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Business Buyout Question

Discussion in 'Other Off Topic Forum' started by Uberpower, Feb 29, 2004.

  1. Uberpower

    Uberpower Formula Junior
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    Feb 6, 2004
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    Hi all-

    Wednesday may prove to be the day that funds my Ferrari purchase. I am sitting down to do a deal with a multi-million dollar company that will net me somewhere along the lines of $800K-$1.2M per annum.

    Apparently, word has gotten out and a few private investors have contacted me regarding a cash infusion in exchange for equity. I countered with the possibility of them owning exclusive rights to OTHER territories where we could duplicate the model... not so sure that they are interested there.

    Here are the questions:

    1. Should I entertain any offers with the deal on the horizon?

    2. How will I know what the "valuation" of my company is, given that it is still pre-revenue until the deal is signed?

    Any advice would be greatly appreciated.

    Thanks,

    Nick
     
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  3. dherman76

    dherman76 Formula Junior
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    #1 - Entertaining offers with the deal on the horizon should net you a better offer from this company as they will want to compete with those deals. However, do it in a smart business fashion and don't be rude about it.

    #2 - Valuation is based on your industry - if you do not mind, which are we talking about? More information about your product/service is needed.

    Would love to help you - just my 2 cents.

    Darren Herman
     
  4. Uberpower

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    Hey Darren-

    I forgot! You're the man when it comes to acquisitions!

    1. The company I am meeting with Wednesday isn't offering to buy me out, but utilize my service. They are in the ground transportation industry, largest presence in USA (built through acquisition). Therefore, I don't know that the investors really have any bearing on this deal.

    2. Industry is internet technology. Service provider to the ground transportation industry. Essentially a highly specific accounting and sales channel management application that will acquire new business and keep current business.

    Also- any idea how to price this? Was thinking percentage per transport of 10-15%, the company is thinking a flat rate per use. Would like for them to buy exclusive rights to a geographic territory... but it's unlikely because the CFO will demand exclusivity just for giving me the deal...

    Okay- now whaddya think?

    Nick
     
  5. dherman76

    dherman76 Formula Junior
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    Nick,
    Its 12:48AM EST - so if any of my rambling sounds a bit off, please excuse me, I'm about to head off to bed. I'll check back on the thread when I get to the computer tomorrow. Ok, here's my stab:

    #1 - The company you are meeting with probably wants some sort of 'deal' within the specific states they are seeking. This 'deal' could border exclusive, or could be non-exclusive (however, when going exclusive, be VERY careful, because that limits all potential business you might receive in that area. Also, make sure if you sign an exclusive deal, it has time-constraints). This company is probably going to say to you that they will want a huge price discount, or something of that nature, in the following territories in exchange for a per annum sum of money. I'm not sure what this software costs, or exactly what the service is, but make sure that you are not underselling yourself. However, the time value of money shows us that money in our pockets today is worth more than money in our pockets down the road.

    #2 - Sounds really interesting - would love to learn more about this service. (which I know very little about the transportation industry, honestly)

    I'm always warry of exclusive rights. This is a major term and the monetary short term implications of it are great, but what if something happens long term and their competitor wants to use you as well? Unfortunetly, per your agreement, you are exclusive and cannot do so. You're losing some revenue by doing this - if you are going to openly market yourselves to this market. Exclusive is good when you are not attempting to go into a niche market and something comes up and want to act on a non-targeted niche market (one in which you weren't going to go after - not in your core strategy).

    As for the % - sounds good...right on target. Just make sure you cover your costs. Remember, if this is a large client, the public relations and publicity that comes from this will generate some press and hopefully bring some people knocking on your door (more potential clients).

    Would love to hear more...till the morning - have a good one.

    Darren Herman
     
  6. Uberpower

    Uberpower Formula Junior
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    Hey Darren-

    Good advice WRT the time limit for exclusivity.

    In this deal, it's really not likely to matter a bunch because they control at least 80 percent of the business in those geographies anyway. The other 20 percent is made up of a plethora of independents. Not really worth going after on an individual basis anyway.

    You still didn't weigh in on the investment percentage/valuation/how much $ I should ask for. Will talk to both investors tomorrow, meet one in person Tuesday...

    Interested to hear your take-

    Nick
     
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  8. dherman76

    dherman76 Formula Junior
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    Nick,
    I sent you a private message - and will tackle this when I'm fully awake in the morning. It's 1:15AM EST and I don't feel like this is a topic I should handle when tired, as giving you false or not precise information will lead to trouble on your end. Will look at this in the morning.

    Thank you for understanding,
    Darren Herman
     
  9. Uberpower

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    Not a problem Darren- I'm thankful for the help. What method did you use for the SEGA acquisition?
     
  10. dherman76

    dherman76 Formula Junior
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    Nick and to anyone else who is following this thread,
    Disclaimer: I am not a CPA/nor CFO, however, I've been through these meetings before and have sold multiple companies. I am just offering my advice as a business man and am going to say straight out, "don't take everything I say as stone".

    Ok, back to the questions at hand. You're having meetings with a company who might want to utilize your service, possibly in an exclusive fashion in a certain territory. As for the actual dollar amount of the figure you should as for, regarding this territory, we cannot determine it due to lack of financial data (only you have this). However, I can speak about a financial model in which helped me sell my first company.

    When I sold TerminalX, which was a game serving company, it was right in the early/middle stages of the internet boom. We used a multiples evaluation method - which was used a lot for 'smaller' companies. This method was:

    net income X number of months - attorneys fees/misc. cost = my final selling price.

    Net income was determined from my financial data. I'm sure you have this already. Number of months is determined from how many months I'd like to be compensated for, upon the sale of the company. This is very common for web-hosting companies. Back in the internet heyday, we were seeing multiples all over the gammut, ranging from 12-72, etc.


    Now, as for your company, here are the formal valuations (as borrowed from another website). I feel like I'm in a Strategy course in college again!:

    Book Value. Total assets minus total liabilities. This method however, ignores the future return the assets can produce and is calculated using accounting practice that does not reflect how much the business is worth to someone who may buy it as a going concern.


    Market Value. (for quoted companies only). Is derived by multiplying the quoted share price of the company by the number of issued shares. This valuation reflects the price that the market at a point in time is prepared to pay for the shares. It is therefore influenced by the condition of the stock market, the concerns and opportunities that are seen for the company in the sector or market in which it operates. Also the investor's view of the ability of management to deliver a return on the capital he or she is using. It may anticipate some of the synergies that acquisition may bring, but is likely to have less of a grasp on the potential as a buyer from the same industry. For companies not listed on stock markets there is obviously no group of investors setting a value on the business on a day to day basis.


    Discounted cash flow method. DFC uses the future free cash flow of the company (after all liabilities have been met) discounted by the firm's weighted average cost of capital (the average cost of all the capital used in the business, including debt and equity), plus a risk factor measured by beta. Beta is an adjustment that uses historic data to measure the sensitivity of the company's cash flow, for example, through business cycles. This means that companies in highly cyclical businesses will have a high beta to reflect the volatile nature of their cash flow. The DCF method is a strong valuation tool, as it concentrates on cash generation potential of a business. However, the risk factor, measured by the beta, is impossible to measure precisely. 4. Price-earning ratio. (PE ratio). This is a popular method due to its simplicity. For non-listed companies wishing to use this method, a comparable quoted company/sector should be used. The difficulty here is in the selection of a comparable company. There could be differences in accounting methods (i.e. treatment of intangible assets like R&D) or an artificially boosted PE ratio due to an atypical drop in earnings. Among many investment professionals, use of accounting net earnings for valuation has declined in favour of cash-flow measurements which are seen as cleaner figures less influenced by the vagaries of accounting practice.


    Profit/sales multiple. This method is sometimes used to value the SME sector by multiplying a years gross/net profit or sales by a certain number, determined as the appropriate multiple for the type of business. This approach particularly with the small and medium sized business has little or no scientific methodology behind it, as it assumes automatically that what has gone before will continue in the future.


    Read over these strategies and these should outline what you're looking for. Its not brain science. You know, instinctively, what you want to be compensated for. Go for it. Put an offer on the table - dont be afraid. Remember though, this is business you said you might not be going for - so any income from it is potentially great income - as it is income that isn't otherwise recognized.

    Hope this helps...I'll be monitoring this all day for you...

    Darren Herman
     
  11. Uberpower

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    Hey Darren-

    Thanks for the advice. It looks as though I will have some amazing people side by side with me thanks to the miraculous intervention of the illustrious Dr. Tax.

    I have some homework to do to make sure I'm totally prepared. I'll keep you updated.

    Thanks,

    Nick
     
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  13. thecarreaper

    thecarreaper F1 World Champ
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    dherman76..... holy cow, do you give lessons, want a student? this is a great thread. i would love to see the outcome of this, minus personal specifics of course! facinating! michael
     
  14. SRT Mike

    SRT Mike Two Time F1 World Champ

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    I always thought most business valuation methodologies were pretty much crap, because why would I sell an asset that generates (for example) $250M a year, for $250M! And that ignores any upside potential for growth.

    On the downside, the buyer needs to work at this company, but on the upside, if the company made, say, $1MM a year, they could hire a CEO for $250M, pocket the rest, and break even after 5 quarters without having to work there. And again, that's aside from the upside potential of growth in the business.

    Where else can you get such a quick ROI? No other financial vehicle I'm aware of is going to generate a profit in 1-3 years (depending on what multiple you choose).

    I know that the bottom line always boils down to it's worth what someone will pay for it, but are there really lots of businesses out there that can generate >$100M a year, that can be bought for a 1x multiple of net annual income? I just can't see a business owner working for years putting in their sweat and hard work just to sell it for what their baby makes them in a year or two.

    Then again, I may be out of touch with reality :)
     
  15. Texas Forever

    Texas Forever Four Time F1 World Champ
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    Mike, welcome to the wonderful wacky world of deal making. Valuation for deal making is definitely an art, as opposed to the ASA types who do litigation support. Simply put, there are two sides to any deal (duh!). The key is to figure out why the seller wants to sell and why the buyer wants to buy. When the lines cross, the value of the deal works itself out. That is, the seller agrees when the price is more money than he can make on his own. The buyer pulls the trigger when he figures that he can make more money with the company than the seller.

    Back in the "Old Days," say before say 1998, valuation was relatively simple. Because I'm an old dirt guy, you took net cash flow and divided it by .10. The result was the value of the company.

    The WWW changed all this. Web-Based software can be very difficult to value because it is not always directly linked to cash flow. The classic case is the "shopping cart" that you see on web sites. It turns out that the initial problem was abandoned shopping carts. Customers would "put" items in their cart and then for whatever reason, they would disappear. Problem is that the computer kept looking for love in all the wrong places. It thought that the items put into the shopping carts had been "sold" and thus needed to be reordered... etc. etc. etc.

    I forget which company came up with the idea of zapping abandoned carts, but whoever did sued one of the major web based vendors (Amazon?) for big $$$ when they, uh, borrowed the idea.

    Long story short, a lot of software deals use a "earnout" or performance structure. That is, the buyer pays for the software on a "as you go" basis. As you can imagine, these deals can be nightmares to neogotiate. The devil is definitely in the details.

    Hope this helps, DrTax

    ps I referred Nick over to a dealmaking buddy of mine who has a lot of experience with this particular buyer. I'll let Nick tell the rest of the story.
     
  16. dherman76

    dherman76 Formula Junior
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    Most people think this - however, there are circumstances when businesses sell for less than the revenue they bring in. Remember, revenue is not profit. Revenue is not net income. We must remember that revenue is essentially 'sales'. This 'sales' figure still has to be discounted down to include costs, etc. That brings us to a lower number. So, to tie this post together, I'm saying that sometimes a strategic buyout for a company would be less than the cash generation because the company may have heavy debt, losses, etc - and for some circumstance, the acquiring company feels it can pull it out of the 'red' or the 'ditch' that it is in. There are more reasons for this - feel free to PM me.


    We like to read the papers and read the 'feel good' stories. Think about how many businesses exist in America alone, and how many we actually read about in the Wall Street Journal or NY Times (or paper of choice). Seems a bit staggering - YES, there are tons of businesses that are bought and sold everyday that don't receive the huge financial rewards that we're used to reading about. Think about it.

    - Darren
     
  17. Ronald Steinhoff

    Sep 17, 2002
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    Hello there,

    What you need to do is make a cash flow projection for the next say, five years (called the explicit period) and then forecast cash flows as they approach infinity and discount this value to the present (called terminal value) using your weighted avergage cost of capital (WACC).

    As someone said below, the only thing that matters is value creation - not revenues, profits, etc. The value of anything - including a human life - is the present value of the total cash flows it can generate of its lifetime.

    STEP ONE: CASH FLOW FORECAST

    Do your projected income statement, blah blah. How do you do this?

    1) Sales forecast - Economic Analysis/Industry Analysis/Company Analysis
    2) Develop regression model to link micro and macro trends
    3) Income Statement and Balance Sheet

    4) Cash flow:

    Do this to arrive at cash flow:

    Revenues - COGS - Selling/General/Admin Expenses - Depreciation + Adjustment for Operating Leases - Taxes on EBIT +/- Increase/Decrease in Accumulated Deferred Taxes + Depreciation = Gross Cash flows

    Gross Cash Flows -/+ Increase/Decrease in Working Capital - Capital Expenditures - Increase in Capitalized Operating Leases - Investment in Goodwill - Increase in Net Other Assets + Non-Operating Cash Flows +/- Increase/Decrease in Foreign Currency Translation Adjustments
    = Total Free Cash Flows

    STEP TWO: CALCULATE YOUR COST OF CAPITAL
    How have you financed your company? How will it be financed? Take the weight of these and multiply them by their cost to arrive at a weighted average.

    STEP THREE: DISCOUNT FREE CASH FLOWS

    STEP FOUR: DISCOUNT TERMINAL VALUE
    Use this formula:

    [(Net Operating Profits Less Adjusted Tax) x (1 + long term growth rate) x (1 - retention ratio)]/(WACC - long term growth rate)

    You may want to call an investment banker!
     
  18. dherman76

    dherman76 Formula Junior
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    Yes, investment bankers are pretty keen on this. Would help to know/have one.
     
  19. Uberpower

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    Meeting with an investor tomorrow. Seems to have big dreams, owns a trucking co in NJ, a hot sauce co in FL, and several others. Wants to buy the technology... will inform all how it goes...
     
  20. dherman76

    dherman76 Formula Junior
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    Yes, please do. Do you have a website associated with this service/product? Or any sales literature? I'd love to read it - feel free to PM me anything.
     
  21. Uberpower

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    PM'd you the details.
     
  22. Uberpower

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    Hi all-

    Just wanted to give an update. Thanks for all of your input, it certainly helped.

    My meeting yesterday went reasonably well. The result was a handshake deal that came in at 60% of my expected offer; however, I expect that I shall grant them an equity position in my company as they are in the position to represent my service to other companies at a significant 100% upcharge in most other geographies (US Cities).

    Once again, Dr. Tax was an enormous help by hooking me up with a lead M&A guy who everyone at the company had heard of before. He was there to basically steer the deal in my favor.

    So end result? I still own my company, AND have an excellent distribution deal covering 80% of the market in 3 major cities. With possibility for 2 additional cities in the next 60 days.

    Respectfully,

    Nick
     
  23. dherman76

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    Congrats! I hoped some of my information helped...
     

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