The decision to sell a business
In my view, decisions are typically made very late, especially for small businesses. If a business constitutes 10 to 20 percent of a company's revenue, there are many strategic discussions about its compatibility and future actions.
Smaller businesses, however, tend to be overlooked. Particularly in a strong market, they're neglected, as corporate development officers prefer acquisitions, and business leaders don't feel any urgency since the business operates smoothly.
When the market weakens, that's when a strategic review usually happens. Over the past couple of years, I believe every company has conducted a comprehensive portfolio review and rediscovered these minor assets. They've realized these assets are off-strategy and potentially draining resources, or if not, they're still seen as a distraction.
That's when the corporate development team is contacted with a directive to dispose of the unwanted small business. This typically marks the beginning of the process for handling these subscale businesses.
Reasons to sell the business
It's not that we can significantly benefit from the money because the amount we're talking about is relatively small. For a company worth 20 or 30 billion dollars, or even 5 billion dollars, a purchase price of 3, 4, 5, or 10 million dollars doesn't really have an impact. It's not a constraint.
More often, it's because the business is losing money, and in a weak market, when people fail to meet their targets, they look for ways to improve their performance. So, a division GM might decide they no longer want that part of the business.
Or, it could simply be a distraction. Consider running a 200 million dollar business and wanting to concentrate on the core 190 million dollars you're building. Yet, at every quarterly and financial review, someone mentions the small business that you inadvertently own, perhaps because it was handed down from another division or included in a larger acquisition.
These businesses become highly distracting, particularly when the market is down, prompting questions about their relevance. Sometimes, a strategy initially envisioned for them is abandoned. At that tipping point, the business decides to dispose of it, and the corporate development team is tasked with the responsibility.
There are times, often years after a business has been identified as off-strategy, that it's handed over to corporate development. It's frustrating for a CorpDev officer to receive an asset that has been neglected, possibly mismanaged, and stripped of its leadership for the past two years, and then be expected to sell it.
They might wish they had the opportunity to sell it when it was in better shape. However, that is the reality for dealmakers; they don't always control the timing of business decisions.
Steps in selling a small business unit
Selling a large asset is different as it typically involves hiring an investment banker and allocating substantial resources due to the significant capital involved. For a subscale asset, the process needs to be efficient.
For instance, you'll have to assemble a data room but will rely on existing materials like marketing, financial, and internal reporting decks to avoid the effort of creating new ones from scratch.
Often, hiring a banker isn't viable for smaller assets due to the cost; the fee structure doesn't make sense. You're left to manage the sale internally, which means identifying which resources can be used. The business is generally reluctant to allocate resources to sell an asset they no longer want, as it does not enhance their operations.
All this necessitates running a streamlined process in terms of material preparation, buyer outreach, and transaction procedures. In some instances, companies may even opt to close a business if the sales process proves too costly or distracting. As a corporate development officer, your role is to streamline the process sufficiently so the business opts to sell rather than shut down.
You also have to do a confidential information memorandum (CIM). You will need the essentials, but it won't be as polished or as meticulously crafted. You might skip the teaser depending on your buyer pool, but you will need something resembling a confidential information memorandum (CIM) containing necessary information.
A data room is also essential. Additionally, for a divestiture, you must carefully consider the transition services. When you dis-integrate a business, it's crucial to contemplate the repercussions for both the divested entity and the remaining business. Unless the business has operated independently, these considerations are vital.
You have to determine what ongoing services a buyer might require and how to handle residual components, like a partial HR resource dedicated to the business being sold. You can't simply eliminate half a position, so you must decide what to do with the surplus HR resource post-sale.
Lastly, you must identify your potential buyer universe. As a corporate development officer, you're essentially performing the role of a banker but in a much more streamlined manner because you cannot allocate extensive resources to such a small transaction. The return does not justify a heavy investment, so you must find ways to streamline all parts of the deal process.
When it comes to transition service agreements, you don't need to prepare for it in advance, but you must clearly know your objectives and boundaries. Understanding what you're willing to offer and what you want from the deal is crucial, as factors beyond purchase price often carry more weight in smaller deals.
Finding buyers presents a challenge without a banker for a very small business. Begin by consulting the business or the team you acquired with the business to identify natural buyers, considering product and customer fit.
You can leverage existing banker relationships for insights but won't be able to explore every possibility. Focus on identifying strategic buyers where there's a natural fit or financial buyers interested in the sector and the business's size and growth dynamic.
However, there's a caveat with strategic buyers: you want to avoid selling to a direct competitor unless you're certain it won't impact your core business or help them compete against you in other areas.
The ideal buyer is a financial investor that specializes in small, growing businesses or a strategic buyer that does not compete with you but needs your offering.
In summary, conduct a brainstorming session, utilize all available resources, including known bankers and your team, to compile a short list. It won't be exhaustive, and you'll miss some prospects, but for a deal of this scale, it's impractical to do more.
Avoid using bankers
If you're selling an asset you expect to fetch around 4 to 5 million dollars, you'll likely handle the sale yourself since only a small number of bankers might be interested, especially in a down market considering the fee structure. Instead of using bankers, you'll directly reach out to potential buyers, inquire about their interest, and run a lean process.
This isn't a drawn-out process. It's more efficient: one week to contact all natural buyers, another week to sign NDAs, two to three weeks for data room review, three weeks for letter of intent (LOI), selection of a buyer, due diligence, negotiation of documents, and closing.
Remember, the corporate development team has more significant acquisitions to focus on, which are more important and strategic to the company. So the goal here isn't to maximize purchase price but to conclude the transaction efficiently while addressing more crucial variables than just the purchase price.
Pitching the deal
Just pick up the phone, call the funds that we think might be interested, call the corporates who might be interested. They don’t necessarily have to be people you already know. If I think they're a natural buyer, I’d call them directly. They will take my call because they are in the business of looking for targets.
And private equity funds are continually searching for potential acquisitions, so they will usually be willing to take a call and consider an asset. It's crucial to maintain discipline by filtering out those who are just browsing, which I refer to as 'looky-loos' from the process.
A concise process is preferable because all parties are interested in gaining insights—strategics want to understand competitor moves, and private equity individuals want to evaluate the assets. Understanding that information sharing is necessary, my aim is to avoid time-consuming due diligence calls.
A streamlined approach involves providing a concise packet of information, one discussion with the business manager, and then swiftly moving to request a letter of intent (LOI).
Avoiding non-serious buyers
There are a couple of ways you can tell if they are not serious buyers. First, a lack of urgency. Those who aim to purchase an asset, like a corporate development officer or private equity investor, have a drive to finalize the deal and achieve exclusivity swiftly.
On the other hand, a casual observer, or "looky-loo," will resist this urgency, probably hesitating to sign a letter of intent (LOI), and definitely not rushing to engage legal counsel.
Second, watch for external expenditures. A serious buyer will invest in legal fees for due diligence, potentially amounting to tens of thousands of dollars. The moment a buyer’s lawyers begin billing is a clear indication of serious intent.
Moreover, the nature of their questions can be revealing. Are they merely seeking to understand the business, or are they inquiring about integration and operational specifics? A serious buyer focuses on the mechanics of the business and potential synergies, while a casual observer concentrates on general market information and customer behavior.
While I can often identify the level of a prospect's interest, I wouldn’t exclude anyone from the process prematurely. Instead, I'd streamline the process to bring them swiftly to the point where they must decide whether to advance or withdraw.
Important factors other than price
When discussing micro deals, there are aspects far more important than the purchase price. For instance, when acquiring personnel, it's crucial to ensure they are well taken care of. I'd want assurances that there will be no dramatic changes to their benefits or job security.
Customers are even more critical. They don't care about divestitures; they'll hold the original seller accountable if there are issues with the product or service. If the divested unit's customers are also significant to the parent company, you wouldn't want to jeopardize a multimillion-dollar relationship over a smaller product that you've sold off.
Thus, I look for commitments from the buyer to maintain certain levels of customer service and not to alter pricing drastically, at least for the first year, to safeguard those customer relationships. I need to make sure that by the time you do anything to make my customer angry, they no longer think of you as part of me.
Transition Service Agreements (TSAs) are vital, and I aim to limit the distraction to my team post-sale. I'd want to minimize the support needed during the transition while managing any associated costs, like HR resources, that aren't immediately reducible.
Regarding legal agreements, lawyers are naturally wary of liability, especially in small deals. A buyer who minimizes legal risks and manages their lawyers to be seller-friendly is highly desirable.
Ongoing commercial relationships are complex. Sometimes you want to divest entirely, but often you need ongoing licenses or want to prevent the buyer from working with competitors through non-compete clauses. Revenue-sharing arrangements or sales partnerships may be more valuable than the actual sale price.
It's also important to recognize that while purchase price affects the overall balance sheet, revenue from TSAs or ongoing commercial relationships can positively impact the profit and loss of a business unit, which division heads often prefer.
Lastly, PR and messaging are essential. No company wants to signal failure, so the way a divestiture is communicated can be crucial. In some cases, retaining a minority stake allows the seller to present the transaction as a partnership rather than a divestment.
These negotiation points can create substantial value beyond the purchase price. For example, as a private equity buyer, I may not care about the press release, which can be leveraged to the seller's advantage.
Committing to maintain customer relationships, even if it doesn't cost me much, can provide immense value to the seller. These non-purchase price factors are opportunities to generate significant value that can sometimes exceed the purchase price itself.
Real life example
The simplest example is the employees. For a certain period, we don't want the employees disparaging the transaction. So if the buyer is planning to reduce benefits this year to save $50,000, You can negotiate and tell the buyers to delay the changes for a year and allow the deal to settle.
This way, we can distance our brand from any potential negative impact on those employees. We're willing to reduce the purchase price by $50,000 because we value the smooth transition and maintaining a good reputation over the immediate savings. We want to avoid any rumors or issues with the employees until they are clearly associated with your company and not ours.
I can often predict their intentions because I'm familiar with my company's compensation and benefits, and depending on the type of employees and their roles within our business, my level of concern varies. I'll address this issue proactively by stipulating in the contract that there will be no changes to benefits or compensation structures for the first 12 months following the closing date.
With regard to legal aspects, there's significant potential for value creation. Statistically, litigation over M&A transactions is very rare, except in cases of fraud. Despite this, lawyers commonly default to demanding heavy representations and warranties because they believe they should have the right to sue if anything is amiss.
However, I will encourage the buyer to manage their lawyers' expectations. If there's fraud, certainly, they have the right to pursue legal action, but for minor inaccuracies or data discrepancies, litigation is unrealistic. Therefore, we should avoid such pretenses and give our General Counsel peace of mind by removing these stipulations from the agreement. In return, we can reduce the purchase price by 20%.
Also, negotiating unusual terms can be complex, as there's often a network of ongoing commercial relationships.
Take the Transition Services Agreement (TSA) for example; it usually presents opportunities to create value for both parties. For instance, I could allow my sales force to continue selling the product for you in exchange for a reasonable revenue share, on the condition that you agree to a non-compete with specific competitors for the next two or three years.
This strategy benefits me by putting them at disadvantage while still allowing you to maintain some market presence. You might also retain a revenue commitment based on how strongly I desire the non-compete. In some cases, I might even offer a minimum revenue commitment.
Technology licenses are another area of negotiation, particularly in tech businesses where technology or data often overlap with other areas of my business, necessitating ongoing access. Conversely, the business being sold might not own all the necessary technology, so you would need to license some from me.
These situations are opportunities to create value: the seller generates ongoing revenue and can introduce new products to customers, while the buyer avoids starting from scratch.
In cases where the business for sale is intertwined with the rest of the company, suggesting previous attempts at creating synergies, there's a strong chance for these to continue post-sale with the buyer. If the business was kept separate and never integrated with other company parts, this may not apply, but that's quite rare in my experience.
The largest valuation gap I've encountered on a divestiture was about a $5 million discrepancy. We aimed to sell a business for $10 million, but the buyer only wanted to pay $5 million, which is a significant 50 percent difference.
To bridge this gap, we first eliminated all representations and warranties from the agreement, essentially offering a seller-friendly contract and only asking the buyer to provide their address.
Next, we expanded the Transition Services Agreement (TSA) since we had various stranded costs within our organization. The business had been utilizing fractions of employees in finance, HR, and so forth, and we couldn't immediately downsize these departments due to the business's small size. We couldn't, for example, dismiss one-tenth of an HR person.
We structured the TSA to last three years, providing us the time to reallocate these employees to other tasks, and we charged the buyer market rates for these services, effectively turning it into a profit center.
Additionally, we incorporated technology licenses and a non-compete clause to prevent our competitors from gaining any advantage through this deal.
Altogether, these measures allowed us to accept a lower price because our alternative was shutting down the business. Shutting down would not just result in zero revenue; it would be a negative outcome as we'd incur severance costs. Thus, a $5 million sale was a substantially better outcome.
Evaluating the business
When I operate, I start with my own valuation expectations. As someone who roughly values a hundred deals annually, I follow a process to determine a reasonable valuation for the assets I'm looking to buy.
I have two figures in mind: the market valuation and what I'd actually accept, which is typically lower due to potential shutdown costs. For instance, while the market valuation could be $10 million, I might be content with $3 million.
Once I have my valuation clear, I seek early indications of valuation in the deal process. After providing the interested parties with the necessary information and a management call, I expect them to submit a valuation range or amount, ideally by the time they present a Letter of Intent (LOI).
I ensure minimal investment of time and resources in any individual buyer before receiving their valuation indication. This includes basic interactions like phone calls and emailing existing materials. It's also important to me that Non-Disclosure Agreements (NDAs) are not heavily negotiated; they should be accepted as is, given their low likelihood of litigation. If a potential buyer is preoccupied with the NDA terms, they're likely not serious about the deal.
By the time I request a valuation, I've only invested a couple of phone calls and a brief interaction with the management team. Sometimes, I even provide a preliminary revenue multiple expectation to avoid wasting time for both parties. If their expectations are significantly misaligned, they can opt out early in the process.
Now, when the business is suddenly hot and there are a lot of interested parties, my behavior wouldn’t change very much. But if I totally misread the value of the business, then I would probably invest more resources in running a more robust process.
For instance if I'm thinking I'm getting 5 million dollars for this business and a bunch of people come back and start valuing at 40 to 50 million, then I'm going to run a much more rigorous process because I want to extract that value. Getting 10% more on a 5 million dollar deal is not worth it, but getting 10% more on a 50 million dollar is worth it.
I've never seen an instance where, when divesting a subscale business, the bid-ask spread is anything but "no one wants this" or "a few people are somewhat interested." Reality dictates that if it's an exceptional business with strong growth, it's unlikely to be divested.
Typically, these businesses are, at best, a diamond in the rough, or at worst, a falling knife. It's very rare to encounter more interest than anticipated. In fact, it's usually the opposite; we might go out expecting serious interest from about ten entities, only to find the first eight we contact are not even willing to consider it. The more common issue is wondering if we have a busted deal on our hands.
Hardest part of selling a small business unit
First, from a corporate development officer standpoint, is not running a rigorous process. We have all been wired with best practices. We’ve spent hours watching M&A Science and learning the right way to do this. So it is very uncomfortable to not pursue best practices.
But, we must recognize that a smaller project doesn't warrant the same resource allocation as larger ones, considering its size, impact, and the nature of divestitures. Acquisitions offer potentially infinite upsides, unlike divestitures, which are more about halting losses and adding a modest amount of cash to the balance sheet.
It's crucial to approach divestitures efficiently, in a manner that's scaled to their size, rather than seeing it as cutting corners.
Another challenge is the perception within companies that divestitures signify failure. This can mean corporate development officers don't receive deserved recognition for successful divestitures, which are rarely seen as a stepping stone to promotion.
It's a struggle because, although divestitures can indeed create value, they do so in a way that is often not acknowledged, such as by mitigating losses. Stopping the pain, as with applying a bandaid, has significant value, even if it's not immediately apparent.
Advice for first time buyers
The first step is self-awareness, recognizing that the deal is complex and will require significant effort. The second step is to establish yourself as the natural buyer. This means positioning yourself as a strategic buyer with synergies and an understanding of the business's dynamics, making it easier for you to take over and integrate the asset.
Being a natural buyer has its advantages, such as corporates being more likely to engage with you if you've made yourself known to them.
For instance, as a corporate development officer in a software company, if someone from a professional services background shows interest in my assets, I'm skeptical about their chances of success. I would regard them as either just browsing or likely to withdraw at the last minute. Therefore, be the natural buyer for the asset, and also conduct market intelligence to identify struggling assets.
Typically, by the time an officer is tasked with divestiture, the business has been languishing for some time and its status should be common knowledge. Aim to get in early, because once the divestiture is underway, if following my advice, the officer will move quickly. They won't contact dozens of potential buyers; they'll target the five to ten most natural buyers to expedite a deal.
Being proactive in the market and engaging with corporate development officers who recognize the compatibility with your existing business is essential. Then, there's an element of chance, being in the right place at the right time since assets become available unpredictably.
Lastly, there's no harm in expressing interest in an asset that may not be officially for sale. If you're aware of a business within a larger corporation that is not receiving investment and is being neglected, reach out to the corporate development officer. Suggest that the business could be a good fit for you and inquire if they've considered selling, thereby initiating the dialogue.
But the reality is that corp dev officers don’t want to focus on divestitures unless they completely have to. So you have to come to them with an investment thesis. The most crucial aspect of our strategy is to communicate effectively with the seller and the corporate development officer. We make it clear that we understand their business and constraints, we are committed to acquiring the asset, and we intend to secure the best outcome for them.
This approach differentiates us from other buyers. We convey that we can create a deal that caters to a corporate seller's needs. The ideal scenario for a seller is to engage with a buyer who is already knowledgeable about these intricacies — someone who doesn't need to be informed about being flexible on representations and warranties, or about taking care of employees.
When I approach a corporate development officer, I can say, "I've been in your position. I know how to structure a deal that will meet your objectives as well as mine." The chances of the deal being completed swiftly, cleanly, and actually reaching closure are significantly higher with me than with others.
There's a distinct reason why they should sell to me — they have an asset they want to dispose of, and they're assured of a favorable result. The final point is, I won't waste their time. There won't be a last-minute fallout because a failed deal, especially for a small transaction, is an exceptionally poor outcome.
Proactively approaching a seller
Let’s role play in your company. You have a product called FirmRoom, which is a standalone data room. NASDAQ used to have a data room that they eventually shutdown. That would have been a good one.
I would have proactively approached them and explained why I am a better home for their data room product, outlining the benefits to them of doing the deal. Purchase price shouldn't be a major point. In the grand scheme, NASDAQ doesn't care about a few million dollars for a purchase price.
Instead, the focus would be on offering a white label NASDAQ product that can still be delivered, cross-selling other NASDAQ services, and highlighting the revenue streams, cost savings, and brand benefits to NASDAQ.
Often, people approach a corporate with a minimal offer for a small business, which is inconsequential to them and dismissed immediately. Instead, my pitch would emphasize that NASDAQ doesn't want to run this non-core business.
Selling it to me ensures their customers are taken care of and they can continue to offer a white label product without managing the business. My product is superior since I'm a market leader, and NASDAQ would still benefit from selling a top-quality product. Furthermore, I can offer adjacent products, exclusive deals avoiding their direct competitors, and cover generous transition services costs.
This new scenario means NASDAQ wouldn't worry about a subscale business that's a nuisance and puts their customer relationships at risk. They maintain the benefits of providing the service, possibly more, and increase revenue with higher margins without maintaining the technology.
Focus on the business impact, emphasizing that for them, P&L is more important than the balance sheet for something this small, and customer relationships, brand, and market presence may even trump P&L. Stir excitement around these points, and when it's time to discuss a reasonable purchase price, they'll be more receptive.
In competitive scenarios, such as acquiring another data room product, emphasize that it's better not to stray too far from the core. However, acquiring businesses can be about more than technology; it's about revenue, customers, brand, employees. You can be upfront about retiring older technology to provide a better experience.
Migration to a better platform offers customers a market-leading experience, which is our specialty, not theirs. The corporate development officer or division leader likely doesn't have an emotional attachment to their tech stack—they just want what's best for the business.
There are valuable assets out there. People often focus on acquisitions, but not all are successful. Some come with multiple parts, and maybe you don't want one of those parts. But there are many assets that haven't found their right home yet.
Earnouts on small deals
Some of them will be open to owning a minority stake in a third-party business, while others might avoid that complexity. You can certainly discuss earnouts; some are comfortable with it, others are not.
Remember, they don't have a balance sheet problem. Their treasury accounts probably have a billion dollars in cash. Your four million dollars is insignificant in comparison—it just adds to the pile.
You can offer to pay generously for things over time. For example, you won't haggle over TSA expenses, which could end up being three million dollars more than usual, spread over three years. In return, you'll negotiate harder on the purchase price. This approach is akin to seller financing.