I’m pleased to announce a special version of the Exit Strategies Workshop in Victoria, BC on May 22, 2013.

Attendees consistently rate the Exits Workshop as one of the best. Here’s some feedback from previous atteendees: http://www.exits-workshop.com/testimonials.html

Two Victoria resident CEOs will describe the inside stories on their very successful exits. Mark Longo, a Viatec board member and veteran M&A transaction lawyer, will be speaking about the legal aspects of exits. For more on the speakers: http://www.exits-workshop.com/speakers.html

Due to the generous contributions of our sponsors, we are able to offer this special half day exits workshop for only $99.

The Exit Strategies workshop has been delivered six times in greater Vancouver – and has sold out every time. Please don’t delay your registration for Victoria on May 22.

For more information, and help with registration, visit http://www.exits-workshop.com/index.html

To register now, visit this page .

I hope to see you there!

My bookshelf has an entire section of books on valuation. Even though I deal with valuation every day, I haven’t looked at any of those books for at least a couple of years. It’s just not a process you need reference books for. Most of the time, acquisition valuations can even be done without a spreadsheet – many professionals will work out the valuation on a whiteboard or even a post-it-note.

That sounds simple, but valuation is actually quite challenging. One reason is because it’s based on the ‘type’ of company and the ‘quality’ of earnings. Growth rate, predictability and market conditions are also significant, but difficult to quantify inputs to the valuation process.

Market Conditions

Valuation depends significantly on market conditions. Changes in valuation can occur because certain types of companies are in greater demand, or because some sectors are perceived to be more attractive by acquiring companies.

For example, in the past few years, SaaS (software-as-a-service) companies have been in high demand. Companies like Yahoo, Google, Cisco and others bid up the prices for these types of companies because they wanted to buy them faster than entrepreneurs could add to the supply.

As a result, it’s been both relatively easy, and relatively lucrative, to sell SaaS companies recently. In earlier times, online storage, online advertising and blogging platform companies have all had valuation peaks as demand grew faster than supply, or as those sectors were perceived to be ‘hot.’

Valuation Principles

That said, the basic mechanics of valuation are straightforward. In financial terms, the value of any business is the present value of the future income stream the company will generate. The present value calculation factors in the ‘discount’ that someone would pay today for a stream of income in the future.

For example, let’s imagine a company that generates $1 million in profit every year. A $1 million profit next year is worth pretty close to $1 million today because you’d only have to wait a year to get it. If you could get an ‘interest rate’ of 18% per year, then you’d value $1,000,000 in a year at around $820,000 today (i.e., its present value). In other words, the ‘discount’ in this example would be 18%.

But $1 million of income ten years from now is worth considerably less. If it’s almost certain that the $1 million would actually be there in ten years, then the discount is pretty close to the interest rate that you could earn on the money over the ten year period.

For example, Figure 1 shows the present value if the interest, or discount, rate was 18% and the company generated $1 million in profit for the next ten years and then shut down. In this case the value is a little less than $ 4 million – or a P/E ratio of about four.

Table 1. Simple valuation model with zero growth

Unfortunately, in real world situations, it’s never quite that simple.

The first complication is that companies are either growing or contracting. So if the income from a company was $1 million last year, the only thing you can be sure of is that it’s not going to be $1 million again next year.

Companies with high growth rates are worth much more than companies that are growing more slowly. If the discount rate is still 18%, but the company’s profits are growing at 25% per year for ten years, the numbers will look like those in Table 2.

Table 2. Simple valuation model with 25% growth 

In this case, the present value of a company with $1 million in profit this year, but a 25% growth rate, is actually worth over $9 million, or more than double the example with no growth. In this case, the price earnings multiple, or P/E ratio, is about 9.

Note to Math Purists: These present value calculations are simplified to make them easier to follow. If you use the Net Present Value (NPV) formula in Excel, the numbers will be slightly different.

Growth and Valuation

This graph shows how the valuation in the example above changes for different growth rates.

The dramatic increase in valuation as growth rates approach 50% per year are a good way to understand why some high growth tech companies are acquired for very high valuations.

Predictability

Another significant, and difficult to quantify, factor in company valuation is predictability. Even if a company has been growing at 25% per year for the past several years, there is no way to be sure this growth rate will continue. The management team may be confident that the growth rate will be even higher in the future—and may say so enthusiastically to potential acquirers. However, the buyers will be skeptical – and one can’t blame them for being concerned that the growth rate might decline in the future.

This uncertainty in the future projections creates another type of discount factor on the valuation. The predictability discount becomes very subjective, and everyone involved in a transaction will have a different perception of what the fair predictability discount should be. For mature stable companies, it might not be a very significant part of the valuation calculation. In valuations of technology companies, especially young ones, this factor can create an enormous divergence in the perception of the fair value.

Customer Concentration

Customer concentration is a good example of something that affects predictability. Most valuations implicitly assume a diverse customer base. But when one customer starts to account for more than 10% of revenue, the valuation will be negatively affected because the risk that the large customer might leave becomes significant to the future earnings of the company. In situations where a single customer accounts for over half of the revenue, the fair company valuation might be reduced by as much as 80 to 90%. In these situations, agreement on prices requires the buyer and seller to reach agreement on the probability that the large customer will continue for a considerable length of time. This can be a challenge even if binding long term contracts are in place.

Before Profitability

Valuation gets even more interesting when the company and its business model have yet to be proven in the market long enough to establish profitability margins. A large percentage of the companies that are sold in the technology area have yet to reach profitability at all, or are growing too quickly to generate any significant profit.

Agreeing on valuation requires the buyer and seller to have a common view about what the profit margins are likely to be in the future and how fast they will grow. It’s easy to see how the difficulty in predicting these future financials can lead to wide variations in what different people think is the fair value.

Pre-Revenue Companies

At the very earliest stages, companies may not even have revenue. In these cases they are being sold entirely for the perceived future value of their intellectual property (IP). A good case study for this type of exit transaction is Brightside, a Vancouver company that developed technology to increase the brightness of large liquid crystal displays.

In this case, the company had effectively zero revenues, but was nevertheless sold to Dolby Labs for $28 million in cash. This was entirely based on Dolby’s belief that the company’s patents and IP would enable them to build a future stream of licensing revenues that would more than justify the $28 million purchase price. Brightside is one of the case studies available here on my blog.

Another example is the $30 million exit of Pacinian. That company was also pre-revenue. (The Pacinian case study will be on this blog soon.)

There are a couple of models to value pre-revenue companies but they really aren’t very useful. Pre-revenue valuation is much more of an art than a science. The best way to determine a current, fair value is to find someone with the experience, and current knowledge of your market, to give you a number.

Comparables

In practice, the challenges of developing even limited consensus around a company’s future growth rate, profit margins and predictability often make the whole financial model exercise too challenging to be useful. As a result, most of the time, both buyers and sellers resort to much simpler math based on comparables.

Comparables are used every day by professional analysts who work for stock brokerage firms. The analysts’ job is to examine individual companies and then put their current valuation in perspective by comparing them to similar companies. Through analyses like these, it’s possible to generate broadly applicable rules of thumb, or multiples, to value similar companies. The most common multiples for tech companies are price to earnings ratios (P/E) and price to sales ratios (PSR).

One factor to keep in mind is the “discount for illiquidity”. The well accepted rule is that a private company’s value is about 30% less than an identical public company. This difference is primarily due to the fact that the private company’s shares cannot be resold in the public market – in other words because it is illiquid.

Types of Companies

Mature companies, with low growth rates, can be fairly valued at P/E multiples of four to five, or a PSR of one (depending on their growth rate and profitability).

For younger companies, earnings are often non-existent or extremely volatile. In these situations, most valuations are based, at least in part, on multiples of revenue. For example, these days software-as-a-service companies are regularly valued in the three to four times revenue range (PSR = 3 to 4). This relatively high revenue multiple is thought to be reasonable because these companies have a high percentage of recurring revenue and good margins. It is also believed that market growth will enable these companies to grow faster than other tech companies.

On the other end of the spectrum are service companies that are essentially ‘body shops.’ These companies can only grow as fast as new employees can become productive. Typical examples are web design firms, management consultants and human resource companies. These types of companies are often valued at PSRs of 0.5 or P/E multiples as low as two or three. This is also partly because the revenue predictability of these types of companies is low and because they usually have small percentages of recurring revenue.

Other Multiples and Factors

Every industry, and every type of company, also has its unique multiples based on key performance indicators (KPIs) applicable to that industry. For example, with Web 2.0 companies, some analysts reference the company price to the number of unique visitors per month, and multiples based on Alexa rank. Almost any metric can be used to build a valuation model.

If you wanted to get an idea of what your company is worth, you could read some valuation books and then do some online research and try to do a valuation yourself. This is not usually very satisfying because most of today’s smaller transactions are not even announced, and the ones that are rarely disclose enough information to be a useful comparable. You also need a lot of experience, and a good feel for the current market, before you can do any type of useful valuation.

Please Don’t Pay for a Formal Valuation

Another common mistake is to pay for a formal valuation, and then believe this valuation will be useful in negotiating an exit transaction. There is a large industry that does business valuations. Some of the reasons companies pay to get valuations done are for tax reasons, public financing or divorces.

Those valuations are usually ten or twenty pages long, cost tens of thousands, and include lots of spreadsheets and comparables. In my experience, those types of valuation can show an extremely wide range of values. In my opinion, they are not usually accurate enough to be used even in a discussion around an exit transaction. (Apologies to my friends in the industry who do valuations – most of you know exactly what I mean.)

The Best Way to Get a Valuation for Your Company

The easiest, and most accurate, way to get an idea of what your company might be worth if you sold it today is to find an M&A advisor who has been doing exit transactions for similar companies. You’ll need to share some of your financials so they can use the applicable multiples to give you a first pass estimate of your company’s value. If you can find two or three real professionals, who understand your type of business, they will probably all give you valuations that agree within 20 to 30%.

As a final note, the price achieved on the sale of a company can be significantly skewed by the quality of the exit design and execution. This is especially true in transactions under $20 million because these are often young companies with little history. The markets for these types of companies are very inefficient.

These companies can also have a much broader range of potential strategic values for different acquirers. With these smaller transactions, the skill of the M&A advisor has a much larger effect than it would in the sale of a large established company with predictable profit margins and growth rates. A very skilled M&A advisor can often get a small company sold for 50% more than the same company would sell for with an average M&A advisor.

If you have questions about your valuation, please send me an email.

This is the first time I’ve described all of the things we did wrong the first time I tried to sell a business. It’s also the story of the first time I lost several million dollars.

How Not to Sell a Business – Don’t Blow The Biggest Deal of Your Life

This is a talk I gave to the Vancouver Chapter of the Entrepreneurs Organization (EO) on February 19, 2009. It is consistently the most viewed video on my blog.

In this talk, I compare my first experience selling a business to a more recent one where everything was perfectly planned and executed.

PowerPoint PDF here

Highlights of Part 1:

• This is the first time I’ve described all of the things we did wrong the first time I sold a business. It’s also the story of the first time I lost several million dollars.
• During this presentation, I compare my first business sale to a more recent one where everything was perfectly planned and executed.
• My story begins with the launch of my first company, Nexus Engineering, while I was still in university.

Highlights of Part 2:

• I wish we had done a secondary sale before we sold the business.
• I confess that we had never discussed our exit strategy.
• We start to learn about exit strategies at the worst possible time.
• We make the classic error of having the CEO sell the business.
• I learn that every business sale needs multiple bidders.
• What happened because we hadn’t checked the alignment on our exit strategy.

Highlights of Part 3:

• Painful lessons about how nasty take-over battles can get when you sell a business.
• I was a rookie and ended up playing defense all the way through.
• We finally get the business sold, but my regret was that we ‘rode it over the top’.
• It took me another ten years to understand all the things we did wrong.
• The truth is… we were lucky. To this day, I wish we’d had a good exit strategy and checked the alignment before we started to sell the business.

Highlights of Part 4:

• This is the story of the Parasun business sale – where we did everything perfectly.
• We developed alignment on a simple exit strategy at an offsite planning retreat.
• At Parasun, we successfully executed two secondary sales before we sold the business.
• We sell the business right on schedule, but the price was 48% higher than the target.
• A comparison on the Nexus and Parasun exits – what to do and what not to do selling your business.

Many of these lessons are described in my new book on selling businesses for entrepreneurs and angel investors – www.Early-Exits.com.

If you enjoyed this video, you might also like this one on Exit Strategies or this series on Maximizing Value in Business Sales.

The Sellability Score was created by my friend John Warrillow who also wrote Built to Sell. If you are thinking about selling your business now, or at some point in the future, the Sellability Score will be valuable to you.

A Sellability Score is an external, unbiased evaluation of your business’s worth on the open market, calculated by grading your company against eight key factors. These factors include:

Financial Performance – Gauging a business’s profitability is perhaps the most well-known valuation method. Basing a sale price off of an evaluation of financial performance alone, however, can be a risky approach for both parties.

Growth Potential – Like every great investment, businesses are not bought for what they are, but for what they can be. Realistic growth projections are essential for setting a sale price.

The Switzerland Factor – Over-reliance on one or a few clients, suppliers, and employees can negatively affect a business’s perceived ability to adapt to change.

The Valuation Teeter-Totter – The relationship between a business’s revenue and expenditures can be best understood through an analysis of the business’s cash flow cycle. There’s a big difference between trying to sell a business with a negative cash flow and a company with overflowing revenue.

The Hierarchy of Recurring Revenue – The degree to which a business’s revenue is recurring directly correlates to the business’s likelihood of sustained stability. A high degree of recurring revenue is an attractive attribute for a business to possess, though it is not a factor for all business models.

Monopoly Control – Businesses with highly differentiated products and services enjoy the luxury of not having to rely on pricing to remain competitive, and are thus, very desirable acquisitions.

Customer Satisfaction – Tracking and gauging the level of your customers’ satisfaction is a good policy under any circumstance, but can be an especially important as a selling point. Businesses with a large base of satisfied clientele are more likely to benefit from referrals and repeat business.

Hub & Spoke – Businesses that are overly reliant on the stewardship or talents of its owners can be viewed as a risky acquisition. The degree to which a business can successfully undergo an ownership transition has a significant impact on sale price and to whom you should be marketing your business.

A Sellability Score will let you know exactly where your business falls on each of these scales, as well as its overall “sellability” as an acquisition. Even if you’re not planning a sale in the foreseeable future, the insight garnered from a Sellability Score can help you identify and isolate weaknesses in your business model, better preparing you to successfully negotiate an optimum price when the time comes.

Get your Sellability Score here (it’s free). You will receive a 26 page report on the sellability of your business. I’d also appreciate hearing your comments on the Sellability Score as a comment below or by contacting me directly. Thanks.

I’m convinced that only about 25% of the businesses that could be sold actually end up successfully exiting.

Yes. I believe that about three out of four times when a company could have been successfully sold, a sale did not end up happening – ever. And most of the time, it was avoidable.

The Frustrating Lack of Data on Exits

One of the most frustrating aspects of researching exits is the lack of data on transactions under $50 million, which are about three quarters of all exits.  I have spoken with the organizations that manage all of the databases that include information on entrepreneurial companies, early stage investments and exits, and I am certain the data does not exist.

There are now a few groups who are just starting to accumulate some data, but we’re at least a decade or two away from having a sample large enough to be useful in developing best practices on exits.

This lack of statistically valid data means that while something may be true, and even fairly obvious, most of the time we just can’t prove it.  For now, the best we can do is develop best practices based on empirical observations.

This article is about one of these truths. Based on my observations and hundreds of conversations with entrepreneurs, investors and M&A professionals, I have no doubt that what I have written here is true, but I wish we had the hard data to prove it.

My Observations on Exits

Since the early ‘80s, all I have done is start, grow, finance and sell technology companies.  I have invested in about fifty companies, sold several dozen and had a front row seat to watch more than a hundred grow from their early stages to their eventual conclusion.  I believe I’ve developed an excellent understanding of which companies were saleable and when.

I Believe Only 25% of Saleable Companies Actually Exit

I’m convinced that only about 25% of the businesses that could be sold actually end up successfully exiting.

Yes. I believe that about three out of four times when a company could have been successfully sold, a sale did not end up happening – ever. To be clear, I am not including unsuccessful exits – for example, where the company has not succeeded and another entity acquires the assets for a low value. What I am writing about here are exits where the investors end up with a smile on their face.

Of course, I’m not saying this happens exactly 25% of the time.  We just don’t have the data to be anywhere near that accurate.  But I’m certain it’s less than half the time, and I’m pretty sure it’s less than a third of the time.

What gets me excited is imagining how much wealth could be created if we could improve our best practices to increase this percentage of saleable companies to even 50%. That would double investor returns and create twice as many wealthy founders and entrepreneurs.

Increasing the rate of successful exits to half would also create a lot more economic activity. Investors would invest more capital, more entrepreneurs would create startups, and more successful early stage companies would be scaled up by cash-rich corporations and private equity funds, all of which would create more economic growth and good quality jobs.

Why Do Only 25% Exit Successfully?

Why do so few companies that could be sold actually exit successfully?

Like many parts of business, or life, there is no single, simple explanation.  Each case includes a different combination of factors which combine to end up in either a successful exit or not. Following are some of the main reasons companies end up failing to successfully exit.

1.    The Exit Team Failed to Execute

In a depressing number of cases, the board of a company will decide that they would like to exit but the team they assemble will fail to execute.  I believe there are two primary reasons this happens:

- The company wasn’t actually saleable (at that time), or

- The team that was assembled didn’t have the skills and experience to successfully execute the exit.

I used to think that when a board decided to assemble a team and execute an exit, they were successful about half of the time.  More recently, though, as I have observed more attempted exits and spoken to at least a hundred more M&A professionals, I have revised my estimate, and I now believe attempted exits under $50 million only succeed about 25% of the time [link].

This summer, I spoke at the national AM&AA conference in Chicago, and another speaker there said that she thought the percentage of time companies successfully executed their exit was only 5 to 7%. Here statement was based on the often referenced study from the US Department of Commerce that reported only 20% of the businesses that are for sale will successfully transfer hands to another owner.

2.    Boards Don’t Realize the Company is Saleable

I’m surprised to see how often an entire board will fail to realize that a company is approaching, or has even passed, a saleable stage of development. I think there are two reasons why boards miss this so often:

- Experienced directors are very difficult to recruit and retain today. Very few boards have even one member who has been closely involved with more than a few exits.

-  Many of ‘the rules’ about M&A exits have changed dramatically in the last ten years. Very few entrepreneurs, directors or investors appreciate how much this part of the economy has changed. Experiences from a decade ago can often lead to entirely wrong conclusions.

These factors often lead boards to develop strategies to:

-  delay starting the exit process,
-  accept additional financing because they believe the company needs to scale before exiting, or
-  accept licensing or partnership offers because they feel like a bird in the hand.

In a short while, I will be sharing some very valuable information about the Pacinian exit.  This was a good example of where directors and stakeholders had a variety of mutually exclusive opinions about the best strategy for the company.

3.    The Board was Waiting for an Unsolicited Offer

This is one of the exit failures I really hate to see. Surprisingly, boards believe the right exit strategy is simply to wait for an unsolicited offer.  This almost certainly ensures an exit valuation significantly below market. But worse, this strategy also dramatically reduces the probability that the exit will actually complete.

As I have said many times before, I think it’s almost always bad news for shareholders when a company receives an unsolicited offer. Yes, just receiving the offer is usually bad news.

4.    Riding it Over the Top

“Riding it over the top” is an increasingly common way to fail to exit. I don’t’ want to be too hard on the decision makers in these companies. This is a relatively new factor in our economy, And the importance of not riding it over the top has increased significantly in the last few years.  Here’s my guide on how to ensure you don’t ride it over the top.

This talk also describes why exit timing is so critical and why missing the optimum time to exit doesn’t just mean exiting later and probably for less money. It very often means not exiting at all.

How to Improve the Probabilities of a Successful Exit

What can your company do to improve the probabilities of a successful exit?

There are quite a few elements to a complete answer, but I think the two most important are:

-    Education – Read all the good information you can find, and talk to as many knowledgeable people as you can get in front of. If you have the opportunity, attend some of the new workshops on exit strategies. (Here is a link to an excellent exits workshop coming in November.)

-    An exit strategy – I strongly believe every company should have an exit strategy. This one best practice alone will dramatically increase your probabilities of a successful exit.

Please post a comment below if you disagree with my 25% estimate of if you have suggestions on other ways entrepreneurs and boards can improve this percentage. Thanks.

Information about M&A advisor fees for selling a business is surprisingly difficult to find.  I’m not sure why other M&A professionals are reluctant to discuss fees and even less sure it makes sense in today’s online world. This is a current summary of the fees I’m seeing in the market.

This is an updated excerpt from: Early Exits – Exit Strategies for Entrepreneurs and Angel Investors (But Maybe Not Venture Capitalists).

Since the first version of this post in 2009 there have been a few other posts on M&A fees. Some of the good ones are linked below.

I hope you’ll share your experiences on fees, or other good links, by commenting below.

Update January 2013

There are no industry surveys or databases on M&A Advisory fees. The only ways I know to get information on fees is to ask people directly, from similar posts to this one and from comments like the ones below.

Because the data is so sparse, changes in fees over time are even more difficult to determine.

As we slowly recover from the mortgage crisis and continue to work in an environment where we have the lowest cost of capital in our lifetimes, I am seeing two recent trends in M&A advisory fees:

1. An increase in success fees of 1 to 2% (of total transaction size), and

2. Much more common “minimum fees”

M&A Advisor Fees and Transaction Size

M&A Advisor and Business Broker fees increase with the size of the transaction, but not in direct proportion. Part of the reason is that the amount of work required to sell a larger business can actually be less than that to sell a smaller company. Where this becomes especially evident is at the smaller end of the transaction size range.

M&A professionals that sell businesses fall into three rough categories:

1. At the upper end of the range there are the big investment banks and accounting firms with teams devoted to M&A.
2. In the middle are mid-sized firms that usually include three to seven professionals, usually called M&A Advisors.
3. At the smaller end of the transaction range, most businesses are sold by boutique, one to three person firms usually called Business Brokers.

Understanding the pricing mechanisms for M&A fees is easier if you look at it from the perspective of the professionals doing the transactions. Very large firms have offices in downtown towers with human receptionists and assistants. The mid-sized firms have smaller offices in less expensive buildings, use automated phone answering and have no assistants. The individuals in boutique firms answer their own phones.

For a transaction to make sense for the big firms with downtown offices, the total fees have to be a few million dollars. For the mid-sized firms, the minimum fee size is in the $500,000 to $1.5 million range. Smaller firms can afford to do exit transactions where the fees are only a few hundred thousand dollars.

Typically, the big firms will compete most aggressively for exit transactions above $100 million because these transactions will produce several million dollars in fees. The $20 to 75-million range is the optimum range for the mid-sized firms. Smaller transactions are usually done by specialized boutique firms. These numbers shift up or down depending on how busy the firms are.

The standard M&A Advisor fee model includes a work fee and a success fee. In some cases, it may also include a contingency or break fee.

The Lehman Formula and Ideal Fee Alignment

Some M&A firms still base their M&A fees on the Lehman formula. This formula was created by the old Wall Street firm bankrupted by the mortgage crisis. The formula was originally used for financing engagements, but somehow also came to be applied to M&A transactions.

If you think about it for a few minutes, I think it’s pretty obvious that a simple linear percentage creates much better alignment between the M&A Advisor and the Shareholders.

The ideal alignment is probably closer to the exact opposite of the Lehman formula. Ideally, the M&A firm would be paid a larger percentage of the last million than the first million. The main reason this is not more popular is the difficulty of accurately predicting the fair value of the company at the time the transaction completes (several quarters after the engagement is signed).

M&A Advisor Work Fees, Retainers or Up Front Fees

Work fees are committed to by the company at the beginning of the engagement.  Some firms will invoice monthly over the first four to twelve months. This initial fee can also be called a retainer, engagement fee or upfront fee. This covers the M&A Advisor’s direct costs during the initial stages, as well as their contribution to the preparation of the selling documents and due diligence materials.

For larger transactions, the work fees are usually $100,000 or more. For boutique firms working on a $20 to 30-million exit transaction, the work fees are usually in the $50,000 to $75,000 range. At the lower end of the transaction spectrum the work fees don’t usually go below $50,000 because no matter how small the transaction, there is still a fixed amount of early work that has to be done.

There are firms that will charge lower work fees, sometimes in the $30k to $40k range. Lower work fees are often an indication that the firm has people who are not completely busy. For that reason, lower work fees are also more common when the M&A market is not very active.

Interestingly, firms that work on transactions valued under $5 million – usually called “Business Brokers” often do not charge a work fee.

It’s very unusual for an M&A Advisor to undertake an exit transaction without a work fee. Part of the reason is that anyone involved with exits has seen a situation where, at the time of the initial engagement, the shareholders and board are enthusiastic about an exit; but by the time an offer gets to the table the shareholders have reconsidered. This can happen precisely because the M&A Advisor has done a good job, and has shown the current shareholders that the company is worth more than they thought. This alone can result in shareholders changing their minds and deciding to continue to own the company for a while longer.

The work fee is a fair way for the professionals to protect their initial investment in helping to facilitate a transaction. It is also a test of how serious the sellers are to actually sell the company.

M&A Advisor Success Fees

Success fees for selling a business in the $10 to 30-million range are typically 6 to 8% of the final value. This means that the M&A firm that successfully completes a $25-million exit transaction will usually be paid a fee at closing of about $1.5 to 2.0 million.

For transactions over $100 million, success fees are usually in the 2 to 3% range. This means that a firm executing a $100 million exit will typically receive a success fee in the $2 to 3-million range.

Where success fees become more challenging is in the smaller size transactions because the amount of work required to sell a $5-million business is not significantly less than the effort required for a $25-million exit.

Minimum Fees

In 2013, I am seeing minimum fees being charged much more often. This clause in the engagement contract specifies the smallest amount the M&A firm will be paid if a transaction is completed.

I find the psychology of minimum fees fascinating. In my experience, most advisors don’t ask themselves what they are saying to the customer.

Just think about it. If the discussions between the M&A Advisor and their prospective client have been open and realistic, why would the engagement agreement need to include a minimum?

(If you are looking at an M&A engagement agreement and this doesn’t make sense to you yet, please contact me below.)

Why Smaller Transactions Are Often More Work Than Larger Ones

Selling a $5-million company can be more difficult than selling a $25-million company. This is because the buyers for smaller companies tend to be either the junior people in the large company acquisition teams, or the CEOs and CFOs of medium-size companies. Similarly, the legal and accounting professionals tend to be less experienced. Combined, these relatively lower experience levels, and reduced availability, means that smaller transactions often require significantly more time and effort from the M&A Advisor.

Even the smaller boutique M&A firms will not usually want to undertake an exit transaction in which the selling price will be less than $ 5 million. Even at a 10% success fee, a $5 million transaction will only deliver a $500,000 success fee. This is approaching the minimum economic size that even the smaller firms can undertake.

This is why transactions below the $5 million threshold are often done by Business Brokers or individuals who have developed expertise in this area.

Because of the amount of work involved in a $5 million transaction, the success fees are usually in the 10 to 12% range.

While the amount of work required to perform exit transactions is similar whether the company is valued at $5 million or $100 million, the fees for large Investment Banks are higher due to their overhead and perceived prestige.

Other Good Posts on M&A Fees

These are some of the other good posts on M&A fees:

http://www.crossbordermanagement.com/en/guides/mergers-a-acquisitions-in-the-us/investment-bankers/investment-bankers-fees

http://www.imergeadvisors.com/ma-advisor-fees/

Please Share Your Data and Links

I’d appreciate hearing from you about your experiences with M&A Advisor fees. The only way I have been able to aggregate this information is by asking CEOs, board members, investors and M&A advisors that I meet. If you have a data point you can share, or another good link on M&A fees, please either leave a comment below or email me directly.

What is an ‘M&A Advisor’? Why haven’t you heard the term more often?

One of the speakers at a recent Exit Strategies workshop in Vancouver (a well-respected senior M&A lawyer) commented that up until a couple of years ago he’d rarely heard the term ‘M&A Advisor’. He went on to explain that while there were certainly professionals helping to execute exit transactions, they didn’t often describe themselves as ‘M&A Advisors’.

At this same workshop, an attendee asked: “What is an M&A Advisor, exactly?” When I didn’t have a crisp off-the-cuff answer, I started to think about writing this article.

In my travels throughout North America, I’ve noticed that the use of the term ‘M&A Advisor’ varies considerably from region to region. In the northeast, people often use the term ‘investment banker’ – or ‘i-banker’; which is still the pervasive Wall Street-centric term for someone who helps sell a medium or large-sized company.

The farther you get from Wall Street, with the exception of possibly downtown San Francisco, the term ‘investment banker’ seems to be falling out of favor. I think this might be related to the negative publicity associated with the damage done to the global economy by the investment bankers who sold mortgage-backed securities. M&A Advisors I’ve spoken to seem to be distancing themselves from the term ‘investment banker’ as a result.

The term ‘M&A Advisor’ is also gaining popularity due to the increasing number of exit transactions in the $5 million to $30 million range. Just a decade ago, most of the press, and discussion, about exits focused on much larger transactions. Today, it’s increasingly obvious that the vast majority of transactions are in the under $30 million range, and the median size of private company exits is probably in the $12 million to $15 million range. As M&A activity shifts to these smaller and mid-sized transactions, more and more companies are looking for professionals to help design exit strategies and execute exit transactions in this size range. The term that is most often used to describe the professionals working to help sell this size business is ‘M&A Advisor’.

How does the term ‘M&A Advisor’ compare to the term ‘business broker’?

Professionals involved in helping to sell companies at values below $5 million are most often described as ‘business brokers’. I’ve been conducting an informal survey of professionals across the country to see if the use of that term also varies regionally. ‘Business broker’ seems pretty consistently applied for transactions below about $5 million in value.

When the definition of ‘business broker’ is discussed, people often say that business brokers facilitate ‘main street’ transactions. By that, they’re usually referring to the large number of smaller sized businesses including everything from restaurants, dry cleaners, retailers and all of the various forms of small service companies.

One of the primary distinctions between a business broker and an M&A Advisor actually does relates to the different methods used to facilitate exits below the $5 million in size. At valuations below $5 million, it’s not usually possible to do a ‘fully marketed’ transaction – one in which a team of professionals might identify as many as 50 to 100 prospects, qualify that list down to 12 to 15 who sign an NDA and then ideally end up with three bidders near the end of the transaction.

Most of the time, in business broker size transactions, there isn’t a competitive bidding process simply because these lower transaction sizes (and therefore fees) can’t justify that much front-end investment in the sales process.

Another important distinction between the popular use of the term ‘business broker’ compared to the term ‘M&A Advisor’ is the fact that business brokers are often licensed real estate brokers. In my experience, M&A Advisors almost never have real estate brokerage licenses. Many main street transactions include the property on which the business is based. The owners usually want to sell the business and the property together. If an M&A Advisor is involved in a transaction that includes a real estate component, they would usually separately engage a real estate agent to facilitate the real estate portion of the transaction – even if both are being sold to the same buyer.

The terminology also changes for much larger transactions

For exits over $50 or $100 million in value, the terms ‘M&A Advisor’ and ‘investment banker’ are used with approximately equal frequency.

There is currently no absolute answer to the question of “What is an M&A Advisor?” but I hope this article provides enough of a definition for general use anywhere in North America.

Please post a comment below if this differs from your experience on the use of these terms. Thanks, Basil.

Highlights of Part 6 – Financing Strategy for Maximum Exit Value:

• Axel Christiansen introduction. And why is he so funny?
• What is Sub Debt and who is it useful to? In what types of exit transactions?
• Company value as a multiple of EBITDA. The “New Normal”.
• Seven reasons to create a financing package.
• Vendor notes and other financing tools.
• Case Study: Buy Me Inc.
• Subordinated or mezzanine debt. Cash flow based financing – no asset coverage required.
• The ‘glue’ in buy-out transactions.
• Vendor objectives, purchaser objectives, BDC objectives. The Perfect Deal.
• BDC Subordinate Finance – the largest national subordinate finance group in Canada.
• BDC for Management buy-outs (MBO), leveraged buy-outs (LBO), strategic acquisitions (roll-ups).

In the fifth presentation at the Exit Strategies Workshop 2011, Blake Corbett discusses public buyers.

Highlights of Part 5 – Public Buyers:

• Who has cash?
• Who is spending it?
• What this means for small cap technology and industrial companies
• Public companies are acquiring to drive growth
• Public company cash balances are the highest in ten years
• The M&A environment has become more active
• Acquisitions are taking place at all levels

There are several new types of buyers actively acquiring private companies in the $10 to 50 million range. Most CEOs and boards think strategic buyers are the most likely to acquire. This video describes why other types of buyers are often the successful acquirers.

Highlights of Part 4 – Types of Buyers:

• For many companies, the number of buyers is ‘almost unlimited’
• Most buyers can be categorized as:
• Big companies
• Medium and small companies
• Private equity and similar funds
• Entrepreneurs – usually boomers
• For many companies, the number of buyers is ‘almost unlimited’
• It’s not unusual to have all four types of buyers simultaneously trying to buy the company
• Each type of buyer thinks and acts differently
• One thing they have in common – too much cash
• Making the current M&A market a fast moving “sellers market”

The third presentation at The Exit Strategies Workshop 2011 explains why every company should have a clear, signed exit strategy.

Highlights of Part 3 – Every Company Needs an Exit Strategy.

• The exit is just another business process.
• Companies should be sold – not bought. Why this is such a critical concept.
• Optimum exits require strategy and planning.
• A focus on exits is healthy – it does not detract the team from their primary mission.
• I believe entrepreneurs and angel investors would have better returns and more fun if we designed and built more companies with a focus on the exit.
• Why the exit strategy is the most important element in the business plan.
• It can be as simple as: “Our exit strategy is to [sell the company] in about __ years for around $ __ million.
• Why it’s essential to have alignment on the Exit Strategy and how to maintain it.
• The importance of having a clear exit strategy before doing any work on financing.
• How I almost lost my first company by not understanding this.

In the second presentation at The Exit Strategies Workshop 2011, Mike Volker describes why Angel investors are saying: “We need more exits.”

Highlights of Part 2 – We Need More Exits:

• The big question: Should we grow bigger or sell?
• It’s all about EXITS!! – need a real “Plan”.
• But, CEOs are in no hurry to sell.
• Angel Investing 101.
• Case study – What’s wrong with this picture?
• Vesting – more important than most investors realize
• Clear, clean cap table – No OPTIONS!
• The Challenge: How to Exit? Who can help?

The first presentation at The Exit Strategies Workshop 2011 describes why this is a “Golden Era for Entrepreneurs.”

Highlights of Part 1 – The Economy Has Changed:

• The whole world has changed.
• The big tech companies aren’t creating wealth anymore – for their investors or employees.
• Startups create ALL of the new jobs.
• What does this mean for the startup economy? How can we make money?
• Four changes that make entrepreneurs money:
• 1. Innovation happens in startups
• 2. Internet acceleration
• 3. Capital efficiency
• 4. Early exits
• The biggest opportunity for entreprenuers is “innovation.”
• Why innovation happens in startups not big companies.
• Our 21st Century economy – “A Golden Era for Entrepreneurs.”

When a saleable company fails to sell, it’s often the seller’s psychology that kills the transaction. Most of the time, the seller doesn’t even know that they were the reason their company failed to sell. This talk describes the seller psychologies that can kill exits.

The Psychology of Exits
Presented at the Alliance of Merger and Acquisition Advisors Summer Conference
July 10, 2012 in Chicago

Highlights:

• What percentage of M&A transactions close after an M&A Advisor has been engaged?
• According to a speaker from a large multi-national M&A Advisory firm, only 8% end up closing
• Why do ‘saleable’ businesses fail to sell?
• Is the fault most often with the Buyers? Or the Sellers? Or the M&A Advisors?
• Two reasons the Sellers are the most likely cause of an M&A failure:
  1. The business becomes un-saleable
  2. The Seller’s psychology – including some of these common psychological pitfalls:
• Unrealistic value expectations
• “It Feels Like I am Selling my Child”
• “My Business is Me”
• “I am Still Having Fun”
• Fear and Greed
• “I am the Smartest Guy in the Room”
• Approach Avoidance
• Cloaked Decision Makers

This is the Powerpoint for The Psychology of Exits.

The Psychology of Exits – AM&AA Summer Conference 2012 from AM&AA on Vimeo.

This is a checklist for the first phase of the exit process. These tasks should all be complete before engaging with the first prospective buyer.

Exit Strategy

• Fully signed Exit Strategy document
• Discuss mechanisms to increase alignment

The Exit Team

• Engage an external accounting firm for a review or audit – ideally a ‘big four’ firm
• Engage an M&A Advisor (aka investment banker)
• Engage an M&A Lawyer – must be an expert in M&A transactions, not a generalist
• Review board appointments and board composition in the context of an exit transaction

Corporate Structure

• Review the company minute book and Share Register
• Review minutes from board and shareholder meetings
• Discuss the ownership structure to ensure optimum tax treatment in either a share or asset sale
• Review share structures to accommodate tax treatment of any type of purchase price payouts
• Options – particularly problematic under the new tax and accounting laws, tax liabilities can be significant to shareholders or buyers
• Complete corporate search – PPSA etc. (by the new M&A lawyer)
• Discuss Articles and shareholders agreement with M&A Advisor and Lawyer – especially in the context of an asset sale

Intellectual Property, Employment, Contractor and Corporate Protection Agreements

• Review every employee and contractor agreement – especially in consideration of how these laws differ from country to country
• Conduct an initial patent search – similar to what a US buyer would do during due diligence
• Software audit – especially for open source code buried in your systems
• Confirm IP ownership of all forms of IP
• Patent search for freedom to operate
• Impact of government grants on IP ownership or transfer

Tax review

• Best possible review of possible tax liabilities – especially at the US state level
• Special focus on states where the company may have a nexus
• Explore tax loss carryforward strategies
• Discuss SRED implications of possibly becoming a non-CCPC
• Meet with tax advisors to discuss tax implications of various exit scenarios

Accounting Systems

• Review internal accounting systems to ensure accurate monthly financials within a few days of month end

Public Relations Plan

• Update the company’s public relations plan to include potential acquirers and the media they are likely to follow (this applies regardless of whether the company will be exiting in stealth mode)
• Integrate the PR plan with a targeted, tracked email campaign to prospects

Exit Sales Collateral

• Financial model with key metrics, 5 years of history, 3 years of projections and a 12 month current year plan
• Confidential Information Memorandum (CIM) – reviewed by the M&A lawyer
• Two page non-confidential executive summary
• PowerPoint – rehearsed for online presentation
• Videos – increasingly used as part of the exit process

Due Diligence – all in PDFs for electronic access

• All financial statements and tax returns including SRED claims
• Thorough review of any agreements with personal guarantees
• All material contracts, insurance agreements, etc.
• Review all contracts for assignability without consent and change of control clauses
• Sales funnel and CRM remote access
• Update Org Chart if necessary
• Trademarks, copyrights, and any patent related documents
• Business licenses, permits, etc. – especially at the state level
• Potential litigation (including employee related) or possible liabilities not in the financials
• Product warranties and support obligations and warranties
• Leases, guaranties, banking agreements
• Asset ledger – especially in the context of a possible asset sale
• Equity confirmations from all current and past employees and contractors
• Review employee share ownership agreements

Reps and Warranties

• Start to discuss reps and warranties with significant shareholders – typical terms, limits, periods
• Agree on who will sign which reps and warranties

New Confidential Email Addresses

• We recommend starting to use new, confidential email addresses at about the time you engage an M&A Advisor. Gmail for example.
• Our team prides itself on open, honest communications and the absolutely highest ethics in all of our dealings.  We only work with clients with similar standards.
• But when you sell your business you hand over your corporate email archive.
• About 20% to 30% of the time, there will be some post transaction legal issue.
• The exact translation is disputed, but Cardinal Richelieu is attributed with saying: “If you give me six lines written by the hand of the most honest of men, I will find something in them which will hang him.” That was 350 years before email was invented.

How Exits Have Changed in 2012 -
Presented at the National Angel Capital Association Summit -
March 8, 2012 in Austin, Texas -

Highlights of Part 1:

• Investing is easy – getting our money back is much more challenging
• Three reasons why it’s more challenging to learn about exits than investing
• Exits just don’t happen very often – learning requires decades of experience
• Why the real estate market misleads us when we think about exits – how the markets differ
• The financial markets have changed – what’s motivating M&A buyers today
• The types of M&A buyers active in the market today and what each type is thinking
• Big company buyers, medium sized companies and private equity fund buyers

This is the Powerpoint for “How Exits Have Changed in 2012“.

The video for part 2 of How Exits Have Changed is here.

How Exits Have Changed in 2012 -
Presented at the National Angel Capital Association Summit -
March 8, 2012 in Austin, Texas -

Highlights of Part 2:

• Boomer buyers – a new category of buyers for companies in the $20 million range
• Family offices – not a term we heard much in North America until recently
• A surprising new type of buyer – Venture Capital funds operating like P-E funds
• International buyers – still small but increasing
• There has never been this much cash looking for acquisitions – well over $10 trillion
• How many acquisitions is $1 trillion?
• The number of buyers for most companies is practically unlimited
• These trends are all combining to create a fast moving, diverse, sellers market
• Prices are up about 20% over the past year

This is the Powerpoint for “How Exits Have Changed in 2012“.

The video for part 3 of How Exits Have Changed is here.

How Exits Have Changed in 2012 -
Presented at the National Angel Capital Association Summit -
March 8, 2012 in Austin, Texas -

Highlights of Part 3:

• Story of a Vancouver company that was acquired before it’s first year end
• A possible new record – the company acquired by AOL just four days after its product launched
• Ideal exit timing for your company and why most entrepreneurs “Ride it over the top”
• The financial loss is not the worst – it’s the part of your life you can never get back
• Why companies that miss the optimum time often end up never exiting
• Exit threats from competition, over-investment by VCs and negative momentum

This is the Powerpoint for “How Exits Have Changed in 2012“.

The video for part 4 of How Exits Have Changed is here.

This video explains why I believe that not missing the “Wave of Consolidation” may the successful CEO’s most important job.

How Exits Have Changed in 2012 -
Presented at the National Angel Capital Association Summit -
March 8, 2012 in Austin, Texas -

Highlights of Part 4:

• The most devastating reason that companies fail to exit
• A relatively new phenomena driven by the amount of cash available, number of buyers and the internet
• The buyers are smart too and how they start the beginnings of the wave
• When you can see the wave, it’s almost always too late
• What happens after the wave – killing the small companies
• My saddest job – explaining why an unsolicited offer is almost never good news
• How we can all be better angel investors – support the ACA and ARI

This is the Powerpoint for “How Exits Have Changed in 2012“.

The video for part 1 of How Exits Have Changed is here.

If you own any part of a ‘service’ business you must read “Built to Sell”.

John Warrillow has crafted an effortlessly readable, but incredibly important, book on business strategy for owners and decision makers in ‘service’ businesses.

I keep putting quotes around ‘service’ because I’m not sure John and I agree on the precise definition. From my perspective, almost every company is a service business. IBM thinks of itself as a service business. John uses the word to describe the huge number of businesses that provide non-physical products. These are usually small businesses, but in aggregate they’re a big part of the North American economy – and an even larger part of the healthy economy.

“Built to Sell” provides invaluable insight into the strategic dilemma faced by every service business owner when they start to think about their exit strategy. Traditional service businesses – using John’s definition – receive the lowest exit valuations of any type of business.

During his thoroughly enjoyable narrative, John describes the hypothetical transformation of a small service business into a ‘product’ business. Several times, I laughed out loud. John brilliantly led me down the path taken by most service business owners and let me smack my head right into the brick wall. I felt it in my gut as he described the agonizing decisions required to transform the business into a fundamentally more valuable, and sellable, model.

John also illuminates some of the pitfalls when selecting an M&A advisor. One of my favorite passages is:

TED’S TIP # 14 Avoid an adviser who offers to broker a discussion with a single client. You want to ensure there is competition for your business and avoid being used as a pawn for your adviser to curry favor with his or her best client.

“Built to Sell” also includes a vivid, and accurate, description of the emotional roller-coaster experienced by most CEOs going through an exit.

The book conveys valuable lessons that can only be effectively described by those who have lived painfully, and expensively, though them.

If you own any part of a ‘service’ business, and aren’t planning to bequeath the shares in your will, buy a copy of “Built to Sell” and visit John’s blog at www.BuiltToSell.com