“Have you figured out what you want to have, or to be, when you reach the end of your personal run in this business life?”

It is a fair question to ask.

Most of us work in our businesses, either as managers or owners, and rarely step outside

to think about how this will end in a perfect world.

Investors call this discussion “exit planning” and of course they include themselves in the discussion.

But this is more personal, isn’t it? 

If you are relatively young, you probably think of this question as too distant to consider seriously.  Of course, you’ll find another exciting venture and start again.

But for most of us, this question is or should be real and very personal.  And obviously, the answer depends upon the circumstances of our lives, our age, and our health among other factors.

The truth behind the question:

[Email readers, continue here…]    And the truth is that sometimes our business runs end badly, not with a crazy–large wire transfer or retirement bonus, but with a quick goodbye or a failed enterprise.

But this question begs for a positive answer. 

How would you like to see your finish line?  If you own a significant piece of the business, is this a time to consider planning an eventual exit or liquidity event?  Or do you plan to pass control to the next generation if appropriate?

Considering the alternatives early in the timeline helps you to monitor growth in terms of valuation, weigh the value of continued investment, bring family members into the discussion, and picture the end game in your mind.

Over the recent weeks in this blog, we have examined issues related to all phases of business management, including a piece on “evergreen companies,” where your picture of success is one involving the next generation continuing your good work, and not a sale of the company.

 But we have saved this question for last. 

Where we have examined your management style and given insights into your business life, now we ask you to consider – even if just for a few minutes – that next or last stage.

Perhaps for the first time, this is a question to share with family.  From considering retirement to plowing right back into another run, family is deeply involved in this, and should be.

So here is my wish for you.  Consider what you want in the end from your years of work, often years of sacrifice between business and family, with business often winning more of the time battles.  And picture how this should finish.  Make that picture vivid and actionable.

Then work toward and enjoy someday crossing that finish line just the way you envisioned.

Obviously, we all want to sell at the top.  And there is the problem.  How do you know when you are at or near that right point to sell for maximum value?  Those of us in the business of calculating (guessing) this mythical peak in value often make the same mistake as our entrepreneurs.  We hang on just a little bit longer, expecting continued or accelerating growth and value as in previous periods of the same.

But there are wolves in the woods.

Yes, there are – when it comes to entrepreneurial growth.  Companies sometime run out of cash in the midst of their increasing success, and often find that sources of loans or investment are not freely flowing at the moment of need.

Growth brings financial issues.

Young companies have been known to outgrow the abilities of management to focus and direct them, failing to make the transition to organized, stable growth.  Competitors, seeing a successful development of a niche, flock into the competitive void with products or services built with a fresh view of the current environment.

[Email readers, continue here…]   Think of major companies, public and private, that have lost their shiny appeal over time, including Zinga, LivingSocial and Fisker in this generation – and Alta Vista in the last.

So, the question: load up with more equity and dilution? Or sell now?

For young companies, often the question is whether to suffer a new round of dilution to stimulate growth, or to sell earlier and not share the (presumably) increased proceeds with additional investors.  Not so long ago, Basil Peters wrote his book, “Early Exits,” after analyzing 150 young companies and their exits.  He concluded that the sweet spot for valuation was in the $20–30 million sales price range, and that many, many times more deals were completed in that range than above $100 million in valuation at exit.  Adjusting these numbers to fit your circumstance, the conclusion is that waiting for higher value after sustained growth becomes more and more of a risk in the majority of early stage cases.

What about those unicorns?

There are only a few Uber or AirBnB investments to point to – where the street value of the company may ultimately validate that amount of investment.  LivingSocial took in $583 million in capital in 2010 and 2011 with little left in time to show for the investment and tremendous dilution to the founders.

And some of us know from experience that, in a retrospective view, some of our entrepreneurs and their boards of directors pay the ultimate price of erasing all economic value by waiting too long.  In such instances, the phrase, “race to zero,” perfectly describes the result of a miscalculation in the name of either optimism or greed.

The first rule: 10/40:

One of my company CEOs recently described his rule for acquisition success, and it resonated with me as a great goal for planning during acquisition exercises.  This CEO states that he has made it work twice when acquiring companies, and that is enough for him to make it his rule for all future acquisitions.

If the target company can show a ten percent EBITDA (earnings before interest, tax, depreciation and amortization), then the acquisition team should be able to create a way to make the resulting acquisition yield forty percent EBITDA after re–engineering the combined entity.

That’s quite a goal to achieve.  But there are obvious and not–so obvious ways to make it happen, even if over time.

The second rule:  The 20/20 rule

If you are experiencing 20% annual growth and 20% net profit before depreciation and tax, or any combination that adds to 40% (such as 10% profit and 30% growth), you are a prime target.

How to “sell” expense reduction and growth prospects

[Email readers, continue here…]   Here are some of the checklist items your acquirer will consider.  Dual layers of senior management remain only during the transition period and transfer of institutional knowledge from acquired to acquirer.  The best performers from the acquired become candidates to outrank or replace their counterparts, showing that a business combination is not all one–sided.

Accounting and HR operations are combined as quickly as possible, as are customer service call centers, retaining specific product skills on the front line from the acquired company.  R&D efforts may remain separate for a period or forever, but R&D management is consolidated as soon as possible to avoid territorial disputes and retention of inefficient development processes.

Sales organizations may or may not be combined, but senior sales management is consolidated so that commissioning, territorial management and product management functions all harmonize.

Facilities may become redundant or oversized after these efforts, allowing for consolidation of facilities as well.

If we follow the reasoning of our CEO who proposed the rule, we can drop an additional 30% of the net revenues (after cost of sales) from the acquired company to the bottom line.  Not a bad goal, and certainly not a bad result.

Finding your strategic partner, investor or business buyer is not something you do haphazardly.  There are many steps to take, each closer to assuring a success.  Research is paramount, and sources are everywhere, especially for public companies and large investment firms.

Start with the “matrix method.”

You and your advisors, board or partners should start by completing what you can of the matrix shown on this page.  It will help you to focus upon the most likely candidates and save lots of time.  Here are the steps to take.

Find up to ten likely candidates that fit your business.

You can list companies you know, have contacts within, or that fit your industry segment.  Think of those who might need what you have to offer.  In fact, that leads to the most important part of this process.

Examine the four columns in the matrix.

[Email readers, continue here.]  Column one is your list of your candidates in no particular order, usually the result of a brainstorming session where you participate or lead.  For corporate boards, even those not looking for a buyer at this time, I often help to manage this exercise in board meetings once every few years. It keeps the board and CEO focused upon an ultimate exit.  That’s important when you’ve taken money from investors and have outside shareholders.  When taking their money, you made a promise to “make them liquid” someday, not to build a lifestyle business where they would be trapped forever, unable to see a return on their investment.

Column two is the golden ticket.

“What would the candidate want from your company in a transaction?”  Think carefully.  Some potential buyers or strategic partners might want your intellectual property, or revenues, or profitability, geographic advantage, or sale force, or your employee base.  Select the most likely reason you’d find if you could “get into their heads” and see what they might value most.  We’ll come back to this column in a moment.

Column three is important for you and your stakeholders.

Here you state in a few words what your company would want for the candidate – other than cash or investment which seems obvious.  Your definition of a great fit might include their distribution capability, their brand, dominance in your field, their sales force, their access to growth capital or more.

Column four is the easiest but also important.

Here, on a scale of 10 to 1, is your best guess of the likelihood of making a favorable deal with the candidate.  A 10 means that you are absolutely sure there is a need and a fit and the ability of the candidate to pay in a range you anticipate.  A 1 is tantamount to a complete waste of time.

Now return to column two.

You will surely notice that a majority of your estimates of the candidate’s interest or needs are the same, one to another.  This may surprise you and the team because this is your (sometimes hidden) core competency as others see you.  A wise board and management would take their own hint and strengthen that core, whether it is your development team, your geographic dominance or other trait.  And strengthen that at the expense of other areas of your enterprise which may easily be outsourced or reduced in scope.

The net result of this exercise.

You will have focused upon your real value, identified a list of companies with executives you need to know soon, even if long before any suggestion of a transaction.  Even a five-minute introductory call to the CEO with no agenda works for later name recognition.  And the exercise of researching through search engines, friends, financial sites or trade publications will begin to help you develop a picture of each candidate’s needs and strengths.

This exercise is time well spent and should pay back in multiple ways in your future if not immediately.

You’ve worked hard for years to reach the payoff, and the money sure looks good as you contemplate the wire transfer to come, and then watch your bank account fill to a level you only dreamed of during those rough cash flow years.  You might even allow yourself to admit that you almost lost it all several times during this long run, and that only you knew how close you came to the abyss.   But you did make it, and that’s what counts.

Your set of complex emotions

Whether the exit was as large as you hoped, or whether your goals of taking care of all the people who helped you get to this point were realized, the exit itself generates a complex set of emotions in all of us.

First there comes a sense of relief and maybe guilt.

You no longer need to worry over daily cash or threats to your net worth.  Then you experience a feeling of guilt when you realize that not all your early associates share the same outcome, either financially or perhaps with their continued employment with the buyer.

Then the money…

Then you focus on the money in your bank account, smiling at the accomplishment of accumulating assets that are tangible and can be valued, perhaps for the first time.

[Email readers, continue here…]   But what about the pause to celebrate?

What most entrepreneurs fail dramatically at is to celebrate the moment.  To celebrate with those who took the journey with you, with those closest to you who sacrificed as you spent those long hours away. To celebrate with your suppliers who helped you, especially during the rough times.  To celebrate with your customers, who worry over continuity and look to you for assurances that the transition will not negatively affect them.  And to celebrate for yourself, for making it all the way to the finish line.

…and consider those whose exits were not so great.

Not many founders or entrepreneurs do experience the success of a favorable sale of the business they dreamed would make them rich.  Many fail multiple times.  Some fail in the first year of the attempt.  Others are diluted by subsequent investors to the point where there was nothing for them to celebrate at all in a sale.

So, as you prepare to turn over the reins to another; to separate from a business that has become a part of your being, it is time to think of nothing but the good done, the examples set, the positive company culture you leave behind.

Remember the lessons learned, and friendships gained.

As you begin to focus upon the future, remember the emotions, the lessons, the lasting friendships from the past.  I often advise managers, CEOs and entrepreneurs always to part on a positive note and never burn the bridges of any past relationship.  You’ll never guess whom you’ll meet in your next act, and how they will be able to contribute positively to your next success.

Take time to reach out.

So, celebrate your exit by reaching out to as many of those who’ve helped along the way as you can.  Close this chapter of your life on the highest note possible.  Take a long breath.  Then do as all good entrepreneurs do.  Start dreaming of the next big idea.  Take with you the best wishes from those in your past and build upon the education you received with this effort.

Here are some thoughts for you.

Write a book. I did.  Write a handwritten letter to someone who helped you make it to the finish line. That extra effort will shock and please them.  Call an early key employee and take that person to dinner as a thank you for those hard times.

Hit the beach.  Pay attention to your family.  Think about investments and tax efficiency.  Go into a mental dark room and dream about your next act.  Take a long breath, or weeks of long breaths. Exhale slowly.  This is what a moment of reduced pressure and responsibility feels like.  Savor that moment.

Then if it strikes you as right, start the process all over again.  May you have only the greatest success in your next act, whatever that is and wherever it takes you.

Sometimes the end game or sale of the company is not a happy event for the early investors, including the entrepreneur or the founders.  Especially when outside investors, venture capitalists or angels have put in substantial money, and the sales price is not enough to give them a reasonable return for the time and money invested, these investors can be – in a word – greedy.

The order of liquidation or payout

Most sophisticated investors will take either a promissory note or preferred stock, both of which come before founder or management stock in a sale or liquidation.  Promissory notes come before any equity, and most late equity investments come before early equity investments, even of the same class of security.  This makes for some head-rubbing when attempting to calculate the return on investment with a proposed sale.

…and there are those accumulated dividends.

Further, preferred stockholders can be recipient of accrued dividends in a sale or liquidation.  A rather common but small dividend rate of six percent becomes a massive amount after seven years, almost half again the value of the original investment.  And some preferred investors have participation rights, where they take all the above amounts, and then also convert their shares into common stock and participate again alongside the founders and option holders.

Sometimes it takes a court case to unravel onerous terms.

It is in this combination of possible methods of amassing a return that greed can become a significant factor, so much so that the courts are sometimes stepping in to void some of the most onerous terms of investment agreements when challenged by those locked out of payment in a sale.

Here’s an example that will make your heart skip a beat.

[Email readers, continue here…]  Take a situation where the VC investors finally see the chance of a return after ten years, with participating preferred and fifty percent of the ownership after several rounds.  A marginal sale at twice their original invested amount could yield a starting value of eighty percent of the sales price due to the VCs (fifty percent invested plus accumulated dividends for ten years at six percent which equals thirty percent of the sale price) and then fifty percent of the remaining twenty percent after participation. The result is that the preferred shareholders would receive ninety percent of a sales price (nearly was double their investment), compared to the remaining ten percent shared by the founders and all others, including angel investors and option holder-employees.  Ouch!

No-one complains if the sales price is ten times the investment since there is plenty to go around.  It is in these marginal sales that the formula distorts returns so badly in favor of the investors.

Sometimes these investors volunteer to be fair to all.

Fortunately, and perhaps because the courts have not looked favorably upon these overwhelmingly one-sided outcomes, many VCs will voluntarily forgive either accumulated dividends or participation in a marginal sale, especially if the sale is cultivated, planned and carried out by the efforts of the common shareholders including the founders.

One tool often used: the “cutout” for management

Although many VCs are openly against allocating a “cutout” for management in marginal sales, practically speaking, management must be taken care of in marginal sales, or the sale might not happen at all.  In a cutout, some percentage, usually fifteen or twenty percent of the total sale, is allocated to management to continue operations through the closing period and help in closing the sale.  That further reduces the amount available to founders if not still in the ranks of management.

Here comes the headline:

So, this advice is directed to those investors.  Don’t be greedy even if you can.  You will not be moving your IRR needle enough by grabbing a few extra dollars in a marginal sale, but you will incur the wrath of a number of stakeholders who would be more than willing to spread the word far and wide about your greedy ways.  And that reputation will last for a long time in the entrepreneurial community.

Conversely, I have praised and seen others praise VCs who volunteer to eliminate participation clauses even before knowing the ultimate sales price in a deal.  It is those investors who receive the loudest accolades since they have given up a right for the good of the rest of the investor and management community.

The emotions we feel when “turning out the lights.”

Several times in my investing life, as the final board member making the arrangements to dispose of remaining assets, I have literally been the one to turn out the lights, carry out the documents, books and records to my car, and become the only remaining contact between the failed business and the investors, bankruptcy court, or creditors.  I volunteered to do this several times when there was no-one else, even the founders, to do this.  And these were emotional experiences to say the least.

We ask ourselves “what if?”

In aviation circles, we read in our pilot magazines about “Never again!” or “I learned about flying from that.”  Pilot-authors tell their stories in the first person, and all of us readers slow down to think while reading of these events, wondering “what if” or whether this could happen to me.  And if it did, would I have reacted differently?  Most importantly, we think: ‘Now that I know this, would I behave differently if it did happen to me?’

How about the entrepreneur -founder?

Professional investors rarely attach a red letter upon a failed entrepreneur.  In fact, if that person can tell their story and relate the lessons learned clearly, there is a positive response many of us will make to the next pitch from that person.

Investor pattern match

[Email readers, continue here…]  We who invest look for patterns from previous experience.  Some of those patterns help us to spot and avoid problems we have seen play out in the past, often to disastrous conclusion.  We learn to worry over obsolete inventory, too rapid hiring, failure to spot industry trends that make an offering less attractive, and so much more.  Most of us can tell specific stories of losses that led to these expensive and gut-wrenching lessons.

Here’s a near miss that just happened.

I just helped an entrepreneur to consider reorganizing his young business from being a value-added reseller into a software and consulting company.  It would not be handling the expensive hardware that is part of its required sale at all, other than to recommend alternatives and charge for coordinating the purchases of differing supplier products, oversee the installation. It could then charge for setting up, integrating, and training the company’s software, all because its customers would not know how to do any of these important tasks.

This follows from my previous insight: “Where there’s mystery, there’s margin.”

Asa result, the entrepreneur could avoid a fundraising effort, reduce working capital, make friends with the salespersons of multiple companies that could supply leads and references, and become instantly profitable.

Some fatal elements that might become only a near miss.

So, what if that startup could not have raised funds? What if it had a hiccup in collection of payment from a large hardware order?  What if the hardware manufacturer had serious problems with product quality on site?  All these things which could have driven the company out of business when betting very large amounts on other companies’ hardware would be avoided.

Why do we tell this story?

Turning out the lights from a company following an existing business plan to extinction teaches us lessons.  Pre-thinking alternatives to the events causing the negative exit might just prevent it.  Which would you rather do?

How it happens today

All the documents were signed in a rolling series of emailed scanned or DocuSign signature pages during the past week or more, with each party signing their own set, never having to be in the same room to sign the single signature page for each agreement.  And in the end, the deal that means so much to you closes with a whisper.  You check your bank account every half hour to see if the wire has been posted.

And if you are a major shareholder:

Finally, it arrives, and you see the balance in your account jump to a number you’ve never seen there before.  You pause for a minute to savor the victory.  And you go back to what you were doing right before that moment.  Or not.  But the closing was such a non-event that you wonder why people even call it a “closing.”

Congratulations.  You have joined an exclusive club and have earned your membership.

Memories of how it used to be

[Email readers, continue here…]   It used to be thrilling to participate in a real “live” closing.  The date and time of the closing would be published for all interested parties.  The lawyers for both buyer and seller would meet the day before to go over a “trial closing” to be sure all documents were ready to sign.  And on the appointed morning, often at 10 AM, all attorneys, the investment bankers, you and your buyer’s CEO would all gather in a large conference room with documents already spread around the conference table.

After pleasantries, you and your opposite CEO would pick up your (fountain) pens and start moving around the table, signing agreements in the appointed spots until your fingers were weak from the effort.  The lawyers would follow and check, then finally all nod that the work was done.  A handshake, applause, a promise to meet the next day, and a celebration closing meal either immediately following or at a future time sealed the deal for all.

Those were the days.  The smell of the newly copied papers, the smudges from the fountain pen ink, the tension followed by smiles all around, all contributed to the feeling that something grand was happening.

And my favorite closing memory…

My favorite closing followed this pattern with a twist.  There must have been 25 of us that arrived for a 4:00 PM closing after the day-before trial closing by the attorneys.  We all expected to be finished and out of there for a late dinner.  At five the next morning, after an all-night session with revisions, midnight calls to the buyer’s parent CEO in New York and more, we finally signed the papers, all completely worn out from the many anxious moments and long, long night.  All the parties vowed to go home and get some sleep.  I went home, took a shower, and went to work as if a typical day, working now as CEO of a subsidiary of a parent company.  And yes, I checked the bank account every half hour for the wire transfer.  Some things do not change.

For those of you who ever experience the muted thrill of today’s electronic closing, you can give a nod to those days when the sometimes-smoke-filled rooms were real and the tension palatable, when a closing was a face to face event.

How investment bankers behave

Investment bankers sometimes slow the process by requiring a cloud-based “data room” and  “deal book” to be prepared containing considerable information about a company to help a buyer.  Deal books are expensive to create.  If you have a data room already, all the better.

Other investment bankers insist that the company create competition for a deal, even if the buyer has already submitted a letter of interest to the seller.    Competition opens the deal to more public access, slows the deal and could give competitors wind of an otherwise confidential process.  And yet, it is almost universally acknowledged that without competition for a deal, the price will be lower, sometimes much lower.

Then there is the question of fees.

For small deals, an investment banker will ask as much as ten percent, although the average is slightly above half that.  For larger deals, expect the fee to start at five percent and scale downward with size.  And expect the investment banker to ask for an advance against expenses of at least $20,000 or much more with larger deals, with any unexpended funds not to be refunded.  If a buyer is already in hand, many will work for far less in percentage fees, and even in advances, because much of their work is done at that point.

An unexplained conflict of interest

[Email readers, continue here…]   And there is the question of whether an investment banker has a personal agenda to get a deal done in minimum time, even if the proceeds to the seller are less than could have been expected.  Is there any conflict of interest?  Is this not a parallel to the question of a real estate agent who cares little about that last five or ten percent of the purchase price, if it would kill a deal or slow its close, since the agent’s  commission amount is only a fraction of that difference?

How about the corporate attorney guiding a deal?

And finally, could not the corporate attorney do just as good a job of negotiating a great deal for the seller, and do it for hourly rates instead of a percent of the transaction?

In my experience, the answer is…

My experience is that good investment bankers do add significant value to a deal in most cases, easily earning multiples of their fee by increasing competition, upping the price, and finding areas for extra value that the seller did not think of.   Good investment bankers work with your attorney to structure the deal, help the seller to see more of the value hidden in the candidate seller, and increase the sense of urgency to close the deal among all parties.

Insulating the CEO and team as negotiations get tough

Perhaps most of all, a good investment banker will insulate the seller CEO against the anger and ire of the buyer during the process that always accompanies stressful negotiations or issues revolving around the seller CEO’s continuing employment contract.  Imagine you’re fighting with the buyer CEO about your expected salary and benefits during a transition period to follow, expecting to work harmoniously with that CEO after all the tension and conflicts during the negotiation of the deal.

And imagine having that buffer in the form of the investment banker arguing on your behalf while you sit silently, giving up little or no good will during the maelstrom around you.

Your next steps

Presented with these mental pictures and the recommendations from so many of us that have done deals with and without investment bankers, you may lean toward interviewing a group of your industry’s best for the size of your deal, and being convinced that creating such a team is a good investment.

Maybe you have not heard the term, “deal book.”  That’s a comprehensive piece on a company for use by a buyer in determining fit.   A “deal room” is a cloud-based or physical space dedicated to storing the massive amounts of data to be used in due diligence by a buyer, lender or by an investor.

Your data room and its contents

Data rooms contain access to or copies of all significant contracts with suppliers, customers, consultants, and others.  All corporate governance documents, from incorporation articles to minutes of all meetings of the board are maintained in the deal room.   Up-to-date insurance policies, leases, financial documents and schedules such as fixed assets are copied here.   Copies of intellectual property filings such as patents, copyrights and trademarks, all owned URL addresses, and even copies of source code, may be resident in the deal room, dependent upon the type of buyer.  Current documents relating to any lawsuits by or against the company are maintained there as well. 

Who will use it and when?

In this day of electronic record-keeping, access to the deal room is available remotely by a buyer with appropriate access, saving the long and expensive personal visits by lawyers, accountants and others to the seller’s facility.   Well-maintained deal rooms enhance a company’s image with a buyer, quicken the pace of the deal, help maintain secrecy from employees while due diligence is in process, and lower the stress levels of all parties during the process.

When to start a data room?

[Email readers, continue here…]   But maintaining such an electronic or physical facility is time-consuming and costly.  The question is whether to start this exhausting process early in the life of a corporation, or rush to complete it when a deal is identified or the run to a sale is imminent.

Because deal rooms have multiple applications, the best advice is to begin the process right after incorporation and make keeping it current a continuing job of your financial senior management.  Whether it means copying physical printouts and creating volumes in three-ring binders or scanning documents and creating electronic folders, incremental additions are much easier to make than an all-out run at the finish.

The payoff

Bankers, investors, strategic partners, and ultimately your buyer or even attorneys providing opinions for an IPO, will all be most impressed by your thoughtful early management decision to make their lives easier and their job more productive.