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Search Funds: A New Option for Entrepreneurs

The Baby Boomer retirement boom is coming. In 2017, 36% of small business owners said they planned to change ownership in the next five years. Though traditional acquirers are eager to purchase these businesses, there’s a third option available: search funds. As a new generation of talented entrepreneurs graduate from elite business schools, many new graduates want to be Main Street CEOs instead of heading to Wall Street. So they’re eager to acquire small businesses.

One increasingly popular way for them to accomplish this end is via search funds. A decade or two ago, this was a strategy virtually no one was trying, and almost no one had even heard of. Now, they’re all the rage in business schools, with some MBA programs even creating search fund-specific programs. This strategy shows no sign of declining in popularity, and stakeholders on all sides of the M&A equation need to be aware of the increasing influence of search funds.

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So could a search fund be an option for fueling entrepreneurship? Here’s what you need to know about this option.

Search Fund Models
Search funds come in three basic forms: self-funded, traditional, and fundless sponsors. Traditional funds allow searchers to raise capital from an investor group seeking a company with specific agreed-to assets. Investors have the right of first refusal on deals the searcher finds.

Self-funded searchers finance their search efforts. When they find a deal, they then seek outside capital. Terms are negotiated for each deal, and deals are often funded via SBA loans.

Fundless sponsors raise capital from either a single source or an investor group. Fundless sponsors tend to be more experienced. They are knowledgeable at deal structure, and people often choose to back them based on prior experience.

Search Fund Education
As search funds become more popular, more programs are being created at business schools. Many students view search funds as less risky forms of entrepreneurship. They allow students to buy from retired founders, and to purchase businesses that are already tested. Students view this as inherently less risky. A combination of increased awareness, a willingness to experiment, and economic forces—such as retiring Baby Boomers—have increased student interest in these funds, and spurred business schools’ willingness to educate about them.

Will the Search Fund Trend Continue?
Search funds may seem like the latest and greatest trend. Most analysts think this trend will continue. The timing is right, and more business schools are educating and raising awareness about search funds. But the forces that drive search funds of the future may be quite different from those that have driven the current trend.

More business school graduates see older peers doing search funds at a large volume. On average, the results are good. That drives interest. There’s plenty of money out there to support a growth of search funds. With private equity returns diminishing, entrepreneurs are looking for higher returns. They’re turning to search funds to deliver on the promise of higher returns.

Doing is the Best Kind of Thinking

tom-chi-eventOne of the most significant reasons why Tom Chi was able to invent Google Glass, self-driving cars, Project Loon, and hundreds of game-changing inventions so fast is this…Tom learns fast and tries oftenmaking small variations until he succeeds

What could our generous community of leaders accomplish – individually and collectively – if we become masters of staging and testing new ideas, learning rapidly, and increasing how many new things we try?

Anything is possible, and we invite you to click the image to the right and dig deeper to discover what prototype thinking can do for you!

How to Keep Employees Engaged During An Ownership Transition

Ensuring that your employees stay on course during your ownership transition should be one of your key areas of focus. There are many key steps that you should take during this delicate time. Let’s explore the best tips for keeping your employees engaged throughout the entire ownership transition process.

Group of confident managers listening to female employeeStep 1 – Establish and Implement a Training Program Early On

If you are selling your business, then be certain that you train replacements early on in the process. Failure to do so can result in significant disruptions. Additionally, if you are buying a business it is of paramount importance that you are 100% confident that there are competent people staying on board after the sale.

Step 2 – Address Employee Concerns

No matter what your employees say or how they act, you must assume that they are worried about the future. After all, if you were them wouldn’t you be concerned at the prospect of a sale? The best way to address these concerns is to meet with employees in small groups and discuss their concerns.

Step 3 – Don’t Make Drastic Changes

Above all else, you want a smooth and fluid transition period. A key way to ensure that this time is as trouble-free as possible is to refrain from making any drastic changes before or after the transition. Remember the sale of the business is, in and of itself, shocking enough.

You don’t want to add yet more disruption into the process by making changes that could be confusing or unsettling. In other words, keep the waters as calm as possible. Drastic changes could lead to employees quitting or worst of all, going to work for a competitor.

Step 4 – Focus on the Benefits

If possible focus on the benefits to your employees. It is your job as the new business owner to outline how the sale will benefit everyone. Don’t let your employees’ imaginations run wild with speculation. Unfortunately, this is exactly what happens when employees and management feel as though they are not receiving any information about the sale. So don’t be mysterious or cryptic. Instead provide your employees with information, and keep the focus on how the changes will benefit them both personally and professionally.

Implementing these four steps will go a very long way towards helping to ensure a smooth transition period. Transition periods can be handled adeptly; it just takes preparation and patience.

Are You Emotionally Ready to Sell?

Quite often sellers don’t give much thought to whether or not they are ready to sell. But this can be a mistake. The emotional components of both buying and selling a business are quite significant and should never be overlooked. If you are overly emotional about selling, then this fact can have serious ramifications on your outcomes. Many sellers who are not emotionally ready, will inadvertently take steps that undermine their progress.

Selling a business, especially one that you have put a tremendous amount of effort into over a period of years, can be an emotional experience even for those who feel they are more stoic by nature. Before you jump in and put your business up for sale, take a moment and reflect on how the idea of no longer owning your business makes you feel.

Emotional Factor #1 – Employees

Ready to SellIt is not uncommon for business owners to form friendships and bonds with employees, especially those who have been with them long-term. However, many business owners are either unaware or unwilling to face just how deep the attachments sometimes go.

While having such feeling towards your team members shows a great deal of loyalty, it could negatively impact your behavior during the sales process. Is it possible you might interfere with the sale because you’re worried about future outcomes for your staff members? Are you concerned about breaking up your team and no longer being able to spend time with certain individuals? It is necessary ultimately to separate your business from your personal relationships.

Emotional Factor #2 – Do You Have a Plan for the Future?

Typically, business owners spend a great deal of their time and energy being concerned with their businesses. It is a common experience that most owners share. Just as no longer being with your employees every day may create an emotional void, the same may also hold true for no longer running or owning your business.

Your business is a key focal point of your entire life. No longer having that source of focus can be unnerving. It is important to have a plan for the future so that you are not left feeling directionless or confused. What will you do after you sell your business and how does that make you feel? Before you sell, make sure that you have something new and positive to focus on with your time.

Emotional Factor #3 – Are You Sure?

Are you sure that you can really let your business go? At the end of the day many business owners discover that deep down they are just not ready to move on. Are you sure you are ready for a new future? If not, perhaps it makes sense to wait until you’re in a more secure position.

Addressing these three emotional factors is an investment in your future well-being and happiness. It is also potentially an investment in determining how smoothly the sale of your business will be and whether or not you receive top dollar

What is EBITDA and Why is it Relevant to You?

If you’ve heard the term EBITDA thrown around and not truly understood what it means, now is the time to take a closer look, as it can be used to determine the value of your business.  That stated, there are some issues that one has to keep in mind while using this revenue calculation.  Here is a closer look at the EBITDA and how best to proceed in using it.

EBITDA is an acronym for earnings before interest, taxes, depreciation and amortization.  It can be used to compare the financial strength of two different companies.  That stated, many people don’t feel that EBITDA should be given the importance that is frequently attributed to it.

Divided Opinion on EBITDA

EBITDAIf there is disagreement on EBITDA being able to determine the value of a business, then why is it used so often?  This calculation’s somewhat ubiquitous nature is due, in part, to the fact that EBITDA takes a very complicated subject, determining and comparing the value of businesses, and distills it down to an easy to understand and implement formula.  This formula is intended to generate a single number.

EBITDA Ignores Many Key Factors

One of the key concerns when using or considering a EBITDA number is that it is often used as something of a substitute for cash flow, which, of course, can make it dangerous.  It is vital to remember that earnings and cash earnings are not necessarily one in the same.

Adding to the potential confusion is the fact that EBITDA does not factor in interest, taxes, depreciation or amortization.  In short, a lot of vital information is ignored.

Achieving Optimal Results

In the end, you simply don’t want to place too much importance or emphasis on EBITDA when determining the strength of a business.  The calculation overlooks too many factors that could influence future growth and prosperity of a business.

Business brokers have been trained to handle valuations to determine the approximate value of a business.  Since valuations take many more factors into consideration, they also tend to be far more accurate.

Keys to a Successful Closing

The closing is the formal transfer of a business. It usually also represents the successful culmination of many months of hard work, extensive negotiations, lots of give and take, and ultimately a satisfactory meeting of the minds. The document governing the closing is the Purchase and Sale Agreement. It generally covers the following:

• A description of the transaction – Is it a stock or asset sale?

• Terms of the agreement – This covers the price and terms and how it is to be paid. It should also include the status of any management that will remain with the business.

• Representations and Warranties – These are usually negotiated after the Letter of Intent is agreed upon. Both buyer and seller want protection from any misrepresentations. The warranties provide assurances that everything is as represented.

• Conditions and Covenants – These include non-competes and agreements to do or not to do certain things.

two businessman shake hands

There are four key steps that must be undertaken before the sale of a business can close:

1. The seller must show satisfactory evidence that he or she has the legal right to act on behalf of the selling company and the legal authority to sell the business.

2. The buyer’s representatives must have completed the due diligence process, and claims and representations made by the seller must have been substantiated.

3. The necessary financing must have been secured, and the proper paperwork and appropriate liens must be in place so funds can be released.

4. All representations and warranties must be in place, with remedies made available to the buyer in case of seller’s breech.

There are two major elements of the closing that take place simultaneously:

• Corporate Closing: The actual transfer of the corporate stock or assets based on the provisions of the Purchase and Sale Agreement. Stockholder approvals are in, litigation and environmental issues satisfied, representations and warranties signed, leases transferred, employee and board member resignations, etc. completed, and necessary covenants and conditions performed. In other words, all of the paperwork outlined in the Purchase and Sale Agreement has been completed.

• Financial Closing: The paperwork and legal documentation necessary to provide funding has been executed. Once all of the conditions of funding have been met, titles and assets are transferred to the purchaser, and the funds delivered to the seller.

It is best if a pre-closing is held a week or so prior to the actual closing. Documents can be reviewed and agreed upon, loose ends tied up, and any open matters closed. By doing a pre-closing, the actual closing becomes a mere formality, rather than requiring more negotiation and discussion.

The closing is not a time to cut costs – or corners. Since mistakes can be very expensive, both sides require expert advice. Hopefully, both sides are in complete agreement and any disagreements were resolved at the pre-closing meeting. A closing should be a time for celebration!

Copyright: Business Brokerage Press, Inc.

Why Deals Fall Apart — Loss of Momentum

Deals fall apart for many reasons – some reasonable, others unreasonable.

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For example:

• The seller doesn’t have all his financials up to date.
• The seller doesn’t have his legal/environmental/administrative affairs up to date.
• The buyer is unable to secure the necessary financing.
• The “surprise” surfaces causing the deal to fall apart.

The list goes on and on, and although this subject has been the focus of numerous business authors, there are more threats to a deal as it enters the due diligence phase. These threats silently can lead to a lack of or loss of momentum; forward progress is to deals what air is to humans – without it we begin to shut down. No one notices at first. Even most advisors won’t notice the waning or missing momentum. More often than not they’re too tangled up with due diligence matters to pay attention to the details. However, an experienced business intermediary will catch it.

Let’s say a buyer can’t get through to the seller.  The buyer leaves repeated messages, but the calls are not returned.  (The reverse can also happen, but for our example we’ll assume the seller is unresponsive.) The buyer then calls the intermediary.  The intermediary assures the buyer that he or she will call the seller and have him or her get in touch.  The intermediary calls the seller and receives the same response. Calls are not returned.  Even if calls are returned the seller may fail to provide documents, financial information, etc.

To the experienced intermediary the “red flag” goes up. Something is wrong. If not resolved immediately, the deal will lose its momentum and things can fall apart quite rapidly. What is this hidden element that causes a loss of momentum? It is generally not price or anything concrete.

It often boils down to an emotional issue. The buyer or seller gets what we call “cold feet.” Often it is the seller who has decided that he really doesn’t want to sell and doesn’t know what to do.  It may also be that the buyer has discovered something that is quite concerning and doesn’t know how to handle it. Maybe the chemistry between buyer and seller is just not there for one or the other of them. Whatever the reason, the reluctant party just tries to ignore the proceedings and lack of momentum occurs.

The sooner this loss of momentum is addressed, the better the chance for the deal to continue to closing. Because the root of the problem is often an emotional issue, it has to be faced directly. An advisor, the intermediary or someone close to the person should immediately make a personal visit. Another suggestion is to get the buyer and seller together for lunch or dinner, preferably the latter. Regardless of how it happens, the loss of momentum should be addressed if the sale has any chance of closing.

Due Diligence — Do It Now!

Due diligence is generally considered an activity that takes place as part of the selling process. It might be wise to take a look at the business from a buyer’s perspective in performing due diligence as part of an annual review of the business. Performing due diligence does two things: (1) It provides a valuable assessment of the business by company management, and (2) It offers the company an accurate profile of itself, just in case the decision is made to sell, or an acquirer suddenly appears at the door.

Due Diligence

This process, when performed by a serious acquirer, is generally broken down into five basic areas:

• Marketing due diligence
• Financial due diligence
• Legal due diligence
• Environmental due diligence
• Management/Employee due diligence

Marketing Issues
It has been said that many company officers/CEOs have never taken a look at the broad picture of their industry; in other words, they know their customers, but not their industry. For example, here are just a few questions concerning the market that due diligence will help answer:

• What is the size of the market?
• Who are the industry leaders?
• Does the product or service have a life cycle?
• Who are the customers/clients, and what is the relationship?
• What’s the downside and the upside of the product/service? What is the risk and potential?

Financial Issues
Two important questions have to be answered before getting down to the basics of the financials: (1) Do the numbers really work? and (2) Are the seller’s claims supported by the figures? If the answer to both is yes, the following should be carefully reviewed:

• The accounts receivables
• The accounts payable
• The inventory

Legal Issues
Are contracts and agreements current? Are products patented, if necessary? How about copyrights and trademarks? What is the current status of any litigation? Are there any possible law suits on the horizon? What would an astute attorney representing a buyer want to see and would it be acceptable?

Environmental Issues
Not too long ago this area would have been a non-issue. Not any more! Current governmental guidelines can levy responsibility regarding environmental issues that existed prior to the current occupancy or ownership of the real estate. Possible acquirers – and lenders – are really “gun-shy” about these types of problems.

Management/Employee Issues
What employment agreements are in force? What family members are on the payroll? Who are the key people? In other words, who does what, why, and how much are they paid?

Operational Issues
The company should have a clear program covering how their products are handled from raw material to “out the door.” Service companies should also have a program covering how services are delivered from initial customer contact through delivery of the services.

The question is, do you give your company a “physical” now, or do you wait until someone else does it for you – with a lot riding on the line?

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Copyright: Business Brokerage Press, Inc.

“Red Flags” in the Sunset: Avoiding Potential Problems in a Sale

Unlike that poetic title of an old-time standard song, Red Sails in the Sunset, red flags are not a pretty sight. They can cause a deal to crater. Sellers have to learn to recognize situations indicating there might be a problem in their attempt to sell their business. Very, very seldom does a white knight in shining armor riding a white horse gallop up, write a large check and take over the business – no questions asked. And, if he did, it probably should raise the red flag – because that only happens in fairy tales. Now, if the check clears – then fairy tales can come true.

SNo swimming sign at sunset with no sign of the sea - acreas of sand on Southport beachellers need to step back and examine every element of the transaction to make sure something isn’t happening that might sink the deal. For example, if a company appears interested in your business, and you can’t get through to the CEO, President, or, even the CFO, there most likely is a problem. Perhaps the interest level is not what you have been led to believe. A seller does not want to waste time on buyers that really aren’t buyers. In the example cited, the red flag should certainly be raised.

A red flag should be raised if an individual buyer shows a great deal of interest in the company, but has no experience in acquisitions and has no prior experience in the same industry. Even if this buyer appears very interested, the chances are that as the deal progresses, he or she will be tentative, cautious and will probably have a problem overcoming any of the business’s shortcomings. Retaining an intermediary generally eliminates this problem, since every buyer is screened and only those that are really qualified are even introduced to the business.

Both of the above examples are early-stage red flags. Sellers have to be focused so they don’t waste their time on buyers that are undesirable. If a buyer appears to be weak, does not have a good reason to need the deal, or is otherwise unqualified, the red flag should be raised because the chances of a successful transaction are diminished. The seller might seriously consider moving on to other prospects.

Red flags do not necessarily mean the end of the deal or that it should be aborted immediately. It simply means that the seller should pay close attention to what is happening. Sellers should keep their antenna up during the entire transaction. Problems can develop right up to closing. Here is an example of a middle-stage red flag: The seller has received a term sheet from a prospective buyer and is then denied access to the buyer’s financial statements in order to verify their ability to make the acquisition. As a reminder, a term sheet is a written range of value for the purchase price plus an indication of how the transaction would be structured. It is normally prepared by the would-be purchaser and presented to the seller and is non-binding. A buyer who is not willing to divulge financial information about his or her company, or, himself, in the case of an individual, may have something to hide. Due diligence on the buyer is equally as important as due diligence on the business.

If a proposed deal has entered the final stages, it doesn’t mean that there won’t be any red flags, or any additional ones, if there have been some along the way. If there have been several red flags, perhaps the transaction shouldn’t have gone on any further. It is these latter stages where the red flags become more serious. However, at this point, it makes sense to try to work through them since problems or issues early-on apparently have been resolved.

One red flag at this juncture might be an apparent loss of momentum. This might mean a problem at the buyer’s end. Don’t let it linger. As mentioned earlier, at this juncture all stops should be pulled out to try to overcome any problems. If a seller, or a buyer, for that matter, suspects a problem, there might very well be one. Ignoring it will not rectify the situation. When a red flag is recognized, it is best that it be confronted head-on. It is only by acting proactively that red flags in the deal can become red sails in the sunset – a harbinger of smooth sailing ahead.

Preparing for a Transaction: Six Tips from Transition Experts

By the time a business owner is thinking seriously about a sale, the window of opportunity is often already closing. This is part of the reason that more than 70% of deals leave money on the table and more than 50% never get to the finish line. It should be tempting in the current market, when strategic buyers have cash on the balance sheet and financial buyers have capital, to explore exit options.

Sellers should always be considering and weighing their options and should plan their possible exit three to five years in advance. The process begins with a rigorous analysis of the business, including sales, accounting, legal, operational, management and staffing. Owners must determine what needs to be done prior to a sale, at the sale, and after the sale.

A team of nationally recognized business transaction experts recently came together to share the most important advice they provide sell-side clients in the current M&A environment.

Bob Forbes, President, The Forbes M+A Group: Identify the key levers that can increase the value of your business — beyond just EBITDA.

Everyone knows they need to focus on growing revenue prior to a sale, but, beyond that, smart sellers are determining what key drivers could make their businesses more valuable. Perhaps employee turnover is an issue in your industry. Recognizing that and implementing strategies to reduce it could be a critical competitive advantage that would increase the value of the sale. Maybe concentration is a problem in your organization. Rather than focusing on increasing all sales, a more advantageous effort might be to identify ways to diversify customers, products, or regions.

Joseph Janiczek, Founder and CEO, Janiczek® Wealth Management: Consider the length of time a life-changing liquidity event must sustain you and what you want to do following the sale.

Many sellers who are of an older, more traditional age for transition face their transaction thinking about retirement and financial independence. There may be family, philanthropic, and legacy considerations that should be explored and these sellers are generally looking for a more conservative, lower-risk asset plan. On the other hand, younger entrepreneurs who plan to sell a business require a whole different kind of post-transaction plan and perspective. They might be thinking about their next deal or their next project and likely want to “stay in the game.” These sellers may become angel investors or may get involved in real estate investments.

Joanne Baginski, CPA, CM&AA, Consulting Partner, EKS&H LLLP: Sellers should conduct due diligence as comprehensively on the buyer as they are doing on you.

This advice is particularly important if an entrepreneur plans to stay with the business after the sale or if it is going to be a multi-phase (e.g., “two-bite”) sale. However, even if the transaction is 100%, sellers often have ideas about protecting their employees or legacy longer term. Do they know and understand your business? In some cases, a financial buyer might provide better options for the business and its existing employees, but, in other situations, a strategic buyer might be right. In either case, a seller can and should ask about previous deals the buyer has been involved in and might want to ask to speak to sellers from past investments.

Pål Berg, Managing Director, Northern Capital: Don’t get greedy — be prepared to take a little less now so that you don’t have to take a lot less later.

Yes, there are windows, and when you see one sometimes you need to take it. All you have to do is look at the oil and gas industry today to find people who should’ve sold years ago. Similarly, buyers should not only consider the highest offer. I’ve had experience with a private equity buyer that knew nothing about the oil and gas industry. In the end, the deal fell apart because they were nervous about the cyclical nature of the business. Several years later, we went back to market. It may have gotten a lower price, but the buyer was right, and a successful sale was achieved.

Lisa D’Ambrosia, Managing Director/President, Minor & Brown, PC: Both buyers and sellers are more cautious than ever but both are looking for the right opportunity, and the right advisors help.

While there are opportunities, this is a very conflicted market. As the due diligence process takes longer, the risk of a sale failing increases. This risk can be minimized by advance planning and preparation prior to entering the market place. Issues arise during the process that really shouldn’t create but a well prepared Seller can address potential issues earlier in the process to minimize delays. The right team of advisors can help you prepare and also help you determine what does and doesn’t need to be an obstacle. Each transaction has different challenges and, therefore, opportunities which need to be identified early. Having an experienced transaction team of advisors greatly increases a Seller’s likelihood of success not only for the transaction closing but more importantly having the transaction close at the anticipated purchase price and structure. Many clients who just have tax preparers don’t ask the right kinds of questions.

John Brown, CEO, Business Enterprise Institute, Inc.: Pre-sale exit planning is key. Sellers need to think about their potential sales earlier than ever.

Particularly for sellers who have not been involved in a transaction before, or have not been involved in one for a long time, preparing for sale before going to market can provide a myriad of benefits in terms of time and money. Proper planning can help increase the likelihood of transaction success, identify costly regulatory and compliance issues, and decrease the risk of inaccurate financial statements and resulting recourse.

Preparing your business for sale involves more than just cleaning up your books. Determining future needs (well in advance), strategically assessing buyers and offers, leveraging experienced advisors, and improving value-added business drivers will ensure the greatest chance of a successful transaction at the greatest possible value.