How To Raise Capital AND Retain Partial Ownership Of A Business

By Generational Equity

02/09/2015

Quite a few of the business owners that attend our exit planning workshops are not there to sell 100% of their companies. Many are there because they need capital for growth and are interested in learning about some of their options for doing so. Essentially each owner wants to attract investors to acquire a percentage of his or her company’s stock and re-capitalize the business for expansion.

Although Generational Equity generally focuses on finding buyers that want 100% of a target’s business, we do provide partial sale services. This is where a buyer acquires 51% (or more) of our client’s stock and retains existing management to help grow the business. Normally the types of buyers who create these deal structures are private equity firms.

This arrangement can be quite lucrative for all parties involved; in fact around 26% of our deals closed in 2014 were with private equity groups (PEGS).

However, throughout the years we have cautioned business owners that are interested in this type of investor to make sure that they are realistic and do their research prior to approaching PEGs, especially if they are going to do so without professional assistance and guidance. Here are some issues to be aware of if you, too, are thinking of approaching this group:

• Have realistic expectations of your company’s value
• Create documentation that contains the typical information equity firms want to see
• Understand that these deals take time to nurture and close
• Be sure to approach equity firms that are interested in your industry/size of company
• Get legal advice to ensure that your interests are protected
• You need to invest money to make money

Since many of these are self-explanatory, I will only highlight a couple of the most important ones for you here. To learn more, attend a Generational Equity M&A seminar. These educational meetings cover a full range of buyer types, including equity firms, and how deals like this can be structured.

What Is My Business Worth?

One of the most important issues you will face is your expectation of the value of the business. All too often business owners are approached by Larry at the country club, who 20 years ago owned a business. After a couple of cocktails Larry tells you that your business is worth XXX millions and that you shouldn’t accept a dime less. Over time in the business owner’s mind, Larry’s napkin valuation typically grows to the point where reality is far off the horizon.

Don’t let this happen to you. If you expect to sell 60% of your company to an equity firm and retain 40% of the new entity, you need to know what 100% of the company is truly worth in today’s market.

On the flip side, some business owners undervalue their businesses because they focus on the negative issues that take up most of their time to control and maintain.

You need to avoid both of these scenarios by having your company valued by a professional business valuation firm (and not an appraiser of equipment, your company is most likely worth more than the depreciated value of your equipment). A professional valuation firm will use a variety of methods to determine the most accurate range of value for your company.

On a side note, Generational Equity’s valuation team was named Valuation Firm of the Year in 2020 by The M&A Advisor. Quite frankly, no M&A team in the lower middle-market has evaluated more businesses than our group. You need to find a company that can provide this type of service as well.

One last thing about valuations: Your accountant may be able to do this, however, chances are good he is not an expert in valuation methodologies and his/her value conclusion will probably be torn apart by an equity firm.

Correct Documentation is the Key

OK, assuming that you now have an accurate value range for your business in hand, you need to create documentation that equity investors want to see. You have to keep this in mind: Professional buyers with these firms will look at literally HUNDREDS of opportunities every year. This means that you need to create information and provide it so that they can quickly decide if you merit further review.

Two key pieces of documentation you will need are:

1. A Confidential Business Profile (CBR a.k.a. a Teaser Letter)
2. An Offering Memorandum (OM)

Note: Both of these need to be based on “recast” financials.

The CBR is a one- or two-page summary of your OM, only it is written in such a way to disclose just enough information to attract interest WITHOUT letting folks know who you are. What you need to do is provide top and bottom-line financial data for three historic and five projected years, explain why your buyers buy from you, what future opportunities your company provides, and generally where you are located (state and region typically).

If you are not a professional writer or an investment banker with experience, this document can be a challenge. It needs to be creative but not bombastic. Avoid terms like “industry leader,” “only one of its kind,” and “no competition” as you prepare your teaser.

The OM is your 60- to 100-page document that you provide after a target has signed your non-disclosure agreement (NDA).

Note: Your NDA needs to be drafted by an attorney. See the fifth bullet point above.

The OM should document your past and, in great detail, explain your future growth. Again, avoid hyperbole here. If your company has been growing at a 5% clip for 20 years and your net profit margin has hovered around 8%, be careful not to suddenly show 30% growth and 15% margins in your OM. It will be discounted and most likely, you won’t get a follow-up call.

Why Hire An M&A Professional?

If you want top dollar for your company, odds are better if you hire an M&A professional to represent you. Certainly equity firms acquire privately held companies all the time that are not represented by advisors. But they do so to their benefit, not necessarily the business owner’s. In fact, in a recent article on the Axial blog (Axial is a leading B2B website matching business owners with capital providers), their research found this:

“In the study, entitled Does Hiring M&A Advisors Matter for Private Sellers?, Agrawal et al. discovered that ‘private sellers receive significantly higher acquisition premiums when they retain M&A advisors.’ Although ‘top-tier’ intermediaries offered the highest acquisition premium, the benefit of the M&A advisor held true across all deal sizes.”

You might ask, why does this happen? Simple: Hiring an M&A professional helps you with all six of the issues listed above.

Once retained, a professional firm will perform a thorough evaluation on your company to determine value. Then, they will create documentation that will help attract buyers and close deals. They will guide you through the 12-18 months it takes to close most deals and help you understand the process.

An experienced M&A advisory firm will approach those equity firms that make sense based on relationships they have developed with them. And finally, in conjunction with your legal counsel, they will help to ensure that any deal created protects your interests while getting you the most value in both the short and long term.

So it is a good idea to spend some money to make some money!

As mentioned, Generational Equity holds educational seminars on these topics since we know that most business owners may have a vague idea of their options and what they want to do; however, they have never formally created an exit plan. We are here to help. If you would like to learn how, give us a call at 972-232-1121 or fill out a contact form and we will give you all the details.

Carl Doerksen is the Director of Corporate Development at Generational Equity.

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