4 value pillars of your M&A
I was approached to give my opinion on a real situation. To facilitate the flow of this article while taking care of the confidentiality of this conversation, we will call the person who contacted me Charlie.
It turns out that Charlie was approached by a company that was interested in acquiring his company, but had no confidence in making a suitable proposal. They asked him to come up with something that made sense.
And now, Charlie?
Firstly, as we have already discussed here, the ideal is not for the buyer to make the first offer. But in this case, let's discuss how to turn this into an opportunity.
Let's start from the beginning: the Thesis. The purchasing company, let's call it Gamble, has a services business model, based on systems development projects. Charlie's company offers information technology consulting. Joining forces would be an expansion into a new product/business line. The segments served by the two companies are complementary, which could also characterize a horizontal expansion. However, the idea is to bring Charlie's know-how to create a consultancy business to serve Gamble's current target clients.
There is a potential for synergy, with consultancy coming into the clients first and identifying the development needs for the original business.
Now that we have identified the theses and synergies, let's think about the proposal that Charlie could make.
Don't propose the price to your buyer, Charlie
The first thing I told Charlie was not to submit a price proposal. Why? In this case, he will either propose a value below what the buyer is willing to pay, leaving money on the table, or a value well above, scaring away and hindering the negotiation at the start.
But that doesn't mean Charlie can't make any proposals. What I suggested was that Charlie come up with a proposal for the structure of the deal. In this case, this structure has 4 pillars.
4 value pillars of your M&A
In the structure of this deal, there are four value attribution factors:
The operation of the business
The non-compete
Charlie’s time as an “executive”
The value of the “new” business built (synergy)
Let's explore one by one.
1- The operation of the business
As Charlie's company has a portfolio of clients and projects, this operation has value. And even if Gamble had no interest in this portfolio, Charlie shouldn't give it up.
In the case of a consultancy, this value is around 1x annual revenue. Depending on the quality of the operation and the customer base, an excellent multiple would be 2x revenue. But Charlie doesn't need to price it. Just leave the message on the table that your business operation has value and that you expect to be rewarded for it. If the buyer has any reasonableness, it should return with a proposal consistent with this range of multiples.
2- The non-compete
Even if Charlie turns the business around and immediately takes a sabbatical, Gamble probably won't let him build a competing consulting business for a few years. This is typically the subject of a non-compete clause, for which Charlie must also be compensated.
There is no standard value for non-compete compensation. To understand the limits, we can consider that the ceiling would be how much Charlie could earn if he continued in the market, whether through a salary at another company or through profits from a new competing business that he could create. A non-compete works like insurance: the buyer pays the seller to guarantee that he will not become a competitor. As with any insurance, the value of the "policy" (the compensation) is typically a fraction of the total risk (Charlie's potential in the market). The fine for breaking this agreement should be much more substantial, close to or even greater than the value that Charlie could generate as a competitor. Thus, if he violates the non-compete, he will pay much more than he received for not competing.
Charlie must put on the table that he is willing to sign a Non-Compete and that it has value. Let the buyer set the price tag on this.
3- Charlie's Time as an Executive
Since Charlie won't be taking his dream sabbatical and will be working for Gamble on selling and delivering new consulting projects to its client base, his time must be compensated in some way as well.
How much would an executive with this experience earn? I don't need to say much more to make the value of this pillar clear. Not Charlie. Just remind the buyer that this has value and that they also expect to be compensated for it.
4- The value of the “new” business built
In addition to time, which has the value of “opportunity cost”, a partner or executive who builds a new business expects to have part of that business. Or at least be rewarded in proportion to the value created. There is a spectrum of models that could apply here, from participation in the resulting company to a bonus proportional to the profit generated.
There is a certain interchangeability between fixed remuneration and this variable component, but I separated the two pillars, because Charlie, as an entrepreneur, knows better than anyone the difficulty and value of creating a business. He should expect to capture some of this value as a share of the business or revenue/profits.
How? I suggest he let the buyer propose.
Payment methods
It is likely that Charlie's dream is to receive all of this in cash. But it's also likely that the buyer doesn't even have the cash to offer this.
In this case, part (or all) of the transaction will probably be done through an exchange of shares. This means that instead of receiving money, Charlie will probably receive shares in the purchasing company. Especially if both companies are small, this is the most likely format.
Depending on how much of the deal is a swap of shares and the difference in size of the companies, this would characterize a merger. If Charlie has confidence in the relationship he is forming, he may take the risk of jumping into this society, betting everything on the future. Ideally, he should negotiate conditions to transform this stake into cash ahead. In other words, after a certain period of time, Charlie should have the possibility of selling the stake received to other partners or to the company itself, according to a pre-arranged value logic. Otherwise, Charlie is stuck with the company without ever turning his M&A into money, perhaps for the rest of his life.
This is a potentially huge subject, so I thought it was important to point it out, but we won't have space to dive into it in depth.
Final advice
Charlie will return to Gamble with this structure and no price proposal. But now that he knows how the acquisition of his company can be evaluated, he should not restrict himself to this buyer alternative.
Having a proposal is the best way to trigger conversations with potential proponents. Ideally, those with whom you have already created a relationship and will feel grateful for the opportunity to make an offer on your company before another company buys it.
It's not something to do at the drop of a hat, putting your company on sale. How to save time?
Charlie may propose a partnership to test the relationship waters. We talked about this in the Relationship Spectrum. While he and the potential buyer can gain confidence in the business, Charlie buys time for other potential buyers to become interested in making offers as well.
Unless this is the subject of an exclusivity contract, Charlie has the right and perhaps even the fiduciary duty to seek more alternatives.
Way to go Charlie. Good luck!