In this episode, we're walking through the differences between selling-in and selling-out in an M&A deal. If a buyer wants the seller to sell-in, what does that mean for the executive team and why does it benefit the combined entity? If the seller is looking to sell-out, how does the buyer manage this transition? What do deal structures look like for each scenario? Listen as we answer all your questions about selling-in vs selling-out.
Selling In vs Selling Out - Revenue Rocket
Wed, 6/15 10:51AM • 20:52
SUMMARY KEYWORDS
selling, business, equity, buyer, deal, owner, oftentimes, companies, ryan, transaction, mike, matt, enterprise, cash, case, founder, structure, client, acquiring, seller
SPEAKERS
Mike Harvath, Matt Lockhart, Ryan Barnett
Mike Harvath 00:04
Hello, this is Mike Harvath with this week's Shoot the Moon podcast, broadcasting live in direct from Revenue Rocket world headquarters in Bloomington, Minnesota. Revenue Rocket is the premier growth strategy and M&A advisor for IT services companies worldwide. And we're thrilled to be here. I have my partners Ryan Barnett and Matt Lockhart. Gentlemen, welcome.
Matt Lockhart 00:31
Well, good day, Mike. Good to be on with you guys. You know, I was gonna jump in, we've got a really interesting topic that I know Ryan will introduce regarding selling in versus selling out. But first, I wanted to, you know, we don't toot our own horn very often, I think it maybe it's the the Midwest roots and us those Norwegian roots. But, you know, we've kind of been experiencing some pretty incredible growth around here. And we've had three new people start just this week, along all lines of the business. Our analysts group, the M&A group and the strategy group. And so you know, it's pretty exciting. And, you know, it's always fun to be part of a growing business, Mike.
Mike Harvath 01:25
Thanks, man. Yeah, we're pretty excited here. It's, you know, epic year for us record year already revenue rocket, and certainly we look forward to serving and helping more of our clients. As we move forward. Ryan, let's talk about selling in and selling out.
Ryan Barnett 01:44
Yeah, it's indeed been a fun year. And Matt, I think congratulations are indeed order. It's been fun to work with everyone here. And part of that has been to this podcast and how we've been able to address a lot of the concerns and topics we see in M&A. And one of the things that we've seen this week, a lot of it is around just questions of a concept of which we call either selling in or are selling out, or leaning in or stepping away. And I love Mike, maybe just start out on just definitions. Just tell me. What do we mean when we say someone is selling in?
Mike Harvath 02:21
Yes. So you know, when you're going to sell your IT services business, you know, I'm often advised in that owners think a lot about what they want to do next. Right. I think it's one thing to say, okay, you know, we built this asset, and it's a great business. And, you know, now we want to move on from this business, or you want to be part of something bigger. But it's imperative that you have clarity as to what that is. And we've sort of coined the term selling in and selling out. An owner who's selling in is someone who's going to join another firm that's going to acquire their business, and play an operating role post transaction for the foreseeable future, with no specific end in sight, one that says, hey, we really, you know, the mindset of you as an owner, in that case, as someone that wants to be part of something bigger, wants to be able to have access to more capital to scale, wants to, you know, take your business along with a bigger business to another level, and maybe contribute in ways to that new business that you can't really contribute to your own because of its size and structure and maturity. Someone who's selling out is an owner that is looking to retire from the business, they may not, you know, be quote unquote, retirement age, but they may decide that they want to move on to either do something else, follow another passion. You know, do whatever they might want to do. Or, you know, maybe go to work for a different business or start another company. Oftentimes entrepreneurs that start IT services companies want to start other IT services companies or sometimes product companies in the tech space. You know, we've actually had owners sell out and start you know, Taekwondo studios very successfully Matter of fact, we had a client on the East Coast, who did that, who runs you know, he's very passionate about Taekwondo and the only runs five location taekwondo studios to train people to do that. So, you know, it just depends what it is. But in any case, selling out has to do with sort of selling the business of providing an orderly transition over time to the new buyers.
Ryan Barnett 04:52
Matt I'd love to get your opinion on this. When you hear kind of selling and selling out to your management team either sticking with you and kind of going through the slog, or for selling out, and when I think there's almost a derogatory term to selling out, and I'd like to get your opinion and is it bad to sell out? What options do you have? And does it really mean that you're gone day one?
Matt Lockhart 05:19
Yeah, ya know, it really shouldn't be thought of as a negative, Ryan and it's just providing clarity to a, you know, to a potential buyer, in terms of the intentions of the, you know, seller. Now, you know, let's put it into the context that oftentimes, this is most applicable for a founder led business, and there are so many founder led businesses that have, you know, thrived and grown and been very successful for a decade or two decades or longer. And, and so those founders are, you know, really, looking at this as a realization of their life's work, and having the opportunity to do something different to have a new chapter, I think that in the cases where it is the intention of those founders, or those owners to sell out, that they've done a very good job of building an organization that will continue forward and sustain without them at the helm. Now, obviously, any founder or owner has a cultural imprint upon the organization and an importance and that needs to be, you know, their transition out needs to be planned for and executed. So that those, you know, benefits and the values that they bring to the organization can be brought forward. In acquiring firm, but you know, it's not a bad thing. selling out doesn't mean that they're running away from the business, that there's anything to hide that there's anything bad, it's just, you know, their desire to, to really have a new chapter moving forward.
Ryan Barnett 07:26
I think that's a really good description, and good definition. There are all sorts of things that are not running a business, and it could be simply getting getting some chips off the table, it could be retirement, it could be moving on to something completely different. And, and I just a note on that, I believe all owners should have some kind of exit plan on their mind. It may be a long transition, it may be short, but it's it's sometime selling the businesses can be a very good thing for for you and your, your assets in your family. Mike, I'd like to kind of transition a little bit if if someone, what's the difference for a buyer when they look at someone who's selling or selling now, when actually, when it looks at the deal structure itself? Tell me kind of what a typical deal structure might look like for someone who stays in the firm or for someone who's retiring?
Mike Harvath 08:25
Sure. So, you know, usually, if someone's staying in the firm, you know, a portion of the consideration will be attributable to aligning interests with the buyer. You know, oftentimes that involves an earn out as an example. Or, you know, and might include an equity role, where you're going to take some of your equity and treat it essentially for the equity of the buyer. And that helps to align the interest around either a future exit in the case of equity or, you know, achieving your goals, or exceeding those goals and optimizing your deal value through that process. Via that earnout. We've talked a lot about how earnouts are misunderstood and oftentimes considered to be a negative in a deal and certainly when you're selling in, that's not the case, if you have confidence in your ability to grow the business and achieve your forecast or exceed your forecast. And certainly there's a business case to be had that if you're not better together in an m&a transaction than you are apart then you shouldn't do the deal. So you know earnouts if you're really truly better together, you should be able to, you know, achieve your forecast and exceed your forecast without as much work as it might take if you're just going solo so that is not A typical for us to see in a situation when someone is selling in there's tends to be more variable consideration that will be paid out pursuant to, you know, the business that's acquired achieving certain goals and opportunities. And the trade off that that seller gets in that situation is a higher purchase price, in essence, because you're taking more risk. Now, if you're selling out, you're likely to want to take less of that future risk, right. And it doesn't necessarily make a lot of sense to, to do an equity role, if you're not going to be around, particularly if it's equity, that you can't really influence or control its value. Sometimes that works, if you have confidence in your management team that's running the business, and that's going to stay and you certainly know that you're going to be able to add value. And this business, you might, as an investor, you know, decide to move from an owner to purely an investor. And you might want to roll some of that equity, but I think that's something you would have to think about, generally earnouts, don't work for someone who's selling out, because you can't really influence the performance of the business, all that materially if you're going to be gone in a fairly short period of time. And so oftentimes, those can get exchanged for what we'll call a seller note or VTB. Some people call it a vendor, take back note, where you can certainly be guaranteed that you're gonna get that money to you, as a seller become the bank. And so there's ways to sort of structure the deal to fortify your your purchase price, if you will, and eliminate risk if you're selling out. And, you know, that's just a couple of things that we typically see in transactions like that.
Ryan Barnett 12:05
And this is for Matt, we typically see kind of a sliding scale of enterprise value. So if you're looking to sell out, the enterprise value might be less at the structure of the deal, maybe or cash heavy, and and therefore, a little lower on the enterprise value. Is that a good assumption?
Matt Lockhart 12:28
Yeah. Oh, yeah. I mean, well, I mean, think of it's very logical, right, the more the cash that's related to guarantee right, then, then the, the buyer is sort of taking a bit more, or could be perceived as taking a bit more risk, right. And so that's natural, that the higher the cash equivalent, the the potential lower overall opportunity for enterprise value that there is. Now, it doesn't need to be thought of as you know, dramatic, we're not talking about, hey, you know, if you're selling out, you're gonna be getting half of what you would if you were selling it, that's not that's, that's not the reality, but, you know, thinking about how things could move 10%? You know, down, if, if it's, you know, primarily all cash that's applicable. Now, there are good reasons to do it, right, cleanliness of a transaction, et cetera, et cetera. But as Mike talked about, and, and the reality is, is that selling in, and I like to even add selling in and growing with, right, so those those then, and we've, we've seen multiple situations, we've had two or three of them this year, where we're representing clients who are selling in, and, you know, they're going to be helping to grow the value of an entity, and they're going to, you know, participate in the, in the spoils of that growth.
Ryan Barnett 14:11
Yeah, I think it's important to understand like that did, we did we represent a company that had gone through this path, and eventually it will mean a much bigger enterprise value. It were, it means growing together, it means perhaps piecing more companies together to help them get to their final goal. In some of the companies that we've seen, for example, we've seen deals in which an initial value of the transaction was 15 million, about 4 million of that was in an equity component. After 34 months that turned into 76 million. So I mean, that's a 19 times turn on on the on the equity value. But we've seen some pretty amazing case studies on how that can make some really good rapid growth and equity for everyone involved. If everyone's leaning in, in everyone has the same vision. I'd love to, to understand that. And that's a kind of an extreme example. But, Mike, we were talking earlier today it's selling in, you really have to be careful with your buyer. And tell me a little bit more about that.
Mike Harvath 15:24
Well, I think, you know, you have to qualify your buyer, right? I mean, we do that at the half of every, every client we represent on the sell side, you have to know, you know, does your buyer have the funds and access to the funds and expertise to do a deal like this? Do they really line up strategically, culturally and financially? You know, if you're selling in, you're getting into a business partnership. And you have to know that, you know, I mean, I'm sure everyone on the podcast knows this. But you know, business partnerships are hard, like all partnerships. And so you have to bet, you know, is this someone that I can work with, and this is someone where one plus one equals three, four, or five? And do I feel confident that we can go places together that we can't go apart. And in addition to that, are they capable, to fund this transaction, the way we're proposed structuring it, oftentimes, buyers will pose as folks that can do that. But once they get you locked up under loi, that's when they begin their fundraising exercise. And that's a bad place to be, if you're a seller, because you have to wait, you have to hope they can get their finance financing. You know, it's a pretty hard place to be. And so I think by qualifying your buyer, to have the capacity to do the deal, as well as the capability to do the deal are really important. But almost more important. And, or equally important, is clearly, you know, do these guys line up strategically and culturally, and can we work together to go to a place where we can go apart?
Ryan Barnett 17:21
I think that that's a, it's a great opportunity for people to take a look at this, if the right company is in hands. Right now we're working with two very, very exciting buyers. There are they're different from each other one is done in 200 deals in the last year. And they are looking at acquiring in the managed services space. And you've got just a track record of being able to take entrepreneurs and find a way that they can continue investing or successfully find their succession plan. But ultimately, what that means is that the people who join up with them, they're going to be part of something much bigger, they're gonna be part of a $3 million, or $300 million business, and $40 million and EBITA mean that scale that it's hard to find elsewhere. And then eventually there'll be another exit. And with that, there'll be able to take another, kind of they took the bite of the apple and now they're going to be able to swallow the whole thing on the backside. We have another client that's doing some very interesting roll ups in which they've done a lot of consolidation in they're looking for management teams to stay on to run the companies a little bit more separately. But they ultimately will take them public on an exchange and have a track record of doing this. We look at how they've done that and what they've been able to, to put together, they've generated over $3 billion in equity value and that's a lot of money to consider as a seller in a lot of opportunity to consider as a seller to go after. So I think there's certainly value in considering selling and or selling out both have their merits. And some of them that I think are beyond just simply equity and cash components, but also being part of something for you, your team and your clients that you would never have been able to do by yourself.
Matt Lockhart 19:35
That's a great point. Ryan, you know, we throw around that the term of the how do we get one plus one to equal you know, four or five or six. But you know, the reality is is that in those rights situations were selling in is desired. And the cultural, strategic and financial fits have been put together. There really is an opportunity for you know force multiplication and the more quickly creating greater value greater value for customers greater value in the marketplace and and greater value for a combined firm.
Ryan Barnett 20:14
I agree. that's all the questions I have for today. Matt anything from you?
Matt Lockhart 20:25
No, I'm gonna wait guys we're gonna go find some more space around this joint for all these these great new people that we've got on board, Mike, so maybe maybe we should wrap it up.
Mike Harvath 20:38
There you go man. Thank you guys for another interesting podcast on M&A related topics right the services companies. Thanks and make it a great week.