Selling a Business - Private Equity? Investment Bank?

In my professional networking I recently participated in a "Speed Mentoring" meeting. Sounded perfect for me. With my short attention span and inquisitive nature, 10 minutes of conversation each with an investment banker, a private equity partner, a forensic accounting and trial expert witness and a VP of an asset management company was perfect. I learned more in an hour of what I have needed to know than I have been able to garner in years. For example, in follow-up conversations I learned that both the IB and the PE firms would not consider my client with almost $10M in revenues and $500k annual Free Cash Flow (FCF). Rather, they were looking for candidates much larger than those I know who want to sell or finance growth. The IB only considers companies with $25-100M in gross revenues. The PE partner looks for companies with EBITDA of $10-100M. Interestingly, in the 15+ years that the PE firm has been doing deals, only a handful have been within a 2-hour radius of the home office here in the Bay Area. (Their specialty is not high or bio tech.)

I concluded that a business that has grown its revenues to $10M is still small time these days. The IB'er suggested any buy-out or investment deal could be done with a good business transaction attorney. The timeline for closing an IB deal is about 6 months and the fees are about $500k. In other words, for small companies there is not enough in potential fees to have savvy, financial, MBA types work on the deal; just get the deal done, whatever it's sold for, and document it properly by a lawyer. That surprised me. I also felt sad because the small business owner might know how to run and grow their business but often does not know how to truly value their company and as a result might sell at far less than full value.

For small businesses (yes, $10M in revenues is small), that tells me that their capital needs are limited to the usual list of friends & family, angel investors, and banks. We all know banks don't give money without collateral so venture money for these businesses is quite limited.

So, about the idea of selling a business, of cashing out, well, if a buyer is ID'd then I would suggest working with them to agree on the best terms because other avenues for exiting are few. (A bird in the hand is worth 2 in the bush.) However you can, get a proper valuation done. Even if it costs $10k it might radically change your perception of the sale price.

If I come across more realistic ideas for selling "small" businesses I'll gladly share them.

Valuation for Restoration Hardware Buy-Out

I see on the front page of the SF Chronicle Business section that an East Coast private Equity firm,Catterton Partners of Greenwich, CN is buying Marin-based Restoration Hardware for $267M.
http://www.sfgate.com/cgi-bin/article.cgi?file=/c/a/2007/11/09/BUCFT8TDC.DTL&type=business
The stock almost doubled on the news but let's take a look at the Free Cash Flow (FCF), at least to the extent that we have information (and time). "Last year, it earned $3 million on revenue of $713 million; in 2005 it lost $29 million on $582 million in revenue", the Chron reported. That is a 0.4% Net Income return on Sales. Not so impressive to me. If I owned the company and that was the return I would be having serious sit-downs with management. And that was the good year. Those returns are a little shocking to me since every time I've ever bought anything at R.H. I have paid top dollar so where is the company spending? On the millions of catalogues? I get 3 each time they mail them out. (= waste) They speculate that while 1/3 of their business is mailorder now and that it will grow to 1/2. No small feat in growth objectives. I will add that RH does carry quality product lines. But what about FCF? Net Income needs certain add-backs like Depreciation, Amortization (D/A) and other non-cash outlays. Unless they have huge D/A charges, that will not add much cash. Doing reverse math, how much FCF/year should $267M buy you? Well, if you just put the money in the bank you could make 5.5% or $14.6M. The 30-year "long bond" (Tsy) yields about 4.75% or $12.68M per year and that is the "risk-free rate". So what rabbit will RH pull out of their hat to beat that? Certainly with a very leveraged deal (50%) there is less cash spent for the PE firm, less FCF that must fall to the bottom, and enough cash to meet interest payments. But I think RH should take the deal and run to the bank. (They are saying they have until 12/13/07 to solicit bids and must pay $10.68M termination fee if they bow out of this deal.) They got a very good price here. Take it.

Interestingly on the strategic front "Catterton has $2 billion invested in what it calls 'the middle-market consumer sector'." It was one of two private-equity firms buying Outback Steakhouse's parent firm earlier this year. Other holdings include Brach's Confections Inc., P.F. Chang's China Bistro, Build-A-Bear Workshop and Baja Fresh Mexican Grill." Not so sure Restoration Hardware is the same "middle market" (towel racks for $200) but they must have something in mind...

To Microsoft SV for Current computer Trend Info

In the never-ending quest to be current with all techno-trends, I am about to leave for Microsoft's Silicon Valley campus where an all-day dog-and-pony show is being put on by many SV regulars. IDEO is one of my favorites, and they are presenters and moderators. I am currently working my way through "The Art of Innovation" by Tom Kelley, GM and co-founder of IDEO. While there are 300+ pages of writing, I have yet to be WOW'ed by the information. I often find that to be the case with Marketing materials. What seems to me to be common sense is apparently not so common. Now, don't ask me to create anything for Marketing, but I can critique the heck out of anything that is created to be sure that it conforms with a brand and a target audience.

If I learn anything amazing I will report back.

Raising Capital

I am about to embark on an Angel investor search for capital on behalf of a client. The last time I attempted to raise private investor money was in 1992 and I remember sitting in a waiting room with a minister who wanted to raise money for his for-profit church in Harlem. (yes, for-profit) We were both waiting to speak with a guy purpotedly from the Saudi Royal family (a very, very, very distant cousin/nephew/something of the King) who was in NYC "looking to invest millions in great business opportunities". I was young and probably gullable. My business plan kept changing after each potential investor meeting. While looking for $200k one moment, someone would say, "Well, as long as you're looking for that much money, you might as well get $1.5M", or they'd say, "We only do investments of $5-10M" and so I'd bring back an inflated business plan matching their needs, not necessarily mine. My idea never changed, but the scope did. I never did find funding for that project; maybe it was just as well.

In the end, what I learned from all that Excel jiggling was that I let the potential and ultimately faux investors decide my financial fate and commitment. Mistake. In hindsight, it showed my immaturity and lack of clarity and knowledge.

As I look for investors this time, I will bring my clear story and financials. I have spent time defining who the proper potential investors are. If the audience does not understand my pitch or believe in my idea, or "get it" I will move on to others who will. In the end, it is not about pleasing them but rather getting my project funded because I (and my client) have done the proper due diligence to lead with confidence knowing that what we have is special, important and fundable. Those who cannot write checks after agreeing with us, need to step aside for those who can. We're on our way.

Where are the breadcrumbs?

It seems most difficult for business owners to choose a path and stick with it. Of course, it is one of the troubles of our society - so many choices- how can I choose one thing at the potential loss of other opportunities? In economics this is called 'opportunity cost' or what we lose in the one instance by choosing something else. For business owners who have so much riding on their decisions, mainly their reputations and the company's potential profitability, it is even harder to choose a path and stick with it. But it is my experience that even if a CEO is not perfectly spot-on in their decision, once they commit to a path that is sound and sane and bring others on board to help execute their plan, they are most assured of success. It is those that languish in the in-between, choosing neither to change nor committing to a strong current path, that lose. All energies can be spilled into anxiety and insecurity, wasting conversations and money.

As a friend said to me many years ago, when confronted with a decision, make one. Contemplate the options with good intention. Then choose the most rational path.

What is my worth?

This can be an existential question or a business owner's dilemma. I come across it often when business owners look for advice on how to raise capital and don't know how much to give to those who invest in or buy their company.

So, how does one calculate one's worth? The concept of Valuation in business circles can range from the simplest conversation to the most complex financial models. Ultimately, whatever a Buyer is willing to pay a Seller is the true Value. That of course, assumes that all potential Buyers know the opportunity is available. Otherwise, the one Buyer who does the deal may just be getting a bargain or even overpaying since there is no one else in the deal to validate the purchase price.

Many deals are ultimately done with the "back of the envelope" method. These can be summary multiples of Gross Revenue used in simple math to calculate a company's value. Such multiples are readily researched for most industries making the calculation fast and easy. They only provide a point of negotiation. There is no absolute answer on business value. Worth repeating: What a willing buyer pays is the true value. What Buyer and Seller agree upon is the correct price on any deal, the correct worth at any point in time.