each step of the process.

For future posts, please follow me on Twitter at: @georgedeeb.



Monday, April 17, 2017

Lesson #263: Having Laser-Focus Increases Odds of Success

Posted By: George Deeb - 4/17/2017

Do you remember the scene during the credits of the movie Forrest Gump , where the feather was floating through the sky, being carried i...



Do you remember the scene during the credits of the movie Forrest Gump, where the feather was floating through the sky, being carried in whatever direction the wind would take it?  That is a perfect visual of what not to do, when trying to build a business.  Business success requires an almost religious level of focus on the goal at hand, and not letting the whims or pet projects of our customers, investors or employees blow us in different directions.  The entrepreneur that can keep the team focused, and not easily distracted, is the one that will most likely and successfully get to the finish line.

WHAT IS FOCUS—A PERSONAL CASE STUDY

The best way to define focus, is to give you a personal example of what focus is not.  Yes, even yours truly has fallen victim to a loss of focus during the early days of my executive career.  And, this example from my iExplore days will pound home the point.  iExplore was a consumer portal to research and purchase adventure tours, where our primary strength was consumer marketing online, relying on ground operator partners to run the trips.  But, in our early days, we got lured into the corporate incentive travel business by one of our customers.  The idea of selling 100 passengers per booking, instead of 2 passengers per booking, sounded like it was worth it, to a startup trying to scale its business.

But, in chasing that business, we quickly learned that the corporate incentive business is driven by a B2B sales team, not consumer marketers (and we didn’t have the right team with meeting planner relationships to be successful).  And, the skillsets required for customer success, were a lot more than marketing; we need professional event planners and boots on the ground to be really successful.  And, that just wasn’t our consumer model (since we didn’t actually have to run the trips ourselves).

Attempting to get into the corporate incentive business for iExplore, was the equivalent of me leading the team down a rabbit hole.  That “flavor of the month” looked like a good move, based on the financial upside of a business like that, but without the right sales and operations team involved, it was simply a fool’s errand.  Which ultimately distracted us from focusing on continued success in our consumer business.  So, the point here:  don’t let your “flavor of the month” lead you down any rabbit holes, as those rarely bear fruit long term.

DON’T CONFUSE FOCUS WITH BEING STUBBORN—CASE STUDY PART 2

Continuing with another story from iExplore, there was a major pivot point in our history, when iExplore began to sell advertising on our website.  I really wanted to stay focused on being a travel revenue business only, as I thought the ads were going to clutter up the site and hurt the user experience.  But, my fellow executives passionately made their case to do a small advertising test on our website.  And, the result was a  new found revenue stream and a 75% profit margin business that far exceeded the 10% profits margins we were getting from our travel revenues.

The point here was, had I stay solely focused on being a good travel business, we would have missed an even bigger opportunity to evolve the business into a big travel media business.  Once we learned that 30% of our revenues were driving 75% of our bottom line profits, the team shifted directions on what we saw as the future of our business success.

YOU CAN ONLY BUILD ONE BUSINESS AT A TIME—CASE STUDY PART 3

Once iExplore made the decision we were shifting our focus to being a media business, from a travel business, that changed everything from a website design perspective.  And, that ruffled a lot of feathers internally from our travel department, that thought that the media business was actually hurting the company.  There was a constant tug-of-war between the travel business and media business fighting from prominence and positioning on the web pages, as what was good for one, was bad for the other.

I actually thought having the two business lines fighting with each other would create a good balance on the website, in terms of not letting the user experience get too gummed down by too many ads on the page.  But, what I should have done, was pulled the plug on the travel business altogether, and let the high margin media business drive the train.  The media business required less people to build, drove 3x the profitability and was very sticky with a high level of repeat clients.  Hindsight is 20/20, but we should have had better focus on that one business line to truly maximize our success.
But, it was a scary thing to do, exiting the core of the business of which the company was founded.  Don’t be scared to make the right business decision, even if it means killing your sacred cows.

DEFINING THE GOALS TO FOCUS ON

In order to define the key business goals that the management team needs to focus on, that requires a more formal strategic business planning process.  And, most entrepreneurs don’t know how, or don’t take the time, to run that process.  Here is a link to how to run a strategic planning process like this.  Even if you do it in an abbreviated fashion, taking the time to define your strategic plan, will make sure the voices of all stakeholders are heard and ensure you are truly focused on the right objectives to maximize success for your business long term.

KEEPING THE TEAM FOCUSED ON THOSE GOALS

And, once the plan is set, your job as the CEO is to make sure your entire management team is staying focused on hitting those goals and not running down any new rabbit holes that come along over time.  At least until your next strategic planning process, where all new ideas can be considered at that time.  You can’t have your CFO building a sedan, your COO building a minivan and your CTO building an SUV, when you all agreed during the planning process you were going to build a luxury coupe. Focus, focus, more focus, will help you achieve your business goals a lot faster.

For future posts, please follow me on Twitter at: @georgedeeb.



Friday, April 7, 2017

The Art of the Follow-Up

Posted By: George Deeb - 4/07/2017

Given how important good selling techniques are to driving revenues, I am shocked how many entrepreneurs and salespeople are just bad at...



Given how important good selling techniques are to driving revenues, I am shocked how many entrepreneurs and salespeople are just bad at working their leads. This includes things like not following up on leads (or following up too much) and not knowing how to break down barriers, to get the lead to actually listen to your pitch. This post will help you become a master at properly working your sales prospects.

Read the rest of this post in Entrepreneur, which I guest authored this week.

For future posts, please follow me on Twitter at: @georgedeeb.


Lesson #262: A Venture Capital Playbook Over Time

Posted By: George Deeb - 4/07/2017

I read two terrific articles this month that summarized venture capital trends over the last several years.  The first was Pitchbook'...



I read two terrific articles this month that summarized venture capital trends over the last several years.  The first was Pitchbook's 2016 VC Valuations Report and the second was CB Insights's Venture Capital Funnel.  They are a must read for anyone thinking about going down the venture capital route, in terms of financing their growth.  Read together, they help you better understand what you can expect along the way.  Below is my summary of these two articles that are most relevant to you.

Starting with the CB Insights data, they looked at 1,098 companies that raised seed stage capital between 2008 and 2010, and then tracked the outcome of those companies over the following years.  Approximately 46% raised a following Series A, 28% a Series B, 14% a Series C, 6% a Series D and 2% a Series E round.  And, of this group, only 28% of them got to an M&A exit for their investors.  And, of those exits, 71% where under $50MM, 10% were $50-$100MM, 8% were $100-$200MM, 6% were $200-$500MM, 3% were $500MM-$1BN and only 2% were over $1BN.

So, what's the conclusion from this data.  Entrepreneurs think they have the best idea in the world and they are on their way to building the next unicorn level company.  But, only 1% do.  So, know going into the process, that there is a big drop off from one step of your growth to the next, with a lot of headwind along the way.  The odds to getting to a huge payday is very low.  And, the odds to getting to any exit are not great, with only 3 in 10 getting to that point.  So, most of you are going to end up either with self sustaining businesses that can't be sold, or more likely, out of business.  A pretty depressing concept before you even get started!!

Now moving on to the Pitchbook data, I put this chart together to help me better look at it:


There were so many nuggets to learn from this chart.  First of all, you are going to have 1-2 years of history before you raise penny number one from professional investors.  So, be prepared to bootstrap finance your business until you get to your proof-of-concept point the investors are looking for.  Second, look how fast the process moves, which says two things: (i) buckle your seat belt, it is going to be a helluva ride; and (ii) you are never going to get out of fund raising mode, which sucks if you prefer to be focusing on the business.  Third, you get some good data here on how much you should raise and how much you should value your company for, at each stage of its development.  And, lastly, when you add up all the dilution from the multiple rounds, the founder's stake is going to dilute itself down from 100% day one to 33% after the Series D.  And, if there are multiple founders that gets split between you.  So, you will be doing a ton of work that the investors are going to see 67% of the benefit.

There were some other interesting data points in the Pitchbook article: (1) valuations are pretty lofty right now, steadily rising in each round level since 2010 (up about 2x over the last several years)--that can't last for much longer; (2) flat or down rounds make up a healthy 26% of the market, so even if you are raising new funds, valuations don't always go up; and (3)  if you have a strategic corporate investor as part of your investor group, the VC's like that, as evidenced by them paying a 54%-65% premium valuation for companies with a corporate backer vs. companies without one (so figure out how to get a corporate investor to take a liking to your business, if you can).

So, there you have it--everything you need to know to in terms of raising venture capital for your business over time, and what to expect along the way.  What do you think?  Still interested in taking the leap, after studying this data??

For future posts, please follow me on Twitter at: @georgedeeb.


Thursday, March 30, 2017

Lesson #261: Leadership 101--Narrow Your Say-Do Gap

Posted By: George Deeb - 3/30/2017

I recently was in a client’s office and they had an interesting collage of words and images hung on their wall, trying to summarize the ...



I recently was in a client’s office and they had an interesting collage of words and images hung on their wall, trying to summarize the culture they wanted to create for their employees.  One section stood out to me, it said, “Narrow Your Say-Do Gap” next to the word “Commitment”.  Not only did I think that was a great way to manage your team’s expectations by, it must be working, as the company has a “love affair” with their leadership team, as evidenced by their employees long tenure with the company and the very high reviews of their CEO on Glassdoor.  There are some juicy nuggets in here, that we can all learn from in trying to be good leaders with a narrow Say-Do Gap.

WHAT IS THE SAY-DO GAP?

Let’s first define the Say-Do Gap, so we know exactly what we are trying to narrow.  Just as the name suggests, as a good leader and fellow employee, it is important that you “practice what you preach”.  If you tell your team you are going to do something, DO IT!!  The better you follow through on your stated promises with visible actions, the narrower your Say-Do Gap.

WHY A WIDE SAY-DO GAP IS BAD?

A lot of bad managers may give lip service to saying they are going to do something, and never follow through.  And, all that does is irritate everyone in the office that was relying on that project to get completed.   While at the same time, delivers a deadly blow to your credibility as a leader.  If your employees can’t trust you to honor your word, they will never remain loyal to you.  Companies with a wide Say-Do Gap typically have a very poor morale in the office and experience high levels of employee turnover, as employees become disgruntled by mismanagement of unrealized expectations.

A WIDE-GAP CASE STUDY

I have been exposed to a lot of poor leaders, during my work at Red Rocket.  The relationship with that CEO typically starts out fine.  They say they have a problem they want to fix, and they are committed to doing whatever is necessary to fix the problem (e.g., capital investment, new incentives, new hires).  But, after the project starts and recommendations are made, when it is time to pull the trigger they never follow through.  And, worse yet, they say they are working on it, but really have no intention of actually doing it.

Maybe they are concerned about the resulting dilution to their ownership that would come from a financing or new stock option plan, or maybe they are debt averse, or maybe they just don’t agree with their team’s recommendations and prefer to avoid conflict.  Whatever the reason, they get the “engines of change” up and running, which gets their team excited.  But, then when push comes to shove: no actions are taken, and their entire team ends up disappointed in the process.

A NARROW-GAP CASE STUDY

On the flipside, let’s remember my case study from my time at iExplore, right after 9/11/01 with the travel business imploding in the wake of terrorism.  I was always honest with my team, both in good times and bad times of the company.  And, I always followed through on any promises I had made to the team over time.  If I told them we were going to raise new capital, we did.  If I said we would sign a new partnership, we did.  And, that history of a narrow Say-Do Gap between 1999-2001, gained me the trust of our team over time and earned me what would become much needed “trust me capital” when we crap hit the fan on September 11th.

More specifically, iExplore should have gone out of business.  Revenues stopped coming in, as people stopped traveling.  We had a large burn rate carrying a staff of 35 employees.  And, our investors went running for the hills.  So, when I had to terminate all employees, and ask 12 of them to volunteer their time for three months, on the hopes of me raising a new round of capital and getting their volunteered back-pay funded at that time, that would have been a monumental ask of most employees in most any other company.  But, our team was passionate about our business and they trusted me to follow through.  Which I did, getting a new funding round closed in January 2012 and all their earned pay from their volunteered fourth quarter of 2001 repaid in full, at that time.

The point here is not how we saved the company.  The point here is I would have never been given the opportunity to save the company by my team, if I had anything other than a narrow Say-Do Gap in the two years leading up to that event.  Trust matters in being a good leader, perhaps more than anything else, especially when things start to go wrong, and you need your team the most.

WHAT DOES THIS MEAN FOR YOU?

Do a critical assessment of yourself.  How many times do you promise to do something?  And, compare that to how many times you actually followed through?  If that answer is close to a 100% follow-through rate, you are a “Narrow Say-Do Gap Jedi Master”.  But, the closer you get to 80%, or God forbid 50%, the damage you are doing your leadership credibility may be too insurmountable to overcome.  Don’t let this be you.

For future posts, please follow me on Twitter at: @georgedeeb.



Tuesday, March 21, 2017

Lesson #260: Where to Find Businesses for Sale

Posted By: George Deeb - 3/21/2017

As many of you know, I have been looking for businesses to buy, over the last few months.  Primarily in the digital technology space.  T...



As many of you know, I have been looking for businesses to buy, over the last few months.  Primarily in the digital technology space.  There are plenty of resources that I am leveraging in this process, from my personal network to business brokers to online websites.  I figured this would be a useful post for any of you looking for businesses to buy, as part of setting an M&A strategy for your business.

YOUR NETWORK

When looking for a business to buy, you need to be well connected to people that know about businesses for sale.  This includes people like lawyers, accountants, bankers, venture capitalists, private equity firms, consultants, etc.  So, be sure to let these types of professionals know you are on the hunt, and what specifically you are looking for, and they may know of current opportunities.  Or, at a minimum, hopefully, they will keep you on their radar for future opportunities that arise over time.

BUSINESS BROKERS

Business brokers or investment bankers are companies that are engaged by a seller, to help them sell their business.  They prepare all the marketing materials, reach out to prospective buyers and act as an intermediary between the buyer and the seller of the business.  Business brokers come in all shapes and sizes, from "one man shows" to big companies, and they typically have a specific area of focus.  Some focus on big companies, others focus on small companies.  Some focus on the Midwest, others focus on the West Coast.  Some focus on the technology industry, others focus on manufacturing.  All as examples.  So, find the business broker that that best serves your target company size, industry and location.  Doing some searches on Google should point you in the right direction (e.g., "business broker Chicago technology").

As a few examples of some of of the better ones I have worked with, focusing on smaller businesses in the digital technology space, reach out to the partners of firms like these:

Corum Group (based in Seattle)

Digital Exits (based in Los Angeles)

Exit Strategies (based in Silicon Valley)

Peakstone Group (based in Chicago)

Petsky Prunier  (based in New York)

Progress Partners  (based in Boston)

Valley Biggs (based in Tampa)


ONLINE WEBSITES

There are a plethora of websites promoting businesses for sale.  Some do a ton of volume, and others are smaller.  Some are the front end of a business brokerage, and others are simply an online marketplace.  But, these are all good places to start your search--many with easy tools to search by location, industry, revenues, cash flow and beyond.  Just understand, on these sites, there will be lots of other buyers looking for the same types of opportunities as you.  So, be prepared to move quickly, as you see new stuff hit the market.  If you see listings that have been hanging around for a while, that can either mean "buyer beware" or use it as an opportunity to "make your best offer".  Be sure to sign up for their newsletters or automated search listing announcements, so you don't miss any new listings that get posted over time.  I have put a star next to the ones I use the most.

Acquisition Station

Acquisitions Direct

Alpine Business Brokers

App Business Brokers

BizBuySell (**)

BizQuest (**)

BusinessBroker.net (**)

BusinessesForSale.com (**)

Buy Sell Website

Empire Business Brokers

Empire Flippers

Enlign Advisors

FE International

Flippa/Deal Flow

iAcquisitions

Latona's (*)

Quiet Light Brokerage

Raincatcher

Store Coach

Sun Acquisitions

Sunbelt Network

W3 Business Advisors

WebsiteClosers.com (*)

WebsiteProperties.com

Woodbridge International


Hopefully, you are now "in the know" on how to find a business to buy.  So, whether you are an established business looking for tuck-in growth extensions or additional market share for your business, or an entrepreneur looking for a base platform to invest in as your next venture, M&A can be a great solution for you.  And, worth mentioning, the more recurring cashflow the target company generates, the easier it will be to help you finance such acquisition from traditional banks or SBA backed lenders.  The acquisition financing is out there for good deals, so don't think you need to fund this entirely by yourself.


For future posts, please follow me on Twitter at: @georgedeeb.



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