Ideas, Opportunities & Futures
Almost every company that is for sale seems to have near limitless potential that the current owners just can’t bring themselves to take advantage of. We routinely review offering documents that list countless opportunities to grow businesses or make them more profitable that, if not for the implied neglect of the current owners, could make the businesses much more valuable. The implication is that we buyers should pay more for these companies, because their futures are brighter than their pasts.
What’s Worth Paying For?
Clearly, there are some projected improvements that have significant value, but others are downright worthless. What separates a bona fide opportunity from a crack pot scheme? Generally, the bona fides require skills or resources that the company already possesses and for which the management team has either developed a credible business plan or has already made considerable progress in executing. While there are no specific definitions, we try to characterize future value-adding initiatives as ideas, opportunities and futures.
Ideas: The most common idea put forth in offering materials is that the new owner could increase sales simply by reaching out to customers in a new market. The implication is that sales would materialize almost immediately, with little cost, risk or investment. No matter that these customers are either unswayed by the company’s value proposition or are content with their current suppliers. For us, an idea has little value and is rarely worth considering in the pricing discussion.
Opportunities: Opportunities have a little more value, but usually do not have a huge impact on our proposed purchase price at closing. Rather, we may use a risk-sharing arrangement, such as an earnout, to address a particular opportunity. Examples include the recent development of a new product or the expectation that, after months of ongoing negotiations, a new customer will sign a multi-year purchase agreement. In these cases, the company has made significant and credible progress in converting an idea into cash flow, but significant execution risk remains.
Futures: Futures are almost certain to happen. When opportunities turn into successes, they also turn into futures. When a new product successfully completes field trials at a customer’s facility, the future improvement in financial performance is more easily forecasted and infinitely more credible. For these reasons, we are willing to factor these “futures” into our valuations.
Recommendations
We recommend that advisors help business owners understand the difference between, on the one hand, ideas and opportunities that may make their companies more attractive to buyers, but not necessarily more valuable, and on the other hand, futures that actually increase the value of their businesses. When business owners can make informed decisions about whether to bring their companies to market now or instead wait until their ideas become opportunities and their opportunities become futures, they are likely to be much happier with the outcomes of their sale processes.
According to Pepperdine University’s 2017 Private Capital Markets Report, 27% of investment bankers’ clients were unable to sell their companies and, in 30% of those instances, the sellers wanted more for their businesses than the buyers were willing to pay. It is unclear how often these unbridgeable bid-ask spreads resulted from owners ascribing too much value to their ideas and opportunities, but our experience is that it is a common factor when deals fall apart.
Bootstrap Capital
If you are aware of business owners who would like to sell their companies, please consider introducing them to Bootstrap Capital. We are keenly in tune with the issues business leaders face when they decide to sell their companies, as well as many other nuances of transacting in the lower middle market. Bootstrap Capital is a patient counterparty and can be a constructive partner in helping sellers through the sale process.