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How To Sell A Business With An Investment Bank, With Matt Tortora
Selling a business can be a life-changing event for many entrepreneurs, but the process is also very stressful, with many potential pitfalls along the way.
Matt Tortora, managing director at BMI Mergers, joins Andy Hagans to discuss the different options available to entrepreneurs who are interested in exiting their business.
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- Background on BMI Mergers, and how the company assists both buyers and sellers in investment banking transactions.
- An overview of the different “tiers” of sellable businesses, and how liquidity events typically occur within each tier.
- Matt’s favorite part of working with clients in the i-banking business.
- Common pitfalls for sellers, and how to avoid them.
- How investment bankers help manage expectations for clients prior to a transaction.
- The typical timeline for a successful transaction, and where each step occurs in the process.
Today’s Guest: Matt Tortora, BMI
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to the show. Today we’re talking about how to sell your business, possibly with an investment bank. This is a topic that I have a little bit of familiarity with, and I think a lot of people wanna know more about. We have a lot of entrepreneurs who listen to the show, so I’m really glad, Matt, that we’re gonna be discussing this. Joining me today is Matt Tortora, who’s managing director at BMI Mergers. Matt, welcome to the show.
Matt: Andy, thanks for having me. I’m excited to be here, and it’s good to reconnect with you.
Andy: Yeah, absolutely. And before we dive in, there’s so much to cover with this topic, you know? And I love transactions. I mean, when you’re an entrepreneur, just the phrase liquidity event, or investment bank, it kinda gets your heart pumping. But why don’t you give us a brief introduction to BMI Mergers, to kinda start us off?
Matt: Yeah, sure. So, BMI Mergers is a lower-middle-market-focused investment bank. We’ve been in business for 16 years now. We’ve been recognized twice as a Top-25 Lower Middle Market Firm in North America for the work we’ve done, and most recently received the recognition of a Top 50 Software Deal Maker this year, in 2023, for the work we did in 2022. You know, we’re focused on about four or five core industry verticals, one of those being software and technology services, which is the practice I run. You know, and we’re working with CEOs and founders, really, primarily in two capacities. Number one, helping them find an acquirer, and exit their company, or secondly, take on growth equity capital, continue to stay on board, and scale the organization. We’ll also work with larger firms, supporting their acquisition efforts as well.
Andy: Okay. So, you guys work on both the buy side and the sell side, essentially?
Matt: Correct. Yep. I mean, more of our work is on the sell side, but yes, we do both work on the buy and sell side.
Andy: And so, for, you know, some of our listeners or viewers who might not be familiar with, like, a typical exit or transaction, who actually compensates the investment bank? Is it the buyer or the seller? You know, I’m thinking of, like, a real estate transaction. Well, the seller, it comes out of the seller’s cut, right? So, who actually compensates an i-bank?
Matt: Yeah. So, the short answer is who we have our fiduciary responsibility with, right? So, if we’ve been hired by the seller to run a process, and take them to market, and market them to our network of buyers and investors, the seller’s gonna compensate us. And the lion’s share of that compensation is predicated on a successful outcome and a sale, commensurate with transaction size. Conversely, if we’re running a buy-side engagement, and supporting, you know, either add-on initiatives or acquisition initiatives for either a private equity group or a large strategic, that firm that we’re supporting from a buy side perspective is gonna compensate us, with, again, and that’s predicated on a successful outcome.
Andy: That’s interesting that you mentioned fiduciary duty, so I wasn’t aware that investment banks operated, you know, as a fiduciary. Is that typical?
Matt: Yeah. I mean, more or less, and, you know, not to go too far down a path of technicalities, but, you know, we talk about a fiduciary responsibility. We have a responsibility to, you know, our clients, to position them as effectively as possible. You know, I guess, for lack of a better term, fight for them, and put the best deal structure in place.
Andy: Understood. Yeah, I mean, as a client, you know, in any context, it’s always reassuring, you know, to know that whoever you hire is acting in your best interest. So, you kind of, you mentioned your sector, your area of focus, lower middle market. Could you kinda walk us through with investment banks and with, you know, businesses being bought and sold, well, what’s lower middle market? But actually, I’d ask, you know, what’s lower market, what’s middle market, and what’s…? Maybe the high market is just IPO, so maybe that’s what high market is.
Matt: Yeah. And a better way to look at this is in tiers, right? So, you have your small businesses, your main street businesses, if you will, that are typically represented by business brokers, and those are companies that are transacting for a million dollars, a million and a half, your typical mom-and-pop shops, if you will. Once you start to get to the upper end of that SMB space, you know, and you look at valuations of, you know, $5, $10 million plus, you’re now creeping into the lower middle market. And, you know, depending on who you ask, that definition of lower middle market varies. But, you know, we shift to middle-market transactions when we’re talking about things well north of $500 million, typically a billion on up. And then, of course, lastly, you have enterprise transactions, which are, you know, typically represented by bulge bracket banks, so your Goldmans of the world, your Bank of Americas, etc.
Andy: Got it. Okay. So, I think you answered this, but what would be the low end, the plausible, kind of, low end or typical low range for a transaction where an i-bank would even…not even just yours, but just any investment bank would consider being involved in a transaction? Is it, like, a $5 million deal size, where investment, it’s even kind of worth the time, and the fixed cost, and all that, to be involved in a transaction, or…?
Matt: So, here’s what I would say. You know, it’s a once-in-a-lifetime, typically, a once-in-a-lifetime event for an owner or a founder or a CEO, who’s a majority shareholder. So, the easy answer is that no matter what the size, anything, you know, $500k, $600k, $700k plus, it’s always wise to have professional representation. And the larger the transaction size or expected transaction size, the more important that becomes, because now we’re talking about a greater degree of risk. So, if I look at us and where we play, it’s transactions typically that are north of $3, $4 million, and in my world, with my team, it’s north of $10 million. But that’s, you know? So, the larger the transaction, the more it is to get professional representation. But, you know, at the bare minimum, you know, hiring, retaining counsels, and having some degree of professional representation, is always a good decision no matter what the size.
Andy: And yeah, you mentioned retaining counsel, so, in full disclosure, I guess, depending on how I kinda, what I count as a liquidity event or an exit, I’ve done this three or four times, and we always would have an attorney. So, and actually, looking back, it’s funny, looking back. I kind of, in these transactions, personally, always got a reputation from the opposing counsel as, like, kind of a crazy guy, you know, and almost, like, hard to deal… Like, I’m the guy who, you give me a 50-page purchase agreement or APA, like, I’m gonna read it. I’m gonna mark it up.
Matt: And you’re gonna be picking apart clauses?
Andy: Well, because, from my perspective…
Matt: No, that’s good. I think that’s good. I mean, obviously, an attorney’s there for that too, but that’s great.
Andy: Well, it’s just, to me, it was kind of nerve-wracking when you get into, like, the representations and warranties, and you start actually reading through, wow, all these things can go wrong. And you’re like, you know, the reason this is in this APA, or this purchase agreement is because there’re so many transactions that have happened previously that this attorney has been involved in, or that, you know, people in the industry have been involved in, and they’ve seen all these things that can go wrong, and so now they’ve put ’em in the purchase agreement.
But anyway, looking back, the interesting thing is, it would be, like, a 14, 21, 28-day legal negotiation period. It would be very, very stressful, and then the transaction would close. And then looking back, I’m like, “Oh, nothing ever came of it.” Well, maybe that was just because we were so transparent and honest with our paperwork and all that, but, I don’t know, looking back, whether I needed to sweat it or not. In your experience, you know, are your clients, are they stressed out during this process? Because, to me, it was always very stressful. Even if it was, like, kind of a good stress, it was very stressful.
Matt: I don’t think I’ve ever gone through an M&A process that where there hasn’t been a good degree of stress from both sides. Typically, there’s more stress on the part of the seller, because it may be their first and only time doing that, and it could be a life-changing event for them financially. So, that, by its nature, causes obviously a lot of stress, yes. Yep.
Andy: And Matt, do you become, then, kind of a therapist, or do you have to wear different hats to kinda calm people down sometimes?
Matt: Sometimes. I think, you know, as investment bankers, one of our jobs is to manage expectations, right? And that’s managing expectations around what’s market, what’s not? Are the seller’s asks, or our client’s asks, realistic or unrealistic? And sometimes bringing them back down to reality, or sometimes saying, “No, you should not accept this term or this clause, or, you know, this structure. Here’s why,” and showing them what’s market and what’s feasible. So, yes, it’s a little bit of therapist, and sometimes some tough love.
Andy: Yeah. Well, you know, talking about expectations, this question is, I mean, in a way, it’s impossible to answer because every deal is different, every company is different. But broadly speaking, you know, in the markets that you play in, what is, like, a range of reasonable multiples? Like, what would be, like, a median multiple of EBITDA, right? Like, we can all go to look at the S&P, and, like, look at the dividend yield, or look at the PE ratio, so we kinda know what the average or typical multiple is in the public markets. So, and I’m guessing it’s very different from software versus other. Maybe it’s not even…
Matt: That’s right.
Andy: …measured in EBITDA with software.
Matt: Yep. So, I’m gonna answer that question in two parts, right? So, number one, there is no mean or median across all sectors, right? It varies wildly from sector to sector. And in the world I play in, when you have IT consulting firms, and you have software, oftentimes, especially in the lower middle market, IT consulting firms are valued off of an EBITDA multiple, to a degree, right? Once you get to a certain size, and you’re a $25 million, $30 million consulting shop, growing really quickly, you’re gonna be valued off of a top line number. Whereas software is almost always, in our world, valued off of ARR, and that top line number. So, and my answer to your question…
Andy: And, I guess, why is that conceptually? I mean, I guess, I would, if I’m theorizing… Let me theorize for a minute, like I’m a buyer. I’m thinking, well, software, ultimately, maybe has higher value in terms of, it’s very, very sticky, or I might pay a higher multiple for software. Like, there’s more IP there, versus consulting, more labor-intensive business, more human capital, seems a little bit, I guess, riskier if you have couple big contracts or something, you lose those contracts, you know, there goes the business. So, is the multiple generally higher with software versus IT services?
Matt: If we’re talking comparing apples to apples from a top-line perspective, yes, without question, right? So, and my question for value… You know, to answer your question on valuation ranges, you know, I’m pulling on data that was from a year ago, right? Before we, you know, started facing the economic headwinds we’re facing now. A year ago, and it depends on, you know, things like the size of the company in terms of their ARR, the growth rate, the sector they’re in… There are certain sectors of software that are more in demand than others. You know, retention metrics, etc., all those variables affect the valuation multiple. But we saw companies trading anywhere from 4X up to 12X, and we would even see some outliers north of 12X. That softened in the past, you know, six to nine months. We’ve seen valuations softened by about 20%, 25%.
Conversely, if you look at IT consulting, IT services firms, and if we’re looking at an EBITDA-based multiple, there’s less variability there. It’s a much more straightforward process of getting a sense of a realistic range of valuation for a company. And, you know, again, about a year ago, we were seeing most companies trading in the 6 to 10 times EBITDA range. Again, some would be north of that, and some would be south. Those companies, those “rocket ships” that I talked about before, that are $25 million, $30 million and scaling, you know, we saw 1.5 to 3 times top-line revenue as a realistic multiple.
Andy: Okay. And in these deals, you know, where an investment bank is involved, a lot of times, not always, but a lot of times, leverage is being used. And so much of what we cover on this show is real estate. You know, and I think one of the, I guess, nicer things about operating real estate is the debt, you know, the debt picture is more… To me, it’s, like, more structured, it’s more templated, it’s more… You know, there are just certain types of, like, standard products. Whereas once you go into the private markets outside of real estate, you know, every business is different. You know, and oftentimes, there’s not really a lot of collateral or hard assets, you know, that a bank can really… So, you know, from the buyer side, you know, are you all involved with helping secure debt to finance deals? Or can you talk a little bit about how that typically works, like, in an acquisition in software, or in, you know, consulting?
Matt: Yeah. So, we don’t get involved in the debt component of it. So, we’re not working with buyers, helping them secure debt. We’re strictly executing the transaction, and, you know, obviously managing that process. But we are hands-off in terms of the debt. So, we don’t have full transparency or visibility, I should say, into how that process is working. I mean, we know, like, for example, if we’re working with a private equity group on a transaction, you know, we’re gonna validate that they’re gonna be able to underwrite the deal, and, I mean, of course, 9 times out of 10 they are, right? Because they’ll have, you know, an ample amount of equity on hand in their fund, and we will sometimes wanna know who are your debt backers? And there’s typically a ticker tape of banks they’ll work with to finance a portion of the deal.
And that’s the same for strategics, right? It’s gonna be usually a combination of debt and equity, or cash on hand, to finance the transaction. And, you know, as an investment bank, we wanna make sure that they have the financial wherewithal to execute the transaction at the valuation we’re expecting. So, you know, we’ll see, you know, who those providers are. Not all the time, but oftentimes. And, you know, usually they’re going to a list of banks and looking at where they can get the best rate and the best structure on a deal, but we’re not involved in actually executing the structure.
Andy: Got it. Yeah. So, they’re shopping around, getting the best rate, and frankly, maybe in today’s market, even just, you know, who will lend to them at all, right? At any rate, depending on the type of transaction. Obviously, with software, to me, that’s something where it’s not tangible. There’s no assets. Like, there’s no office building or multi-family, like in real estate. But, you know, depending on the type of software and the price points, that can be very, very sticky and predictable revenue streams, right? So, you could almost view that as pretty solid collateral from a perspective.
Matt: It is. I mean, because you’re buying, you’re really buying three things, right? You’re buying IP, you’re buying the contracts. And, especially in this market, with a scarcity of development talent, you’re buying talent too, right? Which is value in and of itself. And I would say this, and yes, in theory, you know, an IT consulting firm could pose more risk, because if every customer just pulls their contract, and all of the employees leave, you have nothing at the end of the day, right? But there is a degree of stickiness, and especially when we get into looking at firms like managed service providers, application managed service providers, you’re looking at a stream of recurring revenue that’s contractually booked. So, no, it’s not actual, you know, software IP, but there is a good degree of stickiness with certain consulting firms and IT services firms.
Andy: Got it. Understood. Okay. You know, one more question about the clients that you’re working with. You know, the people, the human beings. Do you have any insight, you know, why they decide to come to you, why they decide to sell their business? Like, is it typically more, like, a good thing? I can think of businesses that I’ve built that I kinda knew in my head, if we can scale revenue to X level, once you hit X level, the business becomes sellable, because it starts to hit a… So, like, I kinda had in my mind from the beginning, like, “I wanna hit this goal, and once we hit this goal, we’ll take the business to market.” But other times, you know, founders can get burned out…
Matt: That’s right.
Andy: …or maybe even they weren’t thinking about selling their business, and someone came to them, and then maybe that deal didn’t happen, but they kinda realized, like, “Oh, maybe I should…” You know, it planted the seed in their head or something. So, what are those typical reasons that a client comes to you, and they say, “Matt, I’m ready to sell my business?”
Matt: Yeah. Well, it’s the first one that you outlined, and I call it, I like to call it founder fatigue, right? And I see it very frequently in software, because scaling a software company is hard, and especially if you’re doing it in a semi-bootstrapped mode, it’s very challenging. And I know firsthand. And I’ll often see founders get to a place where they’re getting four ARR, five ARR, and they really hit a growth plateau, and they’ve been at it for X number of years, and they’re ready. They wanna scale, and they’re ready to kinda pour gas on that fire and, you know, accelerate the growth of the platform, and move on at that point, and they’re fatigued. I mean, because, as I said, scaling a software company’s hard.
You know, the other common theme we’ll see is people are ready to sunset the company, or I should say, sell the company, because they’re ready to retire, or there are sometimes, far less frequently, like, health issues, for example. So, it’s really one of those scenarios. It’s, you know, founder fatigue, and there’s a growth plateau, and they’re ready to exit, or it’s retirement’s on the horizon.
Andy: Got it. Okay. So, I mean, alluding back to the stress thing that we were talking about, there obviously is a lot of stress going into these deals, which is interesting, because they hopefully culminate in a liquidity event, right? Which should be a very good thing. It’s one of those things, you know, be careful what you wish for, I guess. This is something I can share firsthand. You know, when you work for years to build up and scale a business, and sell it, and it is a good thing on a lot of levels. Then you sell it, and the wire hits, you’re kinda sitting there going, “Well, now what?” You know, depending on how you structured the deal, whether, you know, there might be an earnout. You might not even be employed by the acquirer at all, or it might be whatever, three, six months, whatever, you know? So, it is very, very stressful, and I think, to your point, a big part of your job is setting expectations.
What’s the fun part? You know, we’ve talked about the stress, you know? What’s kinda that, you know, moment of joy for you, where, you know, you see, like, okay, this, either it’s going to complete, or it has completed? And, you know, do you ever get to share in those moments with the seller, where…?
Matt: I mean, obviously, and this is a very obvious, straightforward answer, the fun moment is seeing the transaction consummate, and being on the closing call. And, you know, it’s kind of an anti-climactic process. You’ve gone to war, more or less, for the last 60 days in due diligence, and then you jump on a 20-minute call, and the transaction’s done. But more fun than that is hanging up on the Zoom call or leaving the meeting and being able to speak one-on-one with the founder or the partners, and tell ’em “congratulations,” because they’ve made a huge… I mean, they’ve just changed their life, oftentimes. So, that’s the rewarding part. And, you know, I think the other thing that, for me, is enjoyable is you’re working very closely with someone, on a huge transaction, that’s gonna change their life, for six to nine months, and you form a bond, and you form friendships from it, and clients that I still stay in touch with to this day. And that, to me, is very rewarding.
Andy: Totally. Well, you mentioned, you know, the closing call could be anti-climactic. Matt, I have an idea. You know, it’s just an idea. You could get a big gong, you know, and you’d have to go on mute. You’d have to mute yourself, but, you know, when the final signature, whatever, gets signed and the wire’s sent, you can, you know, hit the gong. Hey, just an idea. Just an idea.
Matt: Well, I just, I go and make a pot of coffee, because coffee’s for closers, so…
Andy: Yeah, I love that. I love it. Okay. So, let’s talk about options. You know, let’s say I’m an entrepreneur. I’m not gonna say I have a software business. That’s just not plausible. Let’s say I have some other kind of business. Consulting business, whatever. I wanna bring it to market. What are my options? You know, who do I sell the business to? Is it a full sale? Is it a partial sale? Like, what are kind of the main options on the menu for me as a seller?
Matt: Yep. So, well, and I’m gonna speak, because there are, you know, there’s a litany of options, right? You could, you know, if you’re a seller in a smaller business, you could sell to… You know, you could do an ESOP. You could sell to one of your partners. But in our world, there’s really two primary options. It’s sell to a financial acquirer, like a private equity firm or a family office, or sell to a strategic, i.e., a larger company in your space.
Andy: And which is more common there? Is the strategic more common, or does it kinda depend on the size of the company?
Matt: No, 50-50. It’s a 50-50, you know, in terms of, you know, what we see and the offers we get. You know, in software, private equity’s hyperactive, so we’ve done several deals, and selling into private equity firms.
Andy: Well, Matt, that’s interesting to me because I think, you know, you mentioned some of these software companies will kinda hit that wall. Will hit whatever, $3 or $4 million or whatever it is, and the growth will slow. So, it’s interesting to me, selling to private equity. I would almost think that’d be the point where you’d want the strategic, who would say, “Hey, we own this other software company. We know how to unlock growth at this critical juncture, or we know how to cross-sell it to our other clients.” That’s sort of interesting. You know, does private equity have that kind of plan in place or expertise to kinda get the revenue growth unstuck when that kind of transaction takes place?
Matt: They do. And I think that private equity is one of the most overlooked options for founders who have a company that’s large enough and has the financial KPIs that would interest a private equity group. And it’s a good option if a founder wants to, to your earlier point about you sell and sometimes, it’s “now what?” It’s a good… Not even good, it’s a great option for a founder who wants to take some chips off the table, maybe sell 70%, 80% of the business, and roll over a portion of their equity into “NewCo,” and continue to play a critical role in scaling the business, and get a second bite of the apple, and realize a second exit in 4 to 5 years’ time.
You know, in our world, oftentimes, not all the time, but oftentimes we’ll see higher valuations from strategics than private equity. But what I like to tell, you know, clients and potential clients is, even though the valuation you may get up front, working with a private equity firm, might be a little bit lighter, net-net, you could end up in a better financial situation over three to five years once you realize that second bite of the apple. So, it’s a very founder-favorable scenario if you work with the right partner and the right group. And quite frankly, it all comes down to working with the right group, right? Because it can be a very founder-friendly scenario if you work with the right strategic acquirer. And, you know, I view private… And this is my take on it. I view private equity in that route as presenting more upside than a strategic. Now, that’s not to say there aren’t scenarios where a strategic could give you a ton of equity and there’s a lot of upside, but by and large, from what I perceive, and in transactions we’ve done, that private equity route is a very good route for founders.
Andy: And how often do the founders want to stay involved, versus, “I sold my business?” I’m either walking away, day after, or maybe three to six months afterwards, depending on handcuffs, burnout, whatever. How often are they wanting to walk away versus wanting to stay involved?
Matt: You know, I think it’s a function of age, right? Because I think if I’m working with someone who is at “retirement age,” and I think retirement age is different for everybody, it’s, there’s less of a desire. Where we work with, you know, I’ve worked with younger CEOs who are in their, you know, mid to early 40s, who have been scaling a company for 8, 9 years, and they’ve got a lot of runway left, and wanna stay on, and wanna grow. So, I think it’s more a function of age and how much runway they have left in their career that dictates whether or not they wanna stay on, or there’s a desire to leave once they can leave, right? Because in almost every transaction, there’s a requirement to ensure smooth transition. That’s a very fair ask, to stay on for, you know, at least 18 to 24 months.
Andy: Yeah, I mean, I’m thinking back to some of my transactions, and, you know, every seller is different, right? They’re all gonna have different things that move their needle, you know? And that leads to my next question, which is, what are the pitfalls to avoid? You know, because we were talking before we were recording, and we kinda talked about how some sellers, they kinda zero in just on price, like, on a number. And you mentioned that it’s not… That’s really the wrong mindset. And I agree, for what it’s worth. But tell us about, you know, is that the major pitfall? Are there other things that sellers really need to be watching out for?
Matt: I think that’s the biggest misconception, right? And now, almost every time I’m talking to someone that has come to us or we’ve come to them, and they’re interested in selling their company, it’s, you know, what are the goals? Well, the number one goal is almost always, you know, get the best valuation possible. And…
Andy: Is that their real goal, or is that what they think is their real goal?
Matt: You know, I mean, again, that would be case-by-case, but here’s what I always like to say, and, you know, I’ll get on my soapbox for a minute. You know, the M&A process is really about an exercise in risk mitigation. It’s mitigating risk for the seller, making sure they get a fair deal structure in place, that protects them post-acquisition, and maximizes their guaranteed cash at close. And it’s also an exercise in risk mitigation for the buyer, because, you know, to your point earlier, right, there’s, like, for example, in a services business, there’s a lot of risk there, and, you know, there’s risk around retaining customers, retaining their revenue rate, making sure the company grows, making sure there’s a smooth transition. So, this process really comes down to effectively mitigating risk for both parties.
So, you know, one of the big misconceptions and the mistakes that sellers make is, again, thinking that they need to maximize value when there are a lot of things like deal structure, earnout, you know, cultural fit, integration plans, all that stuff that will have a critical impact on the success of the transaction and the amount of money they realize, that go well beyond valuation. So, if we look at pitfalls, right? It’s things like earnouts, because we see earnouts in a lot of deals. And in this environment, we’re seeing more earnouts, and earnouts that are constituting a larger percentage of the transaction.
Andy: So, what would be typical there, like, in today’s environment? Like, 50% cash upfront, 50% earnout, or, like, what would be a typical…?
Matt: Yeah, I mean, we’ve certainly seen offers that are that aggressive, yes. And it’s usually a combination of cash, equity or a note, and then some form of an earnout. But earnout will be one huge risk, right? You know, is the earnout fair market value in terms of the percentage of the transaction? Is the earnout realistic and attainable? Is the post-integration plan and the terms and conditions around the earnout, does it put the seller in a position to actually achieve that earnout? Another…
Andy: Matt, to speak personally, that’s why I’ve always been biased against earnouts, because, from my perspective, I’m like, “Wait, I’m selling my business, so I’m giving up control. I no longer have control over this machine or this apparatus, and yet I’m being compensated on the results of this apparatus that I no longer have control over with.” So, I always, I would always either try and steer the deal away from earnout, or I would just say, “Okay, you know, one third of the deal is earnout or whatever.” I would discount that internally, like, 50%, or just, like, with some crazy discount, right? Like, it’s almost like mentally, I’d be like, “That’s gravy. If I get any earnout, great, but I’m not gonna count on it,” you know?
Matt: Yep. So, here’s the other thing. And I agree. And here’s the other thing that needs to be taken into consideration. The larger the acquiring organization, if you’re selling to a strategic, now you’re walking into a scenario where there is, you know, honestly, more bureaucracy, more red tape, and the ability to hit that earnout when you’re swallowed by the machine can become even more challenging. So, that’s a huge…
Andy: Do you think that sellers, or excuse me, buyers, are they, when they’re structuring earnouts, are they even, like, structuring them in good faith? Like, an honest question. Like, are they structuring them, or is it more just…?
Matt: I think it depends… Honestly, I think it depends on the buyer, right? Because we’ve seen earnouts that seem aggressive, and borderline unfair, whereas we’ve seen an unwillingness to work on structuring a fair market earnout, and we obviously advise our clients to avoid that. Whereas we’ve seen others, and again, this is what goes back to risk mitigation. It’s not an unfair ask on the part of a buyer, especially, you know, given the nature of a certain company, to ask for some kind of earnout, to make sure that that revenue maintains and grows a bit. But it’s, you know, how willing is the buyer to structure a fair and attainable earnout, and how willing are they to work with us on that? So, yes. The short answer is yes. I’ve seen some head-scratching earnout on…
Andy: So, sorry. So, back to the pitfall, you’re talking about don’t… You know, the whole deal size, or whatever, to maximize value, then, is your typical, is that typical ask, like, maximize the sticker size of the deal that includes the earnout, or is it to, like, maximize the non-earnout value?
Matt: Yeah, it’s about maximizing the non-earnout, and the components that are not guaranteed, like equity, for example, right? Or earnout. Make sure that the structure of that earnout is fair and attainable, like I said earlier. Or make sure, like, okay, you’re acquiring equity. How stable is the situation you’re walking into? What’s the liquidity of that equity? What’s the exit horizon? So, yes, it’s the structure, and it’s really getting to a place where you can guarantee for the seller that they’re gonna receive as much remuneration as humanly possible, and there is as little as possible in terms of unknowns and risk, in terms of, like, you know, not a guarantee that you’re gonna receive X number of dollars. I mean, I’ve heard about, you know, deals, people get all excited, “Well, we saw a 10x offer from this strategic.” Okay, well, what was the deal structure like?
Andy: It was 90% stock, or, you know.
Matt: Right. Yeah. No, and I’ve seen that. Like, equity-heavy, right? Which is a big risk. Or, you know, owes 25% cash and the rest was an earnout in equity. Well, that’s a high degree of risk, right? So, those are the…
Andy: Not only that, the, suddenly, that 10X sounds like 2.5X to me, you know?
Matt: Yeah. Precisely. That’s exactly right. Yeah. Deal structures, yeah, that’s a big, big area of risk, and oft-overlooked.
Andy: Yeah. And you almost have to, you have to take each component of the offer, you know, and value it differently. You know, the stock, the earnout, the note, the cash, it’s all, you gotta imply some sort of discount rate to it. And there’s not necessarily gonna be a playbook, right? Because if there’s a small strategic acquirer, there’s no real valuation on their stock. I mean, maybe they had a recent funding round or something, but even that, you know, I don’t know how much stock you put into that. So, I guess all I’m saying is it’s hard. And, to your point, you know, working to maximize or optimize the cash, you know, the guaranteed aspects of that, is a way to mitigate risk for the seller.
Matt: Yeah. That’s right. And it’s oftentimes the most heavily-negotiated component of a transaction.
Andy: Yeah. Interesting. And, well, so, I’m curious about that. I mean, my experience is a lot of buyers will kind of say, like, basically, “Here’s how much cash we have to work with, either that our lender…”
Matt: Yeah, that’s right.
Andy: “…gave us or…”
Matt: Well, that’s right. That’s exactly right. And so, like, I mean, look at it this way, right? If you own a company and you think you’re gonna transact for $10 million, right? And there’s a $25 million, $30 million company in your niche, in your sector, that wants to acquire you, they’re typically not gonna have the financial wherewithal, and the cash, even with some debt, right? Because they’re not gonna wanna over-leverage themselves, to make a major portion of that $10 million enterprise valuation cash, right? So, it depends on the size of the acquirer too.
Andy: Totally. So, what are the common misconceptions with, you know, sellers or potential sellers who come to you? What’s, like, a typical myth that you have to bust or, you know, that you kinda have to manage your expectations on?
Matt: I mean, the biggest one, again, and not to sound like a broken record, is the total enterprise value being the most important component. You know, and I think, and one of the other… And managing expectations around valuation. You know, there’s, a lot of times, not all the time, but a lot of times a big disconnect between what a seller thinks their business is worth and what valuation they should receive, versus what the market will most likely bear.
Andy: Because for them it’s personal, right? They’re like, “This is my baby. I’m selling my baby. Don’t you understand? My baby is worth $100 million.” And you’re like, “Well, to you it’s your baby, but to the market, it’s kind of an objective thing, right?”
Matt: Yes. And the other thing I think that’s a huge misconception, and this is more ubiquitous in the software world, is, “Well, we’ve just released this new version of the product, and it’s awesome. And we have this feature and this vision, and we’re taking the company in this direction, and this is our growth plan.”
Andy: And nobody cares?
Matt: Nobody cares. Seriously. I mean, like, yes. I mean, of course, people do care, right? But especially if you’re talking about an acquisition by a strategic acquirer, they usually have a plan in place, and a vision for their platform, and you’re gonna have to plug into that. So, nobody cares. And things like, “We excel because our support and the consulting work we do is second to none.” At the end of the day, 90% of this, and founders don’t wanna hear it, and I get it, is a financial exercise.
Andy: So, what can a seller, what can an entrepreneur expect in terms of timeline? Let’s say that they haven’t necessarily… They don’t have an offer on the table. They haven’t even necessarily gotten any interest, anything serious. But I come to you, Matt, and I’m like, “‘The Alternative Investment Podcast,’ my show, we’ve reached $6 million in recurring revenue per year. We’re ready to go to market, Matt, and I think this podcast is worth, you know, $50 million. Let’s take it to market.” And let’s say I have the financials to support it, you know? So, Blackstone, if you’re listening, you know, we’re always interested in… But seriously, what would be the timeline if this is really day one of, you know, my potential exit path?
Matt: Six to 12 months, typically.
Matt: Average obviously being about nine months. We’ve seen engagements go longer, take longer than that, as much as, like, 18 to 24 months. And we’ve sold companies in as little as four to five months. You know, there’s typically a…
Andy: Twelve, Matt? Twelve to 24? That just sounds terrible, man. It’s like, that sounds to me like I’m doing a cross-state move and it takes 12 to 24 months that just, it gives me, like, I get stress, you know, feelings just thinking about it, a 12-to-24-month process of selling my business.
Matt: And bear in mind, that’s an outlier, right? So, when we talk about managing expectations, I typically feel comfortable saying, “Expect this process to take about nine months,” because there’s usually about four to five weeks to stand everything up, get ready to go to market.
Andy: And is that just getting audited financials, and kind of poking around and making a deck? Or what is that?
Matt: You know, building out the book on the company. You know, kind of… And we pretty much have a good feeling going in as to who the logical acquirers are gonna be. But it’s, you know, kinda getting that and delineating that list, you know, out through our database of who we’re gonna be going after, what doors we’re gonna be knocking on, some of which we have, you know, nice relationships that are already in place. Others, we know them, but, you know, it’s a, you know, a knock on the door, if you will. So, it’s getting that data ready, and then, obviously, going out, you know, knocking on those doors, generating interest, receiving offers, vetting those offers, negotiating those initial offers, and then a due diligence process can be anywhere from, you know, 45 to 90 days.
And sometimes, you know, the biggest delta I see in terms of what could make this longer or shorter is level of interest initially, right? Because if we don’t get a high level of interest initially, we’re gonna have to go back and remarket it, you know, kinda go down some paths we didn’t think we had to go down. Whereas if there’s strong interest, the process moves faster. To my earlier point, you know, we’ve sold businesses in as little as, you know, four, five months. But nine months is typically where I feel comfortable saying, you know, you should expect that.
And my mindset is, you know, after 9, 10 months, we… I mean, after six months, we kinda know what direction this is heading in. Are we gonna meet or exceed the seller’s expectations and goals? Or do we think it makes sense to maybe regroup, wait a year, wait two years, until certain financial metrics improve, or maybe a macroeconomic environment improves, and then go back out to market. So, you know, I take a mentality of, you know, let’s get fast learnings on this, so we’re not just dragging our feet.
Andy: Okay. And I know we’re running short on time, but I had one more very specific question. How often does it happen, in these transactions, where you get to due diligence, you know, you have, like, a real offer, the deal’s gonna happen, you’re doing the due diligence, and you realize that the original operating agreement was never signed by the founder, or the other, you know, the original investors? Because I feel like that’s…
Matt: I’ve never seen that.
Andy: Oh, I think that’s happened to me every single transaction I’ve ever done, I’ve realized.
Andy: Yes. But, you know, my partners and I were always, you know, real close-knit friends, but yeah. Okay. So, that’s just a me thing.
Matt: Yeah, you know, I’ll tell you this, though. There are a million… And you mentioned this at the beginning of the call, right? That is a you thing. You mentioned this at the beginning of the call, right? There’s a million things that can derail a transaction, either post-LOI, even in the latter stages of due diligence. I’ve even received alarming phone calls the night before a deal was supposed to close, and had to work through the night on some things to ensure that we got a deal done and a transaction.
Andy: I presume that happened every deal, Matt. You’re telling me that doesn’t happen every deal? I thought that happened every deal.
Matt: Well, when I’m less than 12 hours from a transaction closing and we have a major issue, it’s a little late in the game, but yeah. But there’s a million and one things, and, you know, yes, it’s, you know, the deal’s not completed until the money’s wired and the purchase agreement’s signed.
Andy: That’s right. That’s right. Well…
Matt: And you know that better than anyone.
Andy: Yeah. No, that’s very true. And it is very stressful, but at the same time, you’re helping mitigate risk in these transactions, and when transactions go well, and a lot of them do, it is win-win, because you put the seller, they get to move on to their next phase of life, you know, what they wanna do next, if they wanna retire. And for the buyer, you know, it can be accretive, it can be a source of growth.
So, Matt, you know, can’t thank you enough for kinda walking us through this process today, sharing your insights. And that being said, we have a lot of entrepreneurs and family offices and, you know, folks in private equity in our audience and listenership. So, where can they go to learn more about BMI Mergers and all the services that you provide?
Matt: Yep. On our website, bmimergers.com. And everyone’s contact information is obviously on there, and there’s of course, different areas of sector coverage that our advisors have. So, yeah, our website, bmimergers.com.
Andy: And I’ll be sure to link to that in the show notes, as well as to Matt’s LinkedIn page. So, Matt, you might get a couple connection requests.
Matt: I’m more than welcoming of it, so yeah. And thank you for having me. It was fun to be on, and you guys have a great podcast.
Andy: Thanks, Matt. I really appreciate it.
Andy: Enjoy the rest of your day.
Matt: You too. Take care, Andy.