It's hard to make a big choice in monetizing your life's work. It is important to understand the concept of not running your business like its for sale... but... listen was we dive into keeping a steady hand on the tiller when selling your business,
Mike Harvath 00:04
Hello, and welcome to this week's Shoot the Moon podcast broadcasting live and direct from revenue rocket, world headquarters in Bloomington. Minnesota. As you may know, I've been a rocket is the world's premier growth strategy and M&A Advisor to tech enabled services companies. With me today, for I think, a pretty interesting conversation are my partners Ryan Barnett and Matt Lockhart. Welcome, guys.
Matt Lockhart 00:34
Hey, Mike. Yeah, I think interesting conversation as well, especially, you know, given the fact that we're sort of talking about what happens in post loi for our for our sellers. And well, we've got a number of those situations going on right now. So we thought we'd share kind of real time. Yeah, some of the just sort of learnings and advice that we've, that we've gathered over the years. Ryan, what's going on?
Ryan Barnett 01:04
Yeah, hey, guys, thanks for hosting us. And thanks for everyone for tuning in here today. One of the big pieces of advice that we give in a an m&a process, especially when we're working with people who are selling their business, it's important to understand the concept of really don't operate like your business, like it's for sale. And it's a big concept. It's hard to make a big choice in and monetizing your life's work, and hard to put your company up for people to peek into. And, and not have it impact your life. But at the end of the day, buyers are buying a growing concern. And part of that is running a really successful business, all the way through the sale and the goals of the business. So one of the things we wanted to talk about is that that concept of running that business, but also some considerations for things you that could impact a sale. So if you're in a process, or you're maybe even near the final line, making some critical decisions can have some long term impacts. And I want to dig into that today. So Mike, as we usually do, we'll kick it over you. Why don't you get started on on ticket about this concept?
Mike Harvath 02:26
Yeah, I think, you know, think about is, the main thing to think about is that anytime you're going to commit resources, are committed to liabilities or debt, within the confines of the business. If you're already under loi, for example. You know, that's something that you probably want to discuss with your potential buyer, at a minimum, and or, you know, in good alignment on how that's going to be handled, or begin to think about how, you know, if it's absolutely necessary, you know, it's kind of got a, you know, cover the absolutely necessary test. And the reason why I say that is because typically, if you're making commitments that will involve debt, you know, it can be anything that may be an asset allocation. You know, we've had situations like this where, you know, a client who maybe a cloud service provided by the big sand array. And, you know, they've got some debt associated with that. And, obviously, they have an asset that sort of offsets on the balance sheet. Or maybe they bought it a year ago, and they still have a significant amount of data, they're just beginning to capitalize it, for example. Or there's other debt commitments that are being made. You need to be in lockstep with your buyer before those commitments are made. Otherwise, you may find yourself paying for those proceeds from the transaction with all of the benefit, ultimately going to the buyer. So in short, it will make your ability to optimize the transaction for you as a seller go down. And, you know, we certainly can talk about plenty example of that. Here the next you know, a little bit but, but the short answer is, you know, I think you need to have a very steady hand on the tiller when it comes to managing and running the business. You know, we think up and to the right will open to the right focus on continuing to grow the business certainly provides a lot of lubricant for the deal. You know, if you begin to struggle or you're distracted by the deal and your business is going down, it makes it harder to get it done once you're under loi, for example. So, you know, extreme focus and discipline is required during the loi, period and before ideally Um, in order to make sure that, you know, the buyer has full visibility into what they're acquiring, but much more importantly, you know, don't make any unilateral decisions that involve, you know, contingent liabilities are liabilities that would show up in your balance sheet during the LOI period without discussing it with your buyer first.
Ryan Barnett 05:26
Yeah, I think that's a good start. Like it said, operating is a growing concern, keeping the business running is paramount, making sure that you're heading in the right direction is is also paramount, and keeping things just going the right way are great. One of the questions I think we get a lot and I know Matthew have dealt with this quite a few times is the hiring of new people. And oftentimes, we see companies that are looking for new sales teams and new salespeople. Do you have any additional color on on how a seller may treat hiring, or even letting other people go during during the process?
Matt Lockhart 06:15
Yeah, I mean, I think that, sort of going back to a couple of principles that that you guys have laid out already, right, you know, steady hand on the tiller. Nothing that would be seen as dramatic, or affecting the business to the negative. At post close, AND, OR, AND, or actually, during post loi, if you will. And, and then in engaging, what you expect to be a future partner, or, or the buyer, right, so think about those things as it pertains to hiring and or firing. You know, if there's an individual that you've had on a plan that is not producing for the business, and you view, you think that the right thing to do and operating the business and further go forward, is to let go of a poor performer? Well, that sound seems to be a very reasonable and good decision that would be in benefit for, for all parties. And so you know, in that case, what you may just want to do is is, you know, have a conversation and say, Hey, guys, just so you understand, because you'll see this in numbers, and et cetera, et cetera, this is what I'm doing. And, and that only demonstrates that business has been well managed, right? I'm doing something in terms of hiring is a maybe a touch trickier. Because you're you're adding cost to the business. And in that period, and it very well may be a good decision, you've you found a superstar, you've been, you've got the opportunity to hire somebody that you've been courting for a long period of time. Right. And, and so, you know, again, it may add cost to the business that cost needs to be analyzed and, and understood in the in the projections. But again, again, problem, probably a good idea to think about the visibility and transparency to a future buyer, especially post LOI. Right. And so I think that, I think that those situations, or are oftentimes case by case scenarios, but think about it in the context of of what is, you know, could be seen as an impact, right to the business, and how that would be perceived, you know, by your future partner, and buyer.
Ryan Barnett 09:16
Yeah, I think well summed up like I would, without making a huge laundry list here. I would love to hear your insight on. Are there some major categories that's seller should be particularly aware of, and this can go even pre loi when we're discussing this, as we talked about a lease might be an example or are some other type of liabilities. What some, what are a few things that sellers should be especially aware of?
Mike Harvath 09:51
Yeah, I think, you know, certainly leases are one that is super important. I mean, you're making a long term commitment to space out Typically in a lease extension, we get asked this question a lot, you know, is it appropriate to sign a long term extension, when you're considering the sale your business, whether it's pre or post loi, I certainly would not be doing it post loi without discussing it with a buyer. And I would strongly urge you to think about it before, if you don't have yet a buyer lined up, but are considering an exit, and the primary reason for that is that oftentimes, fire me want to move you into a different space, or it may want to some cases eliminate the space altogether. And they want to have choices. And there is always a negotiation that goes on around long term leases, because the buyer is signing up for that liability, essentially in that responsibility. And so, you know, it's easier if you, you know, either around a month a month are fairly short, or you have a fairly short period of time left in your lease, I'd say less than two years is easy. Less than one year is better. So keep that in mind, if you think you're going to have a transaction coming and coming here. So you need to be very attentive to how you manage, so are sort of your leasing, leasing commitments, others that kind of sneak up and bite sellers are things like changing their rotation policy, and also a little bit of a weird one. But if you add vacation, let's say even to your most tenured employees, and you do it in it in its now suddenly has to come on to the accrual ledger, it will dramatically impact or could dramatically impact. You're either working capital reconciliation, or or the, you know, be a reduction in purchase price to cover that commitment. That's a liability usually that buyers require that the seller's honor. They don't want to inherit that liability. So either have to cover it off with some renumeration in the deal. And then the buyer inherits the liability if you will. So they don't disrupt the vacation, or it gets paid out. And then they begin to accrue new sort of vacation schedules with the buyer. And this can be a, you know, a material number. I mean, we've seen it, it'll be into the hundreds of 1000s of dollars, if not more, in some situations. So, you know, being cognizant of making changes in those policies or understanding that, and what your liability exposure is there, depending on your policy, you know, is is really important. Other things, you know, that become a little more gray are, you know, how are you dealing with equipment leases, and commitments around equipment, leases, or purchases in support of the business. And this could involve furniture, this could involve, you know, things that are not, you know, fully amortized yet, as far as or capitalized, depending on how you deal with that purchase. So, I think, again, thinking about, you know, running the business as if you're not selling it, but at the same time balancing your commitments to these purchases, and potential liability hangover or impact to valuation is really what ends up happening, continuing to cover off some of those costs, without the benefit of that purchase, coming until after, or the lion's share of that benefit coming to, to the buyer, because essentially, what occurs, need to be, you know, well understood and explored with your m&a adviser and certainly discussed if you're under loi with a potential buyer.
Ryan Barnett 14:09
So, so if something happens like that, and we in between an LOI and between a close and in here, if you find or uncover something like that of change, that is material enough. How do you reconcile that?
Mike Harvath 14:28
Well, I think if you're, if you're the buyer, you're gonna call it out. You're gonna say to the seller, hey, by the way, in doing diligence, we see that this occurred since our preliminary diligence was completed, and it will impact purchase price. I mean, I think it becomes a discussion that has to be made to say this is expected now. You've set the expectations with the employees have occasion is a good example that You've added a liability to the business that, you know now has to be taken forth or or paid for by the seller, as a way to, you know, make it right. And that either impacts part of the working capital reconciliation, which is usually or that you know, or I guess it could be a refund purchase price of, for example, there's not enough excess working capital harvest made by the seller to cover that liability. Likewise, it could be, you know, any of the things that we discussed, plus, you know, more that you may have not covered off on employment, airy due diligence, you may have thought it was one way, and then, you know, either didn't find it, or you got to it as part of your comprehensive due diligence review, and task proof work, as we call it. You know, those are things that if they're material, I just really need to address them immediately with a salary and make sure they understand what their liabilities are here. And that, you know, if it was positioned one way, and you find it to be different, that's why you do due diligence is to make sure that there's no surprises, if you will, but if you should find a surprise, you need to sort of immediately address it with the seller to make sure there's, you know, clarity and work out a solution, there is no one solution. And what I mean by that is, you know, as a buyer, you may agree to pay more, right? You may say, Well, yeah, we'll just deal with it will inherit the liability. You know, we're gonna take our lumps, we're getting such a good deal that, you know, adding, you know, minor amount of additional purchase price is not going to impact our desire to do the deal. Likewise, so I may say, oh, yeah, I probably made a mistake there, I'll just take my lumps on it, or there could be something in between, right. So I think it's not a one size fits all solution when it comes to some of these decisions. I think the key though, is to make sure that the decisions are being made it a light of day, pursuant to a buyer buyer's knowledge, if you're a seller, you'd make these changes, if you're under loi, and it's not just going eyes wide open and making these commitments, if your plan is to sell within the next year, that some of these things, you're probably going to have to cover off which the buyer is going to get the lion's share of that benefit that you will be paying for.
Ryan Barnett 17:34
Mike, I've heard you say before, I can't attribute the quote, but the last 5% of a deal may not doesn't matter as much as the first 95% Is there a general calculation? Someone could do that take help put guide rails around? Should I make this investment or make this purchase?
Mike Harvath 18:00
Yeah, I think generally, when you start looking for deals that are, you know, north of 20% internal rate of return and you know, you're working on a deal, you found one, you've come to it together price and terms on the deal, you've done all hard work, right? To get there to see that there'll be a material return on investment, either internal rate of return or return on investment numbers line up. You know, there's, there's some conventional wisdom that says, you know, don't, don't blow it up over something as minor as you know, something like this, right? If it means that it's less than, you know, 5% of the deal value overall, there's probably no business case to make, just blow up the deal yet a lot of people auger in, in due diligence and look for these little events, and then they become kind of a fatal wound, if you will, to the deal. We think that's a huge mistake. Because finding the potential seller if you're a buyer or or vice versa, finding a buyer or seller, getting through, you know, alignment around strategy, culture and finance, getting to a point where you can come to gather on pricing terms, and one that meets the buyers expectation return rate and manages to the seller's desire to either sell it or sell out, as we've talked about in other podcasts are the big block items, right? We have to remember that due diligence, the purpose of due diligence is to confirm that what a buyer is buying is actually there. And that some of these things that may not have been discovered or even assumed will come up and due diligence and by all Alright, so it should impact you know, put in a word but could impact valuation, but as a buyer, I think you need to be smart enough to know that you might not want to throw the baby out with the bathwater, some of these things are fairly minor, you just need to know they're there. And look at what the impact will be on the numbers. Even if it is negative, within 5% of the deal value. You know, there's, there's many buyers have been very successful m&a where they just let that go. So they can get the deal done on time and begin to realize the synergies from it, versus worrying about getting the last nickel out of it.
Ryan Barnett 20:45
Yeah, that's very helpful. Those are kind of the big questions that I had and big common area. Matt, any any other thoughts here.
Matt Lockhart 20:57
I really like your, your description of steady hand on the tiller. Right, and I want to reinforce that, you know, the, the process is emotional. It's inherently emotional, right? Because as for for any seller, whether or not it's a founder led business, or a business that, you know, maybe you were brought in, leadership team was brought in, and they've, they've been very successful with the business, it's been a good run, it's been a great experience. And you know, you're closing the chapter, and you're going to be starting a new chapter. And, you know, the, the old axiom, and that changes, it changes good for other people, or change happens to other people, well, there's gonna be a change, and that is simply emotional, right? And so, you know, working with a good advisor who can help you so that you can, that you can keep a steady hand on the tiller, both in terms of your personal emotional decisions and your personal emotions and how you communicate and how you conduct yourself. And then, you know, how that carries over to your practical business decisions. Is, is just simply critical. And because the number one thing that can that can cause a deal to go sideways is, is, you know, any dramatic changes in the, you know, 60 to 90 days, post LOI. So, just want to reinforce that cool topic. You know, again, one that we're, we're, we're working through an individual basis with a number of awesome clients and so, so fun stuff. How do we tie it out, Mike?
Mike Harvath 23:00
Thanks, Matt. Well, with that, we'll tie a ribbon on it for this week's podcast. Thanks for tuning in. encourage you to tune in next week on pack and explore more, sort of interesting, timely and relevant ideas around growth strategies and m&a for tech services companies. Thanks for tuning in and make it a great week.