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Pre-sale Planning, Selling a Business, Family Business, Raising Capital

Answers to Questions from Middle Market C-Suite Executives: Part 1

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This week Mirus partner Andrew Crain is answering questions from C-suite executives of middle market companies about investment bankers’ role advising private business owners:

Question:  Ideally, how long before a business is put on the market should an investment banker be involved? What are the risks to involving a banker too early?

That’s a great question! While we are of course happy to meet a business owner weeks or months before he or she plans to market the company for sale, an investment bank can add significant value to your eventual outcome if you involve the banker in your pre-sale planning two or more years prior to your planned transaction, for a number of reasons:

First and foremost, an investment banker can advise on your strategic decisions, helping you identify what aspects of the business will be most valued by acquirers and thereby helping you identify which strategic moves are most likely to increase enterprise value within the pre-sale timeframe.

Second, an investment banker can identify up front any company-specific factors which may concern a buyer, giving you time to address those factors before starting the sale process. Customer concentration, concerns about retention of key employees, and intellectual property issues can be minimized with time and planning. Similarly, adverse tax consequences might possibly be avoided or minimized if identified and remedied a year or two before a deal.

Finally, undergoing sell-side due diligence with your own attorney, accountant and investment banker in advance of a transaction can streamline the buyer’s subsequent due diligence process by uncovering up front any issues that could imperil the deal. Working with clients and potential clients to surface these issues before the sale process begins, an investment banker can craft creative solutions that avoid surprises down the road.

Question:  Can you discuss the perspective you have as an investment banker having come from a family business?

Many family members in family businesses have an insular view of the business world. Often they enter the business by default or by fulfilling family expectations (my father, for example, spurned an offer from General Electric coming out of college in the 1950s to join my grandfather in the family business.) One result of that insular view is a decisionmaking bias that favors generational succession and business continuity as the default outcome for the family business.

As an investment banker, the problem I often see with generational succession is that unlike an entrepreneur, the junior generation usually does not put his or her own capital at risk when joining the business. In addition to the small percentage of family businesses that choose to sell to a strategic or financial acquirer, there are many more that should make that choice – either because the next generation does not have the requisite managerial skill to lead and grow the business, or because the company’s industry has matured and growth prospects are limited. Investing rather than inheriting would provide clarity in these situations.

When working with business-owning families who decide that the best course of action for both the business and the family is a sale of the enterprise, I’ve seen that emotion can have an outsized influence on the transaction outcome. For any private business owner the sale of the company can involve complex emotions around self-identity and self-worth, and these emotions can conflict with more straightforward emotions about measurable financial worth and achieving liquidity. Add in the multigenerational aspects of a family business and these emotions can multiply exponentially, complicating the transaction process and challenging the family’s professional advisors.

Having sold our family’s business after 104 years and 5 generations, hopefully my perspective makes me more attuned to these emotional complexities inherent in advising family business owners.

Question:  In your bio you mention private placement of debt or equity. As a middle market company owner looks to get some capital for expansion (or personal liquidity) – when debt or equity is issued, how much control is given up? Who are the buyers of the private placements and how does that change with size of the transaction?

We’ve raised capital for clients in a variety of circumstances and across the financing spectrum, from early stage through growth, recapitalization and shareholder liquidity to full management buy-outs and leveraged buy-outs. We’ve raised capital to fuel the growth of exciting companies, worked with smaller companies acquiring much larger businesses, helped management teams acquire the business they’ve run for a decade or more, and raised capital to provide liquidity for shareholders.

In all of these engagements, the question of whether control is retained or relinquished ultimately comes down to the valuation of the business and the amount of capital raised. For early stage startups, valuation is usually a somewhat speculative exercise based on potential market size and the company’s perceived upside. In these early stage capital raises, raising equity from friends & family, from angel investors, and eventually from venture capital funds, often involves imprecise metrics (remember “number of eyeballs” from the dot-com era?) rather than measurable financial performance. At the early stage, the entrepreneur often retains control because the investors are, ultimately, backing the management team as much as the product or service; although negative covenants may subsequently flip control to the investors if expectations aren’t met as the company evolves.

For later stage companies with an established track record of financial performance, the question of control is more straightforward. Valuations tend to be based on financial metrics appropriate to the company’s industry and can be established by reviewing recent comparable transactions and comparable publicly traded companies, and by reviewing internal projections and discounting expected future cash flows to net present values. Measuring the desired amount of capital to be raised vs.the company’s pre-transaction valuation will dictate whether the raise can be done with debt and/or equity, and whether the equity portion of the raise will be a majority or minority transaction. From there, the type of likely investor can be identified – majority buy-out fund; minority growth capital fund; mezzanine debt providers; senior lenders – and the investment opportunity is marketed.

Ultimately a capital raise is akin to a sellside process – we’re marketing a transaction opportunity to a range of potential investors or acquirers – and the market will dictate the outcome for valuation and for control; but I trust these comments offer useful guidelines.

Question:  Can an Investment Banker help me to decide my best path forward? To issue debt or equity? Or to sell?

An investment banker can be a good resource to help a business owner decide the best path forward by creating a liquidity plan. Liquidity planning provides a strategic roadmap and set of specific recommendations for a business owner to proactively define, evaluate, choose and optimize the most suitable options with the ultimate goal of maximizing exit value. Guiding your company’s development with an exit strategy in mind is just as important to long term success as product development or sales channel planning, and can make the difference in whether your company is valued strategically or just based on average multiples of earnings.

We often provide liquidity planning for business owners and corporate boards seeking ways to increase shareholder value through improved decision-making. We analyze your market opportunity, competitive position and opportunities for expansion and what, if any, transactions will advance your business plan and valuation goals.

With that analysis to guide you, the question of whether to issue debt and/or equity then becomes a simple one – can the proceeds of the capital raise be productively invested to generate a return on investment greater than your cost of capital? If the answer is yes, we can then connect you with appropriate financing and other resources to help make your business growth and expansion strategies a reality.

Similarly, the question of whether and when to sell can be viewed through this same investment lens: is your expected return on your illiquid investment in your private business greater than the return you might achieve by investing in publicly-traded securities or other assets? This is a simple question with a complicated answer based on expected performance of your company, your industry and the economy; it’s also complicated by the additional quantitative and qualitative returns derived from owning your business – salary, benefits, perks, status, identity, and more.

An investment banker can’t guide you on the qualitative aspects of your best path forward, but can certainly provide objective answers to all of your complex transaction strategy questions.