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Sweet marketing music

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
Jun-July 2015

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WORKSHOP-THE FINE PRINT

It can be an uncomfortable experience—most entrepreneurs, after all, are used to running their own show and telling their own story. Here’s how to smooth the way.

Before you make the deal of a lifetime, first you and your company must undergo scrutiny of the closest kind, as experts explained at a recent workshop sponsored by Upsize and Club E.

 

Rick Brimacomb, Brimacomb + Associates and Club E, moderator:

Due diligence is the process of uncovering all the risks in a deal, so you know what you’re getting before you buy it. I’d like each of you to tell us more about your part of the topic today.

Joe Beckman, Hellmuth & Johnson:

I’m kind of the tail on the dog, because oftentimes we’ll get involved once the LOI, letter of intent, has been signed. The due diligence is collecting all the ingredients, and they come to me and say let’s put this in a pie.

How do we do it? I’ve come up with three topics to pay attention to: 1. Put yourselves six months from close and see what you’d do differently. 2. Leverage the services of your advisers at the outset. 3. Work to sniff out the major risks in the due diligence process.

I often hear about things people wish they had done differently post-closing. A real big one is to pay attention to assignment provisions in contracts, because you think you’ll get all this stuff in a deal but then you find revenue has contracts that can’t be assigned.

Post-closing, people often say they wish they would have talked to an attorney when starting the LOI process. Folks are so anxious to sign and move forward, they don’t realize they’ve boxed themselves in.

They realize they can’t use the cherries and the apples, and they have to make a lemon pie. They’re still hungry, but now they have a sour face.

Get me involved either when you’re sending the first draft of the letter of intent, or when you’re responding to it, because that’s when you can ensure you have all the ingredients available to you when you come to make the pie. And don’t agree to everything in the LOI at first.

One final point: Put more back end protection in your document up front. The other thing people say is, they shouldn’t have been so impatient to close. One extra draft to get it right probably makes sense.

Also, many times people say they should have put money into escrow, for an indemnity basket. There’s an impatience to get the deal closed, and they’ll let something slide that their gut says, this could be a problem.

Sean Boland, DS+B:

I’ll talk about three scenarios.

On a $500,000 purchase, you’ll get the CPA involved a little bit. You’re not going to spend a lot on a lot of professionals around that, other than the attorney of course.

But you will talk about revenue and expenses. The other thing to talk over with the CPA is the tax structure. There are a lot of different ways to structure that deal, so it’s all part of the negotiations. The CPA will be able to help you with that.

The next deal, a $5 million deal, is pretty much the same as the first but now you’ll get the CPA more involved. He’ll probably do an audit, and they’ll start kicking the tires. They’ll look a lot more at the non-competes, to make sure your key people are signed long term.

They’ll make sure the contracts are long term. You definitely want to look at key personnel. At a deal that size you’re probably looking at family members, and you have the good kid, the bad kid and the third kid who never shows up.

You have to put that into the purchase price, because the patriarch will have to deal with it. We’ll look at key ratios. What kind of tax structure you want is important in the long run.

The third deal is the $50 million deal. That one the CPA will be very involved, and it’s a long process. Your CPA is going to be in there very deep, 30 days, 60 days easily. And then it’s going to go back and forth with the LOI, the purchase agreement. Your CPA will be hand in hand with you.

Tim Grathwol, Schwegman Lundberg Woessner:

In terms of IP, intellectual property, I think about the overall context in the portfolio rather than the size of the deal.

Having everything properly done beforehand certainly will save you a lot of trouble. There are many issues with IP you can fix at the time and there are some you can’t.

So there are four questions that I want you to think about if you’re selling or buying a company. I called these the four dumbest questions about IP that you’ve probably ever heard.

You come to me, you have a relatively small IP portfolio. Let’s say you have five issued patents, and you have a number of pending applications.

1.  So I say, do you own your patents? And you’ll say, who is this guy? I thought you said you were a patent attorney.

2. The other question I’ll ask you: Do any of your patents cover your products, and you’ll look at me like I have two heads.

3.  I’ll also ask you, do you have the right to make and sell your product? You’ll say what’s going on here?

4.  And then the kind of bonus question is: does your product include any open source software? And once again, you’ll think why is the patent guy asking me about free software?

As it turns out, if your company files a patent application, you do not necessarily own that patent. By default ownership goes to the inventors.

Hopefully, the inventors are employees, but they are not always employees. Why do I point that out? What if you work with a consulting firm, which is very common? So, even if they’re employees, do you have an agreement with employees, with IP assignment provisions?

So ownership turns out to be this technical thing that you don’t think about, and you can usually remedy this. But, it’s a latent issue, which means it remains hidden until it becomes very important.

Let’s turn to the second question on my list—do you have patents that cover your product? A patent covers things that are very specific.

In the patent process, often when we’re arguing with people, the claims change about your product. They can change and narrow, and they can turn out to not cover what you’ve commercialized. Aligning your patents to your products is important.

The next question is: Do you have the right to sell? The fact that you have a patent is a separate question from whether you have the right to sell your product. Someone else might also have a product on that same type of technology or a certain part of it.

We call this freedom to operate, and if you haven’t looked at the question before, it most certainly will come up in due diligence. It’s difficult to fix. We’re really trying to protect you against risk, the risk that you would buy a lawsuit.

A lot of you have heard about patent trolls. All they do is sue people, so this is a big issue and one that is better to be handled earlier on.

On the question of open source software: Beware if you are including open source software in your product. You’re signing on to that license to use it, but you’re signing to that user agreement, too.

If you’re not careful about it you could end up possibly being required to dedicate your source code to the public.

Jeff Johnson, L. Harris Partners:

I want to start this by saying, what is the role of a due diligence expert? I’ve done about 500 transactions that have been closed and due diligence on another 1,000 companies.

The role is to first find all kinds of bad things that lower the price, and then find all kinds of things to extend the payment terms. I got tired of that, and so now I want to help the business owners to be prepared so the due diligence process is not an event. What used to irritate me, was one side wasn’t prepared so I couldn’t find anything.

The biggest piece of the due diligence process is your emotion, managing the emotion. It kills so many deals.

We look at, what needs to happen so we understand what all the due diligence folks are going to look at and why. When you walk into a due diligence process and you have all the information you need, due diligence doesn’t really take very long.

So starting that process is critical. If you walk into my office and say you’re selling in a month, I can’t really help you. But the reality is it should be a process, so you look at where you are and where you need to be.

My starting point is interviewing management. And 90 percent of the time you’ll find out you don’t want any of them. And that’s a big deal because that’s a whole bunch of the value of the company.

If the owner is the only one making decisions, it can drive down the value significantly. You work in the business 90 percent of the time; you need to work on the business, more often than not, to actually start driving value creation. So you can manage your own emotion when you get to that sales transaction.

Everyone who owns a business will leave, either vertically or horizontally. I don’t recommend the last one. So it’s critical to look at the process.

When do you start thinking about value creation and exit? It’s two years before the event: that can be death, disability, picking up a significant other on the side—that happens a lot. It’s burnout, it’s a downturn in the economy.

Do you have the operating systems in place to create value; what is the real valuation—not the country club valuation, 17 X ebitda—that doesn’t work. Those are the types of things you need to start thinking through well in advance.

Dan Moshe, Tech Guru:

Without being too cliché I would like to reiterate to bring your techie people in early and often. It can save a lot of headache down the road to have a trusted adviser on your team who can give you an objective opinion about what’s really going on in a company you’re thinking of partnering with.

In the event you’re not able to do that, I have equipped all of you with a handy due diligence technology checklist. It will help you decide the company is making good tech decisions or has red flags.

Good signs:

There’s someone in technology leadership translating the business vision with technology vision.

There’s a three-year plan for upgrading software.

There’s a technology budget that accounts for operational expenses as well as capital repair and maintenance. Just like manufacturing companies have to plan to repair and maintain equipment, many businesses computers are the machines that help to bring in the money.

I’d also suggest a leading company makes it really easy for their employees to work from anywhere and work on their own terms, and that means both flexibility and ability to get to apps wherever they are. And also provide their employees the flexibility on the type of platforms that they choose.

Look for a general company culture of embracing change and innovation, which generally means that when new apps and new ideas come forward, they are used. I came across this really cool app called tinypulse, it’s a web-based automated weekly survey tool that asks employees one question every week, and it helps us gauge engagement.

To sum up, a good sign is when technology is taken seriously within the company and is considered a strategic competitive advantage.

Now some red flags:

“If it’s not broke we don’t fix it,” generally speaking is not a great way to address IT.

If you walk into a server room and it looks like a hurricane hit it, that is not a good idea. The best thing is if you walk into an IT closet and there’s almost nothing there.

You won’t have to worry about it as much, not because it doesn’t exist but because it’s hosted in a cloud. This day and age the fewer blinking lights in the server room, frankly means a simpler deal and probably fewer surprises.

A lack of technology leadership. Technology leadership should have a place on the leadership team.

Watch out for react, break, fix, deal with it when it fails. My concern there is there may not be a focus on employee productivity.

Expecting employees to bring their own gear and provide their own support—if you don’t have an assistant you are your own assistant. Part of your job description if you’re not providing tech support, is now your employees are providing tech support.

If you find there’s red flags, get us involved early, find a technologist who speaks English not geek speak, and who can also speak business.

There are multiple ways to do technology, and in an M&A situation, it’s important to consider, do you consolidate and integrate technology, or keep it separate so you can sell it more easily down the road.

Jeff Wright, Corporate Finance Associates:

Rule No. 1 is to hire a professional to help. Hire an investment banker. That guy or gal knows the business. You’re probably going to sell your business one time and you’re up against sophisticated buyers who do this a lot. It’s good to have somebody on your side who knows how M&A works.

On the table I passed out a 25-point value drivers worksheet. We use it before we ever engage with clients. We use it for two reasons: one is to help us do a valuation of their business. We do that complimentary before we get started with them, because we want to make sure we’re aligned with their expectations.

We’re in touch with the market. We can say, this is likely where the market is going to value your business. If they’re way out of whack and think it’s worth three times that we just walk.

We had a situation a few years ago where a medial company thought it should be valued on a gross margin basis only. We walked away from the assignment.

When we understand the strengths and weaknesses of the business we know how to market better. A company doesn’t have to be perfect to be sellable.

There are some deal killers: like the owner really is all of the business. When the investment banking process starts, there are four parts:

Document the company, writing the teaser and memorandum about the company’s story.

Looking for high value buyers. We’re looking for adjacencies and synergies. We get very creative when we build a potential suitor list. Usually that list has 200 to 400 companies on it. It starts with a really big funnel and we whittle it down to finalists.

Patience isn’t so much a virtue, to us. We lay out a six month process. We keep the urgency and velocity going because we think that’s in our client’s best interest.

We do our own due diligence on our clients before we put them on the market. We know where the skeletons are before we put them on the market. We manage our own process through our online data room.

Rick Brimacomb: On the valuation question: What are some high level ways to help folks in the audience determine the value of their business? Do they need a valuation? And what’s the difference between a formal valuation or one on the back of the envelope? And then should that be discussed with the other side?

Jeff Johnson: It’s really important for the business owner to truly understand what the value a buyer is going to be looking at. And they’re different depending on whether they’re a strategic buyer or a financial buyer

Jeff Wright: We never put a price on a company when it goes to market. The market drives the price. Our valuation exercise is closer to the back of the envelope. It’s more to get alignment and understanding. It’s an internal discussion with our clients.

Sean Boland: You get a range, so you figure out the ballpark as the seller or buyer. The last thing you want to do is print out a valuation and give it to somebody. You’ve just set the ceiling and it’s only going to come down from there. If you’re thinking it’s $5 million and it’s only $2 million, you’re going to pay a lot of professionals and fees and you’re still going to own that business at the end of the day. You’re going to want a range so you can set up your lifestyle after the transaction.

Jeff Johnson: I get a lot of times, “my business is worth this rule of thumb.” Rules of thumb you can talk about at the cocktail party, but you can’t spend rules of thumb. You can spend cash. Rules of thumb cause so many disasters.

Jeff Wright: Sometimes the poor owner gets poisoned in his mind because he had an offer. “These guys offered me $22 million.” Well, the question is, did it close? No. Well, that’s not a transaction. He’s had an overture and he’s stuck on it, in his mind. The country club number or the fictitious number, that’s not a good idea.

Joe Beckman: Six words: Pigs get fat. Hogs get slaughtered.

[contact]

Joe Beckman heads the business practice at Hellmuth & Johnson:
jbeckman@hjlawfirm.com

Sean Boland is managing principal, DS+B: sboland@dsb-cpa.com

Rick Brimacomb is founder at
Brimacomb + Associates and Club E:
rick@brimacomb.com

Tim Grathwol is a patent attorney at
Schwegman Lundberg Woessner:
tgrathwol@slwip.com

Jeff Johnson is a partner at
L. Harris Partners:
jeff.johnson@lharrispartners.com

Dan Moshe is founder of
Tech Guru: dan@techguruit.com

Jeff Wright is an investment banker at
Corporate Finance Associates:
jwright@cfaw.com