Boomer Notes

It’s often been said that it’s easier to marry off a family member than it is to sell the family business. In many cases, the business was ‘born’ before the first child, and traditionally, the dad primarily raises the business, and mom primarily raises the children, with interchangeable involvement by both, so it’s only to be expected that there is emotion involved when it’s time to marry off your children, or divest yourselves of the family business.

In both cases, it happens, and you’re never quite prepared, but at least as far as the business is concerned, I have some excellent information for you that will facilitate the education process.

Boomer Business Owners divest their companies in one of three ways, ‘succession’, which is to hand it off to a son, daughter or other relative, the ESOP (Employee Stock Ownership Plan), which is to sell it to the employees, or to sell it to a ‘Third Party’ buyer.

For many years, the first two options were the preferred method, but with the internet, global economy and changing interests of the children, the third option of selling the business to a third party is now the dominant option, and in many cases, the only option, and the only option I have knowledge in, which I will share with you.

It’s stressful enough that you are participating in the marriage of your son or daughter to a person that you’ve only met one or more years ago, but the potential buyer of your business hasn’t even surfaced yet, and the business broker you plan to select to represent your interests, is new to you as well.

We have a lot to cover.

Selling your business to a ‘Third Party’ will automatically fall into one of three categories.

1. You will sell to an ‘Individual Buyer’.
2. You will sell to a ‘Strategic Buyer’.
3. You will sell to an ‘Institutional Buyer’.

Individual Buyer:

This buyer in most cases is in some level of management of hopefully, a company in a similar industry, and would like to become his/her own boss, and is looking for a company with EBITDA (Earnings Before Interest Taxes Depreciation Amortization) of less than $5.0 million, annually. Typically this type of transaction, once the price has been agreed to (we’ll cover that later), will involve a down payment, some bank (SBA) financing, with the shortfall held by you the seller, in the form of a carry back note. Real estate is usually involved, because the buyer needs the asset to support the bank financing.

Strategic Buyer:

This category of buyer generally speaking is a similar business wanting to capture more market share, so it could be a competitor, and rather than continue to have a competitor, decides to make the acquisition. Most of these transactions are north of $5.0 million EBITDA, so size is the driving factor. Financing in this case is generally a down payment, bank financing and perhaps a seller note, or perhaps some equity in the parent company, making the offer. Once again, we’ll cover pricing later. Real estate may or may not be involved in this transaction.

Institutional Buyer:

Some refer to these buyers as ‘financial buyers’ or ‘investor/buyers’ and they look for a specific type of company that they can invest in to double, triple or more in size ( EBITDA), in a three to five year period. These investor/buyers are most often referred to as PEGS (Private Equity Groups), and there are in excess of 8,000 of them in the USA.

In today’s market, the preferred industry categories for PEGs are Food Processing, Food Processing Equipment mfg, Medical (equip mfg, services, clinics, hospitals, nursing homes, etc), Energy related (traditional/alternative), Transportation Equipment mfg, Consumer Products (mfg/dist), Internet Related, Software, Homeland Security, Education Products/Services, and Niche mfg in highly fragmented industries, that are ripe for consolidation. There are others, but this is a good cross section.

The acquisition could be a new ‘platform’, which would be a minimum of $5.0 million annual EBITDA and upwards of $500.0 million, or an ‘add-on’ to an existing platform, which would require a minimum EBITDA if $2.0 million, with a top range of $10.0 million. In most cases the seller enters into a 3 to 15 year employment contract to manage and grow the business to the desired goal, with the investor’s financial resources, which usually supports a combination of organic growth, as well as acquisitions. The buyers are primarily interested in giving a good return on investment to their fund participants, and act as mentors to the seller/manager, showing up monthly for performance reviews, so a ‘hands off’ relationship. Real Estate is generally leased.

If the seller wants to leave immediately, the buyer will install a manager, but this dramatically affects the financial outcome for the seller, as we’ll explain later.

Now let’s discuss who will represent you, in the way of a Business Broker or an M&A Advisory Firm.

In both cases, they work with you to determine price, prepare/package your company for sale and then market your company to interested buyers, handle the NDAs, site visits, present offers and work with your attorney/CPA. Brokers normally work in the under $5.0 million EBITDA range, so for the most part they deal with individual buyers. Usually when you are selling a ‘local’ business (restaurant, c-store, machine shop, trucking, etc) you are dealing with a local broker. In my opinion, 90% of these brokers came out of real estate and are not qualified to sell a business. You must find that 10% that are professional and experienced in business sales, with references or you will be in for a world of hurt.

Let me give you a scenario of what happens all too often, with the 90% you hope you don’t get stuck with.

The broker asks you what you are ‘asking’ for the business (which is the wrong approach in the first place - it’s not a house), and you give a price slightly higher that your bottom line number (which is wrong since you are selling a ‘cash generator’). The broker agrees to that and you sign the listing agreement (should be an ownership transfer agreement), which states the broker will get a commission that could either be a flat percentage (5% to 10%) or the M&A industry accepted ‘Lehman Formula’ (10% - 1st million, 8% - 2nd million, 6% - 3rd million, 4% - 4th million, and 2% on the balance). The broker markets your business and qualifies a buyer, financially, but the buyer only wants to offer you ½ of your listing price. Now here’s where brokers should lose their license, however they don’t because what they do is legal. Morally wrong, but legal. You get to pay the commission, but the broker lines up on the side of the buyer, because 10% of anything is a sale, and to heck with you, so think about it. You are paying the broker to beat the dickens out of you to reduce your price, take a carry back note with the chance that the buyer will ruin the business and you’ll have to step back in to pick up the pieces, after the broker has spent the commission, which is not refundable.

Sounds like fun, doesn’t it?

You need to find a broker that understands how to qualify a buyer, and that means a resume, financial statements, net worth and how the transaction will be paid for. The questions that are rarely asked of the potential buyer, are, why are you wanting to buy a business, why are you interested in this business (matching vocational history from resume to the business), what is your purchase formula, how will you know what the right price is to pay for the business, what return on investment or internal rate of return is your objective (ROI/IRR)?

Unfortunately, most brokers don’t spend the time building a database of buyers based on abstract criteria, instead they market the company, always dealing with fresh faces that responded to the blind ad, which may be so far removed from their experience, that automatically, they should be rejected.

If the broker has references, you need to get him/her to bring you the transaction data on each of them, so you can enter that data into the “FREE” transaction calculator that I will send you, so you can see what kind of a deal was put together. Do it for 2, 3 or 4 different deals and then get your CPA involved, and if you follow my advice, you’ll get what you want, because through due diligence, you’ll have chosen a qualified broker.

I can assure you that this will be the first time the broker has ever been shown that, because I’ve trained hundreds of brokers how to qualify businesses, and they ‘suck’ when I first get them. Individual and strategic buyers should tell the broker in advance, what their ROI/IRR is in advance (20% to 25% is normal), which means the broker needs to ask, and when the potential buyer doesn’t know, that’s where the education begins, and when the lesson is over, the conversation should be, “Mr. Buyer, if I can structure this deal to give you a 20% IRR, after you’ve reviewed the financials, met the owner and toured the business, can we enter into an LOI (letter of Intent) and proceed with the due diligence ?”

If the answer is anything but a yes, the broker needs to terminate the appointment or conversation, but they don’t, because even though you pay them, they don’t work for you, they work for themselves, most at your expense, and any deal is a commission.

If you choose an M&A Advisory Firm, you will pay a retainer, but you’ll get professionally packaged, professional negotiators, that will actually try to get more for your company than you expect, because they have more sophisticated buyers (strategic/institutional), and know how the game is played, however in the case of institutional buyers, they will demand an IRR of 30%to 35%, because that’s the cost of private capital, and I’ll include information on that in here for you to review.

Unfortunately, M&A Advisory Firms take companies through what they call the ‘Auction Process’, which is to pit 3 to 4 buyers against each other, which in theory is great, but many deals get ‘burnt’ because of the pressure, seller fatigue, with no deal being struck.

Institutional buyers do not like this method.

The Joint Venture/Deferred Exit or the Bundling Strategy gives the greatest return to the seller, and institutional buyers like it because risk is mitigated, but Brokers and M&A Advisors don’t know how to structure those, and neither do most of the institutional buyers, but we are educating them, so there is hope, and I’ll educate you if you have a company that meets the criteria of the institutional buyer category, and I won’t charge you a dime.

Managing expectations should never be a process you conduct with your broker, for reasons that I’ve outlined above. You should conduct this exercise with your CPA, who will crunch your numbers, after ‘recasting’ has occurred.

When you prepare your tax return, if you’ve made a million dollars, it’s the CPAs job to prove to the IRS, legally, that you didn’t make that much money, by using all of the deductions allowed in the tax code.

When you sell your business, all these layers of the onion, that you paid your CPA to put in place, need to be peeled back, so we can see exactly what real profit you’ve made, because this is the number that will be used, and that is ‘recasting’.

There will be ‘add backs’, such as part of your salary. If you pay yourself $200,000. per year, and you can hire a General Manager for $100,000., then for this exercise, you add the additional $100,000. back into your profit. Most businesses live with ‘warts’, because is easier to live with them than to fix them, but now is the time to address them. If the ‘wart’ is costing you $25,000. per year, and it would cost you more than that to fix it, leave it, but on the other hand, if you can fix the ‘wart’ for $10,000., then do it and all of these fixes, times a multiple of 3 or 4, will add to the price you sell for. On the next page, I’ll show a progression of Managing Expectations, and how it might affect you, more explanation on the JV – Deferred Exit and Bundling Strategies as well as some excerpts from my associate, Rob Slee of Midas Nation, who was kind enough to let me use his material.

Once you’ve reviewed all of this material, if you would like to have a conversation with me, and you are a Business Owner, President , CEO, CPA, Corporate Attorney or Business Advisor, please CONTACT US and we’ll arrange a suitable time to talk and I’ll send you your “Free” calculators, and this conversation will cost you nothing.

MANAGING EXPECTATIONS

BUSINESS DISPOSITION PLANNING FOR THE BABY BOOMER GENERATION
COUNTERING DEPRESSED VALUATIONS WITH CREATIVE STRATEGIES

Abstract

Maximizing the emotional and financial return to the exiting owner, president or CEO of a business that was either created or acquired and expanded over a significant period of time, where succession (sale to family members), or an ESOP (sale to employees) is not an option. A breath of fresh air to the pre-retiring business owner in a turbulent current and future environment comes from the application of proven, but little known techniques applied 3 to 15 years prior to the owner’s complete exit.

The Problem

The ‘third party’ option for a sale of a business as an exit strategy, in the year 2011, and moving forward for the next 5 to 10 years presents two significant problems:

1. According to multiple reports, one of which was published in INC Magazine in 2008, the number of ‘baby boomer’ business owners that plan to retire and put their businesses up for sale in the next 5 to 10 years is estimated to be close to 19 million. As a result, regardless of the future state of the economy, the sheer unprecedented supply of available inventory will depress prices.

2. The state of the current economy means that should a ‘boomer’ business owner decide to retire early and search for a buyer now, though supply is balanced with demand, prices are depressed and financing is difficult as a result of the current economic environment.

The Solutions

A strategy used successfully for decades by industry consolidators, hidden to many non-industry practitioners, creates an ideal solution to these problems for many businesses with the potential to double or triple in size over 3 to 15 years. The author of this report, BizHarmony, specializes in structuring a transaction in a manner which removes the business owner, president or CEO and the asset (the company) from the current state of existence. This strategy does not apply to all types of businesses, but there are many to which this does apply, such as: Manufacturers and / or Distributors of products that are under-developed, such as those not serving the national or global marketplace, as well as companies in the service sector, which are highly profitable, but too small to appeal to institutional investors. Job shops that do not have a proprietary product can also benefit from this approach.

Two distinct solutions to solving the problem as outlined above exist:

The Joint Venture / Deferred Exit approach.

Bundling / Pre – Rollup for consolidation.

Joint Venture – Deferred Exit :

A Joint Venture is broadly defined as a legal entity formed between two or more parties to undertake an economic activity together. JV partners agree to terms outlined in the agreement for a finite period of time and create a new entity, each contributing assets and/or equity to the new entity. These partnerships are created when one party seeks the resources of another, whether financial, managerial, patents, technology or a combination. This strategy is ideal for the business owner planning an exit in 3, 5, 10 or 15 years, that lacks the financial resources to take the company to its full potential in that time frame, thereby missing the opportunity to benefit from the potential growth that a new capital, management or other infusion would provide. Such a partnership is ideal in that it can act to lock up a higher multiple to the shareholders contingent upon the future growth of the company.

BizHarmony implements a JV based strategy through its network of investor / buyers who focus on a broad range of industries including Medical, Food, Energy, Education, Internet, Software, Homeland Security and others, with the following in common:

In order to realize the potential, expansion or growth capital may be required and, if so, becomes part of a strategy that is planned extensively by experienced advisors alongside the business owner. The growth plan may require the acquisition of similar businesses to capture market share, acquisitions to diversify product line and customer base, or a combination of both.

The JV counterparty typically brings more than capital, as many such growth opportunities require new talent to support current operating executives as a cornerstone of bringing a growth strategy together and to ensure that goals are reached.

A joint venture, then, is not a third party sale, but a creative solution to growth of an underdeveloped entity, requiring a vested interest and aligned objectives of both parties, while providing liquidity up front to the owner, and again when goals are reached, at which point the final exit plan can be implemented.

In a transaction as described, typically the new JV Partner acquires a majority share of the business and commits the necessary capital to support the growth objectives as determined by the current owner. The partner expects the current owner to maintain the role of operating the company under an employment contract for 3, 5, 10 or 15 years as agreed upon and the owner retains meaningful equity in the business.

The owner’s equity position is pre-formulated for sale at the time of agreement, and applied to the new ebitda growth objective when the time frame and target is reached and a capable successor is groomed. The advantage of such a strategy in the current environment in part is that it removes the current owner from the competition with others who have decided to wait 3, 5, 10 or 15 years to seek a third party traditional buyer. Such a strategy could provide a return to the current owner of two to three times that of the open market would, simply by planning ahead.

Bundling – Pre Roll Up:

Business bundles are formed in industries where the minimum threshold of company size required for institutional investors does not exist. Simply, it is a method of creating an entity in the absence of one, through the integration of multiple. This strategy is ideal for a company involved a ‘high demand - highly fragmented’ industry.

Some industries are populated with literally hundreds, if not thousands of small businesses, that when combined, have total annual revenues in the billions of dollars. As stand alone companies, they survive because of exceptionally high profit margins, but because of their minimal size, do not appeal to Institutional Investor / Buyers that have the resources to take them to the next level, since in most cases, the desired minimum for a ‘platform’ company, is $10.0 million ebitda.

The problem is solved creatively through BizHarmony, which aids in applying a qualified, licensed M&A Broker to work with the ‘bundling’ leader in identifying other targets which the broker would contact to add to the platform.

Each interested player, would enter into a ‘letter of participation’, and this process would continue until the combined ebitda target was reached, and packaged as a single stand alone company, even though, in reality, they are all individual companies.

BizHarmony, then takes the packaged group of companies, and locates the Investor / Buyer that would acquire each entity individually, with the intention of integrating them post sale in order to create the new platform, which in sum is large enough for the investor / buyer to engage.

The platform then follows an organic and acquisition oriented growth strategy, consolidating the market space and creating a dominant player, with the original platform participants growing their respective interests similar to the JV – Deferred Exit as outlined in the beginning of this paper.

The return to the platform participants can be 10 to 15 times greater than would be realized for a standalone sale, because of the potential created by establishing the platform and capturing market share.

The Job Shop

Job shops that have no patents or proprietary products can often be integrated through JV’s or bundles in order to create an appealing opportunity for an investor / buyer. Doing so involves locating one or more products that the job shop could produce, thereby converting the job shop to a manufacturer which has significantly higher value to a third party purchaser. This strategy represents a combination of bundling as well as joint venturing, increasing value to all involved shareholders through creative solutions.

Conclusion

For those companies that align with the scenarios mentioned above, the astute retiring business owner, president or CEO has many options in light of the current and future exit obstacles. The solution involves starting the planning process today, setting goals and designing a structure to deliver emotional and financial expectations, packaging a deal, locating the investor / buyer now, and putting a plan into action. With a pre – determined exit date and a formulated financial package, the business can literally be extricated from the competitive environment, providing the highest possible return on the owner’s lifetime of hard work.

BizHarmony provides all of the services mentioned in this white paper. Please CONTACT US for a tailored solution.

JV – Deferred Exit / Organic – Acquisition Combo Growth Strategy

Deal Terms:

Seller designs strategy to organically grow the EBITDA by 50% over 3 to 5 years to $15.0 mil and acquire two add-on companies in the same time frame for an additional $10.0 mil, for $25.0 mil total. The JV – investor / buyer agrees to finance the acquisitions by committing to $4.0 mil in new investment for the acquisitions.

Note:

If the EBITDA exceeds the $25.0 mil target, or the time frame is extended achieving the same end, the agreed upon formula is still applied to the final exit compensation. In this example, the ‘backend’ multiple will always be x 8.0 (reciprocal of the front end multiple of x 2.0), and that calculation will always be applied to the remaining sellers stock (23% in this case). It’s a ‘win-win’ for both seller and buyer.

Note: Example of how ‘add-on’ acquisitions might be structured.

Public vs Private ROI (courtesy of Midas Nation)

I resolve that in 2011 I’ll show business owners that: a) it’s 90% likely they aren’t creating any value in their businesses; b) this loss of value means that they won’t be able to become financially independent when they transfer their companies; c) this lack of value creation means America won’t meet its goals for this decade, and likely beyond.

I displayed the following graph during the last Midas webinar. It compares the public capital market line (which summarizes public cost of capital by capital type) to the Pepperdine Private Capital Market Line (PPCML). The PPCML summarizes private cost of capital for lower middle market companies.

There are several noteworthy things about this chart. First, the PPCML is quite steep compared to the public capital market line. Private investors perceive substantially more risk in private capital markets and require commensurate returns. Second, if public and private markets enjoyed the same level of efficiency, the two lines would run parallel to each other separated only by liquidity differences. Finally, both lines represent portfolios of expected returns that group around a point on the line. Individual investors’ experience in either market might not fit on a line. Rather, their experience may fit within a larger portfolio of expected returns averaged to a reference point.

The chart also shows that private companies have costs of capital 2-5 times higher than large public companies. This is startling. It means that private companies must generate returns on investment 2-5 times higher than their large, public multinational cousins. Why is this?

A company does not create value until it generates a return on
investment greater than its cost of capital.

This is true for public and private companies.

So if GE’s cost of capital is 8%, PrivateCo’s is probably 25-30%. All GE has to do is generate a 9% return on investment and they are creating shareholder value. PrivateCo, on the other hand, must be 3 times more effective than GE to create value. And this, MidasNation, spells major trouble for Main Street and for America.

Because PrivateCo isn’t generating a 25-30% return on investment. I believe more than 90% of the PrivateCo’s aren’t generating high enough returns to create value. Yet the PrivateCo’s of America generate more than 50% of America’s GDP.

This must be one of the 2-3 biggest problems facing America this decade. Without massive value creation in the private capital markets, there are not enough jobs, not enough tax base, and not enough loan and consumer demand to keep the U.S.S. Titanic from sinking.

So I resolve – with your help – to not only show motivated owners that this value creation crisis exists, but to also provide the mentoring and educational support to help them become financially independent.

The Value Gap (courtesy of Midas Nation)

I believe 80-90% of private business owners are not increasing the value of their firms. This is an incredibly strong statement, since it means that the largest part of the American economy is slowly, but surely, under performing to the point of going out of business.

Specifically, most business owners are not generating returns on investment greater than their company’s cost of capital. It should not come as a complete surprise that so little value is being created in the private capital markets. First, until the recent Pepperdine surveys, no one knew how expensive private cost of capital really is. Second, most business owners don’t know why it’s important to know their company’s cost of capital. These owners use payback or gut feel to make investment decisions, which are the equivalents of caveman tools used to build a skyscraper. Certainly we can do better in the 21st century.

For this discussion, it’s important to distinguish between public and private cost of capital. As the following chart depicts, private cost of capital is more than twice as costly, on average, as large public companies. In other words, to create incremental business value, private companies must generate returns on investment of more than twice as high as their public counterparts. With no investment decision-making framework to guide them, most business owners are not making maximizing value creation decisions.

Most business owners do not know that their company’s cost of capital is 25-30%, or higher. But what does this high cost of capital really mean? In short, it means that owners must generate returns on investment of 25-30% each year just to cover the risk of ownership. Value creation occurs, in this example, when returns on investment are greater than 30%.

Let’s pull this thread a little more. What is “return on investment?” In short, Investment is the greater of: 1) all expenditures in a business (or project) that have a long-term impact; or, 2) the financial market value of the company. Young companies or those without positive benefit streams are likely to use the first definition; whereas, companies with substantial financial market values will use the second definition.

Relative to the first definition, the concept of Investment is much more expansive than accounting terms such as book value. For example, investment incorporates spending on “nouns” – people, places and things.

Examples of investments in people are: foregone salaries of the owners during periods when the business does not generate sufficient cash flow to pay such; training of productive employees; and long-term bonuses paid. Examples of investments in places are: leasehold improvements; buildings owned by the business; and other structural improvements. Examples of investments in things: subsidized losses from the business; original acquisition cost of fixed assets (un-depreciated); and expensed infrastructure for the business such as computer systems.

Once a company generates a large benefit stream, Investment equals the equity value of financial market value. This makes sense because we’re measuring value created or lost, so financial market value is the correct benchmark. In other words, a company creates additional incremental business value when it adds to financial market value, and loses incremental business value when it detracts from financial market value.

Why does all of this matter? A tremendous and ominous value gap exists in the private capital markets. The value gap is the difference between what owners want/need the value of their businesses to be…versus what the market says they are worth. The longer the period a company goes without covering its cost of capital, the larger the value gap.

Private company managers need to be educated and trained on cost of capital in a way that positively influences their decision-making. This is especially important with global competition. Until this training occurs, it is likely that the private capital markets will continue to underperform financially.

A Word on Acquisition Multiples(courtesy of Midas Nation)

Many owners are confused about acquisition multiples; about where they come from and what they mean. This is an important topic, so let’s clear it up.

An acquisition multiple is a buyer’s expression of risk of the likelihood of realizing the benefit stream that the subject business generates. Benefit streams can be expressed in a variety of ways, such as net sales, gross margin dollars, recast EBITDA, etc. Over time every industry settles on the appropriate stream to use. For instance, CPA firms typically transfer using net sales as the stream; whereas, box converters are valued by using recast EBITDA. The acquisition multiple is then chosen by buyers to indicate how many years they expect to receive the stream after the acquisition closes.

For example, if a company is generating a benefit stream of $1 million, and there are three prospective buyers, each buyer may have a different perspective about the appropriate multiple. This explains why any businesses can have a fairly wide range of market values at any point in time.

The multiple can also be viewed as the riskiness of achieving the stream post-closing. In this case the reciprocal of the multiple generates the risk factor. For example, an acquisition of ‘5’ converts to a 20% (1 divided by 5) risk rate.

My textbook – Private Capital Markets – shows that only one variable correlates well to lower middle market acquisition multiples: senior lending multiples. In broader terms, availability of capital determines private business valuation (at least for ‘market’ purposes) – and senior lenders provide most of the capital structure. In good times, senior lenders get caught up in the moment and aggressively engage in cash flow lending. At the peak of the lending cycle, these lenders will lend 5 to 6 times EBITDA. At that point, acquisition multiples are at their zenith. Ultimately, the economy cools and lenders head for cover, eventually retreating to mainly asset-based lending. At this low-point lending multiples are not used; rather, margined collateral of the borrower’s assets determines the loan amount, which usually results in dramatically less that can be borrowed. This is what has happened in the US economy over the past 18 months.

Let’s not forget about equity. According to a recent survey by Pepperdine University, the typical private equity group (PEG) deal employs about 48% equity in the capital structure. This percentage, by the way, represents an all-time high equity investment level by PEGs. The Pepperdine survey reports that in the current market, senior lenders have moved down to about a ‘2.5’ run-rate EBITDA on total debt. This combination of debt and equity yields an equation that derives acquisition multiples, as follows:

Thus, when senior lenders retreat to a ‘2.5’ lending multiple and equity represents almost half the capital structure, acquisition multiples fall to below ‘5’. Owners just hate selling for less than a 5 acquisition multiple, but the reality is they’re facing these lower numbers for the foreseeable future. Crafty advisors are using economic bridges (earn-outs, seller notes) to boost purchase prices. Assuming that the behavior of lenders stays the same or continues to retrench, which is highly likely, acquisition multiples will continue to fall – as will the total number of deals completed in the lower middle market (companies with annual sales of $5-150 million).

Finally, acquisition multiples tend to group themselves based on company size, as the chart below depicts. In effect, capital providers cause these multiple groupings because they lend/invest differently to each segment.

Your goal as a business owner is to be “viewed” by the capital providers as a larger company. For instance, it’s possible to be generating $3 million in annual sales, but be valued by the market as a “5-6x” company. This is accomplished by demonstrating a scalable business model, sound strategies and tactical capabilities, and a high intellectual capital leverage ratio. In other words, by living the Midas Way.

Private Capital Markets 2 (courtesy of Midas Nation)

At long last, Private Capital Markets 2 is finished. I handed-off the 360,000 word manuscript on December 30…almost a full day ahead of the due date. The publisher, John Wiley & Sons, plans to release this dictionary-sized textbook in early June.

Apparently I have had too much time on my hands over the past decade, as I invested almost 10,000 hours in the PCM series. Let’s put this in perspective. That’s 5 full years of working 40 hours per week for 50 weeks each year. But these books were not written on a full-time basis. Rather, I added hours to each week for the 6-7 years it took to write them. Now you know why I’ve looked so tired since 2000.

In any event, since I know most of you won’t read a textbook (although you are strongly encouraged to buy several copies of PCMs 2), I thought I would reduce the key points of the manifesto to bullet points. Here we go:

• Public and private capital markets are not substitutes. They differ in most important aspects, such as: risk and return are unique to each market; liquidity within each market is different; motives of private owners are different from those of professional managers; underlying capital market theories that explain the behavior of players in each market are different; private companies are priced at a point in time, while public companies are continuously priced; public markets allow ready access to capital, while private capital is difficult to arrange…just to name a few of the differences.
• Capital markets are segmented, meaning that small, lower middle market, middle middle market, upper middle market, and large companies have unique costs of capital, differentiated behavior of players in the segment, and correlated valuation metrics
• The book introduces a new field called “middle market finance,” the study of how managers of middle market companies make investment and financing decisions
• Middle market finance theory – also created in the book - is a holistic theory that shows how business valuation, capital formation, and transfer are inter-related and interconnected
• Value relativity reigns supreme in the private markets. This means that private business valuation is relative to the reason one needs to know the value. Another way of saying this is that a private business value is relative to the value world in which it is viewed. Reasons select value worlds. Each value world yields a unique value. There are dozens of reasons why a private business value needs to be determined; thus, there are dozens of value worlds.
• Private capital is allocated via the rules of a flea market, as opposed to the supermarket of securities enjoyed by large public companies. The private bazaar does have structure, however, as capital providers organize themselves based on risk/return goals.
• For this first time in history, the private capital markets have been thoroughly surveyed, as yours truly partnered with Pepperdine University to conduct the Pepperdine Private Capital Market surveys. The Pepperdine Private Capital Market Line depicts an empirical cost of capital line for the middle market.
• Private business transfer comprises all possible ways to transfer a private business interest. Transfer channels and methods are organized as the Business Ownership Transfer Spectrum. PCMs 1 introduced this spectrum, which provided the structure for the new field of Exit Planning.
• Transfer methods select value worlds! This means that once an owner decides how to transfer part or all of the business, he/she has (usually unknowingly) chosen the value as well.

There are about 50 chapters in the book, so all value worlds, capital types, and transfer methods and their inter-relationships are described in detail. Five years ago I created a semester-long course called PCMs, which is now taught on 3 continents.

Good grief – launching a new field of study is exhausting.

If you have an interest in a conversation, which I’m sure you do if you’ve read this far, then CONTACT US and we’ll arrange a time convenient for both of us, and this consultation will give us a chance to know each other, and it will cost you nothing.

CONTACT US