Buyers Case Studies

As an owner of a specialty niche, commercial staffing, or business solutions firm you must feel at times like a target with a large bulls-eye on your back. Do you feel like you are just more prey for the earnings growth hungry, industry Consolidators?

Acquirers and their representatives are contacting you to see if you are interested in learning how selling your firm and joining the prospective buyer’s management team will make you healthy, wealthy and wise or at least more secure in your ability to compete in the current, more complicated marketplace.

The best way for you to respond is with a courteous thank you for their interest and if you have not thought much about it, let them know. We would not suggest you agree to provide them with any information about your firm, until proper nondisclosure agreements are signed and the potential buyer has been thoroughly qualified as being suitable for you and that they have all the necessary resources to handle this proposed transaction. Find out about them. What is their strategy, their acquisition experience? Many trusting business owners inadvertently expose
their firm and staff to potentially damage risks prematurely. Don’t jump too Quickly.

The interest expressed in your firm is a clear indication that you have built a valuable asset. For many owners this is their most valuable tangible asset. This should be extremely flattering, a clear validation that all that hard work and caring has commercial value at the end of the day. Many owners tell us that the first time they seriously thought about this option was after contact from an interested buyer. Perhaps it is a subject worthy of consideration prior to an inquiry from a Buyer.

Your Objective

It is valuable to explore and prioritize your goals for your business. This can help you determine if you can achieve your objectives on your own. Like Maslow’s hierarchy, we know your current needs have probably evolved over time. If you require a large firm to partner with to reach your goals, you will have a better idea of the type of support you will need to obtain and if you can get where you want to go, in a time frame reasonable to you.

Taking stock

This following question can help you to focus your analysis and has helped some owners determine at what point and under what circumstances it makes sense for them to pursue or entertain the option of selling or merging their business. Some owners find the gap between their goals and their time frames can only be significantly shortened by becoming an acquirer themselves. Sometimes it is less expensive to buy than to build it yourself. The answers to the following questions may help you gauge where you are.

What do you want to accomplish from owning your own business?

• A good living
• Security for you and your family
• A canvas to express yourself
• Create a better mousetrap
• Become very wealthy
• Build a Regional, National or International business
• Other

There are many reasons deals fail. Common reasons we see include:

• Unrealistic market valuations. An overpriced business, like a perfectly good but overpriced house, will sit on the market for so long that potential buyers will assume that something is wrong with it
• Attempting to renegotiate the price or change the terms or meaning of terms after the initial agreement, effectively changing the deal. Be sure that you understand and are comfortable with both the price and the terms of the deal before you agree to them in the first place.
• Rigidity or arbitrary stubbornness about terms or structure. Buyers want sellers to be their partners going forward. They typically don’t want to absorb all of the risk from day one, so they are very interested in earn-outs. A lot of owners initially aren’t interested in earn-outs because they’re leaving or being asked to leave and they don’t have any control over the earn-out, but buyers are saying, “If you don’t believe in your business, how can I?” The reality today is that 99% of all transactions have an earn-out component. A buyer may say, “if we buy your business today for 100% cash, you’ve effectively shifted 100% of the risk overnight. Therefore, in terms of a risk: reward ratio, we’re going to pay you much less – perhaps below your perceived market value, so much so that you may not find the deal attractive. So they then may say, let’s go forward together and share some of this risk. We’ll give you 60% of the value we believe your business has in cash today and the remaining 40% over the next three years. If the business grows, you’ll get more, and if it shrinks, then we both share in that shrinkage.”
• Professional advisors attempting to function beyond their areas of expertise. Attorneys should protect you on legal aspects, financial advisors should give you tax advice and structure information, and the business advisor or M&A intermediary should advise you on the reasonableness of the offer, the terms and structure, etc. The M&A advisor is best suited to coordinating the disparate parts and professionals on both sides and affecting appropriate compromises. Clients have told us on many occasions that a lawyer’s adversarial training can often hamper the process and that some CPAs get so focused on the detail that they may lose sight of the overall objective, which is usually to make the deal work.
• Landlords looking for a windfall. Typically, a buyer will want to take over the lease responsibilities of the seller. In most cases, the buyer’s covenant is stronger than the seller’s because it is a larger company, so from the landlord’s perspective, he is getting a bigger, stronger richer name added to the lease. It’s reasonable for a landlord to charge a minimal amount for the administrative cost of affecting the change, but in some areas, depending on the real estate market at the time, landlords may ask for a $5,000 or $10,000 fee or an extension of the lease rather than a more appropriate $50 to $200.
• Sellers not keeping bankers fully informed, particularly if the bankers are owed money. They want to be sure they will be paid at the time of closing or whenever money changes hands. If the proceeds of the sale are insufficient to repay a bank, the banker will want to know how and when he will get the money owed. The loan agreement the owner signed when he took out the loan probably calls for him to advise the bank of any material change in the firm’s assets or stock, but many owners forget about this provision; the result is that the deal comes to a halt while the bank reviews the Purchase & Sale Agreement.
• Buyers looking to steal a business. It’s not worth the time or expense for a seller to try to negotiate with a buyer that makes an unrealistically low offer and will not increase it when appropriate.
• The seller’s senior staff members holding the seller ransom. Sellers are getting a lot of money from the deal, and their senior employees in particular want to know what they’re going to get out of it, such as a significant bonus in recognition of their role in helping to build the business or a stay bonus to help achieve an earn-out.
• Seller’s spouse not committed to a deal. In many situations, the spouse – in the staffing industry, that’s often the husband – is not very involved in the business and doesn’t appreciate the mental and financial state that leads the owner to want to sell but instead urges the owner to “hang in there.”
• Poor current financial results. One of the most important things knowledgeable M&A advisors do is present the seller’s figures, no matter what they may be currently, in an acceptable and realistic form for the buyer to review. Nothing causes a buyer to lose confidence in a seller faster than inconsistent or unreliable numbers.
• Unrealistic projections of future financial performance. Knowledgeable buyers are familiar with market conditions and aware of what reasonable future expectations should be for your business.
• Overly onerous sales, margin or profit levels required to achieve an earn-out. An unrealistic earn-out offer, whether the seller will be there or not, will affect the total value the seller receives and his ability to compensate senior staff in order to encourage them to stay and help achieve the objectives.
• Lack of attention to or ambivalence about the transaction. We commonly see this when the buyer’s or seller’s business starts to decline – the person is “away,” doesn’t answer phone calls, etc. It’s usually an indication of a more fundamental problem, resulting in inertia and delays, or the loss of the deal.
• Inexperienced buyers with poor internal communication. Many new buyers – private companies – don’t have targeted M&A departments or business development departments focused on acquisitions. Consequently, the CEO, CFO and COO all may tend to have their hands in the process, looking at it from different aspects. This can result in a lack of coordination, with contradictory messages being sent to the sellers or their representatives, which creates confusion.
• Unrealistic adjustments of certain expenses by the seller going forward. Typically, in addition to the cost of sales and SGA expenses, in M&A there’s another section called adjustments. When we’re adjusting earnings, that’s when we see add-backs. An add-back is where the buyer determines what he would have to spend to replace the function the seller has eliminated. For example the seller may remove his own compensation and minimize his contributions to the business in an attempt to jack up the EBITDA, but the buyer will need to pay someone to perform those general management functions, so only the difference in cost should be adjusted. Another seller may say he had a couple of top employees who were ineffective and actually cost the company money, but they’ve been fired, therefore that expense should be deleted going forward. That may or may not be realistic. Or a seller may say he had a dot-com client go out of business, leaving him with a large amount of bad debt, but he’s not going to deal with that kind of firm again so that expense should be deleted. If the firm’s bad debts have been running at half a percent of sales, which is about the industry average, and they shoot up in one year to 2% to 3% because of specific, identifiable customers that went out of business, yes, there might be some justification for that add-back. But ordinarily, if the bad debt goes up to 0.75% or even 1%, how does the buyer know that’s not just a lack of good internal controls on issuing credit? The rule is: When adjusting your earnings, keep your add-backs of expenses realistic.

Finding an acquisition target that meets your criteria and negotiating the Letter Of Intent (LOI) and the Purchase and Sale Agreements, while complex, are often the easier steps for a buyer to navigate in an acquisition. The real measure of success of an acquisition is how well it is integrated into the buyer’s firm. It’s easy to change a company’s name but much harder to change old work habits, ingrained attitudes and values.

Over the past several years, some buyers have acquired excellent companies only to see their investment stumble and fail. Often, this can be traced to the buyer’s inexperience with acquisitions and the inadequate provision of appropriate resources. It can be very challenging to convert an entrepreneurial landscape to an intrapreneurial environment without some casualties.

Acquirers need to think carefully about all transition issues, such as whether to bring the new company under the buyer’s umbrella partially or totally, the timeframe for integration, and who on the integration team is responsible for each change. Successful integrators have the answers to these and other questions ready before the questions arise, and arise they will.

The Human Impact

We are essentially a people business. If we treated our customers with indifference, our businesses would surely fail. Likewise the way we treat the staff of both the acquiring and acquired firms determines the success or failure of most acquisitions. More than one acquisition has been torpedoed by lack of adequate communication between upper management and the people on the front lines.

Management must ensure that the right messages are being conveyed. If the larger vision from the corporate suite is reinterpreted at the branch level, where activities are often geared to the current month’s profit and the branch manager’s bonus, the result can be a disaster. Larger companies typically buy smaller companies for their expertise, local presence, management, contacts, creative methods of doing business and the innovative service offerings they bring to the marketplace.

Unfortunately, it’s not uncommon for a buyer to inadvertently damage or destroy much of the goodwill it is acquiring by erasing the seller’s identity and imposing its own culture prematurely. This is the primary cause of decline in the acquired business – and it is usually self-inflicted. Small companies have a lot to offer large companies. Owners and key staff are usually proud and somewhat proprietary about the way they do business.

For years, they have sold their clients on the very fact that they are small, local, flexible and always available, unlike the giant firm that may have acquired them. It can be especially risky to impose changes before understanding all the elements that made the acquired company successful and attractive to the buyer in the first place.

The culture and processes of a tightly focused small company may be complementary to or even superior to those of the acquiring firm. Since acquirers are typically larger, they may believe that they have greater corporate intelligence and expertise in support systems, advertising, marketing, infrastructure and the overall methodology of delivering services. They may be right. However, it can be very costly for buyers to impose their “corporate systems” arbitrarily or faster than the plan can be communicated clearly to sales and service staff on the front line. People often need time and repeated exposure to new messages and themes before they buy in.