Name Your Price, I’ll Set The Terms
If you’re like most business owners, you’ve dreamt—maybe even fantasized—about what your company might be worth some day. You may not be ready to sell, but there’s a little part of you that is curious about what your business might be worth.
That leads many of us to try and find industry benchmarks online or talk to owners of similar businesses to find out the going rate. These approaches can help you narrow down what someone might pay for your company but, to some extent, the offer you get may be less important than the terms by which an acquirer is willing to buy your business.
I recently interviewed Drew Goodmanson, the founder of Monk Development on Built to Sell Radio. Monk Development was a software company Goodmanson grew to more than $3 million in revenue before he sold it to Ministry Brands. Goodmanson was then dispatched by Ministry to go and buy up similar software companies. Working for Ministry, Goodmanson eventually gathered 10 small software companies into one mega group.
I asked Goodmanson to describe the biggest mistake he sees owners make when approaching their exit and he pointed to an obsession with selling price above all other factors in a deal. Goodmanson recounted an old saying famous among acquirers: “You name your price; I’ll name the terms”.
The Envelope Test
Over at The Value Builder System™, we ask all of our customers to pick a number they would be willing to sell their business for. We call the exercise The Envelope Test because we ask owners to put the number on a piece of paper, seal it in an envelope and refer back to it when they get an offer (many are surprised when they get an offer that exceeded their dreams just a few years before).
Let’s imagine your Envelope Test number is $10 million. Further, let’s imagine an acquirer is only willing to pay $6 million but knows your dream number is $10 million. The acquirer may use several tricks to present an offer that looks like it meets your Envelope Test number, when in fact they never intend to pay a penny more than $6 million. How would they do that?
Unrealistic “Earn-out” Goals
The first and arguably most common technique is to use an earn-out the acquirer knows is unrealistic. An earn-out is a contractual commitment to pay additional consideration for your business if you meet certain goals for your business in the future. These goals are usually tied to the profitability of your division as part of the company, but can also be tied to top line revenue, or even the retention of a single customer or employee.
Machiavellian acquirers often use earn-out goals that are so high, they know in advance you have little chance of reaching them. They say they are willing to pay $10 million for your business, but only offer $6 million up front with the rest tied to an earn-out. You hear 10, they know they are unlikely to pay any more than six.
Short-circuiting Your Financials
Since most earn-outs are tied to the profitability of your company as a division of theirs, another common trick is to layer in additional expenses on your P&L that you have no control over. As a division of a big company, you will likely lose control over your accounting, which means the acquirer’s finance people can and often do layer additional “shared” expenses onto your P&L. Unless specifically forbidden as part of your share purchase agreement, your P&L could be laden with corporate overhead charges that make it impossible to meet your earn-out goals.
Reducing Your Budget
Similar to layering additional expenses onto your P&L, another way your new parent may skewer your ability to meet your earn-out is by reducing your budget. The old saying “You have to have money to make money” is true, and if your sales and marketing budget is cut because of a corporate cost-cutting mission sent down from HQ, there may be nothing you can do to hit your earn-out.
Clawing Back The Escrow
Another truly devious tactic is to agree to your number, but insist that a large percentage of the deal be held in escrow. An escrow is a percentage of your deal proceeds that is held by a law firm for a period of time after you sell your business to ensure the representations and warranties (“reps and warrants” in M&A lingo) are true. These reps and warrants are often glossed over by eager sellers just wanting to get a deal done but the most mercenary buyers can actually put reps ad warrants in a deal they know you are in breach of, just so they will have a claim over the escrow funds. This is not a common tactic and it is only used by the sneakiest acquirers.
Making You Guarantee The Debt
Private equity buyers are notorious for using debt (leverage) to make acquisitions. Usually that’s fine, provided the acquirer’s shareholders and their bank are taking the risk, but in some cases the seller is asked to personally guarantee the debt the private equity company is using to by their company!
A private equity firm may come in and offer to recapitalize your company at a valuation of $10 million, allowing you to take 60% ($6 million) out of the business, but at the same time make you guarantee the loan they use to buy your business. They shift all of the risk back on your shoulders which makes selling your company a questionable strategy. After all, if you’re going to shoulder the risk anyway, why not keep 100%?
There are lots of other underhanded strategies acquirers use to make the number they are willing to spend to buy your business look more like the number you want to sell it for. Your best defense is to only sell when the cash you get at closing exceeds your envelope test number.
