“Patience, persistence and perspiration make an unbeatable combination for success.” – Napoleon Hill
by Max Friar
When the owner of a business hears the word “auction,” they typically get queasy; “auctioning your business assets” is reminiscent of the dark days of 2009-2010 when the phone stopped ringing and many owners were forced to liquidate. Liquidation often entails taking the assets: machinery, office furniture, file cabinets, inventory, etc. and selling it to the highest bidder at auction.
So the intent of this article is to make you think differently about an auction, specifically a “limited auction process” whereby multiple, qualified buyers bid confidentially on an acquisition target after a sufficient period of time to review information and learn about the seller’s business. It is Calder Capital’s firm belief that, if carried out properly, a limited auction for companies with the right characteristics can prove hugely advantageous by ensuring the no money is left on the table and the acquisition is completed in short order.
Why Am I Writing About This?
There are two primary reasons: 1) I am VERY passionate about not only helping business owners get the best possible price and terms for their company, but making sure that they have the best experience during the sale process. Too often brokers do not educate their clients or are simply incompetent when it comes to creating a limited auction style environment; and 2) I feel that there is a misconception of the value that brokers add to the sale process. Brokers are often hired on the premise that they “know buyers.” Yes, I know a lot of buyers. Brokers that have been around for 30 years know a lot of buyers. But rarely do they know the buyer who is going to buy a particular company before it goes to market. Knowing how to run the process is MUCH more important than knowing individuals interested in buying companies because the process attracts the right buyers.
So, What Types of Businesses Work Well for Limited Auction Style Sales?
This is a great question because most companies do not have the characteristics necessary to maximize the impact of attempted competitive bidding. The #1 feature of a business that is ready to be auctioned to the highest bidder is owner-dependency, or lack thereof. If the owner is tied to the day-to-day operations of the company and does not have an exit strategy – other than finding a flesh-and-blood replacement via the sale process – it makes obtaining competitive bids more difficult. After all, many buyers are seeking to buy a company not just to “buy a job,” but to buy an investment, something to improve over time and eventually sell for a greater return. And while it is still possible to obtain competitive bids on an owner-dependent business, negotiating leverage decreases drastically because buyers will typically not overpay for a company whose survival depends on one person. If you push the buyers too hard, they will simply walk.
The second facet of the limited auction ready candidate is cash flow. While there are not any studies that address the level of cash flow necessary to attract enough serious buyers to result in a truly effective auction, my experience indicates that a company with seller’s discretionary earnings (SDE) of $400,000+ marketed correctly will result in strong buyer interest. Why? Because at that level the business generates enough cash to pay the buyer a fair market salary while also allowing him or her to service debt and capital expenditure. For strategic buyers, an owner can often be replaced by a professional manager making $75,000 – $100,000. The additional $300,000 – $325,000 can be used for a variety of purposes. When a small business cash flows $750,000+, the real fun starts because lower-level private equity starts to show interest in addition to strategic buyers and high net worth individual buyers. When I can get individuals, strategics and private equity interested at the same time, a perfect storm is brewing.
So, What Does a Limited Auction Style Business Sale Look Like?
The limited auction style sale begins like any other sale – with a thorough understanding of the company, its value, its marketability and areas for improvement that a buyer can take advantage of. The result of this analysis is compiled into an Offering Memorandum (OM) or Sale Book, which is a professional overview of a company sent to qualified buyers who have executed an NDA. Now, this is when the real grunt work starts. While the financial analysis and OM are being compiled, there is a simultaneous research effort that must take place to identify strategic buyers. Strategic buyers can be found in many places – industry association websites, the client’s records, Dun & Bradstreet, etc. What is necessary is to research a comprehensive list of prospective buyers including names, email addresses, phone numbers, LinkedIn profiles, etc of CEOs, owners and presidents. This list is then called and emailed while simultaneously advertising the business on major M&A listings sites as well as blasting the opportunity out via mass email to the broker’s database of buyers and advisors.
If the business has desirable characteristics, particularly strong cash flow and limited owner-dependency, the first 2-3 weeks of marketing will be intense; it is not uncommon for 50-100 buyers to express interest. This means a lot of phone and email time! During this period, a “funnel” of sorts begins; the marketing efforts reach thousands of buyers. Maybe a hundred will inquire. Fifty of those will not be financially qualified. A further twenty-five will drop out for other reasons. The remaining twenty-five will want to pursue a deeper dive – asking questions, scheduling showings, having conference calls with the owner. Once you know that you have sufficient strong interest, it’s time to set a deadline for offers. It is critical to do this at the right time; buyers need to have sufficient time to get familiar and comfortable with the business, but not too much time. Most buyers will take infinite time and try to conduct the entirety of their due diligence up front if allowed. If there are ten or more legitimate buyers who are interested in making a proposal, then call a due date. Doing so forces the serious buyers to act in unison and incentivizes them to make their best offer if they really want the business.
Now, let’s say you get eight offers. Immediately upon receipt it is critical to examine the offers, ask questions about the offers and create a net proceeds document so that your client can quickly and easily understand what the LOIs mean. Yes, by all means let your client read the LOI, but do not assume that they understand how the words translate into consideration. Make it simple. So, back to the offers. Chances are you will be able to throw 3-4 offers out right away. Despite the intense competition you will find that many buyers will still low-ball or make fair offers. This is because either they think that you’ve staged the process and few buyers exist, or they do not understand that they may have to overpay to really obtain the company. It is amazing to me how many buyers are shocked when they are turned down; on this note, there is sometimes a tendency among buyers to think that they are the best thing since sliced bread because they are qualified to buy a company. There is nothing so humbling as a limited auction process.
The best part about the LOI submission process is typically the sophisticated, professional buyers come out on top. They know how this works and have been here before. They have the money, they present themselves well and they have a plan for the acquisition that is communicated with the seller, which goes a long way in convincing the seller that they’ve made the right choice.
Now, heading into due diligence is never fun. However, when many quality buyers exist, it gives you tremendous leverage should the buyer try to reduce the price or weaken the terms during due diligence. In fact, not too long ago during due diligence a buyer came to the belief that sales were not going to be as strong as the previous year. As a result he attempted to convert $500,000 cash (20% of the deal) into a $500,000 earn out. Now, we had already signed an LOI for a full cash offer, so the seller did not take nicely to this change despite that sales forecasts were legitimately down, and this was discovered during due diligence. However, due to the continued circling of other buyers, we subtly dropped hints that going back to the buyer pool might make more sense rather than taking a hit in deal structure. We also got silent for a few days, which always rattles buyers. In the end, the buyer agreed to turning only $150,000 into an earn out and keeping $350,000 in cash.
In closing, I have never managed a limited-auction style sale process where the best price and terms did not work out for the seller. Creating subtle, professional competition among buyers not only ensures the best offers, but also offers insurance against re-negotiation and nitpicking during due diligence. A limited-auction style sale keeps the power in the hands of the seller the entire time. And if you’re selling your company and relying on the proceeds for retirement, college savings, and your family’s future security, why would you want to give the buyers any more leverage than absolutely necessary?
If you would like Calder Capital to review your business and give you a no-cost, no-obligation value and marketability assessment, please contact us!
Max Friar is Managing Partner of Calder Capital, LLC, a Grand Rapids, MI-based mergers and acquisitions firm. Max is passionate about helping to educate and guide business owners about and through the business-for-sale process. He specializes in transactions ranging in size from $500,000 to $5,000,000.