Chris Weingartner - Investment Grade Advisory

Chris Weingartner 22, Sep, 2021

General

Risks of Selling to a Competitor

For many owners, deciding to sell their business is one of the biggest decisions they’ll make in their lifetime. The company’s value represents the amassing of their life’s work. Successfully selling the business at a premium price is crucial for owners to finance their dreams or fund their retirement. Finding the right buyer or investor will help you obtain premium valuation, but that person could be a competitor.

A quick Google search for “Risks of Selling to a Competitor” returns a litany of articles containing advice and personal stories, both good and bad, from entrepreneurs who were faced with this issue. Owners are wise to be familiar with these risks, and mitigate them as much as possible.

However, these risks must be weighed against the knowledge that oftentimes a competitor or strategic acquirer is the buyer willing to ascribe the highest valuation for the company. The reason for this is simple. Strategic buyers, buyers operating in the same industry and space, often can realize the most synergies from the acquisition. These synergies can including economies of scale, acquisition of talented employees and intellectual property, cross selling opportunities, and geographic expansion.

There are several key considerations that any seller and their representative should be taking to protect the existing operation and assets of the company, in the event a transaction doesn’t go through or the competitor doesn’t end up as the eventual buyer:

– Send Blinded Teaser – In order to protect and mask a company’s identity when first approaching a strategic buyer, teasers are created that reveal enough about the business to enable your competition to know if they’re interested or not, but not enough to identify what company is being sold.

– Execute a Non-Disclosure Agreement (NDA) – Ensure that any material shared will be used only for the purpose of evaluating a prospective transaction. NDA’s and Confidentiality Agreements protect the company from having its employees hired away, intellectual property replicated, customers poached, and suppliers undercut.

– Share Information Two Ways – While your competitor isn’t for sale, it is important for them to share important information with you for multiple reasons. First, viewing their financials can confirm they have the financial ability to undertake the acquisition. Second, understanding their operations can validate that the operational synergies they’re hoping to achieve are realistic. Finally, through sharing material both directions, it ensures that the other company has “skin in the game” to uphold and adhere to the NDA.

– Provide Requested Detail Gradually – There is no need to open up all company records the moment an NDA is executed. The seller will know better than anyone what they’re comfortable sharing at each stage of the process, and the advisor should completely honor and trust their intuition. Think of it as dating. You want to release the least sensitive information first to continue confirming interest and the buyer’s desire to acquire. You typically don’t get married after the first date.

– Blind Sensitive Material – Vendor and customer lists, pricing sheets, and other competitively sensitive material can be sent over with key items redacted. Customer concentration is a big concern of all buyers; you can easily send your top ten list over without the explicit names associated with each amount.

– Implement a Breakup Clause – As you get to the point where you are close to signing a Letter of Intent (LOI), consider including a binding breakup clause with the LOI that results in financial consequences to the buyer if they walk away from the deal without cause. This ensures they’re not entering into the no-shop diligence phase with the intention of just walking away after they’ve gathered intelligence.

Overall, the key consideration is risk mitigation. An experienced advisor will ensure that the correct amount of information is shared to keep competitive buyers interested without exposing their client to any potential pitfalls or threats.

Chris Weingartner 25, Aug, 2021

General

Five Checks to Determine if Your Financials Are in Order

When selling a company or seeking investment, there is no larger deterrent to a premium valuation and a smooth closing than messy financials. For growth companies running at full speed, maintaining accurate and up to date financial statements can easily slip to the bottom of the task list. While it is a common mistake, poor financial reporting will hinder your ability to make informed decisions on managing and growing your company. It will also destroy buyer/investor trust in your company as a potential investment.

The Five Checks

Financial reporting may be a problem for your company if you have any of the following issues:

You do not have up to date monthly financial statements readily available

You do not track financials monthly and/or you are several months behind in reporting. Strong financial departments often produce monthly financials by the 10th of the following month. Closing later in the month reduces the usefulness of financial reporting.

You are not able to track revenue with expenses

You are not sure if your expenses are generating sufficient revenue to achieve profitability goals. Properly recognizing revenues and expenses in the month they are earned (known as accrual accounting) gives a better picture of profitability than cash-based financial reporting. Cash based financials can hamper management’s ability to make decisions.

Your financial statements are difficult to follow

Someone outside of your accounting team cannot easily understand your business model and financial position from looking at your financials. Clean reporting is organized by business unit or division and is consistent over time. Instead of making users scratch their heads, clean reporting enables high-value conversations around the business.

Your financial team does not have clearly defined processes

Lacking a standard set of procedures, such as bank account reconciliations and a monthly budget meeting, your financial reporting may contain significant errors. A written set of financial controls creates peace of mind.

You run personal expenses through your business

Lastly, running significant personal expenses through a business can further complicate matters, as buyers want to understand solely the costs to operate a business. The more of these non-business related expenses that flow through the P&L, the less credit a buyer will be willing to give to the seller for each addback.

Without clean financials, prospective buyers/investors cannot conduct the level of financial analysis required to determine if they want to move forward with an opportunity. If you are unable to provide monthly financials, buyers may be forced to pass or delay a decision. Without confidence in financials, buyers often hedge their offers downward to compensate for the risk of the unclear and inaccurate financials. The duration to close a transaction may also be elongated, as significant effort must be exerted in the diligence phase to validate the accuracy (or get as close as possible) of the unkempt numbers.

Maximizing Value

For business owners seeking to maximize their valuation and minimize the stress of financial due diligence, we advise being sure you can answer yes to the following four questions:

– Do I have audited and GAAP compliant (or at minimum prepared and organized per industry standards) financials?

– Are monthly income statements, balance sheets, and cash flow statements are readily available?

– Does my company regularly update and track performance against a budget/forecast?

– Have I established monthly financial Key Performance Indicators that are used to track and evaluate performance?

If you can answer yes to all, breathe easy as you have positioned yourself well. If your answer to any of the questions were no, we can help understand your current operations and set you on a path to success. Schedule a meeting today!

– Guest Article by Chris Weingartner

Chris Weingartner 4, Aug, 2021

General

Growth or Profitability – Which Should I Choose?

One of the most frequent questions we are asked by founders and entrepreneurs is whether their focus should be on growing revenues or achieving profitability, especially when it comes to the impact on Enterprise Value. It is a complicated question that presents meaningful tradeoffs unique to each company and one that companies should always feel a healthy amount of tension over. There is a difference between choosing profitability over growth and not having the ability to grow efficiently. To build Enterprise Value over time, a company has to be able to execute on an efficient growth model. Efficient growth is what drives Enterprise Value.

At Founders Advisors’ annual Silicon Y’all SaaS and Internet Summit, this question is asked to the Private Equity panel each year, and each year 100% of these extremely sophisticated investors indicate that they are more excited to invest in a company growing 50% and breaking even than one growing 10% with 20% EBITDA margins. However, they universally acknowledge that for operators and owners in the trenches, it isn’t that simple of a decision.

The Case for Profitability

The simplistic purpose of every company is to produce returns for its owners. Beyond that ultimate goal, turning a profit is required to sustain a company and its employees. While serial entrepreneurs may have a war-chest from an earlier exit to fund early losses, bootstrapped companies do not have this luxury and often have to focus on getting to a breakeven level quickly before cash available for operations dries up. Recognizing this, there is no harm in managing to breakeven, especially if maximizing profitability would require taking in capital at an unappealing valuation or bringing on debt with restrictive terms (personal guarantees, risky covenants, high rates, etc.).

The Case for Growth

A true single-instance, multi-tenant SaaS platform has the capacity for unlimited scalability. Once the product and tech are well-developed and hardened, the success of a SaaS company shifts from overcoming product and execution risks (does it work and is the team strong?) to demand and capital risk (is it needed/used and how can we grow even faster?). Because of this, if SaaS companies can show strong bootstrapped growth with manageable churn, investors love to pour capital into a platform that has grown but is constrained by its own capital availability. Private equity investors are great to help think through strategic decisions and guide based on their experience, but they are looking for investments where much of the heavy lifting has already been done. With low churn and high ARR, PEGs can eventually dial back the sales and marketing spend for customer acquisition and significant profitability often results for the company for years to come.

What is the Right Balance between Profitability and Growth?

While they all acknowledge that it is somewhat rudimentary, PEGs examine SaaS companies based on the “Rule of 40” – that is, Growth Rate + EBITDA Margin should be greater than 40. The strongest companies are often scoring greater than 80. Each industry has its own rule threshold. Therefore, as owners weigh their current options to fund growth or focus on achieving a profitability hurdle, they can determine how to effectively budget growth-driving expenses like sales and marketing, development, conference sponsorship/participation, etc. against the anticipated impact to their bottom line.

Ultimately, having a proven growth model is the key for investors and drives valuation upward. Sophisticated investors recognize that some companies may have had to choose profitability over spending for continued growth, but their capital can assist by efficiently increasing sales and marketing expenses in channels that historically have yielded fruit. If it is not clear to an investor that a company has a model for growth, the investment will be less attractive and valuations suppressed. In understanding the growth model, they’ll key in on unit economics – if you can point to past trends around successful sales and marketing campaigns, they’ll be excited to pour fuel on that fire.

– Guest Article by Chris Weingartner