Revenue Rocket has decades of experience helping business owners tackle the most unnatural act in business, achieving their exit goals. Most of the hard work in a sale comes well before deciding to list but there are so many surprises that can happen along the way you may not be prepared for. Listen as the time dives into things that could be surprises for sellers in an M&A process.
Here are the 6 (& a bonus!) we talk through:
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Mike Harvath 00:02
Hello and welcome to this week Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. As you know, if you're a regular listener to this podcast revenue rocket is the world's premier m&a and growth strategy firm that helps IT services firms. And so we are out here talking to tech enabled services companies, IT services companies, that's the world we live in. Today with me are my partners, Matt Lockhart and Ryan Barnett. Welcome, gentlemen.
Matt Lockhart 00:36
Hey Mike, we do live in that world. Every single day. And it's a it's a pretty good world to live in. I think, Ryan, what's going on? What are we talking about today?
Ryan Barnett 00:47
Yeah, you know, today, we are talking about something where if you're looking to sell your company, oftentimes, we do both buy side advisory for mergers and acquisition as well as sell side. And when we say buy side, we mean helping companies buy another firm, and sell side, it's, if you're looking to sell your firm, we help represent your firm and buying the right buyers. So we have a really unique view of seeing both sides of the spectrum. And, frankly, we were working with a deal this week in which we were representing a buyer and someone on the other side of the seller just had a number of surprises in the deal. And we wanted to talk to through a few of these surprises to help someone else as you may be considering a sale and what to look for. So again, that m&a is one of the most interesting and unnatural acts in business. And the more you can understand to prep yourself for some of those surprises, that helps. So I want to just kind of dig into a few things. So we'll start out with just sometimes a seller and frankly, buyers are surprised with the length of the process in general. And Mike, once you get us go on, you know, what should What should someone expect when it comes to when you're talking about the process and getting getting your company sold?
Mike Harvath 02:21
Yeah, thanks. Ryan. You know, I think that it's important to understand that, you know, it sort of depends on how you plan to sell it. You know, if you're thinking, hey, we want to go look at a variety of suitors to acquire our business, we like competition. For our business, we'd like choices, which we think is a excellent way to sell your business, you want to run what's called an m&a process. And in order to do that, you need a competent adviser who's connected to the industry. And primarily because you need to be able to facilitate outreach to the right kind of buyers, develop marketing that will pique those buyers interest, and then be able to have a relationship hopefully with those buyers, with your advisor to move deals forward. And understanding where you know, the inside sausage making of how these buyers think is a huge advantage. Otherwise, you can certainly waste and burn a lot of time. Meaning if you're listing your business with, say, a generalist m&a advisor, I think that's better than not listening with an advisor at all. However, they bring a much lower value to the conversation. And that translates into more time. And since the economic relationship with advisors is typically around a retainer plus a success fee, it means it's going to cost you more money. So I think it's important to note that even with a competent market focused m&a adviser, that finding the right buyer can take you quite a bit of time. And typically that amount of time is months of time, not weeks of time. And you want to have an adequate number of choices. And there's it's very difficult to predict what that length might be, you know, is it three months, four months, five months, six months? It really depends on a variety of factors, not only about your business and the effectiveness of the marketing of your advisor, but also the economy at large. In generally, the size and scope and reach of your business and the profitability of your business all sort of play into that equation. I think once you've found a buyer and let's you know, assume that, you know, process takes, you know, let's say six months or so, it'll take about 90 days to get from our letter of intent to close. It's not atypical, we find it to be just don't manage expectation to get through all the legal and and related, you know, negotiations around not only the business terms, but also the purchase agreement, binding document, that that takes about 90 days as well. So hopefully that's helpful, Ryan.
Ryan Barnett 05:16
I think that I think you nailed it, the timings probably longer than you think. But even if you have the right suitor in place to draft agreements and get through it, that's going to take some time. So prepare yourself to for more than you think, I think is how I craft summarize that and have an advisor is helpful along the way. We've seen sellers be surprised by the complexity of the process. And when you go through and add everything together, by the time you interview with suitors, and posts or due diligence, or the legal paper are things even like a neat lien release, those all are small complexities, Matt, I'd love to hear perhaps some thoughts around the complexity of the process, and what what, what advice can you give to a seller who might be wading through this?
Matt Lockhart 06:13
Yeah, you know, I think a lot of our clients are, this is the first time that they've done it, right. And so to the topic, where it can be a bit of an eye opener, or a surprise, you know, a seller sort of goes, and then again, if they haven't done this before, and they're like, well, this, this is my business, I know my business inside and out. But the maryada buyers don't, and kind of some of what leads to the complexity is is that each buyer is taking is sort of bringing a different lens, to their analysis, the business, and so you can't just say, Okay, well, every buyer is going to be looking at the same things and thinking the same way. Because they don't, obviously, right. And so that can lead to some of this complexity related to the information that people are seeing the sort of the level of the detail of the information people are seeking, as well as when people are seeking a level of detail. Now, this kind of goes back to, you know, where Mike led off of make sure that you've got a competent adviser on on your team. So they can help guide both the buyers, as well as guide you as a seller, in terms of your expectations and, and when and what information is going to be available during the process. So it can be detailed legal due diligence, contractual diligence related to not just, you know, what contracts are in place, but how those contracts can be survivable or not the level and depth of a relationship that is in place with customers, the sort of historical detail around employees and hiring, and which, which then sort of gets into cultural and leadership aspects. Right. I mean, it's, it's, you know, sort of think about if you take a step back and say, okay, really, what are what is every nook and cranny of my business? Well, you know, that that sort of, you know, opens eyes as to the complexity of what may be asked for.
Ryan Barnett 08:59
Yeah, I think that content leads into my next question. And buyers or sellers are often surprised by this, but if we start to look deep on number of buyers, especially if they're being driven, will have a quality of earnings. You might hear that as a q of e. And when you think about that, and Matt, I know you've gone through a lot of these lately. What is a q of e and and help sellers understand what they might go through in that process? So they're not surprised by it?
Matt Lockhart 09:32
Yeah, that you know, quality of earnings is basically a thorough analysis that everything quote unquote, lines up financially, from orders, right contractual orders that are in place all the way through a consistent method of collecting a well billing and then collecting on a consistent basis collecting your Yeah, you know, your accounts receivable, and then you know, seeing that come through and into the bottom line and, and what's in the bank account, right? And including then all of your internal costs, right that that line up accordingly, which then results in the sort of the proof of your net income. Quality of earnings are done by, you know, registered accounting firms. And the no think of it in the, in the context of an audit, if you will. And so it's, it's, it's basically doing an audit on all aspects of of your financials. Now, quality of earnings, and officially signed off on quality of earnings aren't always part of a process. But if you are working with a financial buyer, and or a strategic buyer that is backed by the bank financing, or external third party lending, then in most cases, a quality of earnings is, is going to be required. And if then, to the preceding question, it can add length to the time, and we've never had a had a problem with any of our clients, and successful quality of earnings as part of the process. And again, again, speaks to have the right advisor in place with a with a strong financial and due diligence team. But again, sometimes You know, sometimes, you know, some of our sellers have never even heard of the concept of equality of earnings. And so I think good awareness there. And then when you know, you should expect a quality of earnings based upon the profile of the seller.
Ryan Barnett 12:05
That's great, I think great, great. I did, fellas really prepared to ask them open books and and it's an expect your what you're saying is true. To be true. And it's it can be a surprise, especially the surprise here I would look for is when you get that initial due diligence list, your your eyes are going to become wider saucers, it's, it's more complex than you think. However, if you work through a diligently, and you're, if you're using an advisor, your advisor should really be able to help you tackle a lot of those issues, you know, in order to help get to a compelling, compelling end, and as Matt mentioned that if you have the right advisor on your side, you can sail through those q of e's and get get on to the purchase agreement. Let's switch gears here a little bit. Mike, you've dealt with this a lot. One of the things we've seen resellers is most agreements are going to have kind of a cash free, get free view to them. Mike, I'd love for you to dig into what that means for sellers. And in the concept of having adequate working capital. We actually see this quite a bit. And I'd love for you to explain how would you make a seller not surprised about these terms?
Mike Harvath 13:36
Sure. So tax free debt free does not you know, what that essentially means is any debt you have on your balance sheet other than trade payables, which are debt, of course, but they're considered to be pursuant to the operation of the business. So let's say you get a invoice from your, you know, internet provider, right, that's considered a trade payable, and you owe that money, right? It's a liability that would show up and be registered on your books. And it may be you know, you don't have to pay it yet, but you're gonna put it on the payable side of your ledger. And on the asset, side load ledger, you have AR and cash right. And so, in short, you know, your balance sheet has to balance all the balance sheet for a reason. And you need to have at least enough current assets on the balance sheet to offset the liabilities which predominantly are made up of payables. Any long term debt or any sort of exceptional debt will either need to be transferred to the seller, or extinguished as part of the transaction so that you can sell the business. unencumbered, meaning without any liens or Need to have lien releases from your bank. And oftentimes your bank will file a lien on the business to secure their interest, particularly if they're offering a line of credit. So lines of credit loans, SBA loans, long term debt, all need to be either satisfied in the transaction or satisfied pursuant to the transaction, meaning based on consideration that's paid to you. Now, just because you get to a cash free debt free deal, does not mean that, frankly, you can harvest all the cash. And you do need to make sure that you have enough coverage of what like, well, we often use the term coverage ratio on the working capital, that we'll see that you're selling a going concern. So pursuant to sort of the normal process around selling a business, a business needs to have enough working capital, in addition to having the balance sheet balance at, you know, current assets equaling current liabilities. Now, what's enough working capital, I would say the guideposts it's generally around 30 days of operations. But that number is somewhat negotiable. And it typically depends on the buyer and the seller. As a general rule, you will need to leave about 30 days of working capital in the business in addition to the balance sheet balancing, so that you can treat pay all your trade payables as well as accommodate any unforeseen slow pace that sometimes happen during a transaction. Part of the reason you need a competent adviser who has strong due diligence and accounting skills is to help you negotiate the amount of excess working capital, excess working capital is the amount above and beyond which you don't need to operate the business as a going concern. It typically is held in cash, thus the term cash free debt free. And you will be able to harvest it before or as part of the transaction. And so when we say cash free, I think a lot of people have a misinterpretation that that's all cash no matter what. That's not really the case. It just refers to the excess working capital that is generally held in cash. Hopefully, that helped Ruan.
Ryan Barnett 17:40
Yeah, it's a it's a complex process. But we seem to get companies blindsided more than we should. And part of this goes into a little bit of a question here is it's not always explicitly outlined in a letter of intent. And, Matt, you know, start with a little bit of a curveball question here. But I think you're good at answering that is one thing seller should not be too surprised about is changes from an LOI to a purchase agreement. And I'd love for you to kind of dig into that concept a little bit, not suggesting it had retrieved here. But the LOI is a very specific document and Matt, I'll you dig into that.
Matt Lockhart 18:30
Sure, loi letter of intent. And by by the way, we counsel both buyers and sellers, the most important word in letter of intent is intent. Right? So tahe letter of intent and sets the general terms. So what is the enterprise value for, you know, we can and that can be a little bit fungible, right, it could be an enterprise value range. Now we like to specify the exact enterprise value. But it could be it could be a range based upon some factors that are, you know, sort of an undiscoverable until you get into, you know, post letter of intent, diligence and exclusivity. So, the enterprise value and then the structure, quote, unquote, structure structure is, you know, is there an earn out in place? Is there is there rolling of equity? In, you know, what are the timelines related to an earn out? Is there a seller note? So, that's another common aspect of structure. And so, you know, I think that where we see changes on a consistent basis, and one should expect that there's going to be, if not change, clarification to the terms that are set forth in a letter of intent. And that that some may see is change, others may just see as clarification. So oftentimes you will see the same and overall enterprise value being delivered upon, if there is a material change and enterprise value that then, you know, is considered a Retrade, the term that that Ryan used, so, we're not talking about retrain. So, same and or, you know, non material change to enterprise value. But you may see some changes, say, for example, a buyer comes in and says, you know, I want a three year note, and so I'm setting the term for a three year note, well, through because they want to really, you know, have the owner on the hook to, you know, to ensure, you know, continued progress of, of the business of the going concern, well, and due diligence, they say, Well, geez, you know, what, I, I don't feel as though I need that risk protection in place for three years. And the seller is conveying to me that they really went in with the desire to be done earlier, and be out earlier. And so I'm going to accommodate that seller, and I'm going to reduce that three year note to an 18 month earn out or a 12 month earn out, conversely, on the flip side, somebody may say, Well, geez, I, you know, all I need is a one year earn out. And then they go in and they say, Wow, geez, the seller is key to each and every one of the customer relationships that's in place, I need that that seller around for two years. So there can be applicable changes from an LOI to a purchase agreement, that are the, you know, really the right thing to do for both the buyer and the seller. And that doesn't, you know, materially change the structure of the deal. But again, it just clarifies, you know, what is the right thing to do for the business?
Ryan Barnett 22:37
Great, thanks, Matt, it's really well done, we're gonna move on. I'm going to just tackle one quick issue here, it this is a surprise that comes up. And it's, when you go through it, it can be almost painful. But if there's if it's an asset purchase agreement, part of that is your, those your employees and your customers will be part of a new organization. And technically, you'll technically terminate your employees and hire them back and then in a new company, and that, that can be surprised in just the technical nature, you're still going to keep your employees, you still going to keep things moving. But keep in mind that it can be a shock just to see the word termination of employees when oftentimes sellers are looking for longtime legacy. You're I would say it's it's a formality. And it's something that is more in the legal parts of the document. And the surprise here can be take a weight off your back and thinking that it's, this is not a firing of everyone. But instead instead a, a technical vocality here, but something just to watch out for. And then I'll wrap just the last question here. Before wrap it up. I'll send this one over to Mike. Going through this process is hard for a leader. And I think there's a little bit of a surprise on how hard it is to go alone. And I'd love for you to unpack that a little bit.
Mike Harvath 24:15
I think there's a lot of unknowns and surprises that tend to come for most sellers in an m&a transaction. It's why you need a competent sellside representative that is going to help you understand those and help work with any buyer in sort of helping you mitigate your risk. But also helping you just understand what's normative and what's expected so that a buyer wouldn't take that to mouth and take advantage of you there is a real risk there. Now, I would say in general, that almost all deals are fair and get It sort of negotiated down the middle of the plate. But without some checks and balances in the in play there by you being represented and or the buyer being represented, or both, it can be challenging and difficult. I think the most, it's an emotional ride no matter what. And, you know, I can confidently say, having done this three times myself prior to starting revenue rocket, that it is an emotional time. And you really need to be able to have someone that can, you can talk that through with I think, you know, in some ways, the right adviser is as much a, you know, a psychologist, as they are a deal, you know, deal team to help you get it done, because like, it's likely that your business is your single largest asset, it's likely that you've put a lot of blood, sweat and tears and time and risk into it over the years. And now's the time for you to monetize that investment. And you want to make sure that, you know, not only do you have your financial house in order, and that expectations have been set accordingly. But you also want to make sure that you have your head in the right place. And understanding what is coming next and understanding what the relationship will be moving forward once the deal is done. And being able to reconcile sort of where your life is going, once you're no longer, you know, own management, control this business are all super important aspects to any transaction. And, you know, you want to think through those things before you sign the deal. Can I think a competent adviser who's helped lots of business owners kind of get their deal done, does that, that work with you very effectively, and will also help shield you from some of the things that, you know, may on the surface look like a buyer is trying to take advantage of you when in reality, this is more of a normative part of every transaction that you need some level setting with, with someone who's seen more than get a one deal or a few deals.
Ryan Barnett 27:32
That's That's great. That's great. Thanks, Matt. And Mike, for this podcast, just to summarize a few things here. From a timing perspective, everything's prepared will help reduce the time of a deal. However, finding the right buyer may take a little longer than you expect, kind of think months, not weeks. When you think about the complexity of the deal, it's it is going to be complex, and each buyer may bring a different lens, and each buyer is going to be different. So expect complex complexity throughout that process. You it's likely that you might have quality earnings on it will be in its intensive. And it's expect to have your open books and to prove your earnings. Expect to extinguish your debt and have adequate working capital sellers, you should really be working with an advisor to harvest excess working capital, and make sure that you're able to keep as much cash as you can, at the close. During expect changes between the LOI and the the definitive agreement. So may may set terms like enterprise value, but keep in mind, the first letters of a letter of intent are going to be this is non binding, there certainly will be changes. And then the last thing is that I heard he was expect the process to be a bit lonely and emotionally draining. However, having the right adviser next to you throughout the process can make it much easier. Now with that, I'll turn it over to Matt my close up. Yeah.
Matt Lockhart 29:10
Yeah, thanks. So funny story, Mike, to your point, you know, sometimes you're, you know, maybe one part counselor, someone described it as you are, you know, you are one part bartender, one part therapist, and, and then, you know, one part, you know, merger and acquisition advisor, right. So, it's true, you know, that you develop a real close relationship with your advisor. And, and, you know, that's actually one of the, the, sort of the, the greatest things about the role that we get to play is, is developing these relationships and guiding people along. So, you know, and the last thing that I'll say is that some of this complexity can be removed, if you follow a best practice, right? And that best practice is regardless if you're 10 years away from selling your business, do an m&a Readiness Review, right? And, and understand how the market and external people will look at your business. Right. And, and, and the benefits to that are not just about getting ready to sell the business, but it is getting that outside perspective and allowing you to drive your strategy forward, close any gaps, remove any weaknesses, enhance the great things that you're doing, and aligning to the market. So, you know, do an m&a readiness review on a regular basis. Be that once every two years or once every three years. And I think that you'll be I think you'll be surprised and thankful for doing that. So couple of words of wisdom. And over to you Mike.
Mike Harvath 31:24
Thanks, Matt. I couldn't have said it better myself. I think with that will tie a ribbon on it for this week's podcast. Encourage you to tune in next week when we unpack more m&a and growth strategy topics for tech enabled services companies worldwide. Thanks for tuning in and make it a great week.