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Small Business or Middle Market Company?

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Middle Market Company

The biggest difference in middle market companies from either the smaller “main street” business and the larger “wall street” firms is that there are literally thousands of buyers if you count private equity, strategic buyers, international buyers, etc. The sales process for middle market companies is about a structured process that engages as many buyers as possible.

Many buyers limit their searches to companies with more than a $1 million in earnings so that is somewhat of a magic threshold, above which a competitive fervor helps drive up multiples and the number of qualified buyers.

Characteristics of middle market business sales:

  • Requires a “book” (Confidential Descriptive Memorandum, Prospectus, etc.)
  • Requires a nominal amount of working capital (inventory, AR less AP) be left in the business after a sale
  • Requires a serious, well planned marketing and/or auction process
  • Measures earnings using EBITDA, a measure of how much an investor/owner receives
  • Typically asking price is not published, pricing is determined by market
  • Requires an upfront fee to be paid to an M&A firm

EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization, meaning your earnings are higher than net income when you “add back” depreciation, etc.  EBITDA includes an expense for management salary (could be the owner) at fair market wages.  We’ll go into this in more detail of course in the full program as we want to be able to enhance EBITDA in the year or two before a sale, but for now you can probably get a good estimate so you know which video to watch and which program to subscribe to.

Small Businesses

Small businesses are at the heart of the economy and literally thousands change hand every year. The key to a smooth small business sales transaction with a business broker is good buyer qualification and the ability to manage a complex and multi-faceted process. Most brokers handle up to 10 clients simultaneously so they may not have much time for education, which is where my program comes in – you’ll know what to expect and when to expect it.

Characteristics of small business sales:

  • Typically one to five page summary is sufficient to describe the business
  • An individual, perhaps with an SBA loan, is likely buyer
  • Individual buyers find business on business-for-sale websites – serious marketing isn’t required
  • Measures earnings using SDE, a measure of how much an owner/operator receives
  • Asking price is usually published
  • Requires little ($5-15K max) or no upfront fee to be paid to a business brokerage
  • Usually working capital (e.g. AR) is not required to be left in the buiness

SDE (Seller’s Discretionary Earnings) is everything the owner/operator takes home – salary, benefits, perks, dividends, profits, etc. We’ll go into this in more detail of course in the full program as we want to be able to enhance SDE in the year or two before a sale, but for now you can probably get a good estimate so you know which video to watch and which program to subscribe to.

The Quick and Easy Deal

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Unfortunately I haven’t had one of these.  I’m waiting though – it’s bound to happen.

One of the things preventing this is something I’ve written about in the past – the axiom that there are “no stupid buyers”.   Moreover, if you do happen upon one, they typically have some advisors such as attorneys and CPAs that will set them straight – which typically means stringent due diligence, a few issues and no quick and easy deal.

But they do happen, just not for me yet.  Here are some true (not rumor) examples I’ve witnessed that happened in the last year.  I did change some of the facts because of confidentiality.

A business owner decided to sell and engaged with an M&A broker.  The broker estimated the business value at $1.2 million and the real estate at $800K for a total of $2 million.  The following week a real estate agent walked into the business and said he was acting on behalf of a large national firm looking for regional offices and they wanted to buy the real estate in an expedited deal.  For $2 million dollars.  Done.

A company that has a highly recurring subscription based model was preparing to sell and had received advice that because of their high level of recurring revenue they would likely sell at a premium, well above the typical 5X EBITDA for a company that size.  However they were not yet at $1 million in EBITDA which was the goal before selling.  Well, they were processing a very large amount of credit card charges each month based on their subscription model – and a credit card processing company saw great value in securing that revenue through their platform.  They paid over 20x EBITDA in a quick deal, with absolutely no synergy at all except for the credit card processing.  That is great for the business owners, but the failed conglomerates of the 1960s has shown that true synergy is typically required for a successful acquisition.  I guess we’ll see on that one.

If you have a quick and easy deal you need done, please let me know.  I’m still waiting.

 

 

Upfront Fees for Business Brokers and M&A – Should You Pay Them?

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If you are small business with earnings under $300K then you would probably approach a “main street” business broker to sell your business.  It is industry standard practice for business brokers to not charge an upfront fee.  Actually, in most states it is even more than that – it’s the law.  In many states in which business brokerage is regulated under the department of real estate, brokers are not allowed to collect upfront fees that are a part of the sales commission.  If they do charge an upfront fee, it has to be for a tangible product or service such as a formal valuation (not a 5 or 10 page “broker’s opinion of value”).

So that is pretty clear – if you are small and use a broker – no fee.  It is also pretty clear that if your company has $1 million or more in earnings, you will want to use an M&A firm or investment bank and you will not only pay a upfront fee, you also may have to pay a monthly retainer (for very large companies).

But let’s talk about that middle ground, where it really isn’t clear what is what.  In this space business brokers often call themselves mergers and acquisitions advisors and M&A advisors call themselves investment banks.  Some high growth companies with $500K in earnings may well need a good M&A advisor because of the complexities of the business, while a car wash with $1 million in earnings could be sold by a no-fee business broker.

Here’s a couple of things to remember when considering whether you need to pay an upfront fee:

  1. Like many things, you get what you pay for
  2. However, be sure to ask what exactly you are paying for

What you want to pay for, and what it makes sense to pay upfront cash for, are products and services which help you sell your company and get the best price.  This assumes you agree with the notion that professional marketing of your company increases the chance of getting it sold and with the best price.  These services should ideally be performed (just ask) primarily by professionals, not the broker or dealmaker whose primary payday should be selling the company.  Examples of items you should not mind paying an upfront fee for:

  • A professionally prepared selling prospectus (the book).  By the way, there is a big difference between a professionally prepared book and a fill-in-blanks template that some firms use.
  • Sales and marketing materials.  Executive summaries, photos, videos, blind web summaries, letters of introduction, etc.
  • Marketing research to uncover strategic and financial buyers.   Good research entails using many resources and is very time consuming – and it consists of more than running a list based on SIC or NAICS codes.
  • Actual marketing costs of mailings, telemarketing, etc.  (As opposed to a business broker that typically only pays for a web listing service.)

What you don’t want to pay for with your upfront fee are commissions paid to salespeople for signing you up.  Some firms pay up to 50% of the upfront fee to salespeople to sign you up, and that is money that isn’t  being used to prepare and market your company.  What is worse, often those same salespeople are the ones that have complete authority to sign you up, creating an incentive to say all the right things to get the fee.  However, they are not actually responsible for selling your company.

This business model has led to the rise (lots of new clients and fees) and eventual collapse (only sold a small percentage of clients) of some large M&A firms, most notably the Geneva Group.   There are similar companies out there today, often using telemarketing and a seminar strategy.

The best thing you can do is ask directly about how the upfront fee and commissions work.  Where does that money go and what is it used for? I was in Brazil recently and the prospective client really drilled me about fees and commissions.  He was focusing in on the flow of money and where the incentives would be in my firm.  That rarely happens in the US, but it should.  Ask.

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