It is never too early to start thinking about your exit strategy as it can take years to get to a point where the value you can get from your hard work matches your expectations and desires. Most of the information here is useful for whatever liquidity path is chosen but the focus of the advice is for those who expect their exit to be the sale of their company.
The information buyers of your company or stock to demand to see is listed in Sections II through IX of this document. It useful in pointing out what aspects of your business will be evaluated in determining your worth on a liquidity event. There is nothing novel in what is presented. My value add to the topic is Section I where I explain important considerations, the understanding of which can make a huge difference in the outcome of a liquidity transaction.
I. The Journey
The first thing to work through is picking the liquidity path—sale, merger or IPO. This paper deals almost exclusively with a sale as the IPO route is not one taken by most companies and mergers generally materialize out of an ongoing relationship between the entities involved in a merger.
Key to the process is the selection and management of an advisor (aka M&A firm), or (less likely) an Investment Bank to help with the sale. The balance of this section discusses what to expect in with an advisor and what to expect from the sale process itself.
First, a cautionary warning about M&A firms and Investment banks. They work for you but they are subject to forces that can reduce the realized value of your company:
- M&A advisors make more in fees if they sell your company for the highest possible consideration; but they can be quick to take a lower price in exchange for getting a deal done quickly so that they can move on to the next assignment. In addition, they have a built in and necessary conflict of interest in that if they have a specialty in representing companies in your business, they will have ongoing relationships with potential acquirers for those companies. Their maintenance of good relations with these acquirers, while at the same time getting maximum value for your company, can be a tricky proposition for them.
- Investment banks have a conflict similar to that of M&A firms. In this case the buyers of your stock are clients of the bank that pay commissions to buy the stock of many other companies the bank takes public or sells. For an IPO this conflict can mean the bank has an incentive to sell your stock below its market clearing value so that their investment clients can get an uplift in the price immediately following your stock offering. You have likely heard of companies “leaving money on the table” as a possible result of this conflict.
Advisors work for a combination of a retainer fees, expense reimbursement and a success fee payable if a transaction is closed.
- Retainer fees range from a few thousand dollars a month to much more depending on the expected value of the company and the company’s ability to pay. They are negotiable. I am not a fan of these fees because they work against the advisor working hard to make a deal happen so that they can get paid.
- Success fees generally work on a sliding scale (generally referred to a “Lehman”). For example, the advisor may take 10% of the first $10M in purchase consideration, 5% of the next $10M in consideration and 3% of everything over $20M. These fees are negotiable.
An Advisor can be essential in getting a transaction concluded because that is the business they are in, but selecting the right advisor is key to getting a good outcome. Here are the key questions, the answers to which will aid in selecting the right advisor.
- Does the advisor have an extensive resume for closing deals in your industry?
- Does the advisor deal with companies in your revenue size range?
- Who will be working on your deal? It is important not to get assigned to a junior person.
- Does the advisor focus on sell side or buy side transactions? If you are selling you want a sell side specialist.
- Does the advisor have a potential conflict of interest—e.g. they have a sell side assignment with one of your competitors or they have a strong buy side loyalty to a potential acquirer that could result in limiting your market or maximizing your acquisition price.
- Does the advisor really understand your business, its warts and its potential?
- Can the advisor show you a list if likely acquirers with solid reasons why they should have an interest?
- Is the advisor’s target list large enough?
- Does the advisor’s comparables analysis used to justifying a price target have other private companies in your size range in it?
- What is the advisor’s marketing plan? Will they approach a targeted and finite list of potential acquirers or will they approach anyone on their list of buyers (aka “spray and pray”)?
- Are you comfortable with the advisor?
Be prepared for some disappointment along the path from hiring an advisor to completing a transaction. Here is why?
- The sale process will likely take 6 months or longer. There are several steps in the process:
- It begins with the advisor’s due diligence process which can take a month or more.
- Preparation of marketing materials (a “book” and supporting detail), which can take weeks of drafting and reviews.
- Initial acquirer approaches, which with responses will take a month or more depending on the time of year.
- Lots of initial meetings between the company and potential acquirers. If there are several possible suitors this process can take a month.
- Acquirer due diligence, which will take a month or more.
- Offer or offers and attendant negotiations.
- Acquisition document negotiation. This can take a month or more for larger acquisitions.
2. Downward revisions to your expected valuation are very likely to occur, because;
- The advisor was just too optimistic on the front end of the process.
- The advisor diligence process reveals warts that impact value.
- The market changes in the downward direction.
- Interested acquirers are unwilling to pay the target price.
- Acquirers’ diligence reveals things that reduce the value of your company to them.
- Acquirers sensing they are the only ones at the party will likely take advantage of a tiring seller to get a lower price.
3. You or your advisors may overlook important considerations such as:
- The need for strategy changes
- The need for management changes. This often comes up when the need for continuity past the close of a transaction is an issue.
- Needed service offering changes or additions
- Needed positioning changes
- Existing partnerships that somehow muddy the waters.
- The need to raise equity or debt to fund needed changes for liquidity event or keep the company solvent during the process.
The balance of this paper calls out the information that needs to be assembled to support any liquidity process—sale, merger, or IPO.
The M&A process is complex and getting it right is essential to maximizing the return on your years of effort. I can coach you through the process to maximize the likelihood of the outcome you desire. Please Contact me.
II. Financial Information
A. Annual and quarterly financial information for the past three years—how do the following results stack up in the sector and against key competitors
- Income statements, balance sheets, cash flows, and footnotes
- Management financial and management reports and dashboards
- Breakdown of sales and gross profits or margin by:
- Product or Product Type or Series
- Current backlog by customer, customer type and/or geography
- Accounts receivable aging schedule—with explanations about old receivables and customer concentration.
B. Financial Projections
- Quarterly financial projections for the next (usually three) fiscal years
- Revenue by product type, customer, and channel
- Income statements, balance sheets, cash flow projections
- Financial results and timing for future products and services
2. Major growth drivers and prospects
3. Risks attendant to foreign operations (e.g., exchange rate fluctuation risk, government instability or negative business rules, etc.)
4. Industry and company pricing policies and comparison with key competitors
5. Economic assumptions underlying projections
6. Projected capital expenditures, depreciation, and working capital requirements and their relationship with financial projections
7. Sources and uses of capital if needed to finance the projected results
C. Capital Structure
- Current shares outstanding by class and preferences associated with each class.
- List of all stockholders with shareholdings, options, warrants, or notes
- Schedule of all options, warrants, rights, and any other potentially dilutive securities with exercise prices and vesting provisions.
- Summary of all debt instruments/bank lines with key terms and conditions
- Off balance sheet liabilities
D. Other financial information
- Summary of current federal, state and foreign tax positions, including net operating loss carry- forwards
- General accounting policies (revenue recognition, etc.)
- Schedule of financing history and terms for equity, warrants, and debt (date, investors, dollar investment, percentage ownership, implied valuation and current basis for each round)
III. Products and Services
- Description of each product or service
- Major customers and applications
- Historical and projected growth rates
- Market share and market share position vis a vis key competitors
- The effect and timing of technological change on the business
- Timing of new products, product enhancements
- Cost structure and profitability
- Schedule of investments needed to keep product or services competitive
IV. Customer Information
- List of customers comprising at least 50% of sales for the past two fiscal years and current year-to-date by application (name, contact name, address, phone number, product(s) owned, and timing of purchases)
- List nature and summary financial impact of strategic relationships (name, contact name, phone number, revenue contribution, marketing agreements, etc.)
- Revenue by customer (name, contact name, phone number for any accounting for 5 percent or more of revenue)
- Brief description of any significant relationships severed within the last two years. (name, contact name, phone number and explanation)
- List of top suppliers for the past two fiscal years and current year-to-date with contact information (name, contact name, phone number, purchase amounts, supplier agreements)
A. Description of the competitive landscape within each market segment including:
- Market position and related strengths and weaknesses as perceived in the market place
- Basis of competition (e.g., price, service, technology, distribution, bundling, etc.)
- List of key competitors with detailed comparison of product, service or other important information. Competitive position vis a vis each competitor
VI. Marketing, Sales, and Distribution
A. Strategy and implementation
- Discussion of domestic and international distribution channels
- Positioning of the Company and its offerings
- Marketing opportunities/marketing risks
- Description of marketing programs and examples of recent marketing/product/public relations/media information
B. Major Customers
- Age, status and trends of relationships
- Prospects for future growth and development
- Pipeline analysis
C. Sales force productivity model
- Quota Average
- Sales Cycle
- Plan for New Hires
VII. Research and Development
A. Description of R&D organization
- Key Personnel
- Major Activities
B. New Product Pipeline
- Status and Timing
- Cost of Development
- Critical Technology Necessary for Implementation
- Product or service offering release schedule
VIII. Management and Personnel
A. Organization Chart
B. Historical and projected headcount by function and location
C. Summary biographies of senior management, including employment history, age, service with the Company, years in current position.
D. Compensation arrangements
- Copies (or summaries) of key employment agreements
- Benefit plans
- Incentive compensation plans
- Equity or debt holdings or options for key employees
E. Significant employee relations problems, past or present, including identification of relatives or family members in key positions.
F. Personnel Turnover
- Data for the last two years
IX. Legal and Related Matters
A. Pending lawsuits against the Company (detail on claimant, claimed damages, brief history, status, anticipated outcome, and name of the Company’s counsel)
B. Pending lawsuits initiated by Company (detail on defendant, claimed damages, brief history, status, anticipated outcome, and name of Company’s counsel)
C. Description of environmental and employee safety issues and liabilities
- Safety precautions
- New regulations and their consequences
D. List of material patents, copyrights, licenses, and trademarks (issued and pending)
E. Summary of insurance coverage/any material exposures
F. Summary of material contacts
G. History of SEC or other regulatory agency problems or licensing or operating permissions in a state or country
Download the Exit Strategy Guidance and Check List Below
Exit Strategy Guidance and Check List
The purpose of this document is to tell company owners what to expect should they decide to sell their company or merge it with another unrelated entity. It deals with five topics; planning for an exit, picking an advisor, the process, expected bumps along the way, and the data that needs to be furnished in support of the process. The M&A process is complex and getting it right is essential to maximizing the return on your years of effort. I can coach you through the process to maximize the likelihood of the outcome you desire. Contact me.