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Many entrepreneurs cite the exit process as being one of the most difficult, time consuming, and emotionally trying experiences of their lives. The reality of selling a company stands in stark contrast to the manner in which it’s often portrayed in the media, where the entrepreneur allows the accountants and lawyers to sweat the details while she plans her vacation for the day after closing.
Because of the inherent difficulties of the process (and because selling a business is something that most entrepreneurs do only once in their lives – if they’re lucky), many entrepreneurs wisely seek help from an M&A advisory firm. These firms can include investment banks, corporate finance firms, business brokerages, and departments of larger accounting firms, among others. Broadly speaking, their mandates tend to include things like collecting and presenting relevant data about the company, building financial projections, approaching potential acquirors, soliciting and evaluating offers for the company, and guiding the CEO and her team through the extensive due diligence process.
This blog isn’t about whether or not to use an M&A advisor (as much has already been written on that subject), but instead what to consider when choosing between the seemingly endless number of potential advisors once you’ve already decided to use one.
I have used both good advisors and mediocre ones, and have had both unsuccessful and successful exit attempts as a result. Based on these experiences, I have an enhanced appreciation for the specific variables that I think are important to consider when making this critical decision. I hope you will be able to benefit from these lessons without having to experience the pain that led to them in the first place!
Lesson 1: Get Clear on the Type of Deal That You Want to Do, and Hire Accordingly
The concept of selling your company isn’t nearly as simple as it may sound. Exits can feature an enormous variety of acquirors, deal structures, financing tools, and plans for ongoing company operations, among other variables. As a result, the specific constitution of your exit can look wildly different depending on how these variables change: There are 100% sales, majority sales, and minority sales. There are strategic buyers (often larger companies operating in similar industries) and financial buyers (often private equity or similar firms). There are cash deals and stock deals. There are deals where the CEO exits on day one, and deals where the CEO must stay with the company for two or more years after closing. There are deals where all proceeds are paid to the seller on day one, and there are deals where proceeds are deferred or contingent upon some future event(s) transpiring. And so on.
Though it’s certainly wise to remain open to a number of different possible exit scenarios, when hiring your M&A advisor it’s prudent to be clear about the specific type of transaction that you’re looking to do. Though this may sound obvious, the type of deal that you want to do may (at least in part) dictate the advisor that you should choose. For example: If you’re seeking a sale where you sell 100% of your interest to a strategic acquiror and remain with the company for as short a time as possible, that may lead you to choose Advisor A, all else being equal. If however you want to sell <100% of your company to a private equity firm to fund future growth initiatives while you still remain at the helm of your company, that may lead you to choose Advisor B, all else being equal.
In my case, I was looking for the former type of sale (full exit to a strategic buyer), though I hired an advisor who specialized in the latter type of sale (partial exit to a financial buyer). Throughout the sale process, I found myself questioning why my advisor seemed to keep pushing me to consider the latter type of sale, despite my initial position that I preferred the former. “Take some chips off the table while giving yourself a chance to take a second bite of the apple!”, they’d say. In retrospect, it’s now clear to me that they were pushing me to consider this type of deal largely because they didn’t have the necessary relationships in place with the strategic acquirors who could have executed on the type of deal that I was looking for in the first place.
I’m not suggesting that any given advisor is either good at one type of sale or the other. Indeed, there are many M&A advisory firms who are entirely capable of guiding a CEO through either type of transaction successfully. Instead, I’m suggesting that it would behoove CEOs to enter their exit processes with clarity around the specific make-up of their desired sale, and ensure that their chosen advisor has a track record to suggest that they can capably help them execute on the same.
One way to run a quick sanity check on this is to simply visit the website of the M&A advisor to look at the transactions that they have successfully consummated in the past. In the case of the advisor that I had hired, an overwhelming majority of their previous transactions were exactly of the type that I didn’t want to do. This should have served as a warning to me, but it wasn’t a variable that I had really considered at the time.
Lesson 2: The Importance of Relationships
As alluded to above, one of the most important variables for you to consider is whether or not your M&A advisor has existing relationships with the type of buyer that you’re seeking. Though it may sound obvious, the existence of a trusting relationship between your advisor and a potential buyer is critically important. CEOs of companies who may be in a position to acquire your company are bombarded with calls and emails on a near-daily basis presenting them with acquisition opportunities. Because these CEOs are endlessly busy, they naturally can’t evaluate all of these opportunities with the same level of thoughtfulness and diligence. However, experience has shown me that when a CEO receives an email from a trusted investment bank (or business broker, or corporate finance firm), they often listen. This is so because the specific advisor in question has a tendency to only reach out to them with opportunities that are of high quality and demonstrate the potential for a mutually beneficial fit between buyer and seller.
As I stated in my previous blog “What I Learned During my First (Failed) Attempt to Sell my Business”, different potential acquirors are likely to ascribe different values to your business based on their own unique circumstances and considerations. In this way, businesses don’t have an absolute, objective, unambiguous value, but instead have relative value. A good M&A advisor will spend a lot of time seeking out those specific parties for whom your company has high relative value. A mediocre M&A advisor will offer the opportunity to anybody with capital to deploy, which inevitably includes those buyers for whom your business has low or neutral relative value. There is a high opportunity cost to spending undue time speaking with potential buyers for whom your business has low or neutral relative value.
Lesson 3: Size Matters
Though you may (mistakenly) want JP Morgan or Goldman Sachs to be your financial advisor when selling your SMB, that almost certainly won’t happen. Very tactically, M&A advisors often have minimum transaction sizes below which they aren’t permitted to participate. Even if a large advisor like Goldman Sachs was (theoretically) able to work on your transaction, I’d suggest that you’d be better off selecting an advisory firm similar in size to your own business. After all, where do you think Goldman Sachs will devote their time and attention? Towards a transaction where they can generate a 3% fee on a $200M sale, or towards your transaction where they can generate a 3% fee on a $20M sale?
In my experience, you’re much better off choosing a small but reputable advisory firm who is big enough to run a sophisticated and well-structured operation, but small enough where a deal of your size is going to be of material financial importance to them. Chances are, the degree of importance that your deal represents to them will be reflected in the time, energy, and degree of thoughtfulness that they dedicate towards it.
Lesson 4: The Fee Isn’t the Only Variable That Matters
When CEOs receive draft engagement letters from potential M&A advisors, the first place where most eyes go is to the success fee (aka the price) that the advisor is proposing to charge, often expressed as a flat percentage of the total transaction value. Fees expressed in this manner are common, and do tend to align the interests of sellers and advisors (the higher the price that the advisor is able to solicit from the buyer, the more money both the advisor and seller can make). Even better however is the “scaled percentage” structure, where advisors receive a higher percentage fee if the value of the transaction exceeds certain agreed upon thresholds. Success fees charged by M&A advisors can range considerably, though in SMB sales they tend to be roughly in the neighborhood of 2% – 4%.
Regardless of how your fees are structured however, fees are far from the only variable to consider when selecting your M&A advisor, as we’ve seen above. Beyond fee amount and structure, here are three other key terms to look out for:
- The “Tail”: An official engagement with an advisor can end for any number of reasons: Perhaps the transaction in question never gets consummated, perhaps the seller changes her mind and decides not to sell at all, or perhaps the relationship got frayed somehow along the way. In situations like these, the formal engagement ends and a “tail period” begins, often lasting as long as 12-24 months. If a sale transaction occurs after the relationship with the advisor has been formally terminated but during the tail period (i.e. 12-24 months from the date of termination), the M&A advisor will still be entitled to their fee even if the advisor did nothing to actually help consummate that sale. From the perspective of the advisor, this term is understandable, and prevents a situation where an unscrupulous seller fires them shortly before a transaction closes simply to avoid paying them their success fee. From the perspective of the seller however, these tails can present challenges: What happens if you fire your advisor after only a handful of months because they’ve proven themselves to be incompetent, and in 6 months you end up selling your company after having worked with a better advisor? In a situation like this, the success fee would still be owing to the terminated advisor, all else being equal. Naturally, sellers want tail periods to be as short as possible, and advisors want tail periods to be as long as possible. A few ideas to negotiate a better tail structure can include:
- Have the tail period clause applicable only after a certain number of months have elapsed after the initial engagement letter is signed. Let’s say, for example, you agree upon a figure of 3 months. In this way, if you fire your advisor within 3 months of the initial engagement, no tail period would commence. If you fire them after 3 months, then the tail period would begin should the agreement ever get terminated
- A success fee should only be payable to the advisor if the actual acquiror of the business turns out to be a firm that was uniquely introduced to you by the advisor. This way, if a company acquires you that the advisor had never contacted (perhaps had never even contemplated), then the tail fee would not be due or payable to them
- Timing of Payments: Though some fees only become due and payable upon the successful consummation of a transaction, just as frequently advisors charge “milestone” payments. For example, a fee could become due after the seller has been introduced to X parties, has had management meetings with X companies, or has received X LOIs. Other times, interim payments become due simply based on the passage of time from the initial engagement date. Though these interim payments are often netted against a success fee if a deal gets consummated, they still represent cash that sellers have to part with that come with no guarantee of a deal getting done. Again, it’s understandable why advisors propose fees like this (they expend material resources themselves in the early days of a deal), but in an ideal world, sellers would prefer their fees to be fully contingent upon the successful consummation of a transaction.
- What’s Included in “Transaction Value”: As I’ve discussed in “What I Learned During my First (Failed) Attempt to Sell my Business” and “Busting the Biggest Myth About Selling Your Business”, the proceeds that sellers receive in return for selling their companies isn’t always composed of simply cash. It could include things like debt assumed by the purchaser, earn-outs, “rolled over” equity, or seller notes, among other things. Of course, advisors theoretically want as many of these variables as possible to be included in the definition of “Transaction value” (as their fee is expressed as a percentage of that value), yet buyers presumably want to include only those amounts that are certain to be received, which can’t be said for something like an earn-out. Because of the non-standard definitions of Transaction Value, simply comparing the “headline fee” between different potential advisors can lead to an apples-to-oranges comparison: A 3% fee isn’t necessarily more expensive than a 2% fee if the former is based only on cash proceeds, but the latter is based on cash proceeds + assumed debt + fair-market-value of earn-outs + value of seller financing.
Structuring a mutually palatable engagement letter is ultimately a negotiation between yourself and your potential advisor, and like any negotiation, you’re unlikely to get everything you desire. Though the terms above represent items to which CEOs should pay particular attention, I would not necessarily expect to see each term lean in the favor of the client. Ultimately, the terms of the engagement need to present a sufficiently attractive risk/reward profile for both parties.
Lesson 5: The Importance of Reference Checks
Though many CEOs wouldn’t hire a C-Suite executive without performing a few reference checks, surprisingly many of these same CEOs don’t bother to perform reference checks when selecting their M&A advisor. This is surprising, as naturally the best source of insight on any given advisor is likely to be the other CEOs with whom they’ve worked.
Importantly, you should seek these CEOs out by yourself (if you ask your advisor for references, do you think they’ll send you anybody other than those who have glowingly positive things to say?). Instead, look at the “historical transactions” portion on their websites, and find the CEOs who worked on each of those deals. You can use tools like LinkedIn, or you can read the press releases that often get issued after a deal closes, which often feature a quote from the selling CEO.
These conversations are worth their weight in gold, and any advisor selection process would be incomplete without them.
Lesson 6: Beware the Advisor That Tells You Only What You Want to Hear
Good advisors are just as selective in choosing their clients as smart clients are in choosing their advisors. This makes sense, as a good advisor will dedicate an enormous amount of time and resources towards your transaction, and as a result wants to select only those deals that present them with a sufficiently high probability of successful closure (all else being equal). For this reason, unless you run an objectively top-decile, world-beating company (by definition, most people don’t) you may wish to add an additional layer of skepticism to an advisor that wants to take on your mandate without a thorough understanding of your company, industry, and all of their attendant risks and opportunities.
This is particularly true if you’re interviewing multiple potential advisors simultaneously: Beyond the fee that they charge and some of the other terms already discussed, another lever for them to pull to differentiate themselves and ultimately persuade you to hire them is for you to simply like them. As flawed human beings, consciously or otherwise, we tend to like people more who say nice things about us, make the future sound easy, and provide us with a sense of comfort in an otherwise uncomfortable and uncertain time. In other words, they appeal to our egos, and usually not by accident. Though optimism and compliments in and of themselves are not necessarily warning signs, you should be duly skeptical of advisors who don’t paint a realistic picture for you. One practical (and very common) example concerns valuation: Mediocre advisors sometimes float unrealistically high valuations to sellers before they’re formally engaged as a way to get the seller excited. Often, these advisors over-promise and under-deliver, but collect the success fee nonetheless once the transaction closes. In contrast, a good advisor will likely propose a palatable but realistic valuation based on their relevant experience and depth of understanding of both company and industry. They’ll further counsel you on both upside and downside cases, but will ultimately aim to under-promise and over-deliver.
A literal scorecard (as presented below) is by no means required, but when I was choosing between potential advisors, I found it helpful to list my decision criteria in a single place, and use it to evaluate each possible advisor based on the variables that were uniquely important to me. You’ll notice that my scorecard goes well beyond the six lessons that I’ve discussed above, as naturally there are many more variables that one will likely consider when selecting their advisor. I’ve included my own specific considerations below, but you will likely have your own.
A word of caution: Instead of using your scorecard as an unassailable, objective source of absolute truth, I’d suggest that you simply use it as another tool in your toolkit to help you make this critical decision: If one advisor has a score of 37.5 and another advisor has a score of 37.0, that doesn’t necessarily mean that you should choose the former, as the score is only as useful as the inputs, which are inherently quite subjective.
The selection of your M&A Advisor is one of the most important decisions that you’ll make in the process of selling your business, because so many other decisions (and their likely outcomes) will likely flow from this one critical choice. As a result, take your time, and be clear on the criteria against which you’ll be evaluating candidates. Though price is an important consideration, it is certainly not the only consideration, as a truly good advisor can be worth every penny that they earn.
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