In Episode 1 of our new podcast, Chris Kramer and Chase Hoover dive into a simple question with complex answers — why do middle-market business owners hire investment bankers? The simple answer … transitioning ownership in a closely held business is anything but simple.
Transcript
Chase: Hello welcome to What’s Next, hosted by Acuity Advisors, the show where we help business owners understand how to monetize the value of what they’ve built and navigate one of the most crucial steps in their financial lives. Which is to say, succession planning, transition, and ultimately exit. I’m your host Chase Hoover, and today I’ll be joined by the owner and managing director of our firm, Chris Kramer, to talk for our very first episode about the basics. What do we mean when we say that we are investment bankers?
So, when you hear investment banker, once you recoiled reflexively and reached to check your wallet, you might think of how people in very nice suits on Wall Street or very large corporations get rich. Or you might think of IPOs, the Dow, the NASDAQ, so on and so forth. But in reality, outside of the giant multi-billion dollar banking firms, it’s really not quite the same as what you see on the news. So from there, more importantly, we’ll get into the question of, “Why do we as middle market investment bankers exist?” What do we do for our clients, who are our clients, and how might the process work, whether it’s the sale of the business, a sale to an ESOP, gifting of shares, etc. etc. How might that process typically unfold? Without further ado let’s get into it.
When we talk about investment bankers in the middle market, what we’re really focused on is advisers working with the owners of closely held businesses to help them plan, negotiate, and ultimately execute either a sale of their business or a transition of some other kind. So that could be a sale to a third party, whether that’s a private equity group or a strategic buyer, which is a company in their industry, or it could also be the sale to something like an Employee Stock Ownership Plan. There are myriad, different types of transactions that investment bankers help business owners select from, evaluate, and ultimately pursue.
Chris: So yeah, the way I think about it, I guess, is like a really complex construction project, where in the beginning maybe you’re not exactly sure what you want to actually build or how you want to build it or the specifics around it. You might have a concept, but not necessarily the specifics. And so you can start, go it on your own right, and you can maybe hire a designer or hire an architect or hire a number of subcontractors. Or you can hire effectively a general contractor or project manager to help you through all aspects of this really complex situation.
The way I look at it is, if you’re going to do a simple project, maybe you’re going to pour a concrete pad in your backyard, probably go to Home Depot buy some supplies, maybe watch a YouTube video, and do it yourself. But if you’re going to build a brand new house, you probably – unless you’re a construction expert – are not likely to do that on your own. And if you are and if you do, you’re not likely to be as successful as if you were to hire a trained professional.
Chase: Right. And to use your example, unless you are a construction expert or a home builder, odds are you have something that needs your attention besides the building of that home. And for a business owner, it’s running the business not spending the majority of your time evaluating, planning for, and executing a sale of the business. So working with an investment banker, one of the primary benefits of being able to have that partner, that general contractor in that situation, is that it frees you up to basically remain focused on managing the success of the business, because, you know, keeping the business performing leading up to a sale is a pretty helpful aspect in negotiating the best possible outcome.
Chris: Yeah that’s obviously a super important component because we’ve had lots of instances where clients have said, hey I went through this process, and it just sort of sucked the life out of me right over a 6 or 9 or 12 month period. But I think it’s even bigger than that. Because the sale of a company, if you will, or the transition of this company that you’ve probably founded or built or maybe you’re in the second or third generation and you’ve inherited it or been charged with growing and nurturing it – is probably the biggest decision you’ll ever make in your life. It’s certainly the biggest financial decision or business decision, and it’s complicated, right?
So what we have to do as investment bankers is really, first and foremost, get to the heart of what your optimal or best outcome will be. What are you trying to accomplish, what’s important to you? And once we figure that out, we can figure out the best strategy to get you there, and then of course help you through that whole process. So I think it really all starts with planning. And so in our approach, we start first and foremost with a kind of deep dive approach into a business owner’s real psyche if you will, to understand what they really want to get out of this transition.
Chase: Yeah, so I would sort of classify that as unpacking or planning for what are the “must haves” in any transaction that we’re going to pursue, versus the things that might be particularly nice to have. So a business owner may have a sale price in the back of their mind that they thought they’d like to achieve in a transaction, or there could be all manner of things that are much more important than just a headline value. So whether that’s a structure to preserve tax treatment, or making sure the legacy of the company is intact long after the deal, making sure certain key employees have a place to work for a long time after the transaction…it goes far beyond just the purchase price. And making sure that you have your head around what those vital aspects are versus the more ancillary components is critical to the success of actually achieving a transaction.
Chris: Yeah, one of the big things is what does the seller/owner want to see happen for himself and his family post-transaction. We have lots of instances where somebody might be in their fifties or sixties, let’s say or seventies even, and they still have a plan to work for some period of time. Others are sort of done with the job of being a CEO, and are executing the strategy to be able to leave the day-to-day operations. And that matters. We help crystallized those thoughts and hopefully formulate a strategy that’s consistent with the varying and often conflicting goals that the owner might have.
Chase: Yeah. So tie it back to what the investment banker really does. The business owner has all of these thoughts spinning around in their head, for example, I’d like to see this, or this would be great, or I have to have this. And at any given point, odds are, their email inbox or their voicemail is just amok with private equity buyers or people who are saying, hey let me buy your company.
Unless you have your ducks in a row, and you get organized before you seriously entertain any of those offers, you as the business owner can find yourself walking down a path with a buyer and asking some pretty scary questions. Is this the best possible offer I can get? Am I too far along in this transaction to pull out of it? What are my other options? It’s sort of not knowing what you don’t know. The investment banker’s job is basically to answer those unknowns before you find yourself walking down the aisle with a buyer without actually knowing what your other options are.
Chris: Yeah. Every buyer is different, every transaction is different. And so certain buyers are going to behave in a certain way or do certain things – or not do certain things – with the company, with the employee base, with family members, with key leadership – that you may or may not feel are appropriate and that may or may not be consistent with what your longer term goals are.
So we go through a process and say look, here’s what a private equity sale will probably look like, here’s what it probably means to you and your family and your team, post-transaction. Here’s what a strategic buyer might look like in terms of what their goals and motivations are in the transaction, and they’re often different. Here’s what an Employee Stock Ownership Plan (ESOP) might look like and the benefits of that, and some drawbacks, and why that might make sense. Or, what does it look like if you just give the stock or some of the stock and sell some of the stock, to your family members? Or are there a few key people that maybe can buy the company if we structure it in a certain way. Finally, what about doing nothing? What about business as usual, just keeping the business alive for as long as you feel like working there?
Those are all options. Some of them are going to be imposed on you and some of them you have some control over. So our job as investment bankers is to help you understand the various options, vet through them, and ultimately settle on a strategy that hopefully accomplishes as I mentioned before, the majority of your sometimes conflicting goals.
Chase: And from there, sometimes the next step in that process once we’ve selected a strategy, the very “step one” of execution, is soliciting offers, initial outreach to potential buyers, running an auction, and doing it in a way that’s not going to disrupt the operations of the business, nor damage the business’s reputation.
So a lot of times business owners are very concerned about word getting out that they’re evaluating a sale, and that falls under the purview of the investment bankers well. But sometimes it doesn’t involve a real broad auction. Sometimes the buyer, or the structure is something that sort of known or knowable and it doesn’t require that big outreach. Even then, and even if you’ve already been approached by a buyer, the investment bankers jobs sort of pivots to fielding the interaction between the parties in the transaction, making sure that you’re negotiating in a way that keeps the leverage in your favor to the extent it’s possible, and then that hopefully all leads to an offer. And then we get to this big bucket of what we call due diligence.
Chris: Yeah, even before that in anticipation of diligence, there’s a fair amount of planning and pre-sale activity that we can undertake that will help that diligence process later. If you want to use a simple analogy of selling your house, given a million dollar house that you’re selling, wouldn’t you spend ten or twenty grand to maybe give it a paint job, or power wash the driveway, or plant some new plants in the front, if your curb appeal was on the decline? Well of course you would.
So there are a number things that we can do early in the process to – at a minimum – anticipate issues that might arise in due diligence. So this process of diligence, it’s really a continuous process up until, and frankly after, the moment of closing. And what we really use to describe it as an analogy of information, equalizing the information and balance between the buyer and seller. So basically what that means is you’re the seller, you know everything about the company that you’ve gathered over 10, 20, 30, 40 years, and the buyer comes in basically cold, and doesn’t know any about it. So from the very first interaction, they’re doing their due diligence and you’re providing information. And they’re, therefore, becoming more and more knowledgeable about the company.
Once we have a transaction in principle negotiated, the formal of diligence process starts, and that’s where the services of a banker can be very, very critical because that process is multifaceted, complex, and frankly very onerous for most small to medium-sized businesses.
Chase: Onerous was the word I was going to underscore. Because I can’t tell you how many times we’ve gotten to a signed a letter of intent, it’s a very exciting milestone, we’ve reached an agreement in principle, and then the day following, there’s this big dump of request lists. And unless you’re prepared or at least have managed your expectations to know that that’s coming, it can be a fairly intimidating and daunting request. We’re talking about 20, 30, 40 pages of things that a buyer wants to see, and just not the buyer, but the buyer’s advisors. Their lawyers have their own request list. And their tax accountants have their own request list. And their quality of earnings people have their own list. So the list goes on and on and on. And if you’ve got a business to run, it’s totally overwhelming to try and field and respond to those requests. And by the way, they want you to do it yesterday. There’s a huge rush to get all this done and provide all this information. They don’t want you to take weeks and weeks and weeks to go find all this information. So anticipating the request is hugely advantageous.
Chris: Yeah. It would be one thing if all you had to do was to respond to the request, but a couple of things are super important to remember in that process. One is, you’re going to get the same request from multiple parties in the diligence process for multiple purposes. What does that mean? Take for example your employee census. It’s very common for you to have to provide an employee census to the buyer. Well, the lawyers are going to look at that from any legal or compliance or wage-and-hour issues perspective. The operations people want to see it because they want to understand who your people are and how they’re going to actually run the business post-transaction. The HR people want to see it so they can perhaps marry up the benefit plans and map different things pre- or post- to what they’re doing currently. And there are probably two or three other people that want to see that information for a different reason, the insurance diligence for sure, probably outside HR diligence.
And so ultimately, what you end up finding is that we’ll have a data room set up that we will manage. And we might have four, five, six people in our data room, our team plus you, your CFO, and whoever else is in the tent. And to Chase’s point earlier, you’re not going to necessarily announce to your senior leadership team that you’re selling the company. For various reasons, you want to keep that confidential internally. Well, that means that there’s even more strain on the people that know, to provide all this information. You’re not going to be able to delegate it to your seven, or ten, or twelve key people.
So what happens is, we have a limited number of people in the data room, the buyer has an unlimited number of people. We’ve had 50, often 60 names, that people have access to the data, and so they have huge resources to vet through information and we have limited resources to respond. Having somebody on your team that’s coordinating that, that’s frankly negotiating some of the diligence – because it’s not automatic that you have to provide it – somebody that’s able to package the information and explain it or pre-vet it to the buyer, is critical. For example, let’s say you have a piece of information they requested and it’s sensitive. Or maybe it’s kind of damning in some way. It’s going to indicate that there is exposure, or there’s something that was going to potentially cause consternation on the part of the buyer? You want us to basically pre-sell that to the buyer, you don’t want to just provide a document then have somebody look at, and say, what the heck is this. All those things matter in a deal, they matter from a credibility perspective, and they matter from a trust perspective, and they matter from an overall transaction perspective. Because if you surprise the buyer, they can get spooked, and that is rarely a good thing in a transaction.
Chase: Yeah, so Chris to your point, as we can kind of tell from just talking about this there are all manner of complexities regardless of the strategy that you ultimately select – executing the transaction, getting into due diligence, and navigating it in a way that preserves the beneficial transaction that’s on the table. And so, to sort of bring everything full circle, it’s pretty essential, in my opinion, also for my experience, that you have that general contractor or the investment banker to be your ally in the transaction process.
Chris: So you can see regardless of the strategy, transitioning the ownership of the business is complicated, it’s complex, and doesn’t really matter if it’s a sale to a third party, to a private equity fund, to an ESOP, to a family member, you need help and you really want to be thoughtful about how you proceed in any transaction.
Over the weeks and months ahead we’ll be drilling down on these topics and many more, and we think that you’re going to be interested to know a broad cross-section of information around the sort of high level concept of ownership transition. So these things might include tax avoidance or mitigation strategies, how to maximize value, how to prepare for sale, maybe how to deal the estate tax issues, or other tax issues, how you can attract and retain senior talent through equity incentives, and preparation for a sale and life after a sale.
There are many topics that we plan to cover, and we’ll often invite guest speakers to help us drill down and share whatever information we can on the topic. I think that one of the best ways to get the most out of a podcast like this is to hear and understand real life examples which were also going to share with you in future podcasts. So stay tuned for our next episode where will be discussing these and other issues and how we maximize value and delivered a great result for the shareholders, and one of our recent wins.
Chase: Alright. Thanks for tuning in to listen to Chris and I talk about what investment bankers are and what they do. Hope you enjoyed it. If you’re looking for what’s next in planning your exit strategy, and you want to maximize the value of what you’ve built, let’s talk, we’d love to hear from you. Quick, fine print. This podcast is for general informational purposes only, it does not create an advisor client relationship between Acuity Advisors and the listener or reader, and is not intended as advice for specific situations. And as always, we want to thank our sponsor, Acuity Advisors, take care, until next time.