AxialMarket blog

Patent Valuation: Excerpts from Breakfast with David Wanetick

Jaime Romero — Thu, 02 Jun 2011 13:23:50 +0000

AxialMarket hosted David Wanetick of IncreMental Advantage for its latest Member breakfast in midtown NYC. David is a recognized expert on patent valuation and the enormous complexities patents present in the context of licensing, M&A, and accounting scenarios.

The discussion centered around the key factors that impact a patent's value and how that value gets created and derived. We then let the attendees do some Q&A with David and have included some excerpts below. David's contact information is at the bottom of the article. Enjoy!

Q: How do you value a patent?

What do valuing Patents and Fine Art have in common? Hear David discuss different methods used to value a patent, and why the story value is a critical component of patent valuation. Having a good story behind the patent truly matters.

Q: What are the sources of patent value?

What kind of value can the patent deliver to the acquirer, where the invention was discovered, the network effect, switching costs, and reputation are all different ways a patent derives its value. Here David explain each of these providing context and real world examples.

David Wanetick, Managing Director at IncreMental Advantage is an internationally recognized expert on valuing intangible assets. He teaches Valuation of Emerging Technologies at The Business Development Academy and developed the Certified Patent Valuation Analyst designation. He can be reached at dwanetick@incrementaladvantage.com.

This article is provided by AxialMarket Inc. and its affiliates for educational and informational purposes only and is not intended to constitute, and should not be construed as, legal or business advice. This article is a summary that we believe may be of interest to you for general information. It is not a full analysis of the matters presented and should not be relied upon. Prior to acting upon any information set forth in this article or related to this article, you should consult independent legal counsel.

Four Trends Impacting Lower Middle Market M&A Activity

Jaime Romero — Tue, 24 May 2011 17:25:10 +0000

The Deal.com did a very helpful analysis of the 2007 U.S. Economic Census. According to U.S. Census data, 369,122 companies constituted America's middle market in 2007, double the number registered in 1992. Further analysis of the data finds that 174,000 of these companies, or about 50%, have reported revenues between $5 and $10 million, and 177,000 have reported revenue between $10 million and $100 million.

While traditionally the middle market is defined as companies with revenue between $5 million and $1 billion, US Census data suggests that 95% of the middle market is made up of lower middle market companies.

A confluence of factors is starting to point towards a more active capital raising and M&A market in the coming two years that will send overall deal flow activity higher. As a result, we’ve identified four trends that will impact the middle market:

Inventory - In a recent AxialMarket survey, 48% of sellers indicate that retirement is the number one reason for selling their company. The first of the baby boomers are turning 65 this year and others are approaching retirement imminently. While the golden era of 2005-2007 valuations may never return, sellers owning high quality companies have been waiting patiently on the sidelines for better economic conditions to bring their companies to market, and are likely to consider the current conditions as “good enough” to pursue their exit strategy. Additionally, private equity firms waiting to maximize their return have also been waiting out the recession with over $477 billion in committed but undeployed capital [PDF] and have been holding on to companies longer than intended. As the pressure to “show some exits” increases, Private Equity Groups are taking advantage of favorable market conditions [PDF].
Quality - According to a World Economic Forum report, companies backed by private equity are "on average the best-managed ownership group." Management practices were categorized as operations management, monitoring, targets, and incentives. With the impetus for private equity firms to exit their portfolio during the improved market conditions and as a core requirement before being able to raise their next fund, more portfolio companies backed by private equity groups will drive higher quality lower middle market deal flow. In addition, the recession has forced companies to operate leaner and more efficiently to cope with flat sales and cautious customers. As the economy improves, companies can begin to expand while operating from a leaner base.
Credit Markets - In GF Data Resource's first quarter 2011 report, B. Graeme Frazier, IV, Principal and Co-Founder of GF Data, indicated that credit markets are beginning to loosen up. "What’s really important to note in this quarter’s data is that total and senior debt multiples held steady from the previous two quarters. In terms of multiples of adjusted EBITDA, total debt remained in the low three’s and senior debt in the low two’s, confirming that debt continues to be available in the middle market, which is a welcome improvement from where we were a just a year ago.”
Use of Technology in M&A - As more and more M&A Advisors and business owners begin adopting and using technology to better market opportunities and more efficiently identify qualified buyers, the ability for companies and private equity firms to build a pipeline of acquisition candidates is becoming more and more systematic. Considering how large the middle market has become, it has a staggering impact on how M&A Professionals market themselves and shape their deal origination and client acquisition strategies, making it nearly impossible to maintain a consistent and meaningful presence in the marketplace. We’re seeing more and more tools available to M&A professionals to perform research, market themselves, and communicate. These tools range from deal management, deal sourcing tools, and seller relationship management tools like AxialMarket, cloud based document management solutions, and email solutions.

With such an expansive middle market and improving economic conditions, we’ll continue to see an evolution within M&A. Let us know below if you’ve seen any of these trends or been impacted by them in any way.

Technology Tools for M&A Professionals

Peter Lehrman — Thu, 19 May 2011 22:40:43 +0000

This week, the IBBA and M&A Source trade associations held one of their twice-yearly conferences. The conference serves as a successful forum for the lower middle market intermediary community to get together, discus lower middle market M&A activity, share best practices with other members, and network with other attendees, including private equity firms and corporations that are actively investing in or acquiring small to medium-sized companies (5M to 50M in revenues).

As part of the best practices track, the conference covers topics including Managing Due Diligence, Structuring Earnouts and Seller Financing to help close the pricing gap, and How Technology Can Help Intermediaries Grow Their Business and Improve Close Rates. I was invited to present on this last topic, and to talk about how AxialMarket and other software tools and applications are being used to maximize customer acquisition (getting engaged to sell a business) and customer success (successfully selling the companies that you represent). This article summarizes the various tools and services that were discussed, provides a summary of their offering, and links to their respective websites.

In general, the tools and applications that an intermediary can leverage to improve their work break down into one of three buckets:

Buyer research and M&A transaction data
Marketing and communication tools
Database and data management tools

Buyer research and M&A transaction data are part of any successful M&A process. Every business is different, will attract potentially different buyers, and will have owners with different preferences for who to sell to. Without rich data on Buyers and valuation benchmarks to set expectations, you can't serve your client effectively. Communication tools are critical to acquiring customers, communicating with them during an M&A process, reaching prospective buyers, facilitating the M&A and due diligence processes, etc. Database and data management tools help intermediaries by providing secure repositories for data, such as sent emails, correspondence and contact information with clients, buyers, attorneys, CPAs, etc.

The following companies provide software-based tools that are valuable to the lower middle market intermediary. Some of them have offerings that fall into multiple buckets, others fall more neatly into one bucket. We want to clarify that there are other tools out there, but these are the ones that were selected to present at the M&A Source / IBBA conference to their respective memberships.

AxialMarket: AxialMarket helps intermediaries answer the question: "who are the most qualified and active buyers I should approach on behalf of my client?". The company then integrates that data and information on Buyer preferences with AxialMarket's marketing tools to help intermediaries confidentially connect with and engage buyers directly, whether they are buyers in your personal rolodex, or buyers you connect with through the AxialMarket network. AxialMarket provides pre-due diligence document hosting tools to store teasers, NDAs, executive summaries and offering memorandums and gives you control over who and when buyers can access various information. AxialMarket offers capabilities across all three buckets but is especially focused on buckets 1 and 2.

Cost: FREE for intermediaries, M&A attorneys and CPAs advising private companies.

Cool Life Systems - Cool Life Systems is a CRM company with built-in integration to online social media platforms. The company combines a CRM system to house your company and customer contact information with tools to help you engage your audience of targets thru social media channels online. Because it's both a communication tool and database management tool, it falls into buckets 2 and 3.

Cost: Contact Cool Life Systems for pricing.

Constant Contact - Constant Contact provides web-based email marketing tools to help small businesses conduct email marketing more efficiently. They provide email deployment tools, easy-to-use email templates, and reporting capabilities to evaluate and manage email campaigns. Have a quarterly newsletter you want to blast to your rolodex? Constant Contact is great for this, among other things. As a communications and marketing tool, they fall neatly into bucket 2. They are one of largest email marketing companies, and since their founder was a Stanford grad, we are holding back from being overly biased in support of their app!

Cost: Pricing as low as $15/month.

GF Data Resources - GF Data Resources gathers data on private equity transactions in the lower middle market on a no-names basis, aggregates that information, and presents it to intermediaries and other customers so they can conduct valuation research, provide guidance to their clients on valuation expectations for various businesses, and allow private equity firms to more accurately bid on companies, and more easily mark their portfolio companies to market. The data is proprietary, difficult to obtain elsewhere, and goes back to 2003. GF Data falls neatly into bucket 1, providing highly specialized data that is directly relevant to the lower middle market dealmaking community.

Cost: Free for contributing private equity firms; contact GF Data for specific pricing if you're an intermediary, law firm, or accounting firm.

Navatar Group - Navatar Group is a reseller of Salesforce.com's web-based CRM software. Salesforce.com, a global company with over $1B in annual revenues, provides a CRM solution that is used by companies of all shapes and sizes with all kind of data management and CRM requirements. Navatar provides a customized version of Saleforce.com software that is tailored to the individual needs of its clients, which include private equity firms and intermediaries. Salesforce.com's CRM tool offers email marketing capabilities (though not necessarily as advanced a set of marketing tools as Constant Contact), so this product falls into bucket 1 and bucket 3, serving as both a marketing / communications tool and as a data management tool where you can store customer information and activity.

Cost: Contact Navatar for details.

ShareFile - Sharefile (bucket 3) is a provider of web-based file transfer and virtual data room (VDR) solutions and technology. When you're selling a company, you should ensure that you keep the information of your client secure during due diligence but still allow it to be accessed by potential buyers who you're working with. Sharefile provides VDR solutions that securely host that information. Sharefile also provides watermarking capability, user access and download permissioning, as well as intelligence on who is accessing the uploaded materials and how often and how frequently. This information and capability helps you figure out which of the potential buyers are doing their homework! Sharefile has partnered with M&A Source to offer a limited version of its VDR solution for free to M&A Source members.

Cost: Pricing as low as $29.95/month.

As an intermediary, your scarcest resource is your time. You need to be spending your time either acquiring new clients as effectively as possible or serving existing clients with the greatest efficiency possible (closing deals with high rates of success). Each of the above tools can help you achieve success and improve outcomes for your customers, you just need to choose them at the right time and to help with the right job.

We've included the session presentation below. Good luck, and if you have any questions, feedback, or suggestions regarding other tools to use, etc, please share them in the comments below.

May 2011 Lower Middle Market M&A Activity Report

Jaime Romero — Mon, 16 May 2011 03:20:36 +0000

Quick Look

59
New Buyers

77
New Intermediaries

438
Opportunities

$7B
in Revenue

AxialMarket's monthly activity report provides real-time analytics and transparency into lower middle market M&A activity. You can subscribe here to receive our monthly activity report, weekly articles, and our quarterly research publication, MarketPulse.

Sell Side Marketplace Activity

In the last 90 days, 438 opportunities with $7B in Revenue and over $550M in EBITDA were delivered via AxialMarket from 70 unique Intermediary sources.

During this same period, 77 new Member Advisory firms joined AxialMarket. These new members, which include M&A consultants, super-regional investment banks, boutique advisory firms, and qualified business brokers/finders, have already delivered 144 opportunities totaling over $2.8B in Revenue and $305M in EBITDA.

Dealflow by Industry: Companies headquartered in the South Atlantic region generated the largest volume of dealflow over the past 90 days, followed closely by companies headquartered in the Pacific, Midwest, and Southwest region of the US.

Dealflow by Industry: This chart displays the relative volume of opportunities taken to market by AxialMarket Members over the past 90 days, segmented by industry. Over 27% of dealflow is classified as opportunities within the Capital Goods sector, with no change over the previous 90 day period. Dealflow within Consumer Services increased 116% to 13% of overall dealflow activity. Additionally, dealflow within Healthcare increased 70% to 17%, and Information Technology increased 55% to 14%. Telecommunications demonstrated a decrease in dealflow activity to 2% from 7.5% of overall marketplace activity.

Average NDAs Executed/Deal Normalized: This chart expresses the average level of interest per opportunity within each industry sector by displaying number of NDAs executed per deal - normalized. Opportunities in the Materials sector saw the greatest amount of interest per opportunity, with Healthcare following in per unit activity. Retail experienced an increase of NDAs executed per deal by 86% to 5.6 and Consumer goods increased 45% to 6.35 NDAs executed per opportunity. Energy saw the largest decline in per opportunity activity by 57% to 6.75 NDAs executed per deal.

The purpose of the above chart is to isolate the amount of buyer interest in a particular category independent of the number of deals that have come to market in that vertical, which otherwise influences the perceived activity in each space.

NDAs Executed by Industry: This chart displays the percentage of NDAs executed by industry by AxialMarket Members over the past 90 days. Capital Goods -- which encompasses Aerospace & Defense, Industrial Machinery, and Electrical Components & Equipment – saw the greatest amount of activity, with opportunities in this vertical accounting for over 27% of all buyer interest, an increase of 4 percentage points. In addition, Healthcare continues to see an increase in buyer activity within AxialMarket over the past 90 days, nearly doubling share of NDAs executed to 19%. Activity within Retail and Consumer Services doubled over the previous 90 days to 10% and 6% respectively. Consumer Services saw the largest decline in interest from buyers.

Buyer Activity

59 new Buyers joined AxialMarket over the last 90 days, comprising 22 Financial Buyers and 37 Strategic Buyers. The financial buyers include 13 private equity groups, three holding companies, two search funds, two family offices, one fundless sponsor, and one high net worth individual.

The strategic buyers fall within the Consumer Goods & Services, Financial, Healthcare, Industrials, Information Technology, and Materials industries. These buyers are focused on making acquisitions between $5M and $50M in revenues, and EBITDA in excess of $1M.

Summary of Buyer Profiles on AxialMarket

Members use AxialMarket's Buyer Presence and Profiling tools to articulate and communicate their acquisition strategies to the seller community across multiple sub-industries, transaction sizes, geographies, and transaction types.

Buyer Demand by Industry: The chart below details the industries in which AxialMarket buyers seek to make acquisitions, as identified by their transaction profiles. Over the last 90 days, the most sought after companies were within Industrials (67%), which includes Capital Goods, Commercial and Professional Services, and Transportation & Logistics, followed by Consumer Discretionary (55%).

Buyer Demand by Revenue & EBITDA: The two charts below highlight the target revenue and EBITDA ranges detailed in the Buyers' transaction profiles. 91% of AxialMarket buyers indicate their desired revenue range for target acquisitions fall between $15M and 50M. As seen in the second graph, 81% are seeking opportunities whose EBITDA fall between $3-5M, closely followed by $5-15M (79%). This includes transaction profiles articulating private equity platform acquisitions, portfolio company add-on acquisitions and strategic buyer business unit transaction profiles.

The Letter of Intent – A Primer for Business Owners

Jaime Romero — Tue, 03 May 2011 13:32:11 +0000

At this stage you have likely held anywhere from one to three (or more) meetings with a prospective buyer. If you are running a structured sale process soliciting multiple buyers, then you have spoken with several suitors and narrowed the prospects to 1-4 prospective buyers for these more in-depth discussions. Ideally the prospective buyer(s) and you should both be at a go/no-go decision point on continuing the discussion. If the buyer elects to continue, then expect to receive a Letter of Intent (LOI) outlining the buyer’s proposed deal structure and terms. Receipt of an LOI from a potential buyer is a clear signal that they are serious in their intentions; however it is not a “given” that they are fully committed yet. In fact, some buyers are known for not closing a high percentage of issued LOIs since their strategy is to lock-up as many potential deals as possible and close only the top 3-4 of the lot.

The Letter of Intent should include a summary description of all of the material deal terms that will later appear in the Purchase Agreement. There are differing schools of thought on how detailed an LOI should be, so your LOI may be anywhere from two to over ten pages long. Those advocating for a shorter LOI argue that using a short form speeds the negotiating process since the parties are focusing their efforts on the primary terms of price, consideration and timing. If there is no agreement on these then there is no need to have covered the other deal terms. Those advocating a long form prefer to have all issues addressed upfront and not have future surprises that can sink a transaction (e.g. reps and warranties, treatment of unvested options).

The following are the common terms you should expect to see in an LOI. Terms are generally non-binding (a non-binding LOI is typical) but a few will be binding beyond the term of the LOI. These surviving terms are noted below.

Deal Structure. Defines the transaction as a stock or asset purchase. Generally the seller prefers a stock transaction from a tax and future legal liability perspective. Asset transaction preferred by the buyer to protect against prior liabilities and provides a stepped-up tax
Consideration. Outlines the form(s) of payment to include cash, stock, seller notes, earn-outs, rollover equity and contingent pricing.
Closing Date. The projected date for completing the transaction. It is common for this date to extend past this date unless there have been no surprise in due diligence or the Purchase Agreement.
Closing Conditions. Lists the tasks, approvals and consents that must be obtained prior to or on the Closing Date to close the transaction.
Exclusivity Period (Binding). It is common practice for a buyer to request an exclusive negotiating period. This is to ensure the seller is not shopping their deal to a higher bidder while appearing to negotiate in good faith. Expect to see requested periods of 30 to 120 days. Expect the period to be negotiable but the exclusivity term to be non-negotiable.
Break-up Fee (Binding). Relatively common to have a break-up fee of approximately 3% or a fixed amount in larger deals (>$500MM est.) but uncommon in the lower middle market.
Management Compensation. Describes who in senior management will be provided employment, equity plans and employment agreement. This term often vaguely worded to provide buyer with latitude since they may not be prepared to make commitments to senior management.
Due Diligence. Describes due diligence requirements of buyer from seller.
Confidentiality (Binding). Although both parties have probably signed a confidentiality agreement, this ensures all discussions regarding the transaction are confidential.
Approvals. Lists any approvals needed by the buyer (e.g. board of directors) or seller (e.g. regulatory agencies, customers) to complete the transaction.
Escrow. Provides the summary terms of the buyer’s expected escrow terms for holding back some percentage of the purchase price to cover future payments for past liabilities. Highly negotiable and often excluded from the LOI and presented for the first time in the Purchase Agreement.
Representations and Warranties. Will include indemnifications in the Purchase Agreement so best practice to include any terms that may be contentious or non-standard.

The following are less common terms but of no less importance to either party if applicable to the transaction.

Employment Agreements. This relates to Management Compensation above but may also include favored or long-time employees of the seller. Requiring the buyer to provide employees with employment agreements, maintain current compensation structure, etc. may fall outside their standard post-deal integration practices, and they may simply refuse or require the seller to compensate them.
Retention Bonuses and One-Time Payments. Similar to above, while seller’s may want to “share the wealth” from selling their closely held company, buyers may not want the additional administrative or financial responsibility.
Option Pools. Treatment of unvested options, vested but underwater options, etc. are not standardized practices. Buyers may opt to honor current option plans by converting them into their plan or similar structure.
Fees. Generally the party who incurred the charges pays fees, but there are circumstances where ambiguity is possible. For example, if the buyer requires reviewed or audited financial statements from the seller and the deal does not close, then the seller may want the buyer to pay the audit fee.

While the LOI is not binding and the transaction terms, if completed, will be memorialized in the Purchase Agreement, it is a best practice to include all terms that are your deal-breakers in the LOI. Inserting terms into the Purchase Agreement that were not included in the signed LOI is not uncommon, but expect the other side to extract a cost for that change. For example, if you have employees who do not hold equity but you want them to receive a payment at closing or an extended employment contract, that should be in the signed LOI. Secondly, if you have issues that may impact valuation or a buyer’s decision to close the transaction (e.g. unresolved equity disputes, regulatory/litigation), it is best that these issues are disclosed prior to signing the LOI. Expect all such issues to be exposed in due diligence and better to have them addressed in the LOI, or dismissed as non-issues by the buyer, than during due diligence when you have incurred legal costs and agreed to an exclusivity period.

The LOI is an important milestone towards a successful sale of your company. If you have not engaged an M&A attorney yet, then now is the right time to add him/her to your deal team. Likewise an opportune moment to consult with your tax accountant and wealth manager for their input on optimal deal structure relative to your personal needs and to engage a seasoned investment banking firm to ensure you are receiving the best deal.

About the author
Eric King is a Managing Director at Viant Capital, a provider of transaction advisory services to lower middle market companies. He has led or participated in transactions totaling $12 billion and has served as a turnaround CEO and start-up co-founder/CFO. http://www.viantgroup.com.

Selling More Than Just Your Business – A Primer on Successor Liability

Jaime Romero — Tue, 26 Apr 2011 19:46:39 +0000

When you sell your company, it’s possible, even likely, that some liability originating from the period of your ownership will befall the new owner who buys your company.

This creates for a sticky issue when you are negotiating the terms of the purchase and sale agreement in an M&A transaction. Neither party wants to assume any liability post-transaction, and the buyer will do everything they can to protect themselves against any assumed liabilities, which include, but are not limited to product, contractual, tax, and environmental liability issues. To avoid post-transaction litigation, it’s important to identify all knowable liabilities and clarify specifics around who is assuming what when drafting the purchase agreement.

In general, when the sale is structured as an asset sale, the buyer does not assume liability, whereas if it is structured as a stock sale, they do assume at least some amount of liability.

Regardless of how the sale is structured, the development of Successor Liability Laws has defined the situations when a buyer is always responsible for the liability of the previous owner, under any and all circumstances.

The Successor Liability Exceptions are:

Continuation: If the sale of the company is a continuation of the original company, the buyer can assume liabilities. Depending on which state litigation occurs, what defines a continuation can be interpreted very broadly or narrowly. Characteristics of a continuation include ownership of assets, continuation of the company officers and their roles, and inadequate consideration paid for assets.
De facto Merger: Technically speaking, a merger differs from a continuation, but in terms of successor liability, they share similar characteristics. In addition to the factors mentioned under continuation, the courts can also look to see whether operations or the physical location are the same, whether the new owner maintains the company name, and whether or not public perception has changed.
Assumed Liability: In this instance, the buyer chooses to contractually assume specified liabilities from the seller.
Fraudulent Transfer: If a seller sells the assets of its business with the intent to defraud creditors, they continue to assume liability for the company.

When selling your company, you should consult an attorney to fully understand what measures you should take to negotiate liability. Negotiations over the assumption of liabilities is usually a give and take but also can surface some real dealbreakers, so during the negotiation stage of the M&A transaction, keep the following in mind:

In the purchase agreement, clearly define to what extent the buyer should assume liability under different circumstances.
Make sure you indicate a resolution for liabilities not stipulated in the purchase agreement.
Understand your liability if you plan on continuing with the new company, either in a consulting, executive or board position.
Be sure to take into consideration how the company is paid for (cash, stock, debt), as it can impact who assumes responsibility for certain liabilities.

By assuming any post-transaction liability, you reduce the risk for the acquirer, which can impact the purchase price. An experienced buyer will often uncover much of the liability risk during due diligence, which will help avoid post-transaction complications. Moreover, a good M&A Advisor will help you navigate and negotiate your rights as a seller.

Private Equity and Strategic Buyers -- A Distinction Without A Difference?

Peter Lehrman — Tue, 26 Apr 2011 16:13:17 +0000

According to Pitchbook Data's 2011 Private Equity Breakdown, a company providing data on private equity deals and related information, there were 5,994 private equity-backed portfolio companies at year-end 2010. According to a recent survey AxialMarket conducted interviewing its private equity customers, 57% of the respondents indicated that their portfolio companies were actively looking to grow through acquisitions, while over 80% of the respondents indicated that their portfolio companies would opportunistically review acquisition opportunities.

Why does this information matter to business owners? Because the most likely strategic buyer for your business ironically might well be a private equity firm instead of a Fortune 2000 corporation.

We speak with thousands of medium-sized business owners and M&A Advisors every year. They discuss the importance of identifying strategic buyers in addition to financial buyers as part of running a well-rounded sell-side M&A process. In particular, they cite the following reasons for wanting to work with a Strategic Buyer:

Strategic Buyers tend to be able to pay more because of revenue or cost-based synergies and lower costs of capital
Strategic Buyers can move more quickly because they have industry expertise and will understand things right away
Strategic Buyers have multiple considerations when buying a company, whereas financial buyers are purely focused on ROI (return on investment)

What business owners and to a lesser extent M&A Advisors appear to under-appreciate is how significant the private equity community has become as its own strategic buyer category. In addition to having over $400B of committed but undeployed capital that must be deployed in the coming years, private equity firms collectively own almost 6,000 private companies.

Part of the reason why private equity firms' portfolio companies grow through acquisition is to take advantage of what is called "multiple arbitrage", which means that as a company grows in terms of its overall size and EBITDA, the multiple it can acquire in the open market rises all other things being equal. In other words, if two companies are essentially identical in terms of products, markets, and team, but one has $4M of annual EBITDA and the other has $12M, the latter will fetch a higher multiple on exit just because its size makes it less risky.

But another key reason driving private equity-backed portfolio company M&A is the opportunity it presents to the private equity firm to put out more capital productively. Let's say a private equity firm buys a business for $50M and pays for the business 50% with equity and 50% with debt. Let's say that 2 years later, the acquired company has an opportunity to acquired a competitor for $25M. This presents a great opportunity for the private equity firm:

Because of the initial acquisition they made, they already have a management team in place
They are already up to speed on the business because of the due diligence and ongoing portfolio company monitoring
They can deploy more of their fund capital into an opportunity that is likely to be substantially less risky than investing in an entirely new company and management team

It's for these reasons that if you're a seller and you're evaluating different potential buyers, finding a private equity-backed portfolio company can be a win-win for you because:

They have money to put to work
They have a management team that can help integrate the businesses post-transaction
Because they are making the acquisition through their portfolio company, they have the posture of a strategic buyer

For sellers using AxialMarket, researching potential private equity-backed strategic buyers is something you can do for free with the Buyer Discovery Tool. There are also different online databases such as Private Equity Info, PEDatabase, and others that you can query. Regardless of how you do it, make sure you have a process for identifying the private equity-backed strategic buyers. There are thousands of private companies owned by private equity firms and our survey makes it clear that over 50% of them are actively looking to make add-on acquisitions as part of their growth strategy.

After the Ink Dries, with Zach Coopersmith of Leading Ridge Capital

Jaime Romero — Tue, 12 Apr 2011 16:00:38 +0000

In partnership with the team at Leading Ridge Capital Partners, an AxialMarket member since 2009, we are covering a topic that gets little coverage despite its critical importance both to business owners and private investment firms: post-transaction strategic planning and implementation.

When a private equity firm steps up to the plate to buy a company, they need to have a plan for how they are going to create value from the investment. Value can and often comes from financial engineering, but in the case of certain private equity firms, value is created by actually helping the management team improve the business operationally.

If due diligence has been thorough, the private equity firm should have a good sense for what it can expect to achieve in terms of performance gains and the timeline over which those gains are achievable. Less clear is what the company's management can expect from the Private Equity firm.

To gain some insight into what happens after the ink dries on a deal, we talked to Zach Coopersmith, a partner with Leading Ridge Capital Partners, a private equity firm that targets middle market companies with less than $50 million in revenue with specific expertise for businesses in the asset-light logistics, business services, and distribution categories.

In many cases, Leading Ridge's chosen portfolio companies are still being run by the founder or the second generation and have reached a certain threshold of performance without being able to surpass a growth ceiling, either in terms of product or revenue. "They often have strong operations but the founder is not a good salesperson or the founder is good at sales but not a good manager of larger numbers of people," says Coopersmith. "We are not turnaround specialists, so we are not coming in to fix major structural problems with our companies, but we do often find a significant number of opportunities for business improvement." Although each of Leading Ridge's post-deal plans are unique to the needs of each portfolio company, Coopersmith provides a window into the firm's key priorities in the first several months following the closing.

Systems-based infrastructure to support growth. When Leading Ridge purchases a company, it must often implement systems necessary to support the next level of growth, such as human resources practices, more sophisticated financial measurement systems, a stronger sales and business development function, a credit facility, and processes for holding people accountable for results.

"This is the time to get under the hood and evaluate appropriate benchmarks and key performance indicators. We are aiming for rapid but controllable growth and expansion," says Coopersmith. "We need to make sure there is infrastructure that can support those goals." For example, if the company improves the sales function, it also needs to make sure customer service doesn't suffer as the company expands its customer base.

Such changes play out in ways small and large. For example, during due diligence, Leading Ridge found that one portfolio company was planning to pay cash for a new piece of equipment that promised to double output. When the deal closed, Leading Ridge and the new management team delayed the purchase long enough to negotiate better pricing and arrange for equipment financing to minimize the impact on the company's cash position.

Effective management. For these efforts to succeed, Leading Ridge recognizes the importance of a strong management team. Depending on the circumstances, the firm will either partner with existing management or bring in new management talent. In the latter situation, the firm tries to retain the company's former management to ensure an overlap of at least six months to ease the transition. "Having no overlap between the outgoing and incoming management teams is not ideal, but you can overcome that by learning as much as possible about the company during due diligence and before the former owners or managers exit the business," says Coopersmith.

Although existing management can provide insight into company operations after the closing, starting fresh with a new management team can often reinvigorate a company after the closing. "It can be difficult to change a culture without changing senior management and starting with a clean slate," says Coopersmith. "This sends a clear message that things are going to change, ideally for the better, and that in many cases the status quo is no longer good enough."

As a smaller private equity firm that focuses on only a few portfolio companies, Leading Ridge can focus on each company and its needs. "Our companies need different things from us at different times," says Coopersmith. "Our focus is on being a partner of the CEO and being ready to pitch in and supplement the management team in a variety of ways whenever necessary."

Communication. Once the long-term management team is in place, Coopersmith emphasizes ongoing communication regarding short-, medium-, and long-term goals. "We need management to understand what the firm wants and expects," he says. "Clear concise communication can solve a lot of problems. The trick is to find the balance between too much and too little."

For example, if the firm wants weekly cash flow reporting and the CEO wants to provide additional reporting on actions plans or specific initiatives, that needs to be clear to both the firm and the management team up front. "The CEO needs to provide the information and data that the PE firm expects based on mutually agreed upon metrics and dashboards," says Coopersmith. Anything beyond that should be discussed and negotiated beforehand.

AxialMarket's Q1 Lower Middle Market Report

Jaime Romero — Thu, 07 Apr 2011 18:45:36 +0000

Quick Look

72
New Buyers

$6.4B
in Capital

67
New Intermediaries

505
Opportunities

$7B
in Revenue

Sell Side Marketplace Activity

In the last 90 days, 505 opportunities with more than $7B in Revenue and over $800M in EBITDA were delivered via AxialMarket from 176 unique Intermediary sources. This represents a 12% increase in dealflow activity, 27% increase in aggregate revenue, and 7% increase in aggregate EBITDA.

During this same period, 67 new Member Advisory firms joined AxialMarket. These new members, which include M&A consultants, super-regional investment banks, boutique advisory firms, and qualified business brokers/finders, have already delivered 135 opportunities to the AxialMarket platform totaling over $2.7B in Revenue and $280M in EBITDA.

Companies headquartered in the Southeast generated the largest volume of dealflow over the past 90 days, followed closely by companies headquartered in the Pacific, Midwest, and Southwest region of the US.

This chart displays the relative volume of opportunities taken to market by AxialMarket Members over the past 90 days, segmented by industry. Over 27% of dealflow is classified as opportunities within the Capital Goods sector, a decrease from 29% over the previous 90 day period. Telecommunications and Media demonstrated the largest percentage increase in dealflow volume increasing by 288% to 7.5% of overall marketplace activity.

This chart expresses the average level of interest per opportunity within each industry sector by displaying number of NDAs executed per deal - normalized. Opportunities in the Materials sector saw the greatest amount of interest per opportunity on average, with Energy following in per unit activity. Both saw a 3X increase over the previous 90 day period.

This chart displays the percentage of NDAs executed by industry by AxialMarket Members over the past 90 days. Capital Goods -- which encompasses Aerospace & Defense, Industrial Machinery, and Electrical Components & Equipment – saw the greatest amount of activity, with opportunities in this vertical accounting for over 23% of all buyer interest. In addition, Healthcare saw the largest increase in demand doubling the total NDAs executed within AxialMarket over the past 90 days. Consumer Services saw the largest decline in interest from buyers.

Buyer Activity

72 new Buyers joined AxialMarket over the last 90 days, comprising 28 Financial Buyers and 44 Strategic Buyers. The financial buyers include 16 private equity groups, six search funds, three family offices, one fundless sponsor, one holding company, and one hedge fund collectively comprising over $6.4B in capital.

The strategic buyers fall within the Business Services, Capital Goods, Consumer Goods & Services, Energy, Financial, Healthcare, Industrials, Information Technology, and Materials industries. These buyers are focused on making acquisitions between $5M and $50M in revenues, and EBITDA in excess of $1M.

Summary of Buyer Profiles on AxialMarket

The chart below details the industries in which AxialMarket buyers seek to make acquisitions, as identified by their transaction profiles. Over the last 90 days, the most sought after companies were within Industrials (67%), which includes Capital Goods, Commercial and Professional Services, and Transportation & Logistics, followed by Consumer Discretionary (55%). Both saw a 3 percentage point decline in demand.

The two charts below highlight the target revenue and EBITDA ranges detailed in the Buyers' transaction profiles. 90% of AxialMarket buyers indicate their desired revenue range for target acquisitions fall between $15M and 50M. As seen in the second graph, 86% are seeking opportunities whose EBITDA fall between $2-5M, closely followed by $5-15M (79%). This includes transaction profiles articulating private equity platform acquisitions, portfolio company add-on acquisitions and strategic buyer business unit transaction profiles.

11 Stages of Selling a Company

Peter Lehrman — Mon, 18 Apr 2011 22:12:44 +0000

Selling a company is a long and complex process. Preparing for a sales process takes at least 12 months, and then the actual process itself can take another 12 months. If you think of selling your business as something similar to a very long multi-year enterprise sales cycle, you'll begin to realize that a business sales process is like any other sale process in that it can be broken down into its core component stages and elements.

This article provides an overview of the key stages of an M&A sale process, whether it's for a lower middle market company, a large public company, or anything in between.

Stage 1: Defining Potential Options and Exit Strategies

When considering the sale of a business, there are potentially a wide variety of transaction options. These options must be understood and evaluated by the CEO, owner, and/or board. Understanding these options and the decisions they lead are the most strategic decisions a company will ever make when it comes to realizing value. Leveraged buyout, strategic M&A sale, minority recapitalization, ESOP, etc -- these are all fancy investment banker terms but they essentially boil down to various methods by which a company sells itself or part of itself or to whom it sells. Buyers break down at a high level into two categories: financial buyers and strategic buyers. They both have their pros and cons. Neither one is better by nature, it's highly situational. A good M&A banker will work with the business owner to understand the selling requirements, the range of valuation expectations, and strategic goals. This also includes defining: exit strategy alternatives; thinking through the most appropriate types of acquirers; timing of sale; tax consequences and owner's desire for future involvement with the company (or lack thereof).

Stage 2: Determining a Valuation Range For The Company

Determining a reasonable valuation range is a critical step in the process. If the banker thinks they can achieve a valuation range that isn't acceptable to the owner, the process should stop right there. Too many deals get derailed by sellers and buyers having completely different expectations about business value. While it's the job of the banker to close that gap with negotiation prowess and transactional expertise, immense gaps can't be bridged no matter how skilled you are. Valuation technique ranges from the highly academic and analytical methods of discounted cash flow and dividend discount models (DCF and DDM) to the more pragmatic comparable company valuation methodologies. Unfortunately, none of them is a replacement for the actual process of engaging with high quality and highly relevant buyers. Analysis and number-crunching is necessary but not sufficient, and will only take you so far. In the end, the price is determined in the market by the buyers and the quality of your engagement with them.

Stage 3: Pre-Marketing Value Enhancement

Often, Advisory firms will review a company's strategic and financial condition and have suggestions for how the company, over a 6-12 month period, can make some changes to make it more desirable. These should not be massive changes in strategy because those take too long and are risky, but should be valuable changes to management team or business strategy that make the business more attractive in a reasonably short period. Sometimes a trigger-happy CEO just wants to sell the company, but the best thing to do is make some changes and adjustments first before going to market. Again, working with a knowledgeable banker or informed board members that have relevant industry experience and business strategy context can be very valuable.

Stage 4: Information Gathering, Data Collection, and Presentation

Spending the time to properly aggregate, interpret, and present a company's financial and business history and future projections is a crucial element of the sale process. This requires trust between a business owner and his M&A Advisor because at this point, the kimono is being opened. The engagement letter should reflect the confidentiality that an investment bank commits to before they have access to such sensitive information. Business owners typically prepare their financial statements for tax purposes, not for business sale purposes. Using tax statements for business sale presentation is a major mistake, as it usually obscures the earnings capability of a business. Taking the time properly present a company's earnings power can have a big impact on how the buyers view the opportunity. Of course, the seller can go too far here and lose credibility, which is also a big mistake in the other direction. However, making sure that the appropriate financial adjustments are made is an important step and takes time and analysis by the CPA and the M&A team.

Stage 5: Marketing Materials Preparation

When potential acquirers evaluate a company, they expect the records and facts to be properly organized and documented. Disorganized or poorly collated material on a business delays the process, looks sloppy, and therefore hurts the seller tremendously. It's another area where many sellers are pennywise and pound-foolish and pay a terrible price for trying to save money in the wrong place. Well-packaged and presented business summaries increase a buyer's confidence and comfort level and increase the likelihood of a successful sale. A business owner spends years establishing name recognition, market niche, vendor relationships, operation & production systems, management, personnel, distribution channels, customer loyalty and numerous other intangibles. This is a story that needs to be properly told to educate potential buyers.

Stage 6: Buyer Research and Buyer Outreach Strategy

While large multi-billion dollar companies often have only a handful of relevant and sufficiently capitalized potential acquirers, lower middle market companies (this generally refers to businesses whose value ranges generally between $10M and $250M) often have an enormous number of potential buyers. Some of these potential buyers are known to the business owner, some might be known by the Advisor, but no one's rolodex is usually broad enough to know every potential buyer. This means that the banker and the business owner must have tools and resources to research and access the largest and most qualified data set of relevant buyers. Databases and tools of varying qualities exist out there, but there is no silver bullet. This research process should be exhaustive, not rushed. The banker should review competitors, customers, strategic buyers, private equity firms with relevant expertise, and other sources of highly suitable capital and partnership. This is one of the most time-intensive elements of the process but it often determines the overall success of the sale process. If you don't approach the best buyers, how can you get the best outcome?

Stage 7: Qualification of Potential Buyers

Many potential buyers that express interest in a business will not be qualified to purchase the company. These companies are referred to as tire-kickers. A good banker will know the right questions and have enough market intelligence and expertise to smoke these buyers out and pre-qualify the right potential acquirers before the tire-kickers impact the CEO or management team's time and attention. This isn't a particularly complex or time-intensive step, but if it isn't done, the CEO will waste a lot of time and effort speaking with unqualified buyers and increasing the confidentiality risk of the entire process.

Stage 8: Negotiation Process

There are many schools of thought on how to run the negotiation and buyer engagement process. Some Advisory firms suggest a negotiated process with only one highly targeted buyer. This strategy has tremendously high risk but can be extremely expedient if it works out. In general, Sellers are more likely to achieve a stronger outcome when negotiating with multiple qualified buyers, rather than just one or a handful. This can of course be taken too far as well, where every buyer feels like they are part of a huge auction process, in which case they walk away for fear of over-paying. Competition in a sale process does typically drive up purchase price and quicken the pace and accountability of buyers, but it should be handled carefully, respectfully and professionally.

Stage 9: Transaction Structure

The sale of a business has many financial and professional considerations for the management team / owner. The purchase price is only one component of the overall result. Other decisions and considerations include: stock sale versus asset sale; earnout; terms and interest rate on financing; liabilities assumed by the acquirer; employment contracts; non-compete agreements; current assets retained by the seller; stock ownership and equity options packages; relocation; employee preservation versus redundancy layoffs, etc.

Stage 10: IOIs, LOIs, and Purchase Agreements and Closing

Typically, buyers express interest in a company at three stages through three documents: the IOI, LOI and Purchase Agreement. The IOI is non-binding and provides the proposed terms, valuation and structure for a transaction. The owner will review this with their banker and make a determination as to whether or not to invite the buyer to learn more about the company and become more serious. LOIs (letters of intent) are a more serious signal of interest by the buyer; once they are jointly executed, the seller is typically under exclusivity with that buyer, such that they are not able to meet with other buyers during a stated period of time. Meanwhile, that buyer is beginning to conduct heavy due diligence on the business with the intent of acquiring it. During the exclusivity period, the buyer must move quickly to determine if they want to proceed. If so, the purchase agreement must be drafted to define all the details of the transaction: legal, financial, representations, warranties, etc. The purchase agreement is the definitive document outlining the terms of the sale.

Stage 11: Post-Closing Issues & Business Transition

The transition period typically involves a period of cooperation during which time the seller will assist the acquirer in transition. There are instances in which the seller is specifically not interested in doing this, however a lack of willingness to ease the transition typically lead to a lower valuation and in plenty of cases can derail the deal process entirely. Sellers should proceed with extreme caution if they elect to have no post-closing commitment. Post-closing commitments often include transferring customer relationships, explaining key management or market dynamics, and other proprietary information and trade secrets needed to operate the business optimally.