Kaulkin Ginsberg Company, the most experienced strategic consulting and transaction advisory services from for the accounts receivable management (ARM) and related business process outsourcing (BPO) service providers, hosted a Mergers & Acquisitions Planning webinar.
Pricing and seasonality trends, competing motivations between buyers and sellers, and transaction planning best practices were among the critical topics discussed.
Watch the 60-minute webinar below, or read the accompanying transcript. Enjoy!
Welcome
Kelsey Flinko: Hello and welcome to the Mergers & Acquisitions: A Planning Discussion with Industry Experts webinar hosted by Kaulkin Ginsberg Company. Before we begin we’d like to thank you for attending. We know you’re busy and time is valuable so thank you for being here. My name is Kelsey Flinko and I will be your meeting manager today.
Now I have a few housekeeping items to address. You’ll notice the phone lines are muted. Should you have any questions please submit it in the questions box and we will answer it during the dedicated Q&A session at the end of this webinar as time permits or we will personally reach out to you with an answer after the webinar ends.
Second I have a disclaimer that I need to read to you so bear with me as I read it on your screen:
This information is not intended as legal, financial, or advice of any kind and may not be used as such. Advice must be tailored to the specific circumstances of each case. Every effort has been made to assure this information is up to date as of the date of this presentation. It is not intended to be a full and exhaustive explanation, nor may you use the information to replace the advice of your own legal counsel. The presenters assume no liability for typographical or other errors contained in the presentation, or for any changes that occur in the future affecting anything discussed herein.
Next I will tell you a little bit about Kaulkin Ginsberg Company. Since 1991, Kaulkin Ginsberg Company has provided critical strategic advice to the outsourced business service industry. Our client-centric approach covers almost every stage of a company’s lifecycle and enables us to maintain long-standing relationships as trusted advisor. The firm provides mergers and acquisition advisory, strategic consulting, valuation and financial solutions, market intelligence and analysis, as well as litigation support and expert witness.
And with that, we’re ready, and I’ll turn it over to Mike Ginsberg, president & CEO of Kaulkin Ginsberg Company.
Mike Ginsberg: Thank you, Kelsey. Hello everybody thank you all for taking time out of your busy schedules to join us this afternoon. Before we get started I want to make sure everyone knows about our sister company, Topline Valuation Group. First and foremost I want to thank them for sponsoring this important webinar. Topline is the only valuation firm that we know of focused in on the accounts receivable management and revenue cycle management industries. Maybe I have a little bit of a bias viewpoint but I will tell you that the services that they provide are unmatched. Because of the team’s extensive knowledge of these industries. They’ve really submerged themselves into this marketplace which is critical when they work on things such as valuations, budgeting, and various other financial related projects. So I encourage you to reach out to them for all of your financial needs related to those dollars. Thank you.
As many of you know mergers and acquisitions is very prevalent in the accounts receivable management and revenue cycle management industries. Industry players of buying companies to add clients, expand their own footprint, increase their service offerings, and for a variety of other reasons. Strategic buyers for companies from related industries are buying these companies to enter a new market segment or to diversify their service offerings. Private equity firms and other financial buyers are also attracted to this industry typically because of the high levels of sustainable profits and the growth potential realized by many companies.
Today we’re going to spend time talking about transactions. We’re going to jump into pricing structures and what’s motivating both buyers and sellers. So why don’t we get started?
Michael I’m going to turn it over to you and you can start talking about tracking deals.
Semi-Annual Deal Tracking
Michael Thomas: Thanks, Mike. Let’s get started.
So the first thing we want to talk about today is going to be the semi-annual deal tracking. Right here, you’ll see this chart where we track all the different transactions occur within the ARM space. This one focuses on publicly announced transaction. And we submit that data into a semi-annual distribution because we found a seasonality tend to take place within these transactions – where about 60% occur during the first half year and 40% in the second half. This is an interesting trend that you know will help with on a business planning and determining when is best go to market but it’s not so extreme that we would ever want to deter anyone from trying to make an acquisition or perhaps sell their business here in the second half. There are just certain considerations that we need to make.
As for some of those considerations and the nuances to that seasonality that we were talking about today – things like timing. With the release of full calendar your financial data coming out during yeah the first few months of a calendar year that tends to be one consideration. If you’re trying to get that transaction done during the second half of the year clearly you’re
not gonna have a full calendar year so it’s going to be a trailing 12-month calculation. Or you’re going to be rushing to get things done shortly after the new year which creates its own issues. From a strategic planning perspective you know there are a couple things that we like to talk about. First buyers tend to have all their strategic planning take place during the second half of the year as they get ready for that first half year when they’re going to make those acquisitions. Private equity as well will tend to be looking at making their acquisitions during the first half year when they have more available for that purpose. As the year goes on you’re going to have more issues with a buyer either making a transaction or being in the middle of a transaction which is one of those contributing factors towards that seasonality where that first half is just slightly higher.
Another thing that we like to talk about though is yeah we do record a lot of transactions and as you can see from this chart there’s quite a few that occur just within the receivables management space throughout the year but this list is not going to be comprehensive everything that’s out there. We limit to just do those transactions that are publicly announced as well as those that we can identify from a transaction database but there are a number of transactions that made for one reason or another not actually getting announced during the year. It might be due to client sensitivities, not wanting to disrupt anything within a client’s business because that would ruin value. So those sort of considerations go into this and contribute to maybe a lower degree of announcements than you’ll actually see within this but overall we think that this list is pretty comprehensive in the way that it gives us a good look into what sort of seasonality and transactions to occur throughout the year.
Additionally it’s gonna vary by you know what we’re actually considering as a receivables management company versus a BPO which might include someone in the medical billing and coding space or someone within a RCM segment. So all those considerations tend to go into effect.
Mike, I’ll pass it back over to you.
MG: Thanks Michael.
Two things. Number one by way of introduction Michael Thomas is vice president of Kaulkin Ginsberg. He is also instrumentally involved in transactions and he tracks this data religiously. Also if you have any questions please be sure to submit them if for some reason we don’t get to them today, which we hope to do live at the end of this webinar, we will absolutely make sure we get back to each and every one of you individually.
One of the things I wanted to talk about as it relates to deals and deal tracking are the trends that we think are impacting transactions in today’s marketplace. One of the biggest things we’re seeing on the healthcare side which really makes up the large percentage of the accounts receivable management industry and virtually all of the RCM industry as it exists today especially where we’re tracking what we’re seeing on the healthcare side is a significant amount of client concentration and consolidation. So from a consolidation standpoint a hospital systems continue to merge. Large hospital systems like Tennant are on the marketplace – on the market for sale as many of you already know. But also larger hospital systems continued to acquire physician groups and individual practices in their region. So a lot of consolidation causes owners to consider their options as it relates to ownership. Buyers who want to be on the front end of that want to make sure that they’re servicing the larger systems maybe looking to acquire some of these players through an
acquisition of a smaller service provider. And the sellers who might see on the horizon the loss of some market share if not a significant client or two down the road might want to consider joining forces either through a merger or an outright sale to a larger player. So we think that’s impacting transactions in today’s marketplace.
Another aspect that’s impacting transactions is technology disruption. A lot of companies are moving into various new ways of communicating with consumers. Very much on the front burner right now is AI artificial intelligence, being able to reach the audience through that means. A number of companies, smaller and midsize especially, don’t have the financial means to really bring in these new technology advancements and still operating profitably their own business so they look to join forces – they might look to join forces with larger players who are making those extensive capital investments. We’re also seeing buyers try to get into marketplaces that are experiencing significant growth. For example whether it’s eight local or some aspects of federal outside of the US Department of ED, the US government has increased their outsourcing levels significantly, many going to an RFP process. Companies who are not in the state, local or federal arena might look towards acquisitions to jumpstart their involvement in that growing space. We’re also very fortunately seeing increases in loan origination within financial services at levels that we haven’t seen since the Great Recession. So there are a number of companies who are getting back into financial services or looking to expand into that marketplace for the very first time.
I do want to touch upon which markets or segments that are attracting the most attention. Overall this has been going on for forever – we’ve seen this since we started in this industry almost thirty years ago. Generally speaking companies that demonstrate consistent revenue growth and strong profitability margins attract attention regardless of what’s going on around them in the market. So if your company is performing well, top line bottom line continues to check all the right boxes from the perspective of a buyer really in any market it will attract attention. Over the past 12 months we’ve seen considerable new interest in financial services we talked about that. Healthcare continues to attract a lot of attention. Self-pay is a considerable interest as patient has become even more responsible for individual payments. We’re also seeing considerable interest over the past 12 to 18 months in the b2b or commercial sector. The problem with the commercial sector is the interest is certainly there but buyers can’t find the company sizeable enough for them to make that acquisition. So they’re looking for a platform some might put together multiple companies to that critical size but you’re really only talking about a handful of sizeable commercial players that would attract that kind of attention.
Transaction Review
We’re going to discuss now two key transactions that have taken place in the marketplace. I’m gonna get started into the first one. Michael said earlier there are a number of transactions that have occurred over the past 12 months in this industry but these two we think are worth talking about. Really the first one for Michael to discuss before I turn the microphone over to him let’s talk about the Bolder transaction.
For those who don’t know Bolder Healthcare Solutions based in Kentucky this company was just started a few years ago by industry veteran Michael Che and his financial backers. Bolder grew predominantly through acquisition I’m sure they grew organically as well but they have acquired a number of companies providing various revenue cycle management services before they themselves were acquired by Cognizant. Twenty-five-year-old NASDAQ listed international BPO service provider Cognizant for those who don’t know them they don’t focus exclusively on healthcare so this really increased their presence in that marketplace. According to the public filings you might be surprised to know that the purchase price this transaction was 472 million dollars of which goodwill non-deductible goodwill covered 335 million dollars of that allocation and other customer relationship other intangible assets were 113 million. So nearly all of the purchase price was allocated to goodwill. And I want to point that out because regardless of the size and transaction that’s very very typical. And why I chose to highlight this particular transaction the sale of Bolder to cognizant was because I think it still shows the consolidation strategies and roll-ups are not a thing of the past in the accounts receivable management industry. Bolder is obviously in RCM as well but these industries overlap considerably as many of you already know. Bolder acquired a number of companies before they themselves were acquired. We’ve seen this strategy before in the accounts receivable management industry with a lot of consolidators, Outsource Solutions Group, RMA years past. We also saw it in the healthcare space when companies like the Outsource Group emerged and acquired a number of companies before they themselves were acquired by a large strategic. Health care itself lends itself this strategy because there are numerous acquisition targets that provide specialty services or dominate their particular region and they’re small enough to be gobbled up by some of the larger players.
Michael do you want to talk about this other transaction?
MT: Yeah, absolutely. Thanks Mike.
So on the other end of the equation where Cognizant was looking to diversify, we actually have an interesting trend that took place where Bradesco made an acquisition of RCB which was originally a subsidiary of PRA group. Well PRA Group decided to divest its interests in this Latin American base entity for non-performing loans because according to them it aligned with their strategic focus. PRA group also in recent months decided that they were going to after years divest several different companies within the government space and their collection areas. They fell behind this according to their public filings was that the company’s strategic focus was gonna be on primary business such as the purchase, collection, and management of portfolios of non-performing loans. Which is kind of interesting since RCB was a non-performing loan company in Latin America. So they almost
seem contradictory. But if we instead look at it from the perspective of PRA Group is choosing focus not on non-performing loans but on specific geography as well as non-performing loans then it starts to make a little bit more sense. PRA Group decided to divest it’s in the US government entities and more recently this RCB Latin America non performing loan group and maintain its investments within the North American and European regions where it seemed to apply more of a focus on non performing loans for those markets. Now this could have to do with any number of reasons such as in terms abroad with political stability, just general international performance in the economies, or just focusing more on domestic because they have more known and experience within that group. But what I find really interesting is that it presents a number of yeah acquisition and roll-up opportunities for both private equity groups and strategic buyers in the mid to large-sized range where they can perhaps benefit from making acquisitions of you know former subsidiaries of something that doesn’t necessarily focus on non-performing loans and more on general receivables from somebody like PRA Group. It just presents a number of opportunities there and it’s almost kind of the opposite of what Cognizant has been doing as it tries to grow its diversified footprint both internationally as well as across different types of services and verticals. So very different strategies from two different publicly traded entities that will have a significant impact on the ARM industry going forward. To that extent we’ll have to see, but definitely some interesting changes there.
Pricing Trends for the BPO Market
So moving on now, I think it’s gonna be time to talk about some of the pricing trends within this BPO market and what to really as you’re trying to figure what is a business worth, how are we gonna price it, and other things of that nature. So first up we’re gonna talk about the three major approaches that we’re gonna discuss today.
Integrated financial models is the first of those approaches. This tends to include things such as a discounted cash flow analysis, M&A modeling, trading comms for public companies. Generally speaking a lot of people associate these with a much larger client base where you tend to see larger firms or publicly traded doing all these integrated models and some worry that it’s not appropriate for a smaller business. And there may be some basis for that but there’s also arguments made on the other end of the equation where academically yeah it’s hard to argue that there’s anything other than DCF that’s valid in valuing a company because it factors in the time value of money. The problem here of course tends to be on all of the assumptions – that whole Devils in the details component there. Well if you have crummy assumptions, it’s going to lead to a crummy outcome and you need to have a deep understanding of the business, the markets someone’s operating in and how best to come up with those assumptions if you’re going to really try to get something out of a DCF process and any other integrated financial model. Otherwise it’s kind of that all garbage in garbage out process. And that’s why you know working with some of our small business owner clients, midsize companies, we always try to encourage them to engage in a
forecasting and a budget process but when that’s not available yeah trying to make too many assumptions if you’re on that buy-side equation or if you do certain evaluation it tends to create some issues.
Now to take this further we’ve actually seen an increase in the number of buyers that have started to employ these financial modeling practices whether that be on the private equity or on the corporate finance side for someone’s internal divisions within another strategic buyer. But the unfortunate aspect is as I mentioned garbage in garbage out. We’ve seen some people put together some models where there’s let’s say questionable assumptions that aren’t necessarily indicative of best modeling practices and the things that people should be looking at when trying to valuate business. So this can be a complex process that we employ and do in large part with a lot of our clients but we do caution some yeah questioning of the outcomes when somebody tries to do this if they haven’t really dug into these models consistently. And that’s when we can see more often times that strategic buyers employ one of two scenarios and we’ll discuss on the transaction comp side for market approaches.
The next approach we’re going to look at is the enterprise value to a EBITDA or EV over EBITDA approach. So within this transaction multiple method it sounds really easy retain enterprise value divided by EBITDA gives us our transaction multiple. What could be
easier than that? Well it becomes a bit of a question of what you’re including when you come up with this transaction multiple. For a long time people just said hey a business is worth 5 times whatever revenue or EBITDA generates. Which might have been a good rule of thumb but it doesn’t account for a number of deviations in the businesses relative to their profitability, market dynamics, the strength of leadership, and so many other qualitative and quantitative factors. So you start to really get more of a range just based on the size of the company and these other intangibles that might create more of a 2 to 4 times, 5 to 7, 7 to 10 and so on as a range for the multiple based on those quantitative and qualitative factors.
Looking a little bit more in depth at this EV over EBITDA multiple it is something that is very much considered whenever you do a valuation on a business and a lot of valuations that are put before the IRS impact work. They want you to consider a market approach because they think that’s the best possible way of looking at it. But it needs to consider whether or not that target company you’ve identified for comparison to derive that multiple are truly comparable. You’re not getting the kind of an apples to oranges scenario here. Not having enough transaction to really to draw a strong conclusion. I have two transactions it’s hard to make any real conclusions on that as opposed to you tracking this really diligently having multiple transactions as well as different transactional databases that you can be used to derive a sound value for your transaction multiples – those become important. And
considering the different investments that are needed to grow and maintain the
business. We’ve seen the unfortunate outcome where someone has a attached a high multiple to a business but not factored in those investment components lo and behold they are making as much money. They had to put in a lot of excess cap backs and now the business is kind of profitable but it should have been profitable far sooner. And those are some of the different considerations we like to highlight with this approach which yeah while easy, it might be deceivingly so and it gives a lot of things to be considered.
The next approach we wanna talk about is the transaction multiples for the enterprise value relative to revenue. Now this tends to be a very popular approach because again it’s simple but more than anything else it’s a great approach because you almost always have revenue as an adviser for your enterprise value. Whereas some transactions don’t like disclose how much cash flow is actually being generated. And that can create deviations. So this tends to be a very popular one in general but in particular when you have a company that maybe is generating net neutral profitability there’s no real positive or negative there or they’re generating negative profitability. The unfortunate truth is that yeah we have seen companies that were one time generating 27 million dollars 30 million dollars in revenue but they lost a big client to no fault of their own perhaps and yeah all of a sudden you’re generating 20
million of revenue but they’re still generating loss or a break-even because they have way too much capacity relative to what they’re doing. And that creates an issue where you can’t value a cash flow as you would in an DCF process which is essential and you instead
need to come up with a transaction multiple.
That’s where price to revenue really becomes a key differentiator and when you have a good comp case of companies that are much more in that range of healthy or maybe not so healthy and you’re using that to derive a value based on revenue it can be a powerful
tool. But as with all things you really need to make sure that you have a great deal of confidence within those companies that you’re using as comparable in order to establish that multiple. And you also need to consider what exactly it is that you’re using for revenue. That maybe sounds a little silly but the fact is as we show in this little graphic here, revenue isn’t going to be something that’s a constant. It will change over time – it might grow, it might shrink, it might be on a net growth trend, and you need to put a lot of consideration where that has been historically, where it is today, where it is going to be going forward, and what you’re using to support those assumptions. Without all that detail anything that you come up with can be questionable at best. And yeah that’s concerning, especially if you’re going to buy a company, or if you’re on our side of the equation you’re advising the purchase or valuation and it’s perhaps going to the IRS for gift and estate tax purposes we don’t want to get in trouble by giving the inappropriate valuation. So all of that so has to be considered.
And you know going one step further yeah we now want to look at a graphic for you that shows if we’re focused instead on the entire BPO space – yes this is an enterprise value relative to revenue transaction multiple that we put together on the entire BPO space using a couple transaction databases as well as our own internal transactions. This details both collection agencies, call centers, revenue cycle management, collection software companies, and the like within this BPO diagram here and shows how that price relative to revenue
has trended between 1995 and 2018. Interestingly we had 161 transactions that we’ve decided to put into this analysis. About 151 of them actually reported all the information necessary to do a basic enterprise value relative to revenue multiple. Surprisingly some of them just show deal value which again that’s one of those things where you don’t want to use those transactions and you really need to be considerate of what it is that you’re valuing.
Taking the analysis a step further, if we look at this the smallest and largest transactions within this multi-year trend one was four hundred twenty thousand another was one point two four billion dollars so quite the variance there in the range. And you know the average value if we normalize this across all the years and remove that outlier for like a large transaction that 1.24 billion range is really about 6.1 million dollars is the average enterprise value when we adjust for that outlier effect. So overall you’re seeing a lot of companies that are going to be in that lower to middle market range and we see valuation on the transaction multiples from a low of 0.29 times revenue probably a less healthy company not as stable of a fly base to a two point three nine times revenue which much healthier company. Larger versus higher client base. All those key things that you really want to look for. But when we normalize that and look at okay where is the market really at on average across all these periods you see look about a 1.1 or 1.2 enterprise value multiple. And that’s telling us that if we track this across all periods, normalize all those different transactions out there you’re seeing about 1.1 or 1.2 as the revenue multiple across all of these companies.
But yeah we do want to caution anybody from attaching a one times whatever multiples do their business because yeah you want to be apples to apples in all things and this is looking at as I mentioned multiple verticals across multiple years and you can’t really compare a company that has five million of revenue to a company that’s got a hundred million in revenue. It wouldn’t be an appropriate comparison so this kind of gives you an idea that yeah something around plus or minus 0.2 of revenue also equal healthy companies probably good indicator but a number of qualitative and quantitative factors need to be considered within that range. And you know once you consider those you can really come up with a strong valuation for transaction purposes and for general valuation or estate and gift purposes when valuing these companies.
Mike?
MG: Thank you Michael.
Before we move on to some of the structural considerations to purchase price, I just want to
mention that size does matter when it comes to an acquisition. I’m sure many of you tuned in here to try and get a sense of ranges that you could apply on your own business or acquisitions you might contemplating. We tend to look at things in groups – small being under five million in revenue but when you start to get to three to five million in annual fees or revenue dollars, you start to see some infrastructure being built, multiple tiers of management, a little bit more of client diversification. So the mid-sized companies typically start around three to five million and they go up about twenty to twenty-five million dollars in annual revenue or fees. And then twenty-five to as much as even a hundred million are large companies but that also includes and then larger companies can be classified as jumbo companies with platform companies. Starting with the platforms. The platform’s tend to inject a newbie into the marketplace that could be a financial or a strategic buyer into an
industry such as RCM or ARM. But if they truly perceive it as a platform something that has grown and shows evidence of growing going forward, has a lot a lot of infrastructure in place to be able to support the growth, a very knowledgeable management team, sophisticated technology, etc., top line and bottom line performance is strong, it’s not unusual for discussions start at the six to eight time multiple and it could exceed 10 to 12 times we’ve
seen that before as well – times adjusted or normalized EBITDA. Michael talked about a little bit earlier as a methodology or approach to value. Smaller, midsize, and large really depends on a lot of factors. Smaller you’re not going to get significant size transaction compared to a midsize or large deals but if the company is doing well and it’s growing and it’s got a diversified client base, conversations tend to start at about three to four times normalize EBITDA and they could go as much as six to eight times on the higher end, especially for larger companies.
Structural Considerations to Purchase Price
Let’s move on to some of these structural considerations – also known as the finer points to an offer. I do want to break down about a half a dozen of these things I’ll do it very quick. Cash is still king. Cash is absolutely critical. If I’m closing sellers really don’t want to part with their business unless they get rewarded for that at time of closing and cash is usually the biggest reward that they’re seeking. It really does depend upon the performance and the size of the company selling. The cash can equate to as much as 80 percent or some transactions as much as a hundred percent of total consideration. For a service business is extremely rare because even if a buyer is gonna pay a hundred percent of the purchase price in cash they may put a portion of that into what’s called escrow or an escrow hold back for a period of time at least one cycle. And by cycle I mean an audit cycle even if the company doesn’t go through an audit procedure it still goes through an accounting procedure so a buyer gets more comfort in knowing that tax and whatever reps and warranties are included in the definitive purchase agreements are at least accounted for in one year. Sometimes we’ve seen escrows longer than one year eighteen months to two years but certainly a minimum of a year applies. Especially when at least 80 percent of purchase price is in cash at
time of closing.
Smaller companies may also get cash but there tends to be what we referred to as a retention based earn out at least in some portion of the transaction in some cases it could be over 50% of the total consideration or enterprise value of the company selling.
That’s really because they want to make sure that those clients are repaid they’re not necessarily looking for growth at least not in this component for the structure but they are looking at major retention of revenue in some transactions that might be relying on one or two clients so by name if those clients start with using market share or eliminate their relationship with the service provider the buyers not left on the hook as they have this retention clause built into those specific clients. What we try to do is smooth out those edges by saying if the seller is successful in replacing revenue dollars at least at that level they should be paid at retention bonus. If they exceed it maybe there’s more if it falls short maybe there’s less we like to put in what we refer to as a collar around the retention bonus or an earn out structure so as to quantify what those amounts might be.
Earn outs they’re prevalent when a significant client concentration might exist or if we’re experiencing erratic financial behavior. Michael talked about companies earlier that are net 0 or generating less than zero and profitability and that typically happens when a company
has erratic behavior like a loss of a major client that they decide to keep the infrastructure in tact, their payroll the same because they’ve already trained these these various employees they don’t want to lose them. Then all of a sudden the client doesn’t come back or they haven’t been able to replace the revenue and they’re operating at a significant loss. Earn outs are usually there to bridge the gap between where a buyers going to be in a cash component in the transaction and where a seller needs to be overall in enterprise value.
There’s also another component which typically involves larger businesses and that is what we refer to as equity retention also known as a second bite of the apple and this exists when the owner buys back into the business proportionate to the amount that they receive at time of closing and it keeps their skin in the game for at least that period of time in which the buyer is going to be involved in this. So we typically see this with financial and
not strategic buyers.
You might notice here and question why we include salary post closing as the fourth bullet. We include it because may impact purpose price as well as deal terms. This is less the case when the owners are compensating themselves at a fair market level but it’s certainly the case when they’re not. We have many owners who pay themselves well in excess
of fair market value which is fine, but we need to reduce that amount so it’s not to impact its price.
The last point is non-compete and non solicit. Owners should expect to sign a series of definitive purchase agreements when they sell their business obviously the definitive agreement itself it might be an asset purchase agreement, they might be selling the stock of the enterprise, but in addition to that many times two other agreements emerge – non solicit non-compete agreements as well as employment agreements for not only owners but key executives within the business. These two might become a component of the transaction either for tax reasons or for retention reasons. They might build in a portion of that enterprise into either a non-compete not solicit or into an employment contract.
Competing Motivations between Buyers and Sellers
Let’s move on to competing motivations. Michael do you want to talk about these between buyers and sellers.
MT: Yeah, absolutely.
So look at a competing motivation yeah it’s really this interesting dynamic between the buyers and the sellers since you both need to be present to get a deal done. But at the same time you also both have the same objective in that do you want to get a good deal. The real question here becomes what is a good deal for the buyer and for the seller? From the buyers perspective yeah they’d tend to want to pay as little as possible for something because that
diminishes risk and increases potential reward. By the same token yeah if I’m selling something I want to get as much money as possible right here now because that diminishes risks in the future and increases my reward in the present. So you have this interesting dynamic that’s playing out on the opposing forces and we often caution yeah both sides that it’s important to try to find that balance when we’re looking at how these things get valued.
This graphic that we have in front of us we can see that yeah you have on the left side a closing transaction cash which might be anywhere from 0 to 100% and on the right side the earn out out which can be 0 to 100%. Clearly you have the inverse values there but somewhere in the middle conveniently within this diagram it’s right in the middle we have that kind of sweet spot range that we like to talk where both sides are netting out a good
deal. And this is going to be a case where yeah the owner has some degree of structure and since then stay on, support the transaction make sure that yeah they’re not competing with the new buyer business, they’re maximizing their value. But the buyer by the same token is not going to be in jeopardy of paying for something that they can’t possibly sustain because the owners gonna turn around and try to compete with them that just wouldn’t make any possible sense. So we try to find that “sweet spot” in all transactions as we try to work with both buyers and sellers.
And a good example of that is in a recent transaction that we worked on yeah we had a owner who wanted to sell their company that had been in their family for two or three generations and they wanted to get fair value for the business. We did a valuation for them – what the transactional values should be for the business, they were actually
surprised at what we suggested from it being higher than what they thought, and set out to sell the business. Ultimately we brought them multiple buyers for the business, but they didn’t actually go highest possible offer. And the reason yeah they found a buyer that wanted to step out, start their own collection agency, sounds a little crazy to me but hey they want to start their own collection agency and run the business because that’s what they’ve
been doing for a while. Well they also wanted to keep all of the employees, keep the business in tact, not change the name and the owner loved that. Emotionally this made
the most sense for that owner because they were able to get a price that we said that they would get, they were able to ensure the people that they’ve worked with for fifteen – twenty years would still be there, have a job be able to take care of their families, and yeah see
the business continue on. As opposed to if they sold to a much larger buyer it may have resulted in the business shutting its doors and just becoming a small satellite hub in which guess probably a number of those employees would have been gone. So price isn’t the
be all and all in transactions.
Now at the same time it’s a definite consideration as well as structure so that same logic does have to apply buyers as well and trying to make sure that the transaction is going to be you know a valuable transaction, makes them feel good about their business. Because
if you’ve maybe run a business for several generations you’ve never made acquisitions and suddenly you’re making an acquisition and I’m sure that’s going to make some people scratch their heads and say what’s going on? And you want to make sure that when that happens it’s a good transaction for the company that adds value to the bottom line, create some sort of a benefit relative to diversification long-term growth you’re hitting on all these key aspects and we try to make sure that that happens in all elements of that transaction process when we’re coming up with values structures so that everybody’s kind of meeting at the appropriate sweet spot in these transactions. Because in balancing those emotions, that’s important and some extent that’s where yeah Mike and I come in. Yeah we get to play a therapist on either side of that transaction equation sometimes somebody where they may not want to sell their business know that it’s right thing to do or they decide they want to buy a business but it’s hard for them to get across the hurdle of officially sending out that letter of intent and signing on the dotted line because that’s a big first step. That’s where unofficial
therapy sessions come in and I think Mike’s been playing in therapists for quite a few years and you can tell you horror stories about that.
Mike do you want a little bit more about some of the best practices to avoid those headaches?
Transaction Best Practices
MG: Absolutely Michael. Let’s get into some of those and then we’ll answer questions that have been raised by our our audience as well.
Whether you’re a buyer or a seller in our opinion successful transactions really do begin and they actually end with a plan and definitive steps to achieve success. A lot of times transactions happen organically. Buyer and a seller might know each other. Buyer reaches out to the seller. Seller reaches out to a buyer, and the transaction gets done. And that’s fine
they may not know if they’re leaving any money on the table or overpaying for that particular business from the buyers perspective but they’re comfortable that they found the right buyer. They might be more comfortable with the chemistry or the cultural fit because they know each other than going out and talking to multiple buyer candidates if they want to sell business. Or conversely a buyer going out and talking to multiple sellers. They may feel most comfortable with just the buyer’s or seller’s that they’ve identified on their own. However and I will strongly say this sort of like putting up a house you could put up a house with a very weak foundation but chances are pretty good over time that house is going to need a lot of work. Hopefully that house won’t come tumbling down. But with a stronger foundation and support up front, typically the house stays not only strong in very good shape down the road when it comes time for that owner to sell that house once again.
So we do look at this as a series of phases here. Phase one is creating that project timeline. Having a realistic expectation that transactions do take time even if you’ve identified that buyer or seller on your own just know that going through a due diligence process potentially arranging financing, you want to put together a realistic timeline anywhere from a low end of three to a high end of six months is a reasonable period of time. It can be more or less depending on the nuances associated with that transaction. Perhaps they’re both private they don’t need board consent or they don’t have to deal with regulatory hurdles or approvals in the marketplace. Perhaps the the sellers really only accountable to themselves one owner that could accelerate things perhaps the buyers using a lot of cash from their balance sheet and they don’t need outside financing that could accelerate events as well.
Phases two and three focus on developing that foundation for a successful transaction. For buyers this means let’s make sure we have a defined criteria if we’re out there talking to multiple companies let’s turn down the ones that don’t fit into that criteria. We could quite possibly visit them again down the road but if we stay close to our commitment then we have a better chance of completing the right transactions. It also means in this stage of developing the foundation it means identifying the right target companies whether you’re buying or selling. It might mean securing financing for the seller it might be also and I really do think this is critical and that is defining value in advance of the sale. So the sellers expectations are number one realistic and number two doable in the marketplace. This is really about preparing the company for sale so also it’s about the seller getting their financial and operational house in order and having the documentation to be able to support it. Because let’s face it when the buyer comes in they’re gonna often say this they’re gonna grab this seller by the ankles, turn them upside down and shake them until everything falls out of their proverbial pockets. So having a really good set of documents in place
well in advance of a sale is critical. I can’t tell you how many owners don’t have a budget out there. Many of them still don’t have a financial statement. What they do is go right to a tax return. So having an annual statement is helpful whether it’s reviewed or compiled depending on the instances with the business is fine it doesn’t always have to be an audit. However having some semblance of a budget will give a buyer very good comfort and those that have a look into the future one two maybe three years out it starts to get fuzzy in years two and three I realize that but some forecasts might help in phases two and three making sure that the developing the foundation is strong.
Phase four is going to market. This is where you’re out there you’re kissing
frog as I’d like to say you’re talking to seller candidates, if you’re a buyer you’re out there and you’re talking to a variety of those sellers. And if you’re selling your business you want to make sure that you’ve connected with buyers certainly protecting confidentiality because you don’t want everybody knowing that your potential businesses for sale and disrupting your outcome.
For buyers phase five is doing a deep dive into the sellers financials and operational information. On the sell side sellers will be evaluating offers and they’ll be zeroing in on the right buyer.
Phase six usually involves exclusivity and phase six does due diligence. You find that that’s where documents are executed, securing the financing necessary for the closing, money changes hands at time of closing. And phase seven is very important to what’s happening post transaction – integration, synergistic cost savings being realized. And from the seller, are they losing personnel, like dealing with severance, moving on or seller even involved in the business post closing?
So I think we’re right on time here. We appreciate your involvement. For the next couple of minutes what we’d like to do is focus in on questions that we’ve received now from you. Continue to submit those questions.
Michael do you have the first one that you want to deal with or should I choose the first one?
Q&A
MT: I’ll go first. So the first one that I saw came in was on the semi-annual deal tracking. It says you list timing as a consideration for transactions which appears to focus very heavily on the buyer. What if anything should the seller know about timing or anything else for that matter?
That’s a great question. Timing can be a fairly all-encompassing and broad response for everyone involved. But with respect to the seller, you know things like holidays, vacation planning, and the ability to complete those financial documentation requests, those tend to be some of the key things. For example a seller may want to avoid a late year closing during the end of November and December since you are going to be competing with PTO requests from your staff. You’re going to be dealing with your attorney and your accountant wanting to go on vacation. All the different holidays, family coming to town. Probably creates more headaches you ever want to take on. So maybe trying to avoid that last like six weeks
of the year.
But at the same end of the equation, you knew that you have a recurring family vacation in July then maybe plan for going to market after your family vacation or going to market around the same time so that we have a chance, for example the person representing you for the sale, to begin that transaction process, talk with potential buyers gather all the detail questions, and when you get back, we can work through the steps and you’ll feel hopefully refreshed. But yeah trying to make sure that you’re not taking on way too many things all at once in terms of family, holidays, and I don’t know, perhaps Snowmageddon hitting and you know where you are in the country. Those are some things to consider as relates to time in
on seller side of the equation.
Mike?
MG: Thanks Michael.
I have another question here – is financing available for RCM and/or ARM transaction? The short answer is yes.
It’s not maybe not as readily available as it once was prior to the Great Recession going back some 10 years now where financing was extremely accessible in the marketplace at very
very very desirable rates. So a lot of other transactions were getting done that in today’s market might not get done with the same level of financing that’s available today. Cash flow lenders look favorably at this industry. They become somewhat more conservative over the years but their financing these transactions you just need to make sure you’re not dealing with a hard asset based lender that’s looking for a strong balance sheet. That’s a major major taboo especially after you get the company under letter of intent if you’re buying the business make sure you prequalify well in advance the financing and the lenders that you’re dealing with to make sure they’re in tune with the type of company that’s being bought or sold.
Couple of things that I’d like to also say on that I think is very important – for smaller and midsize deals a lot of the financing comes from the owner themselves – seller financing, may be a retention based bonus, those types of things. Larger transactions, that’s typically where financing becomes more relevant and something that has to be dealt with but the short answer to the question is yes financing is readily available you just need to know where to look for it.
Michael do you want to deal with one more question? I will as well.
MT: Sounds good.
Actually here’s an interesting one. This person writes in, you talked about how the price of a business in general comes into play specifically for sales, but what if I don’t want to sell the
business? What if I want to gift the potential portion of the business to my child? So that creates a whole different topic of things that really we could probably talk for hours and days on how purpose really should drive the valuation taking place and whether that’s going to be a valuation for estate and gift purposes to someone’s child, whether you’re giving like a minority stake, you’re doing a valuation for ESOP’s transactional value, all of these things come into play and that purpose will create a variance in the valuation to that business. And that’s an important thing that anytime you’re working with a transaction adviser or a person performing a valuation you really should communicate upfront.
I have a horror story that we encountered a while back where one client hired us and said they want to do a fair market valuation for the business. They just needed it for estate planning purposes. We confirmed all these things had multiple meetings, talked about the purpose of the valuation, got the reports put together for them, and then during our final presentation and answering any questions they had on our findings, they said great so how do I submit this for my divorce for my wife? And we said what? Yeah you don’t do that because that’s a completely different purpose. In the end we ended up having to go do a
lot of research on the different legalities for where they are because corporate divorce valuations are local jurisdictional so someone in Maryland is gonna be different from New
York versus Virginia versus Chicago. So all that came into play and they ended up having to get a whole different valuation, they were behind other deadlines for getting the valuation
to the court and it created a little bit of chaos and everybody’s side.
But yeah communicating upfront what the purpose is for valuation is critical and it’s going to result in totally different conclusions for the value. Where a sale business might result in a higher valuation than a fair market value or giving out a minority stake for the business because control factors come into play for example. And it’s just a very important topic that yeah if you want to talk about in greater detail we’re happy to get on the phone and talk about your needs. But yeah purpose drives value and that’s a big takeaway we want everybody to know about valuations and whether it’s transactions or for personal use.
MG: Yeah and Michael, I’ll just piggyback that component there and just, that question there, and just say one more component which i think is critical too.
If you’re contemplating a valuation, and maybe there’s a divorce reason that’s a good reason, maybe it’s buy-sell, maybe there’s other stipulations between you and a disgruntled client for example, make sure you run it through your attorney so you have attorney-client privilege. In the instance that Michael just described a smart attorney on the other side will request that documentation and realize the valuation for the enterprise would be significantly higher so make sure things run through attorney so you don’t have to disclose everything. Certainly you will to your counsel but not necessarily the opposing side. So that’s an important component.
Before I answer this last question, two things I want to say. First every question that’s been submitted is important. We’ll make sure we get back to you promptly with an answer. And number two I want to thank Kelsey once again and our team for putting together this slide deck, for working with us here, and making sure that this was a seamless presentation. We’re right on time. We told you we take an hour of your and that’s pretty much all we took. We would like your feedback. We do this for you guys. Our sponsor at Topline Valuation Group. It’s very much appreciated as well. I want to make sure I mention them too.
One last question here which is an interesting one and I think you’ll find my answer even more interesting. Which phase of the buy or sell process is the easiest or the most difficult? interesting question.
A very open-ended question right? So I’m gonna say this. I think the easiest part of every transaction is the pricing part of the transaction. Interestingly enough a buyer’s gonna come up with a price the seller is gonna come up with a price they each have their own expectations. If they overlap or their spheres are close that’s a transaction that can get done. If the seller is looking for 7x for a business that a buyer’s only willing to pay 2x for or if a seller’s looking for 100% cash but they have one client making the whole of the revenue and there’s no way a buyer’s ever gonna pay 100% cash.
First of all they should never get past the advisor into the open market. Sometimes they do. But if the seller or the buyer have unrealistic expectations, those deals end very very quickly,
usually very painlessly. The real complication comes in on the intangible side of things. The chemistry. The corporate culture. The way one business might be running different than another. Not necessarily right or wrong, but different. Differences do exist. In those
instances although they are extremely complicated and they do require advice on both sides of the equation and negotiations, negotiations, and negotiations. But one thing that I would recommend that both parties do – buyers and sellers – in every transaction is come in seeking best practices. If you’re selling your business and the buyer is bringing a different mousetrap to the equation, don’t be opposed to that. Ask questions. Find out how your business could be integrated because that might provide upward opportunities for your staff, increase compensation, more roles, and those types of things.
And best practices on the other side prevail too. The buyer and the seller they don’t know everything. What they know is how they operate their business and how successful that’s been for them. So both parties have an opportunity to learn and maybe improve, but if they don’t check their egos at the door, and they really really push that there’s the best, usually those are the most complicated transactions to complete.
Closing
Once again on behalf of Michael Thomas I want to thank each and every one of you for participating today. We recognize your time is important. Thanks for spending some of that with us this afternoon. But we’ll look forward to seeing you out in the marketplace or speaking with you on the phone or the next webinar. And do follow up with us if you have any questions or comments.
Thank you very much, have a great day.