Imagine you’re planning to buy a business. Regardless of industry sector or market, if you’re a smart buyer — and of course you are! — you’re going to have some fairly high expectations for whatever business you buy. It must be comprised of top talent. It’s got to be run well. It must be making money and growing steadily, and it must have potential for continued growth in the future. In terms of contracts, cap table, business practices, intellectual property, and executive management, it’s got to have its act together. After all, nobody wants to buy a business that’s a poorly run mess or legal liability.
Now imagine that you’re a startup who wants to sell your business. Do you fit all of the buyer’s requirements? Are there areas of your business in which you need to clean up your act before you’ll be taken seriously? Can you produce the documentation required to showcase that your business is a sound investment? What story do your financials and legal documents tell?
Finding a buyer for your business can be a highly intimidating process. Nobody wants to look desperate, unprofessional, or unprepared. Nobody wants to settle for a buyer simply because they’re the only option on the table. With that in mind, how can you make sure you’ll have the right pieces in place? How can you make sure the buyer will provide a good home for your business? How do you avoid looking desperate — and thereby lowering your company’s valuation? And how can you set yourself apart from other potential acquisition targets?
To help demystify the process of paving the way for successful sale of your startup, Distillery sat down for a Q&A with Lori Murphree, Managing Director at Diamond Capital Advisors. Murphree focuses specifically on advising marketing service and digital media companies through their sales processes, so we asked her to help us sort out the DOs, DON’Ts, and best practices for selling your startup.
Work with a trustworthy advisor that knows your industry.
As Murphree relates, if you decide to sell your company, it will change your life. The impact your M&A advisor has on exactly how it changes your life is huge. In addition, it’s a relationship that’s likely to extend over a period of years. Accordingly, you want to be certain you’re working with a good advisor who you’re positive you can trust.
In addition, since your advisor is there in part to help you make sure your business is an attractive target for acquisition, it’s crucial that they have a strong understanding of both your business and industry. In large part, your advisor’s role is to help you tell the story of your business in the best light possible to help you attract the right buyer. To do that, they need to understand both the good and the bad aspects of your business. Often, that means advising you on the best ways to capitalize on your good points and either mitigate or get rid of the bad aspects.
Find a buyer whose vision aligns with yours, and make certain your continued involvement with them will bring you happiness.
Murphree is absolutely passionate about this one. As she explains, when you’re working with an advisor, you want to “Make sure they’re going to negotiate for YOU, and for whatever your objectives are. That they’re not just in it to make a quick buck and run off. Yes, hopefully everybody makes a lot of money. But you want to find a home for your business, because it’s your baby. Especially in the creative industry, people do it because they love it. So you want to make sure you’re selling to someone who you’re going to be happy about.” Murphree continues, “Honestly, the way you’re going to make a lot of money is if you’re happy enough to stick around long enough to get your earnout. Not enough people talk about that. We want you not just rich, but rich and happy. Not rich and miserable.”
NOT have a CFO.
“This is a big one,” says Murphree. Sadly, however, it’s a surprisingly common mistake among early-stage companies. Companies without CFOs may lack crucial components such as:
- Internal processes (not only for financial reporting, but also for keeping all legal documents accounted for, making sure documents are signed, etc.)
- Cash management
- Budgeting and three-year projection plans, which are absolutely essential components
- Good margins and control in spending
Wait too long to start talking to an advisor.
Murphree advises talking to an advisor as early as possible. Typically, businesses desiring to sell can begin talking with potential acquirers when they’re at about $1.5M in EBITDA. To begin working with an M&A advisor, however, “You don’t need to wait till you’re at that size,” asserts Murphree. She advises, “Come talk to me when you’re at 800k or $1M in EBITDA.” Why? Well, the acquisition process itself takes at least nine to ten months — and, as a seller, your business will be in much better shape if you’ve been proactively seeking future-focused guidance and advice during the years leading up to your sale. Says Murphree, “If you want out in three years, you need to start [the process] at one.”
Assume you’ll never want to sell.
You may think you’ll never want to sell. But none of us can predict the future, and if circumstances change, you’ll be left without an exit plan. (More on this later.)
What are buyers looking for in the companies they acquire?
While every situation is unique, smart buyers seek out several specific characteristics in the companies they acquire. According to Murphree, these characteristics include (but are not limited to):
- Revenue growth and possibility. After all, all buyers — whether they’re venture capital firms, private equity firms, large holding companies or corporations, or smaller players looking to grow — are looking for sound investments. Do you have a sizable market, as well as significant traction within that market? For example, if a business has an iOS or Android app with a massive potential market but only limited traction, that’s simply not attractive for a buyer.
- A great company culture that fits with their vision. Buyers want to see happy employees, low turnover, and a focus on training. After all, the buyer is essentially buying your team, which means they’re buying the creativity, ideas, and execution power embedded within that team. So they’ll look at cultural fit, as well as how your company fits into the acquiring company’s big-picture goals.
- Year-over-year growth in your client/customer base. In particular, says Murphree, they don’t want to see a lot of turnover in your client or customer relationships. If you do a lot of project-based work that lends itself to shorter-term relationships, that can be okay. But they’ll want to see that, in addition to having repeat clients or long-term customers, you continue to attract new ones.
- An impressive, diversified client list. According to Murphree, having some big-name clients can be an important consideration for many acquirers. In addition, having a client concentration — in which a single client is responsible for more than 50% of your revenues — can make buyers nervous. While it’s not necessarily a deal-breaker, it is something they’ll want to discuss with you in detail.
- Specific disciplines. For example, Murphree says, “Within marketing services, buyers may be looking specifically for experiential marketing, brand marketing, or mobile marketing, depending on the areas they want to grow. Or they may want to round out their own service offerings.” In addition, given the ever-increasing market demand for data, in-house data analytic capabilities may be attractive to buyers.
- Geography. While not always a factor, a target’s location can play into a buying decision. For example, this may be important for East Coast companies looking for a West Coast presence, or international companies seeking to establish a presence in the United States.
- Numbers. Of course, your numbers matter. Those numbers will come in many forms:
- Revenues. Typically, buyers are looking for revenues over $5M. If you have revenues of $10M-$15M, you may gain the attention of some of the bigger holding companies.
- EBITDA. This is an important figure for any potential buyer outside of the technology sector, and for some technology buyers as well. In the service industry, a company’s valuation is typically based on a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization). According to Murphree, the minimum potentially acceptable EBITDA for service companies is probably 10% of revenue. An EBITDA of 15% would be about average, and 20% would be considered good. Advises Murphree, “Above 20% tends to get the seller a higher valuation.”
- Cash position. You don’t want to run out of cash during a process. That means it’s very important that you either have ample cash, good investors behind you who will put cash in, or AR (accounts receivable) that will soon convert to cash.
- Debt position. Using debt is okay, but you don’t want to be over-leveraged — where all of the cash coming in is constantly going back out to pay down debt. In addition, a buyer is going to want to make sure they can make an offer that will make the owners happy. If they offer an amount for the company, any debt will come out of that amount. Therefore, if you have too much debt, you can potentially not be paid anything for your company except the relief of the debt the buyer will end up taking over.
Does it matter to buyers if my startup is funded with equity or debt?
According to Murphree, the short answer is no. There are, however, caveats:
- About equity-funded companies, she advises, “Make sure you don’t have a really mess cap table with multiple raises from hundreds of people. It’s not horrible — and it’s not not-doable — but it’s very messy.” Buyers prefer situations in which the cap table isn’t too messy, since there aren’t a ton of different equity holders with potentially disparate preferences. They also prefer when you yourself have “skin in the game.”
- About debt-funded companies, she says, “It’s fine to use debt, but you don’t want to be over-leveraged.” After all, in your company’s valuation, they’ll subtract any debt you have from your company’s value.
What materials will I need to prepare to entice potential acquirers?
As Murphree explains, pitching potential acquirers typically involves three different documents:
- The first is a highly detailed deck that provides an overview of nearly every part of your business. That deck could be 60 pages in length. You or your advisor will send that deck to potential buyers for their review, which means that you won’t have the opportunity to present that document in person.
- If a potential buyer is interested in learning more, you’ll be asked to come in person to give a management presentation. A typical management presentation will comprise approximately 30 slides, and can run from anywhere between 45 minutes to 2 hours.
- Finally, there is an anonymous one-page document that includes a high-level summary of the key attributes of the company, including what they do and some very high-level numbers (typically revenue and EBITDA for the past three years, and the projected amounts for the next three years).
What should your materials focus on? Says Murphree, “If someone is looking at buying you, they’re going to want to see: Have you grown and been profitable? That’s the first detail they’re going to look at.” Accordingly, you want to make sure your materials tell a compelling story that reflects both growth and profit.
What due diligence package should I have ready to go when I begin meeting with potential acquirers?
Acquiring companies expect to see fairly comprehensive due diligence packages. According to Murphree, your package will include documents in each of the following primary buckets:
- Legal documents for your corporation. For example, if they closely review your operating agreement, will they see that you are following it correctly? Are you making correct distributions and equity injections? In your debt agreements, is the debt correct? Will you be able to cover any payoff penalties stipulated within those debt agreements?
- Client and vendor documents. Are all of your vendor and client contracts signed? What are the details and arrangements within each of those contracts? What’s your revenue breakdown per client? They are likely to interview several of your top clients.
- Employment agreements and other HR matters. For example, do you have signed non-compete agreements with all of your employees? Have you been following appropriate HR policies?
- Taxation. Have you been calculating, withholding, and paying correct taxes?
- Past financial statements. Again, have you grown and been profitable? Are your finances what you say they are? What’s the state of your P&L, your balance sheet, and your cash flow? At minimum, they’ll expect to see the past three years’ worth of statements.
- Projections. Where is your business headed? Have you laid a strong foundation for future success? At minimum, they’ll want to see projections at least three years into the future. They could ask to see projections for as many as five years out.
- IT systems. How are you handling and storing data (e.g., cloud)? How is it secured?
As Murphree relates, you’ll typically have both a pre-diligence meeting and a more formal diligence meeting with your potential buyer. “It’s a pretty robust process. They will look at everything,” explains Murphree. “You want to check all your documents, making sure everything is tidied up and signed.” As an early part of your diligence process, Murphree strongly recommends bringing in an advisor to proactively look through all of your documents, “playing devil’s advocate and pointing out holes.” Murphree and her colleagues perform that service for their clients during the initial diligence check, before marketing materials are created. That way, they’re positioned to help their clients either mitigate any issues that arise, or find a way to write them into the story.
How do you find companies to work with?
Murphree often meets potential clients through third-party referrals or at events. Given her industry focus, marcoms conferences or events hosted by organizations such as ThinkLA or Ad Age pose good opportunities. She’ll also look at indices relevant to her market (e.g., Ad Age’s lists of top agencies) and reach out to companies on those lists.
In addition, Murphree looks for firms that are winning awards and otherwise standing out in the market. “Good PR goes a long way,” says Murphree. In other words, companies who wish to be regarded as an attractive acquisition should be strongly focused on cultivating good PR.
What should I look for in an M&A advisor?
As previously outlined, trust and industry expertise should be at the top of your list. In addition, Murphree recommends seeking an advisor with:
A complementary mindset.
Does the advisor understand how entrepreneurs and startups think and operate? Murphree and most of the other partners at Diamond Capital have past experience running their own businesses. She explains, “We understand that this could be the biggest decision of their life, and we don’t treat that lightly.”
Passion, persistence, and a focus on your best interests.
Will you feel confident that your advisor is working for YOU — and not just for their cut? As discussed earlier, the right advisor will be focused on helping you find a genuinely good home for your business. In addition, the right advisor won’t be a fair-weather friend: instead, they’ll also stay by your side through the inevitable ups and downs experienced by all businesses, and they’ll stay committed to helping you find and complete the deal that’s right for your future. Says Murphree, at Diamond Capital, “We tirelessly work to make sure it gets done and gets done right.”
What’s the single most important piece of advice you can give to a startup founder that may hope to sell someday?
Murphree doesn’t hesitate. She says, “Plan for the exit in the beginning. If you want to get from point A to point B, look at point B.” She explains that people sometimes hesitate about doing so, telling her, “I don’t want to sell because I love what I do,” so they don’t want to think about forecasts or exit plans. Murphree tells them, “Things might change, and then you won’t know where you’re going. You have to have something in mind.” In that mindset, thinking of your exit just as you’re getting started isn’t a defeatist mentality. It’s simply smart thinking that helps you plan for your own future.
If you have any additional questions for Lori about planning for your startup’s financial future, you can email her at email@example.com.
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