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.