When parties sit down to hammer out the details of the purchase and sale of a business, agreeing on a valuation can be one of the biggest challenges.
In focusing on the value of a business purely in terms of monetary worth at a particular moment in time, it’s easy to forget the numerous other ways that parties can add value to or receive value from a transaction. Examination of the buyer’s and seller’s approach to business can offer a lot of insight into how a deal will work, and by understanding and considering the full spectrum of your motivations— and those of your counterpart, you can often find opportunities to move the needle in ways other than arm wrestling over the purchase price.
This series will highlight some of the business owner characteristics, motivations, and fears we often encounter in the world of mergers and acquisitions. The hypothetical business owners discussed here are amalgamations of personalities we’ve seen and are not meant to perfectly describe any particular person. You may, however, recognize some of these circumstances or motivations in yourself or others. Each time you do, consider it an opportunity to dig a little deeper and find opportunities to craft a better transaction for all parties. This discussion is by no means exhaustive or scientific, so make sure to apply your own judgment and experience. The real goal here is to help to get you thinking along potential axes for negotiation outside of the enterprise value on a specific date.
The Company is My Baby
Many business owners see the business as an extension of themselves and have a hard time understanding where the business ends and they begin. They typically pay themselves way too little and value the business way too highly. They will often have gathered trusted business, tax, and legal advisors over several years — and when the consensus that the owner has hit a wall and needs to retire/sell/raise money reaches a critical mass, he or she will do so. This does not mean the owner is happy to have other people involved in the business. This ownership approach often characterizes first time entrepreneurs and business owners who were deeply involved in starting and building a business offering, team, or location.
If you’re buying:
Entrepreneurs often value the resources and connections to make the next steps or work on their next project. Keep them on a management contract and point them toward business coaching - perhaps even make it part of their contract and compensation.
If you’re selling:
This is a win, celebrate it. Take your resources, contacts and rep to make your next project bigger and better. Consider a consulting agreement, press release, big celebration bash, and other ways to smooth the transition.
The Company is a Bureaucratic Necessity
Treatment of a company as an unwanted, but necessary structure that allows for the sale of a product or service is common view among professionals and others who are highly trained in a specific discipline. These owners are the primary productive engine of the business and spend most of their time working in the business, often to the detriment of organization, finances, and other formalities. For many such owners, making money is a secondary priority after carrying on their profession. These owners often continue to be personally responsible for delivering the goods or services of the company well into the life cycle of the business and rely heavily on professional advisors for the operations and management of the company. The owner will often have a strong sense of obligation to his or her patients/clients/customers, that is reciprocated by those parties, making the owner instrumental in retaining those revenue sources through the transition.
If you’re buying:
Understand that the owner’s sense of the value of the business can inextricably wrapped up with the owner’s personal reputation and history of contribution to the business. Separating the ongoing economic value of the business from this history can be a difficult task. Go to lengths to make sure that you will take good care of their customers, and make sure you keep the owner around to introduce and endorse new service providers and otherwise smooth the transition.
If you’re selling:
When it’s time to move on, make sure that your legacy is sustained through happy and successful clients/patients. Often the best way you can do this is to help to align the culture of the new owners with the expectations of your clientele, to ensure the best outcomes. Arrange to stay on in a reduced role, if possible, make some money, guide the business, and help your clients gain a level of comfort with the new owners.
The Company is a J.O.B.
This business owner got into business to secure employment and income for him/herself or family members. Consulting, small mom and pop shops, family-owned restaurants, and service franchises are places you’ll commonly find these owners. With time and success, it can be difficult to contrast these owners from others, but heavy involvement of the owner and other members of his or her family in day-to-day operations is often a tell.
If you’re buying:
The biggest concern for this owner will often be ongoing financial security (or financial security for family) and healthcare. If price becomes an issue, consider payment over time to guarantee income. A consulting or employment agreement, or agreement to employee the family may help. If access to health insurance is an issue, you may arrange to include the owner and family in your healthcare plan for some period after closing.
If you’re selling:
Consider staying on as a manager or consultant. You may be able to combine an active role in the company with a higher purchase price through a performance based earnout pad over time.
We’ll follow next week with some thoughts on working with (or being) a team focused owner, a retiring professional, and a serial entrepreneur -- but remember, every deal is different, and every party is driven by his or her own concerns and motivations.
If you see yourself or people you know in this article, great – hopefully we’ve given you some new options to think about. If not, use this as a jumping off point to explore the ways you can advance the discussion on a transaction without going back and forth on price. Please feel free to contact the team at Stock Legal to discuss ways to structure a winning transaction.
