Determining how much to offer to pay for a company took a long time to get comfortable with.ÿ600 companies were on my target list, I got positive responses from 60 and decided to make offers on 12 of them.ÿ The first one took 3 weeks, the last one 3 days!ÿ PE companies make hundreds of offers, but for me, it was my own money, my career, a new life and my dream, not a business to add to a “portfolio”.
First of all, I realized that the seller was more interested in developing “trust” in me than they were in the price and terms.ÿ Most were private business owners who had been running their businesses for years and were afraid I would “steal” their business or set up as “competition” down the street once I learned fromÿ them how “easy” it was to run it.ÿ Since a significant amount of my offer was in the form of a “seller note”, they wanted to be sure they would get their money from me.ÿ When I could not explain who the “Associates” were on my business card that read “Sharpe Associates”, I threw them out and just printed my name; after all, it was just me, no smoke and mirrors.ÿ I always made sure I kept every promise, returned phone calls and met deadlines; I wanted to be sure they could trust me.ÿ I listened a lot more than I talked and encouraged them to share the details of their businesses with me. ÿOne guy wanted his seller note paid in the third year because he was headed off to jail for bribing government officials in his rubber galoshes business; we did not proceed any further!
Early on in the dialogue, I would try to explain the concept of “Multiple of Earnings”, giving them a range of 4-6 times their last year profit levels. ÿNo sense confusing them with the jargon about EBITDA! ÿThe “newbies” who had never been through the process before were incredulous.ÿ They would say:ÿ “I made a million dollars last year, and and you tell me my business is worth $5 million; but if I just keep running it for another 5 years and then sell it, I will collect $10 million”.ÿ Those discussions ended quickly and generally the owner was young, had lots of energy, loved the business and was not really ready to sell.ÿ It was the “re-treads” who had already pulled quite a bit of money out of their businesses or were ready to retire or had some extenuating circumstances that made them open to sell.ÿ I always asked, repeatedly, why they wanted to sell – just to be sure I got the same answer each time!ÿÿ
Since the offer would be based on historical profit, it was important to delve deep into the financials to extract the “add-ons” to the profit that help bring “truth” to the cash flow that the business generated.ÿ Adding back depreciation and interest was simple.ÿ But each business would have its own set of “tax strategies” that were unique.ÿ Leased automobiles were always there; but sometimes more than the business needed – the family Minivan, the father’s Cadillac, Mom’s SUV and the owner’s Mercedes and sometimes a boat were a little excessive and were “add backs” to the profit numbers.ÿ More complicated equipment or real estate leasing were also suspect and often “inflated”.ÿ In one case, equipment was being leased back to the company from a Trust in the name of the owner’s two kids at twice the market rate as an unusual tax shelter.ÿ In another, $50,000 of construction costs at the owner’s home had to be backed out.
With all these adjustments to the P&L and sometimes the Balance sheet, I plugged them into a spreadsheet model that re-cast the historical results and allowed me to model cash flow projections for 5 years that would be required for obtaining bank financing for working capital and the purchase.ÿ This was the hard part, and one “flinty” New England banker shot down my application because I had projected growth rates in revenues of 15% when, after some discussion, it was clear that he wanted to see only 5%! ÿI made sure the next banker saw a lower growth rate. ÿI always delivered the offer letter to the seller by hand, and it was never reviewed by a lawyer, so was simple to understand!
The biggest anxiety centered around that final offer price. ÿIf it was accepted, I had to live up to my own forecasts.ÿ If rejected, it might be just the continuation of more negotiations and peeling of the onion to get at further financial add-backs.ÿ More importantly, I was imagining where I would park, the desk I would sit in, how my first day would go and that the search process would be over! ÿThe ups (3 acceptances) and downs (9 rejections) in this process were emotional roller coasters; my future was in their hands. ÿI remembered from my son’s soccer games: you have to make shots on the goal to get points. ÿIn the end, it was worth it, and I could get back to “running a business”.
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Jim Sharpe (MBA `76) is one of theÿHBS Entrepreneurs-in-Residence for the 2009-2010 academic year, who ran an aluminum manufacturing business for 21 years while working with his wife, Debby Stein Sharpe (MBA `81) after both left careers at GE and large companies and sold the business in late 2008. Jim can be reached at: firstname.lastname@example.org, 310 Rock Center, 617-496-6285 or sign up on his wiki for office hours or Brown Bag lunches at //wiki.hbs.edu/confluence/display?Sharpe/Home.ÿ