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Tanner Montague came to town from Seattle having never owned his own music venue before. He’s a musician himself, so he has a pretty good sense of good music, but he also wandered into a crowded music scene filled with concert venues large and small.But the owner of Green Room thinks he found a void in the market. It’s lacking, he says, in places serving between 200 and 500 people, a sweet spot he thinks could be a draw for both some national acts not quite big enough yet for arena gigs and local acts looking for a launching pad.“I felt that size would do well in the city to offer more options,” he says. “My goal was to A, bring another option for national acts but then, B, have a great spot for local bands to start.”Right or wrong, something seems to be working, he says. He’s got a full calendar of concerts booked out several months. How did he, as a newcomer to the market in an industry filled with competition, get the attention of the local concertgoer?

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by Beth Ewen
October-November 2016

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Workshop: Due diligence

How to buy or sell a company?

A panel of experts breaks it down, from valuations to due diligence to preparation to psychology—all aimed at achieving the proper modus operandi when doing mergers and acquisitions.

 

Rick Brimacomb, moderator, Brimacomb + Associates: This mergers and acquisitions panel is co-hosted by Upsize and Club Entrepreneur. Our focus is on the M&A market in order to improve your chances of success when buying or selling a business, or making an investment decision.

We will introduce you to a group of experts who can serve as your trusted advisers.  Each of you, explain how you fit into the discussion.

 

Sean Boland, DS+B: We’re a local CPA firm. We deal in the manufacturing, healthcare, retail space, etc. We are connected, proactive and accessible to our clients. I have a six-year- old and I live in Apple Valley. I’m one of 12 kids. I definitely call St. Paul my side of the river. I love motorcycles, I love golfing, hockey, fishing, anything outdoors.

Peggy DeMuse, Sunbelt Business Brokers: I’m from St. Paul as well. I’m a CPA by background. I worked at Ecolab, then went to Ernst & Young and spent five years with their tax group. I was managing partner with SALO Finance.

From there I opened my own small business and ran it for a year and a half and decided it wasn’t the right fit for me, so I worked with Sunbelt to sell it and decided it was a great opportunity to help owners find a business to buy or get their business properly positioned to sell.

Micah Thor, Tech Guru: We’re an outsourced IT provider. We provide everything from a strategic level to crawling under the desks and among the wires. We handle everything with buttons and lights. We help those companies that don’t have their own IT department.

My experience for this panel comes from firms that have undergone mergers and acquisitions, and integrating their information technology.

On Sunday I’m moving to London; my wife is doing a master’s degree program in London, so my two-year-old and my wife and I will be there, and I will be living in two places.

Melissa Johnston, Highland Bank: I’m a business banker at Highland Bank. I started my career at a bank holding company and I was on the due diligence team when that bank was in acquisition mode.

Now it’s enjoyable for me to be on the front line, talking with business owners like you, when you’re making decisions about acquisitions. In the last two and a half years I have zeroed in on acquisitions, helping my clients with that.

On a personal level, I have twin boys who are 7 ½ and a daughter who’s three. And I’m a farm girl, my dad has 10,000 hogs and I’m still very active in helping on the farm.

Rick Brimacomb: Peggy, from your perspective at Sunbelt, what are the top value drivers for buyers and sellers to focus on?

Peggy DeMuse: Most buyers are looking for a sustainable business, which means when the owner walks out the door the business is not going to go with him. The best thing the business owner can do is to start working himself out of a job.

Another thing that buyers look for is return on investment, so strategic buyers are looking at how quickly they can make back their original investments. Individual buyers tend to look for, can I make a reasonable salary for this business, pay down the debt, and still look at a return.

Rick Brimacomb: How long should the financial due diligence take and how do you know when enough is enough.

Sean Boland: A half million dollar deal, there’s not much due diligence. At a $5 million deal, there are a lot of people involved. At a $50 million deal, it’s a large deal and there are a lot of people who will be chasing it.

Rick Brimacomb: Melissa, from a financing perspective, what are the best ways to finance a transaction, based on deal size?

Melissa Johnston: I am a banker, so I will say the best way to finance a transaction is with a bank. But really it is. As a buyer, you shouldn’t use all your dry powder, or as you might call it, cash, to buy a company.

Interest rates are low. If you’re buying a company up to $15 million, it is good to use a bank. Use a bank that you can have a relationship with. In financing the smaller deals, the seller typically participates in that financing, whether it’s 10 percent or 15 percent.

You may want to use your cash later when you want to buy a larger company, so it’s worth having those conversations with a bank.

I can tell you stories about people who have used seller financing, and then they didn’t have a bank to ask the questions that were needed. There is also private equity; not all banks do cash flow loans, but if they do, participations are common, so lots of options are available.

Rick Brimacomb: Micah, tech firms are commonly brought in to help with due diligence, so what happens when an acquisition takes place and they reach out to you?

Micah Thor: Boy, do we wish they gave us a lot of advance notice. I made a quick list for due diligence checklist items. Email platforms can be very, very different, and email itself can be a huge mess that will need to be unraveled.

What finance platform are they using? Are they on something that doesn’t even have support and nobody knows how to use it except for that one 75-year-old employee?

What remote access exists and could potentially have exposure after the transaction? What kind of control mechanisms do they have on their data, to make sure sensitive IP is not being transitioned out during the transition? What are the support needs the new company is going to have?

Most important if they’re running lines of business software that they developed that is a big part of this transaction, and you want to fold that into your own company, you want to make sure it’s best of breed software, and you have access to a consultant that will integrate it and provide support.

Rick Brimacomb: Peggy, when someone is looking to sell part or all of their business, how do you know when they’ve built a business they can leave?

Peggy DeMuse: It in large part goes back to what I said earlier: working themselves out of a job and having a good team in place, and allowing the new owner to be able to look at new ideas.

Rick Brimacomb: Sean, same question from the accounting angle.

Sean Boland: If they’re down in Florida for the winter they probably built a good management team. Make sure you lock down your sales, make sure the non-competes are in place.

Make sure you’re running it to industry norms. Make sure the key people will stay. Get some of those key things in place because a buyer will be attracted to that.

Micah Thor: Some people buy a company that’s a fixer upper, and it’s a huge opportunity for us to create opportunity through technology. If you’re buying a turnkey, you ask how up to date is your technology, and if it’s updated you know you’ve got a business owner who has a philosophy of supporting technology.

Melissa Johnston: The most important thing a seller can do to prepare a business for sale is to have cash flow and to be able to show cash flow.

A lot of business owners are very good at minimizing taxes, but as a buyer you’re looking at the bottom line, the cash flow, and the last three years are very important to you.

If the gross margins are getting tighter, those are all things that your company might not be in the best position to get ready for sale. We say, you’re going to have to pay some taxes and you’re going to have to show your company is making money.

The more you show to the buyer as discretionary income, the buyers won’t be as interested. It can get really messy going through those financial statements.

We see it all the time, with all these add-backs. If you want to get the most back from selling your business, you have to show your company is making money.

Rick Brimacomb: From a personal side, how do you know the time is right to sell?

Melissa Johnston: It’s a sellers’ market right now. There are a lot of buyers out there. Just think about for you as a seller what’s important to you. Is it leaving a legacy? Is it keeping the traditions in place? Or is it simply about how much money you get? You need to think about that.

As a seller, you need to work with a personal financial planner because how you allocate your company is important. What’s listed as equipment, goodwill, etc. will be important as to how you get taxed.

When you sell, you’ve been making a good income, so how will you get that income replaced? So it’s sitting with a financial planner well in advance so you can prepare yourself personally, and then in terms of your business.

Micah Thor: A lot of business owners can relate to this. You’ve probably merged your personal and professional life when it comes to technology. For example, the email address. So, what kind of access are you gong to retain after the transaction to those contacts?

It can be negotiated a lot of different ways. Speaking from the IT department, the ideal is you make a clean break, and you don’t have to maintain access after that transaction. Your laptop, your phone, and everything else, make sure you have a clear path to separate those two.

Peggy DeMuse: It’s interesting when you sit down with sellers, often times we have people that it’s their identity, and they struggle with if I sell the business, what am I going to do next? So having a plan for that is super important.

From a business perspective, often times we see business owners are running everything through the business. If you could stop doing that for a year or two, you’re going to get multiples on that money that you would have saved from taxes, so I would reiterate that.

Sean Boland: They’re all legitimate expenses, so I’ll put that out there. But it’s an emotional sale. It’s 40 years of creating this business. It’s your lifestyle. It’s a big emotional sale. A lot of people don’t realize how big that is.

I had a client who was looking for a couple million dollars from the sale. It didn’t work out. Our client got it for 0 down. He was 84 years old, but he did not want to sell the business and he had a preconceived notion that his valuation was up high, but he couldn’t get it.

Rick Brimacomb: Sean, tell us about how to tell what a business is worth.

Sean Boland: Easy example: Who picked the Vikings to win the Super Bowl yesterday morning at 8 a.m.? Then hours later the odds were much different. [The workshop was Aug. 31, the day after quarterback Teddy Bridgewater was injured during practice and was out for the season.] Valuation is the same thing, it’s a point in time.

Peggy DeMuse: I agree with Sean, it is definitely a moving target. Depending on who the buyer is they will value that business as more or less. We use EBITDA or seller’s discretionary cash flow as a starting point, but many factors cause the number to go up or down.

We look at: how much is the business dependent on the owner; what’s their customer concentration; are there high barriers to entry. It’s hard to say; there is no set number.

Micah Thor: We’ve seen a couple of different things from the technology perspective that has created value. We saw a client in Colorado that acquired a company here because of utilizing a software.

Some other simple things to consider:

The age of the equipment; will you have to replace every piece of equipment in that place. Maybe it turns out you’ve inherited old servers and you have a large infrastructure spend to account for.

In a perfect state, we’re trying to build an application we use that does everything we need it to do. So your employee comes in and logs in and there’s no way they can screw up their job. For all the back office staff, the more they can utilize a piece of software that is customized for their job the more efficiencies they can gain.

Melissa Johnston: I will just say, people can do their own valuation, but even if you’re buying a company for a couple hundred thousand dollars, companies will do valuations for you for a modest cost.

So, get a valuation.

Get an outside opinion and get your emotions out of it. That’s extremely important.

Rick Brimacomb: You can use a public company that is similar to yours, and then slap a discount on it, because a privately held company is worth less. And then you can get help from your advisers to look at comparable companies, to help with valuation.

From the audience:

What are some typical EBITDA (gross earnings) multiples? And how does structure of the deal affect valuation?

Rick Brimacomb: If you’re doing mainstream American businesses, you’re going to do a 3X EBITDA and maybe on the high side 8X. Other businesses you might go off a revenue multiple, one to three times. Technology multiples will be higher than Main Street America. It’s dependent on the company, the industry you’re in, and the multiples in your industry. Plus then how it is structured.

Peggy DeMuse: I would say, we look at price, terms and we also look at taxes. As you’re looking to sell the business, there are actually benefits to financing some or all of that transaction because you can delay taxes. And the third piece is structure: how you structure it can definitely change what the tax liability is. So you have to work with advisers on that.

Melissa Johnston: We are required to order a business valuation if the finance amount is $250,000 or above. Buyers beware, the multiples are four to five times EBITDA with sort of normal add backs. Four times EBITDA is pretty normal. We’ve seen a few deals with five times EBITDA, but you have to have contracts with vendors and customers.

From the audience:

How to handle add-backs?

Melissa Johnston: There are legitimate add-backs. But I did a manufacturing deal that the seller was saying his insurance costs were higher than normal, etc.We always see add backs, but it’s making sure they’re legitimate and they make sense. Some sellers really get carried away. So just clean it up and make sure they’re sensible.

Peggy DeMuse: We see add-backs all the time, and if it’s clean and easy to support that’s fine. When we start to squirm is if we hear, 20 percent of that is for my household. That’s very difficult to support.

Sean Boland: Ideally you’re going to run those expenses through your W-2. If you’re running your golf membership through, and a board meeting in London, you don’t want to run that stuff through your business two to three years prior to sale.

From the audience: When should business owners start to manage what they’re running through the business in preparation for a sale?

Sean Boland: Ideally you want two, three, four years ahead of time. We kind of whip them through this sale. We’re going to pay tax at a higher tax bracket for a few years—great. If you’re paying taxes, you get it on the back end, when you sell for 5X EBITDA.

Rick Brimacomb: And you don’t want to create doubt in the buyer’s mind.

Peggy DeMuse: There’s a lot of things that get added back and a lot of those things are quote unquote legitimate. Often what we see is more automobile that’s taken for expense than is used for business. Those are the types of things that bother the buyer.

Rick Brimacomb: How best can an owner get help from advisers, and what should they consider when making their choices.

Sean Boland: Make sure they’ve done the work. It’s on your dime, so make sure they specialize in M&A work. Make sure you’re dealing with that same type of professional. They’ll get the deal done faster and better. Get them in as early as you can.

Peggy DeMuse: Whether they’re looking at buying or selling, you need somebody that will respond quickly because the market moves quickly.

The other thing is to make sure that your adviser understands that it needs to be a win-win situation. You don’t want an adviser that’s driving so hard from the buy side that the seller walks away, or vice versa.

Micah Thor: In a perfect scenario you have two IT companies representing each company, and they can go down the list and say we have this app, or that app, and any time they don’t line up they can figure that out. They can also highlight some opportunities to negotiate.

Melissa Johnston: I’ll just share a little story about how important it is to assemble a team of advisers. I work with an accountant, and about 10 years ago she was excited about buying another accounting practice. She did it and did not consult with a team of advisers.

And it turned out that one of the key CPAs was looking at buying a company. She had agreed to take over the lease, which was five more years in a location far from her space. A lot of things happened, and shortly after closing revenue was cut in half.

What I’m trying to say is having an advisory team that you can talk to is very important.

Equally important is making sure that roles don’t overlap. So something as simple as creating at EIN number: who’s doing that? Be clear about the roles and who’s doing what, and not accruing unnecessary fees.

Rick Brimacomb: What should due diligence look like?

Melissa Johnston: So many businesses are seasonal, so we even get as detailed as, what is the company doing monthly, weekly and daily? Do you have enough dry powder so if you have three great months of revenue, but your clients aren’t paying you for 60 days, what does that look like for cash flow?

Banks look at acquisitions as a start-up. There’s a lot of risk in taking on another company. So does the owner have transferable skills, relevant skills to do this? It’s a big change, it’s a big risk, and what does that mean after the sale?

I talked a little about the lease, but I had another person talk to me that they had a lease agreement but the real estate taxes went up a lot, and that was in the lease. Just things like that, getting into the details of what you’re inheriting and buying.

Micah Thor: I’ll give you the flip side of the story I told before, the Colorado company that bought the St. Paul company almost solely for the software. The problem was, it was developed by an employee who left after the transaction, and nobody really knew how to merge this in so they were scrambling to find a developer.

That was a total blind spot in the buyer’s due diligence: there was a key employee who wasn’t retained in the transaction. They’re now looking at this transaction as a mistake.

Peggy DeMuse: Also look at due diligence from an operational perspective. Make sure you understand how it runs on a day-to-day basis. How will you be able to retain key customers and key employees?

Sean Boland: Inventory turns; accounts receivable turns; make sure working capital is good. Cash flow is a driver of the deal. Family involvement: If I’m buying the owner’s son is that a good thing or not?

Rick Brimacomb: Talk about mistakes that are made commonly, from a buyer’s or seller’s perspective.

Sean Boland: Realistic value from the seller’s standpoint. God forbid the person dies and you’re left with the spouse as owner. Make sure your buy-sell agreement is good.

Peggy DeMuse: We often see the seller has a business that’s doing fabulous, and they know they want to sell but they wait. And they miss the opportunity to sell on the upswing. Once that happens, it can take several years to come back up.

If you’re on the upswing and you’re thinking it’s a good time, start looking at it a lot closer now.

Micah Thor: If you’re thinking in the next three years about selling, it’s a great time to look at investing in your technology. If you can show a tangible change in your profitability, and tie it to your investments, this increase in profitability is something that will be stable and scalable as well. Make smart moves in technology to pump up the value of that company.

Melissa Johnston: I will share just setting up your corporate entitites is important. I did a deal last year and he had set up an S corp and he decided to use that S corp to buy real estate. He wanted to do a 1031 exchange, and that became very convoluted. So , setting up your companies right, owning it right, and getting everything set up on the front side.

Rick Brimacomb: To summarize, any final thoughts that buyers or sellers should keep in mind?

Sean Boland: Make sure you have a realistic buyer, a realistic seller, and the deal will get done. A lot of those professionals should not get in the way. Don’t get caught up in the hiccups.

Peggy DeMuse: I would say from a seller’s side, the one thing is to keep it confidential. It’s not the time to tell your key employees or neighbors. It’s a huge risk if people start knowing it’s for sale. Employees, customers get nervous.

From a buyer’s side, it is a seller’s market right now. You may be in a multiple offer situation. Be prepared to put your best foot forward, and understand that you are trying out for the seller’s side.

Micah Thor: If you are a buyer, get an IT consultant in the target company to do an audit, so top to bottom you know what you are buying. From the seller’s side, realize that you can do some nice stuff with technology that can exponentially increase the value of your company.

Melissa Johnston: If you leave with one thing today this will be it: leave your heart out of the buying decision. As humans, we buy based on emotions, and we rationalize our decisions later. I challenge you to check your emotions at the door and use your process.

Talk with other resources/advisers. Do the due diligence without analysis paralysis. Follow a process and leave your emotions out of it. I’ve seen people ignore their teams or skip their process because they’re too in love with a company.

 

CONTACT THE EXPERTS

Sean Boland is managing principal at
DS+B CPAs and Business Advisors: 612.359.9630;
sboland@dsb-cpa.com; www.dsb-cpa.com

 

Rick Brimacomb is managing partner at
Brimacomb + Associates and Club E: 612.803.3169;
rick@brimacomb.com;
www.brimacomb.com

 

Peggy DeMuse is a broker at
Sunbelt Business Brokers:
pdemuse@sunbeltmidwest.com;
www.sunbeltmidwest.com

 

Melissa Johnston is a vice president at
Highland Bank: 952.858.4798;
melissa.johnston@highlandbanks.com;
www.highlandbanks.com

 

Micah Thor is COO at Tech Guru:
micah@techguruit.com; www.techguruit.com