Discounted Cash Flow (DCF)

The Math Behind DCF in Valuating Your Company

by Terry Stidham



Target Search Group

Have you ever wondered what a business like yours would sell for? Ultimately, it’s what a willing and informed buyer is willing to pay for it.

 

Focusing on your valuation is a little bit like a hypertensive person focusing on his or her blood pressure. To really understand the number–and how to move it–you have to understand the calculation.

 

Financial buyers acquiring a company will usually do some calculations to determine what they are willing to pay today for the rights to your business's future profits.

 

An example of a similar calculation is when someone invests $100 in a bond that offers 5 percent interest per year. That $100 spend would be worth $105 a year later.

 

To see how this math affects the value of your business, imagine you have a company that is expected to generate $100,000 in pre-tax profit next year. Buyers looking for a 15 percent return on their money in one year would pay $86,957 ($100,000 divided by 1.15) today for $100,000 a year from now.

 

When valuing a business, financial buyers will typically value not only the next year's profit, but all expected profits in the foreseeable future. For every year into the future that buyers must wait to get their profits, they will "discount" the future profit you are projecting by the rate of return they expect.

 

For a simple example, if you project your company will generate $100,000 of profit per year for the next 10 years and then nothing in the eleventh year, financial buyers would "discount" the $100,000 by 15 percent for each year they have to wait for their money:
 

End of year	Pre-tax profit	15% discount
1	$100,000	$86,957
2	$100,000	$75,614
3	$100,000	$65,752
4	$100,000	$57,175
5	$100,000	$49,718
6	$100,000	$43,233
7	$100,000	$37,594
8	$100,000	$32,690
9	$100,000	$28,426
10	$100,000	$24,719
Net present value		$501,878

 

Therefore, an investor looking for a 15 percent return on his or her money would pay $501,878 (in "net present value") today for a business that he or she expects to generate $100,000 a year for the next 10 years.

The price an investor is willing to pay for an asset relates to how risky he or she perceives the future stream of profits to be: the riskier the investment, the higher the return investors will demand. Today, investors can put their money into relatively safe bonds and get a few percentage points of return, or they can buy a balanced portfolio of big-company stocks and expect perhaps a seven or eight percent return over time.

But when buying one relatively risky business rather than a balanced portfolio, investors will expect a much higher return on their money. For illustrative purposes, imagine an investor is looking for a 50 percent return for buying your business because he or she deems your future stream of profits to be very risky (or the likelihood of you meeting the targets very uncertain). The following table illustrates the effect a 50 percent discount rate has on the value of a business projecting $100,000 in profits per year:

1. $100,000 - $66,667
2. $100,000 - $44,444
3. $100,000 - $29,630
4. $100,000 - $19,753
5. $100,000 - $13,169
6. $100,000 -  $8,779
7. $100,000 -  $5,853
8. $100,000 -  $3,902
9. $100,000 -  $2,601
10. $100,000 -  $1,734

Net present value            $196,532

The same business projected to generate $100,000 for the next 10 years is worth less than half as much when, due to perceived risk, the investor demands a return of 50 percent instead of 15 percent.

To understand the relationship between growth potential and value, imagine that, instead of generating a flat $100,000 in profit for the next 10 years, you expect profits to grow by 20 percent each year in the future. The table below illustrates how a financial buyer, looking for a 15 percent return on his or her investment, might value this company.

End of year	Pre-tax profit growing at 20% per year	15% discount
1	$120,000	$104,348
2	$144,000	$108,885
3	$172,800	$113,619
4	$207,360	$118,559
5	$248,832	$123,714
6	$298,598	$129,092
7	$358,318	$134,705
8	$429,982	$140,562
9	$515,978	$146,673
10	$619,174	$153,050
Net present value		$1,273,207

Note that the only change between this example and the one using a 15 percent return on investment is the projected growth rate. The business expecting a 20 percent growth rate over the next 10 years is worth more than double the business that expects its revenue to remain flat.

In the end, as a business owner, you have three levers to manipulate in order to increase the value of your business for a financial buyer:

1. How much profit you expect to make in the future
2. The rate of growth of your profit each year
3. The degree of risk associated with your future profit stream

 

Terry Stidham, Managing Member of Target Search Group (TSG). TSG is a business development firm providing acquisition and investment opportunities for private equity and corporate clients. TSG sources and originates investment opportunities that are aligned to their client's strategy, size and focus. TSG also advises clients on developing and improving their own in house business development teams. TSG works with client's portfolio companies on Sales Force Effectiveness and Excellence.

Mr. Stidham is a Sales, Marketing and Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment. He has served as the head of business development and sales for entrepreneurial organizations as well as Fortune 500 companies. His experience includes companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience working on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of private and corporate transactions. Mr. Stidham provides guidance to businesses on improving their sales and operational efficiencies leading to increased revenues and earnings.

Plan for a Successful Exit from Your Practice

Pre-Sale Planning Tips

by Terry Stidham, President of Target Search Group

Pre-sale planning is the process of identifying weak areas of your practice and proactively resolving these issues in order to attain a higher value for your business when it is sold.

Many practice owners believe that once they reach the decision to sell their practice that the next immediate step is to market the firm via either a broker or through the For Sale By Owner (FSBO) route.  However, what they fail to realize is that they are missing a vital step in the sales process, one that if correctly implemented will not only improve the price they finally attain for the practice, but that will also lead to a smoother sales process with fewer complications, time delays and nasty surprises. This process is known by those in the M&A market as pre-sale grooming.

Is pre-sale grooming a pre-requisite for a successful sale?
Much of course will depend on the motivation and ambitions of the practice owner and the timescales they are working towards, as well as the strength and marketability of their practice.

Sellers that are looking for a quick exit will have little time to fully undertake a thorough appraisal of their practice and to implement improvements to rectify weaknesses that they have identified.  In an 'ideal world', once the process of pre-sale grooming has been undertaken the practice should continue for a full year in order to get a full years set of financials.  You could therefore be looking at a period of 18 months from the moment the decision has been made to sell to the point where you actively market the sale of the practice (6 months to appraise and implement improvements and 12 months to obtain the impact of these changes on a full financial year).

It's worth clarifying then that pre-sale grooming is not a pre-requisite for a successful sale. In fact, rightly or wrongly, many practices are sold each year with little to no grooming.   The motivation of the practice owner and what they are attempting to achieve out of the sale plays a pivotal  role in determining the extent (if any) of pre-sale grooming that is undertaken.  For one reason another, price may not be the overriding factor behind the sale, or they may simply not have the time or desire to drive through change and improvements in their business.  Other's too may lack the necessary commercial business skills, or may be so entrenched in their working methods that they find it difficult to 'see the wood from the trees'.

I have yet to see the 'perfect practice', and I doubt very much if your practice is perfect.  By undertaking pre-sale preparation sellers are not only in a position to fix inherent weaknesses in their business, but may also unlock hidden value in their practice during this process. 

Naturally practice owners need to be aware that it is not an 'all or nothing' process.  If time is a limiting factor consider identifying 'quick wins'.  Also bear in mind that a trade off exists between fixing a weakness and the corresponding value that this adds to the business.

Key areas to consider when undertaking pre-sale planning
Practice owners should consider reviewing the following areas of their business:

1. Financial
2. Legal
3. Infrastructure
4. Client Base
5. Marketing
6. Strategic Business Plan

1. Financial
a. Clean finances
Buyers will want to ascertain the real profitability of the practice and  sellers should ensure that they remove all non-recurring and non-business expenses from the practice.  Buyers like clean and transparent accounts from which to base their valuations, so ensure that you provide them with this by identifying and removing personal assets and expenditure.   Identify and eliminate unnecessary perks from the practice. These actions will also have the dual effect of improving profitability.

b. Taxes
Ensure that your practice's tax affairs are up to date.

c. Outstanding loans and debt
Focus on attempting to reduce liabilities in the balance sheet by paying off outstanding loans and other debt.

d. Working capital
Improve the cash position of the business by proactively focussing on the working capital process.  Buyers like to see cash in the business and will be comforted by a tight and well managed working capital cycle.  Set up processes to provide them with this.  Identify slow payers and reduce debtor days.  Pay creditors on the agreed terms and not before.  This is 'bread and butter' financial management yet I'm still amazed how many practices fail to follow the advice that they preach to their clients.

e. Revenue and profit
Timing is everything when it comes to accounting and tax practice sales.  I'm often asked by practitioners when the best time to sell is. 

The answer is twofold.:
(i) Sell when you don't need to, and
(ii) Sell after a period of rising revenue and profits.

Selling a practice can not only be a complex process but is also one where emotions, pressure and strain can run high.  Your negotiating position will be enhanced, and you will attain the maximum value for your business when you are not under pressure to sell.

Nothing puts buyers off more than a practice with declining revenue and profits.  Often there are justifiable and explainable reasons for the decline.  However, the fact remains that it raises a number of negative questions.   Buyers become focused on identifying what's wrong with either the practice or the market that it is operating in.  There will always be buyers looking to turn around failing or declining practices, but the perceived risk associated with a purchase of this kind will be reflected in the transaction price.

Provide buyers with what they are looking for.  Sell at a time of rising revenue, but also ensure costs are controlled and profit margins are improving year on year.

2. Legal
a. Legal disputes
Ensure that any legal disputes that the practice has are settled.  They create uncertainty in the sale and they will always be identified by buyers during whilst undertaking due diligence.

b. Asset ownership
Ensure the ownership of assets is clear and that the necessary supporting documents are in place as they will be required during the sales process.  

c. Licenses
Ensure that all licenses required by your practice are current and up to date.

d. Property and leases
Ensure buyers focus on the positives of your business.  Ensure that no unfair equipment leases exist and that all landlord property lease issues have been resolved.

If you own the freehold on your premises, start the decision making process of identifying whether this is or isn't going to form part of the sale.  Seek valuations from suitably qualified professionals.

If your premises are privately owned by the practitioner and are leased back to the practice then ensure that any agreement is at market rate and that there are no onerous lease terms that could hamper the sale of the business.

e. Employment contracts
Buyers will want to see employment contracts and terms at some stage during the sales process. 

Seek professional employment advice from a qualified specialist lawyer to review existing contracts and to ensure that any new contracts or changes to existing terms are implemented in a legal manner.  The emphasis here should be on ensuring employment contracts aid and not hamper a future change in ownership of the business.

Address the issue of non-compete agreements for your fee earners.  Do not underestimate this issue.  The major risk that a buyer faces when purchasing a practice is the real, or perceived threat of a major fee earner within the practice leaving, taking a large number of clients with them, and setting 'up shop' down the road.  Buyers like to see non-compete agreements in place, preferably with a geographic exclusion zone.  This is a sensitive area, and will naturally arouse suspicion amongst your staff.  Nevertheless, consider starting the process of getting legally binding non-compete agreements in place, and ensure that the communication of this within the practice is managed in a planned and positive manner.

3. Infrastructure:
a. Streamline operations
Undertake an appraisal of your business processes indentifying areas that can be streamlined and improved.   For example;

• Does your practice have an organization structure and does this structure reflect the nature of the services you provide?
• Are processes in place to communicate and pro-actively manage clients in order to ensure bottlenecks at tax or accounting year ends are minimized? 
• Are processes in place to identify 'client churn'?  Are questionnaires (written, email or verbal) sent to clients in order to understand the reasons they no longer need the services of the practice? 
• Are processes in place to ensure that responses to these questionnaires are actually acted upon and are fed back into the practice?
• Do you have a process map that shows the life cycle of a client through your practice, highlighting not only possible exit points but also opportunities and routes to cross sell other professional services to them?
• Does the practice know what it's Key Performance Indicators (KPI's) are?  Are these being recorded and reported?  These will form a key part of the Sales Memorandum and could include: number of new clients, client attrition rate, average fee per client, clients by revenue/hours billed, client sector, revenue by work category.  If you don't currently have KPI's, start the process of identifying relevant KPI's for your practice.

b. Systems
What do the systems and software you use say about the professionalism of your practice?

• Is the software you use in your practice properly licensed?
• Are you using the outdated software that is no longer supported?  

Systems and software can be an expensive area, and whilst I wouldn't suggest spending vast sums to purchase the latest 'must have' practice software, do consider how you can improve current systems and versions to ensure that they are viewed at the very least neutrally, rather than a negatively by potential purchasers.

c:  HR Management and succession planning

• Are systems in place to recruit, train, retain and develop staff?
• Do you have a structured succession plan in place in order to ensure senior fee earners are replaced within the business?  This not only reflects the professionalism of your practice, but also offers some security to potential purchasers concerned with staff turnover post completion and the possible effect that this could have on  client retention.

4. Client Base:
The quality of the client base will have a direct impact on the price that is attained for the practice.  Dedicating time pre-sale to identify weaknesses in your client base will therefore be time well spent.  Buyers will naturally focus a considerable amount of their energy into assessing the client base they are acquiring with the practice.  Issues to focus on include:

• Is your practice reliant on a small number of large clients?

This poses a considerable risk to the potential buyer, and every effort should be made to reduce these dependencies by diversifying the client base.

• Have your practices professional fees remained unchanged for a number of years?

Often this scenario will be accompanied by a declining gross margin as costs rise.  Take the time to review the practice's fee structure and ascertain where this fits within the market place.  Revenue and profit are key factors in determining the market value of a practice, so consider raising fees where they fall below market rate.

• Does your practice cross sell other services to your clients?

Focus on identifying cross selling opportunities to existing clients.  Be proactive in this regard, and ensure fee earnings are in frequent contact with their client base at regular periods throughout the year and not just at year end.
 
5. Marketing:
Spend time to improve the presentation, professionalism and profile of the business.  Press releases are a proven method of raising the profile of the business, particularly in the accounting and tax trade press.

Consider  investing in your branding and corporate image if it is perceived as outdated by either clients or employees. 

Also realize the importance that the web plays in today's accounting market, both in the acquisition of new leads through search engine queries as well as what your website says about your business.  The days of an amateur looking site are well and truly over, and in today's' tech driven world leave your business looking like a dinosaur.   Replacing such a site with a simple, yet professional looking one can easily be achieved at a reasonable cost.

6. Strategic Business Plan
Start the planning process for your business and what you expect to achieve in the pre-sale period.  This plan will include action points and targets from items we have discussed in points 1 through to 5. Determine where your business fits within the current marketplace and put in place a strategic plan to highlight where you want your practice to be and how it is to get there.  Ensure that financial forecasts are in place for the next 2 years, and that plans are in place to review monthly performance to forecast so that issues and opportunities can be easily identified and addressed.
 

About: Terry Stidham,  President and Founder of Target Search Group is a Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment.  He has served as the head of entrepreneurial organizations as well as Fortune 500 companies.  He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions. 

Considerations for Selling Your Accounting Practice

YOU SELL YOUR ACCOUNTING PRACTICE FIRM ONLY ONCE . . . THERE ARE NO SECOND CHANCES . . .

What do you have to contemplate when the time comes to sell your accounting practice?

by Terry Stidham, President of Target Search Group

By the time clients are five to ten years from retiring; most accountants have already reviewed and assisted in working out their financial and continuity needs, including possible future mergers or sales of the businesses. Many accounting firm owners with only one to three years to retirement, however, may not have not yet established a successor, either within or outside the organization.

The answer, of course, is for the sole proprietor or mid to large size accounting firm to give careful thought and planning to the succession of the practice. The practice may have taken many years of hard work and quality service to establish. It probably is expected to be the source of income in retirement years, either through the form of periodic payments or as a lump sum from a successor. In any event, maximizing the benefit from the practice will depend upon the successful transfer of clients to another practitioner--either future partners or a purchaser of the practice. Both the transferring firm and the successor firm will want a successful transition. Clients that are lost in the transition will usually reduce the payout to the retiring party as well as being a dampener to making future deals by the successor firm.

Ownership transitions are difficult. How to prepare for and maintain continuity, especially when egos as well as dollars are at risk, is indeed a major question.

 

Considerations When Selling a Practice

The single most important concern to selling or transferring a practice is the likelihood that the clients of the transferring practitioner will remain with the successor firm. Without the prospects of continuity, there can be no viable transfer. Although many variables come together in deciding when and how to sell a practice, there are some that have greater impact than others. For purposes of the discussion, the transferor will be referred to as the seller, even though the client service may be assumed by another in a merger or by the formation of a new partnership.

Time and Client Comfort

The more frequently a practitioner usually services or communicates with its clients, the easier and more quickly a transition can take place. If a client is visited monthly, within just one calendar year, the seller and his successor should have ample opportunity to execute a proper transition. For example, during the first quarter, the seller and his successor could visit the client together. The next several visits they can alternate between the successor alone and the two together. By the last quarter, the successor should be able to go alone with the seller making an occasional follow-up by telephone.

If the seller generally sees clients on an annual basis, such as to prepare tax returns or prepare a year-end financial statement, it may take several years for clients to see the seller and successor together often enough to create a comfort level. In this type of practice, the time to put a transition plan in place is several years before the seller's actual or full retirement.

Aside from the number of visits, consideration must be given to the relationship between the seller and the clients and the level of services performed some work is so involved it may very well take additional time for an effective and lasting transition.

While some clients may be visited infrequently, the practitioner and the client may be in constant communication by telephone. After an initial personal introduction, the important thing is to get the successor involved in these communications. In the beginning, conference calls including the successor can provide the answer.

If the seller's staff has an abundance of client contact, the seller may not be needed for as long a transition. In many instances, the staff can be of greater value with certain clients then the seller. If that is the case, it will be important for the successor to continue to employ key staff that has developed the confidence of clients.

Desire or Willingness to Continue Working

This is a personal decision, affecting not only when to sell, but to whom. If a seller wants to continue working full time or even part time while a successor is put in place, he or she may have to consider successors with their own self-sustaining practices. The seller might merge with such a successor early on, in order to promote the image of greater continuity without immediately reducing workload or income. In this type of merger, a merger out (a euphemism for sale), practitioners generally phase out over a given or contractual period of time. They merge with their successor and gradually shift from full time to part time and then perhaps to consultant status.
By affiliating with a successor who has a self-sustaining practice, the seller need not subsidize the successor or change his or her immediate lifestyle. If a practitioner wants next tax season to be the last one with a full-time role, a successor should be in place by May or June of the preceding year! Most practitioners have a percentage of clients that they see only during tax season. In the "perfect world," clients should see the seller and successor working together for, at least, some period of time. By the time the seller's clients realize that he or she is phasing out, the successor will have had ample opportunity to prove his or her own competency. If the successor is in possession of the client records and the seller remains a consultant to the practice, the successor will most likely have to mess up to lose the clients.

Upcoming Investments

What if a seller is close to considering a sale or merger but anticipates the need for a significant investment that may affect the timing of the sale process? Investments might include lease renewals, computer upgrades, or a new phone system. Any of these could accelerate the desire to consider an affiliation eventually leading to a sale or just a "plain vanilla" sale. For example, if within the next year, a practitioner is considering some form of transition, why should he or she commit to an investment now? Remedying some of the needs or problems may represent unrecoverable additional costs that may be addressed by the existing resources of a buyer.

Staffing

Can staffing affect when to sell or merge? Absolutely! The loss, by a sole practitioner considering retirement, of a manager or strong senior may be a triggering point to contemplate the sale or merger, up, down, or out. On the other hand, such an event could lead the practitioner to bring in an individual, not only to fill the current void, but to be the ultimate successor. Why should a practitioner hire, train, and work with a new employee without this potential if the plan is to start moving forward soon with some form of transition?

Sale Transition Exit

This is how most small to midsize practitioners sell their practices. The successor acquires the equity from the seller and a transition of some sort follows. The key to making this effective is the transition; there is always a need for the clients being transferred to get as comfortable as possible with the new firm.

In some client transitions, the first time many clients really understand what is happening is with the arrival of a letter announcing the new arrangement. The envelope would probably have the seller's firm name and address, ensuring that the envelope will be opened, read, and just not junked, as just another firm's marketing piece.

Most transfers start with the appearance of an affiliation, not a sale. While people, per se, cannot be bought and sold, client retention can still be amazingly effective with a proper transition.

Contact us today if you have a practice that you would like to sell.

6 Key Components of a Letter Of Intent

Letter Of Intent

by Terry Stidham, President of Target Search Group

There is a potential buyer that has expressed interest in your business, you feel that it might be a good fit and now this buyer wants more information. It's time to move to the next step via the letter of intent, or LOI. It’s important to understand that a letter of intent is not the end of the negotiation process but merely the beginning of formalizing it. A well-written letter of intent can reduce the potential for misunderstandings later and will get all of the parties’ assumptions and views on the critical terms of the deal on paper. A letter of intent is not, however, the actual agreement that governs the terms of the purchase, and in fact, if written properly is not an agreement at all.

Although LOI’s resemble written contracts, they are usually not binding on the parties in their entirety. Many LOI’s, however, contain provisions that are binding, such as non-disclosure agreements, covenants to negotiate in good faith, or "stand-still" or "no-shop" provisions promising exclusive rights to negotiate to the potential buyer. 

6 KEY COMPONENTS of a LETTER of INTENT

1. Clearly identify the document as a Letter of Intent - The document should make it clear that it is not a binding contract to buy or sell the business. The parties may want to include, and some states will impose automatically, a duty to negotiate in good faith. A good faith provision can be useful, especially for the seller, to prevent one party from using the negotiation and due diligence process solely to collect information about the other party and their business.
2. State from the outset whether the deal will involve the sale of stock or the sale of assets - It would be unfortunate if both sides spent significant amounts of money but one party thought from the outset that they were talking about a stock sale and the other party thought they were talking about an asset sale. If this point is not discussed from the very beginning, the deal could fall apart as the deal structure that is preferred by one party may not be feasible for the other party.
3. Include both a purchase price and an explanation of the assumptions that the purchase price is based upon - During the due diligence process, it may turn out that many of the early assumptions used in calculating the purchase price will turn out not to be true. If the method for calculating the purchase price is included in the letter, the parties have a road map on how the purchase price should be adjusted.
4. If the deal is an asset purchase then the parties should allocate the purchase price to the different assets on the acquisition target’s balance sheet - This allocation can have great effect on the tax implications of the deal for the parties. Since tax considerations are often critical to whether a deal is feasible, there needs to be a common understanding of purchase price allocations at a very early stage of the deal process.
5. The method of payment - As in point 2, if one party has in mind an all cash deal, and the other party has in mind a deal where the seller will hold onto a note or some other retained interest in the acquisition target, then it is a good idea for the parties to get on the same page from the outset, before either party has spent significant amounts of time and money on the deal.
6. All other major deal points - If either party has any other deal points that are crucial to them, they should let the other party know relatively early. Examples of these include: whether key employees must be retained for the deal to close, any expected non-compete agreements that the seller will sign, and if the buyer will be assuming any liabilities of the seller. Springing these on the other party late in the process may result in a failed deal after everybody has spent a lot of time and money.

The LOI is the entry point to the due diligence phase, where the buyer examines in varying degrees of detail, important trade secrets of the company. These may include customer lists, contracts, employee details, supplier agreements, etc. Because this information is so important, and in many cases, critical to your business, the  LOI serves to let only the  right buyers through the door.  Following successful completion of the due diligence phase, the LOI is replaced by the final purchase and sale agreement.

This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.

Are You Attractive For An Equity Investment?

Equity Investment Candidate

by Terry Stidham, President of Target Search Group

Equity capital generally is composed of funds that are raised by a business in exchange for an ownership interest in the company. This interest can be in the form of ownership of common or preferred stock or instruments that convert into stock.

In addition to taking an ownership interest in your company, equity investors may also participate as a member of the company’s board of directors and take an active role in managing your company.

However, in comparison to debt financing, or loans, which must be repaid over time, equity financing does not have to be repaid.

While equity investing can come from family and friends, it’s often raised from high net-worth individuals or from venture capital or private equity firms. Investors are looking for early stage companies that can’t yet obtain traditional financing; a return on their investment of at least 30-40 percent and a clear strategy to realize their investment within 3-7 years.

What Makes a Company Attractive for 

Equity Investment?

• Industry – Typical companies that receive equity investment are high-growth companies, with the potential for a high rate of return.  These high growth industries include the energy sector, technology and media and entertainment to name a few. The companies receiving investment generally have the ability to be a market leader and often capitalize on "first mover advantage" in other words,  being first in a growing marketplace or industry sector.
• Clear Exit Strategy – Angel investors and venture capitalists are attracted to companies that have a clear exit strategy, allowing them to obtain the return on their investment. Often known as a "liquidity event", this includes an initial public offering; private placement, acquisition or merger with another company or management-led buyout. In general, investors are looking to exit an investment within 3-7 years.
• Financial Return – Equity investors are attracted to companies that clearly demonstrate the likelihood of significant financial returns. In general, these investors would like to see profit margins of more than 50 percent.

Requirements for Obtaining Equity

If your business is a likely candidate for venture capital, you must prepare certain information to sell your idea. This includes a very short oral presentation; an investor-oriented business plan and executive summary; and documentation for any due diligence analysis.

Oral Presentation - In searching for venture capital, you will have to pitch your idea to potential investors, often in informal settings. To do this, you must present your business concept and reasons for a high return in a short, concise (no more than two minute) presentation. If you are then invited to make a formal presentation to a venture capitalists or group of angel investors, these presentations generally last between 5-10 minutes.

Business Plan - You must prepare an investor-focused business plan that remains current based on market or business model changes. This business plan must include the following: .

• Executive Summary
• Description of the Company
• Analysis of the Marketplace
• Discussion of Products and Services
• Marketing and Sales Activities
• Discussion of Management and Ownership
• Organization and Personnel
• Funds Required and their Use
• Financial Data
• Exit Strategy

Due Diligence - Any company looking for venture capital should anticipate and prepare for the due diligence analysis that will be undertaken by any investor. In general, investors will want to see support for the assumptions and projections that are made in your business plan and presentation and to assess any liabilities. They will review financial statements, tax liabilities and any other potential legal liabilities. They will also want to test any technology and review any licenses, patents or documentation required to operate your business.

If you are ready for an Equity Investment then contact the Deal Sourcing Professionals at Target Search Group today.

Sell-Side Due Diligence

Why Now More Than Ever

by Terry Stidham, President of Target Search Group

Many sellers are told not to worry about doing their own due diligence because the buyer will be doing it instead. This can be a big and costly mistake. The right time to identify problems or issues to be addressed is before going to market.  Sell-side due diligence is best described as a self assessment of a seller’s own financial position plus anything else deemed material to the sale. It enables sellers to proactively identify matters impacting value, negotiating leverage and speed to close, while minimizing uncertainty in the sale process.   Note that sellers should also perform a level of due diligence on potential buyers to confirm their ability to purchase, as well as other items that could affect the purchased business or the seller after the sale.  I have seen many sellers spend a tremendous amount of time and emotional energy in what was thought to be a deal, to only find out that the buyer could not even buy a cup of coffee. There are other times where the "buyer" has no intention of buying but is only there to gather intelligence on the seller's business. At it's simplest level, sell-side due diligence is identical to buy-side due diligence; it’s just performed earlier in the sale process.  None of this is new to the sophisticated investment banking professional, who realizes sell-side due diligence can play a critical role in maximizing value from a deal.   Exit activity is expected to be robust in the near term and private equity groups have a large backlog of portfolio companies that are well past the typical three to five year hold time according to PitchBook.  A look at today’s deal environment emphasizes why sell-side due diligence is more important than ever:  Dry Powder – PitchBook reports that in 2012, 47% of all exits were secondary, private equity to private equity buyouts.  Three years ago, that figure was 25%.  This trend will be exacerbated by the current capital overhang from vintage 2007 and 2008 private equity funds.  These funds are reaching the end of their investment mandate, so investors may lose access to these funds after this year.  The incentive for private equity firms is to put this money (dry powder) to work.   Buyer Due Diligence Intensifies – Serial buyers are putting more capital to work in each deal as valuations are being pushed upward. They are not only accepting potentially lower returns but an equal or higher risk that a problem overlooked could become a much larger one.  An issue viewed as insignificant a year ago can delay or derail a deal today.  Buyer reaction is to intensify their due diligence, focusing harder on historical earnings (searching for negotiating leverage), forecast assumptions, working capital trends and operational drivers of the target company.  Return on Investment – Sell-side due diligence can uncover positive findings that improve the seller's financial results.  An EBITDA adjustment of $100,000 could increase purchase price by $700,000 (assuming a 7x EBITDA multiple as the purchase price). The buyers might discover the adjustment in their discovery but it is up to the seller to let them know that they know. Mutually Beneficial – Historically, a sell-side due diligence project culminates in a written report that can be provided to a select number of prospective buyers. Today, potential buyers are asking for more.  In addition to validating adjusted EBITDA (quality of earnings) and analyzing working capital trends, management teams need a partner to assist them in compiling and presenting data room materials, analyzing historical operating performance, creating/validating assumptions used in a forecast and defending information offered to prospective buyers. Sellers, management teams, investment bankers and buyers all benefit from sell-side due diligence. Contact Us To Discuss Your Next Steps If you have a quality business to sell, now may be the time to sell it.  The general consensus on the street is that there is too much capital chasing too few deals. The easiest way to jeopardize a deal is to raise concerns about the reliability of financial information, operating performance and forecast assumptions presented by the seller. Maximize returns, minimize uncertainty and improve your chances for completing a deal by doing sell-side due diligence.