Selling a Small Business Unit

This is a conversation with Michael Frankel, Founder and Managing Partner of Trajectory Capital. He has over 25 years of M and a experience from the legal banking Corp Dev and now as an investor. In this interview we'll discuss the intricacies of selling a small business unit. We discuss reasons to sell a business, steps in selling a small business unit, how to find buyers, and advice for first timers. Hope you enjoy the conversation. This episode is brought to you by firm room. Over 1200 organizations have experienced the simplicity of Firm Room, the world's most intuitive virtual data room. Top players like jpm, Morgan Stanley and Pfizer have chosen Firm Room as their data room solution. The Media at every stage, Firm Room keeps things simple with scalable storage, unlimited users and industry leading security features. Elevate your deal management with Firm Room. Modern pricing, no hidden fees. Take advantage of our 14 day free trial and when you're ready, sign up for limited users and 10 gigs of storage starting at just 495amonth. Firm Room a tool built by dealmakers for dealmakers. Check it out@firmroom.com Again, that's firmroom.com I'm Kisam Patel and you're listening to M and A Science where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals. Hello M and A Scientists. Welcome to the M and A Science Podcast where we learn from the best in M and A to uncover proven, proven techniques for enterprise value creation. If you're interested in learning more about the solutions we develop to support world class M and A teams or want to get involved with our community of forward thinking M and a practitioners, visit mascience.com you can get started by subscribing to our free weekly newsletter for the latest insights and events. Again, that's mascience.com I'm your host, Kisan Patel, CEO and founder of M and A Science. Joining me today is Michael Frankel, Founder and Managing Partner of Trajectory Capital. Trajectory Capital is a private equity fund. Today we're going to talk about how to sell a small business unit. Michael, welcome back.

Thank you. Thanks for having me back.

Are you going for a record of how many times you can come back?

I'm just going to keep showing up at your door.

Well, keep coming up with good wisdom to share. I'm more than happy to have you back. Thanks for making time. I reached out to you on this particular topic and we're here live back in VRC's office in New York. City. Can we recap your background?

Short version. I've done deals from every perspective. I was an M and a lawyer. I was a banker. I was a corporate development officer for a bunch of big tech companies, CFO for a couple small ones. And then I launched Trajectory Capital with a partner and we acquire enterprise technology businesses.

Do you have a good amount of corp dev experience?

I do.

How many years? How many deals?

Roughly 20 years and roughly 110, 115 deals.

Okay, you know what you're talking about. Just want to make sure you're qualified for anybody tuning in here. Sometimes you're a little weary of the PE folks, but coming in in house roles, you've operated these M and A mandates. Can we talk about the decision process that leads to selling a company?

These decisions are usually made super late, especially when it comes to small businesses. If you have a business that is 10%, 20% of your company's revenue, there's a lot of strategy conversations around, is it a fit, Is it not a fit? What are we going to do with it? But the businesses that are super small tend to get ignored. And what tends to happen is, especially in a strong market, they just sit there and nobody pays any attention to them. The corp dev officers would rather be doing acquisitions. And the business leaders don't really feel any pain because the business is just running along. And then usually when the market gets weak, that's when everyone does a strategic review. My guess is over the past couple of years, every company has done a big portfolio review and sort of rediscovered these little assets that they have figured out that they're off strategy. Maybe they're burning cash. But even if they aren't burning cash, nobody really wants them. They're a distraction. And that's when the corp dev team gets a call. We've decided we don't want this little business. Make it go away. And that's sort of usually the beginning of the process. When you're talking about sort of subscale.

Businesses, okay, we got larger company, several different business units. You tend to just run them and focus on buying things. But then things get tough, market gets rough, then you start reevaluating and saying, hey, maybe we don't need this. Maybe this business is a distraction. There's the specific reasons why. Is it purely financial performance? Or we could take this money and offset some expenses.

Or it's usually not that we can take this money because the amount of money we're talking about is comically small. If you're a 20, $30 billion company, even a $5 billion company, 3, 4, 5, $10 million of purchase price really doesn't affect anything. It's not holding you back. More likely it's either that the business is losing money and during a weak market, suddenly people aren't hitting their numbers. They look for any way to improve their business. And so the division GM says I don't want that anymore, or it's just a distraction. Imagine you're running a $200 million business and you want to focus on 190 million. That's your core, it's what you're building. But at every quarterly review and at every financial review, somebody brings up the little business that you accidentally own because it got gifted to you by another division or it was part of a bigger acquisition. There's a high distraction factor to these businesses. Usually, especially when the market turns down, somebody goes, why do we have that? Or in some cases, originally we had a strategy for it, but we've decided we're not doing that anymore for whatever reason. And so there's this tipping point where the business says, make that go away. And they usually dump it on the lap of the corp dev team, sometimes years after it has been determined to be off strategy. That's the heartbreaking thing if you're a corp dev officer, is they give you an asset and they say, we want to get rid of this thing. We've been under investing in it, treating it badly, maybe stripping the management team out of it for the last two years. Now we want you to sell it. And of course the corp dev person is saying, I wish I could have sold it two years ago when it was in better shape. But that's the nature of being a deal maker. You don't always control when the business wants to do stuff.

So you make the decision to sell. What are the steps that happen after?

These vary a lot from selling a big asset. Big asset. You're going to hire an investment banker. You're going to throw a whole bunch of resources at it because you're talking about a lot of company capital. If it's a subscale asset, you got to figure out a way to get the process done. Lean and mean. As an example, you're going to have to put together a data room, but you're going to try to free ride on existing material that the business already has. Marketing decks, financial decks, internal reporting decks, because you don't want to devote the resources to building all that stuff from scratch. Secondly, you're not going to be able to hire a banker in most Cases probably too small to hire a banker. The fee structure isn't there, so you're going to be doing it yourself. So you have to figure out the resources and the business isn't going to want to devote a lot of resources to this process because from the business's perspective, this is a negative. The outcome here is to get rid of something I don't want. It doesn't make my business any better. All those things mean you're going to have to run a really lean process. Lean in terms of developing the materials, lean in terms of reaching out to buyers, and lean in terms of the transaction process. In some cases, companies will even decide to shut down a business because the transaction process is too expensive or too distracting. As the corporate edit officer, your job is to make it lean enough that they don't choose to shut it down, they choose to actually sell it.

Okay. Pretty much got some prep to sort of figure out what you're actually selling.

Yep.

And then you got to put some materials together. Some basic. Do you do the same thing at the bankers? Do you do a teaser sheet in a sim or do you.

Yeah, you do, but it's not going to be as pretty, it's not going to be as well thought out. You might not bother with a teaser. It depends on what your buyer universe looks like. But you're going to need something that looks like a sim, something that has the information that would be in a sim. Your you're going to need a data room. There are a bunch of other things, especially on the divestiture side. You're going to need to think through the transition services process. So when you, I like to call them disintegrate a business, you have to think about the torn parts of both that business and your remaining business. Unless it's been run in a bubble on its own, you're going to have to think about that stuff. What is a buyer going to want in terms of ongoing services? What are you going to do with the tail pieces that you have? Good example would be if you have a 5 person HR team and 1/2 of 1 HR person is devoted to this business. You can't get rid of a half an HR person. So what are you going to do with that extra HR resource once that business is gone? So you're going to have to think through all that. And lastly, you want to think through who the buyer universe is going to be for this. Again, you're effectively as a corp dev officer, you're effectively doing the banker's job, but you're Trying to do it in a really lean way because you just can't devote the resources. The squeeze doesn't bring the juice for such a small business. So you're going to find ways of streamlining all these different parts of the deal process.

TSAs, you have to prepare those things ahead of time.

You don't necessarily have to prepare them ahead of time, but you better know what you want and what you don't want. You don't actually have to have a legal document and in fact you probably shouldn't bother until you're pretty close with a buyer. But you better have a very clear understanding of predict what the buyer is going to want and what you're going to be willing to give them. And what do you want out of the deal? Generally, the smaller a deal is, the more other variables than purchase price matter.

How do you find buyers?

This is sort of a challenge. You don't have a banker. This is a very small business. So I start with either go to the business itself or if you acquired it, you go to the team that you acquired with the business and you sort of ask them who's a natural buyer? Where would this asset fit? From a product perspective, from a customer perspective. You can free ride on banker relationships by going to the bankers and asking them those questions. But you are not going to be able to turn over every rock. So you're going to have to very quickly identify either strategics where it's a really natural fit and I'll talk about a problem with that in a second or financial buyers where it's a fit. Problem with financial buyers is you're automatically given the size of the business and probably the speed of growth of the business to wipe out majority of financial buyers. It's going to be too small for almost every private equity fund and unless it's hyper successful within your large corporate, it's not going to be growthy enough for most venture funds. So you're going to have to go find an investor who focuses on this sector and wants something of this size and of this growth dynamic. The strategics. It may be more obvious that there's a fit, but you have a problem and that is you want to sell to strategics that aren't going to therefore damage your core business. You're not going to want to sell to a direct competitor unless you are really sure that you don't want to be anywhere near this space and it doesn't help them compete with you in other ways. The perfect buyer is either a financial buyer who loves small businesses like this, that are growing like this, or a strategic who happens to not compete with you, but have a need for this kind of offering. It's a long winded way of saying you do a brainstorming session, you leverage all your resources, you leverage bankers, you know, you leverage your own team and you come up with a short list, it is not going to be complete, you're going to miss people. But for a deal of the size, it's not worth it to do much more work than that.

Okay, so come up with a list best you can. Don't use bankers.

If it's a big enough asset, you can use a banker. But the reality is if you're selling something and you think you're going to get 4 million of purchase price, 5 million of purchase price, fairly small population of bankers that'll take that deal. Maybe in a down market the fee structure works, but on oftentimes you're going to do it on your own and you really want to pay the banker that big a chunk of what's already a small purchase price to run a tight process. So if you're not using bankers, then you reach out to the buyers yourself and you're straight with them. You say we got an asset, are you interested or are you not interested? And you run a lean process. This is not a five month cycle through people, talk to other buyers kind of process. This is a one week to reach out to every natural buyer, one week to sign NDAs, two weeks for them to review the data room, maybe three weeks loi pick a buyer, three weeks for diligence, negotiate docs close. Because honestly, the thing to remember is that corp dev team probably also has acquisition priorities that are way more important to the company. The people that you're using on this deal are the same people who are out trolling for 100, 200, $500 million acquisitions that are highly important to the company and strategic. The end result of this is removing distraction and getting a few million dollars in cash. It's just not enough of a priority. You have to be lean in everything and realize your goal is not to maximize purchase price. Your goal is to get this done cleanly, easily and address a whole bunch of other variables you care about more than purchase price.

How do we pitch the deal?

I believe in just direct conversation. So if I were the corp dev officer, I would literally me or people on my team would pick up the phone, call the funds that we think might be interested, all the corporates we think might be interested. We're a large corporation, we're corporate development officers.

These are people you know. You're dialing people you know.

These are not people I know. If I think there's a natural buyer, I'll reach out to the corp dev officer. If I'm a corp dev officer, they'll usually take my call. They're in the business of looking for targets.

Okay, so you're your peers, you're reaching out to other corp defo.

Exactly. And private equity funds are always in the business of looking for targets. So my experience is if you have a asset, they will always take the call. They'll always take a look. And then I think you just have to be disciplined about removing what I call looky lose from the process. So that's why I like a nice tight process, because everyone is interested in learning strategics, want to see what their competitors are doing. Private equity guys want to see what the assets look like. I understand that I'm going to have to share information with them, but I don't want to burn lots of my time having them do lots of diligence calls. You get a tight piece of information, you get maybe one conversation with the person who manages this business and then give me an loi. Don't give me an loi.

Seems pretty fair. We start pitching, we get conversations. You're looking for the look you lose. Can you sense them when they're like that?

Yeah, absolutely. A couple of ways. One, they don't have a sense of urgency. People who want to buy an asset want to. When I'm a corporate development officer or private equity investor, when I see an asset, I want, I want to get the deal done. I want to get to exclusivity as fast as possible. If I'm a looky loo, I want to avoid that. I'm probably not going to sign an LOI or even if I sign an loi, I'm certainly not going to light up my lawyers. So number one, no sense of urgency. Number two, no outside spend. Because if I'm just trying to get market intelligence, I'm not going to spend 50 grand or 100 grand on my lawyers. So one of the things I always look for is when the meter starts running on the buyer's lawyers, that tells me that they're serious about it. And then the other thing is, you can tell from the questions they ask. Are they asking questions designed for them to just learn about the business, or are they asking questions designed to figure out how they would integrate or own that business? You tend to see it split pretty early on where the Person who's really serious is thinking about a lot of the mechanical details of how the business works and how it'll fit into my business or what I can do with it, what the synergies are. The looky Lou is just trying to learn market. They're much more focused on what are customer behavior, market dynamics, stuff like that. So I can usually figure it out. But the reality is I'm not gonna throw somebody out of the process. I'm just gonna accelerate the process so that they hit the brick wall of I don't wanna go any further. As fast as possible.

That's helpful. I'm gonna be looking out for these.

Looky loos now we're all looky loos.

You know, I am, I'm guilty of doing that.

Yeah, yeah. And fair enough. It's just the smaller the deal, the less time I have for that.

Let's talk about the other variables to consider. Yeah, we have customers, employees, PSAs. You mentioned PR messaging around the deal, contract terms, especially ongoing liability after closing. And then the people ring, fencing stays, who goes. You want to just talk to them one by one?

Yeah, absolutely. And especially when you're talking about these sort of micro deals, these things become much more important than purchase price. We run through them. My people, the people you acquire are going to talk to my existing employees and I hired them, they're my employees. I wanna make sure they're taken care of. I may wanna know that you're not gonna change the benefits, things like that, or that you're not gonna fire them. So I may be looking for commitments about maintaining the employees, customers even more. So this is a fundamental truth. The customer doesn't care that you've divested the business. You are the one that sold them the product and they're gonna be mad at you if the product doesn't work or if the product or the service isn't good. Especially if the customers for this little divested unit are also much bigger customers in your existing parent company. The last thing you want I make up numbers is to risk $20 million your customer because they are unhappy with the performance of a $50,000 a year product that you no longer own. So I'll often look to get commitments from the buyer that you're going to maintain certain levels of customer facing resources, that you're not going to change pricing dramatically, at least for the first year. All those things that ensure that by the time you do anything to make my customer angry, they no longer think of you as part of me. That's my Goal, I want to disconnect in a way where I don't damage my existing customer relationships, which could be worth orders of magnitude more than this little tiny business. TSA is really important and it can go in multiple directions. So I want to limit the amount of distraction my team has supporting you. Once you buy the business, I recognize there's going to have to be some transition services, but I want to minimize them, number one. Number two, I may want some of them to maintain the costs associated with resources that I have. The four and a half HR executives is a good example. I don't want to suddenly lose a portion of the revenue that was paying for those resources if they are not instantaneously downsizable, which oftentimes they are. Number three, you have the legal agreements. And as any Corp dev officer, private equity partner knows, your lawyers are very uncomfortable with legal liability. In a deal this small, they're even more uncomfortable with it. And so you want a buyer who is willing to minimize the amount of legal liability they're keeping with you. You're a large corporation, you don't need that overhang of a potential lawsuit. Having somebody who understands that and is going to wrangle their own lawyers to be very seller friendly is really important. There's also the ongoing commercial relationships. Yeah, in some cases when you divest a business, I never want to see it again. It's got nothing to do with our company, just be gone. But oftentimes it's more complicated. You use the technology or the data somewhere else. You want an ongoing license to it, you don't mind divesting it, but you don't want them to play with your competitors. So you want some kinds of non competes in place. You want to continue to sell the thing, you just want it off your books, but you don't mind getting some revenue share, continuing to sell it, or if it has a sales team, you want them to continue to sell your product. So there's a whole bunch of ways that you may want an ongoing commercial relationship that may be more important than purchase price. And then lastly, and this is sort of a subtle point, but in any of these ongoing commercial relationships, the tsa, tech, licensing, all that stuff. How do I say this in a way that my accountant friends won't get mad at me? It's good to recognize that purchase price gets added to the central balance sheet of the company, but revenue from a TSA or revenue from any kind of ongoing commercial relationships gets added to the P and L of the business unit. And as a general matter in my experience, division heads are much more concerned with extra revenue and extra EBITDA than they are with returning balance sheet capital to the mothership. And frankly, the mothership may feel the same way as well. The last one that you threw in there, which I also think is important, is PR and messaging. It's a very small business, but no company wants to signal failure. They may care more or less depending on what kind of business it is. If it's a business in a new cool area of tech, they don't want to show that oh, we couldn't figure out AI we had to sell this business. So when you're looking to sell, you want to understand whether the buyer is going to play ball with you in terms of the way you want to message. And I've even seen extreme examples where the buyer didn't buy the whole business, they bought 90% of the business. They bought control. And that allowed the seller to say to instead of announcing we've divested this business, they could spin it as we brought in a partner to help us further optimize this business for our customers. Depending on your organization and your PR function, you may care more or less about that, but those are a whole bunch of gives that you may want out of the buyer that aren't purchase price related.

That's interesting. You covered all of them.

I find this fascinating because purchase price is always a net zero gain. The dollar that's in the middle of the table, either I'm going to grab it or you're going to grab it, but there's only a dollar. All these other areas are great ways to create value out of nothing. As an example, I'm a private equity buyer. I generally don't care what the press release says. I'm just in it to buy a good asset at a reasonable price and be able to grow it. I'm glad to give you your press release which creates value for you. Similarly, committing to not damaging customer relationships may not be that much of a give for me. I wasn't planning on doing it anyway. Gives you comfort, gives you some value. Even if I was planning on doing something that might be customer damaging, the value to you of me not doing that may be way greater than the value to me of doing it. So there may be a situation where I'm glad to give up something that's worth a dollar to me and worth $10 to you. I like these non purchase price issues because if you really think them through and you have the right negotiating partner, you can create value that sometimes dwarfs the size of the purchase price, a whole bunch of different ways.

I like this. Teach me more game.

I'm a professional negotiator, and I understand that my job is to take as much money off the table as possible. But it's so much easier to just magically create value than it is to try to elbow you out of that buck that's sitting in the middle of us.

What are scenarios or examples? You did a couple, but I want to know more just to expand my peripheral when it comes to negotiating these deals.

Sure. The employee one is pretty easy for at least a certain period of time. You don't want the employees badmouthing the transaction. The sold employees. Maybe I would have reduced benefits this year and it would have saved me $50,000. It's probably worth it for you to say, hold off on doing that for a year so that we have time for the deal to settle. We get to distance our brand from whatever you're going to do to those employees. We'll take $50,000 off the purchase price because we really don't care that much about that. We don't want anything to happen to those employees until they are clearly your employees and they're separated from us.

You would want to negotiate that as a seller?

Yeah, absolutely. I have negotiated. I've divested myself.

But how do you know that part of your diligence as a seller, that, hey, what do you plan to do with their comp plan?

No, usually you can certainly ask. The reality is I can probably tell because I can put myself in their shoes and say, what would I do? And I know my own comp. I know my own benefits. And then depending on who the employees are, what kind of employees there are, where they are in our business, I care more or less about that issue. And I'll proactively go to you and say, this is going to be part of the contract. This is a give that I want your rep that you will not change benefits or comp structures for the first 12 months after the closing date. Usually I can figure out what they're going to do with the business because it's not that complicated a business. This is a small business. It's millions of dollars of revenue, not tens of millions of dollars of revenue. I can usually guess what their playbook is, whether they're a strategic Legal is another great example where I think you have huge value creation because the reality is, statistically, other than in cases of fraud, almost nobody sues anyone over ma. The number of litigations over MA transactions as a Percentage of deals is insanely low. But every lawyer autopilots to heavy reps and warranties because they feel like morally I should be able to sue you if anything is not accurate. Getting to the buyer and saying, look, just wrangle your lawyers because we don't want. Unless we committed fraud, sure, you can come after us, but for small things, for things that are just, we got it wrong. The data was a little bit off. You're just not going to sue us over it. So let's not pretend you are. And let's give our GC comfort by just taking that out of the agreement.

Sounds very familiar to selling how many software to large corporations like you worked for?

Yep, absolutely. Large corporations. Lawyers are trained quite appropriately to worry about catastrophic events because they're deep pockets. So the potential for a lawsuit in the GC's mind costs a lot more than the value that the buyer is actually seeing from those reps and warranties. It's different if you're selling a billion dollar business. If you're selling a $5 million business, coming to the buyer and saying, let's just take those out, or step one is let's take those out, step two is let's take those out and let's just reduce the purchase price by 20%.

All right, fine, we'll do that. I'll agree to take more risk and we'll put the price down.

Yeah, exactly.

Anything else? Like odd things you negotiate?

There's a whole maze of ongoing commercial relationships. So we talked about the tsa, but there are usually ways to create more value for both parties. So a good example is I'll let my salesforce keep selling the thing for you. You'll give me a reasonable rev share, but you have to agree to a non compete against these five competitors. I'll keep selling the product, you get access to my massive salesforce. But you're not gonna go play with, at least for the next two years or three years, competitors 1, 2, 3 and 4. That benefits me because it puts them at a disadvantage.

I'm retaining some go to market from your side.

Exactly. You're retaining some go to market. Maybe even a revenue commitment, depending on how bad I want it, how bad I want the non compete. So maybe I even give you a minimum revenue commitment. Technology licenses are another one. Whenever you have a technology business, there is some chance that that technology or that data has been isolated in a hidey hole to just this business. But it's much more likely that it's bled into some other parts of my business. So I probably need ongoing access to it. Or the flip side is the business I'm selling doesn't actually own all the technology necessary. You're going to need to license some of my stuff. Those are all opportunities to create value. The seller gets a bunch of revenue running through them. They get to show a new product to customers, all that kind of stuff. The buyer doesn't have to build all of it from scratch. There are a bunch of these sort of win win scenarios in these ongoing relationships. The easy way to think about it is if this business has any tendrils into the rest of your company where you tried to create synergies. Whether they worked or not, that suggests a whole set of synergies that you may continue to want to have with the buyer. If you truly isolated this thing in a lockbox, you and you never integrate it with any other part of your business. Maybe that's not true. In my experience, that's a relatively rare fact pattern.

What's the biggest valuation gap you've had?

When I'm selling one of these things.

Yeah. Or even on the buying side, I.

Would say the biggest valuation gap that we were able to fill. So start with insane valuation gaps. Any corp dev officer always has this where you show up and go, I think this is worth a dollar, and you say, oh, it's worth $1,000. I. It's like that TV show Pawn Stars. Okay, we should just stop talking now. If you set those aside, I'd say probably the biggest valuation and gap I've seen on a divestiture was probably like about a $5 million gap, which sounds small, but it was on a business where we wanted to get 10 million for it and they wanted to pay us 5 million. So it was 5 million, but it was 50%.

Yeah. So half. Right. Okay, I got it. That's what I was trying to get the spread. About half. That's a pretty big gap.

We were able to fill it. Yeah.

How'd you do it?

We basically pulled all of this stuff. First thing to go was all the reps and warranties in the agreement. We were like, we're not going to spend any time with our lawyers on this. Here's the agreement. Here's the seller friendly agreement. You're going to take it. The only thing we want you to do is fill in your address. Second, we beefed up the tsa. So we actually wanted a big TSA because we had a bunch of stranded costs in our organization. This business had been using a portion of a finance person, a portion of an HR person, a portion of. And we couldn't immediately size all those organizations because this was too small a sliver. Like you can't fire 1/10 of an HR person. We actually wanted a very robust TSA that was gonna last for like three years so that we would have time to grow into needing that person to do other stuff. And frankly, we had them pay us rack rate for it. So it became a profit center. So we increased the amount they paid so to be what it would have cost them to hire these kinds of resources on the open market. So full cost. And that was nice because that ran through our P and L. And then we got some technology licenses. We got a non compete, which was important to us because we didn't want. We thought it was a bad strategy. That's why we wanted to get rid of the asset. But we still didn't want any of our competitors to get any benefit out of working with these guys. And so all that stuff together was able to get us comfortable with a lower price. The reality was our fallback was shut it down. If you think about it, shut it down is not just zero, Shut it down is a negative number because you have to pay money to shut it down. You have to pay a bunch of severance. Shut it down as a negative number. 5 million was a materially positive number. So we were happy with that.

Help me get a sense of what do you need to come to evaluation, because right here there's this piece we just talked about. We could be way far off and say, forget about it, this is not going to happen. Ideally, want to get to that point as quick and inexpensive as possible.

A hundred percent.

What exactly do you need to be able to do that?

The way I like to operate is first, I have my own valuation expectations. I'm in the business of buying assets. I'm doing rough valuation on 100 deals a year. So I go through that same process as if I was buying this asset and I say, what's the reasonable valuation? Then I say, what would I really take for it? I'm not going to share this with the buyer, but it's a much lower number because I'm looking down the barrel of a shutdown that's going to cost me a couple of million dollars. So I have those two numbers in my mind. So if we take the example 10, and frankly it was probably more like three. So I thought if somebody were trying to maximize value, if a private equity fund were spinning off this business, they would pitch for a $10 million valuation. So that was full market valuation. We would have been happy taking three. Once I have that in my head, I ask for indications of valuation super early in the process. I give people that package of material. I tell them, next step is going to be an loi. You can have one call with the management team, ask questions. And by the way, either before the LOI or at the loi, I expect you to give me a valuation range or evaluation amount. And that allows me, without having done too much custom work on the buyer, if you think about it for a second, what have I invested on that buyer? I made one phone call to initiate contact, another phone call to give them a description of the deal. I emailed them stuff that I had already set up. Oh, that's another point. NDAs are not going to be heavily negotiated. It's going to be as is. I'm not burning my lawyer time going round and round in the NDA. I'm gonna put forward a very reasonable NDA.

When they send back. Everybody does this. They send back comments on NDA, then what do you do?

I say, we're glad to accept our original version of the NDA. I personally hate NDAs. They're one of the least valuable legal documents. Like, if you actually ask any lawyer what percentage of NDAs that they have structured have been litigated, I'm gonna say it's not even. I'm not even sure it's measured in basis points. So I personally think NDAs are a waste of time. If somebody really cycles with me on a reasonable NDA, they're not that serious about the deal. So I've had a couple of phone calls with them, I've emailed them stuff that I already had prepared. My management team gives them an hour, even an hour and a half call. That's all. I've invested in them as an individual buyer. By the time I get to an indication of valuation, and in some cases, I might even give them body language on valuation early on so that I'm not wasting their time either. I would expect to get 1 to 2 times revenue or 2 to 3 times revenue. And if they are way off from that, then they'll just make it known there because they don't want to waste their time.

What if you pitch this deal and it strikes iron while it's hot, you get a bunch of interested parties. How do you handle that?

I don't think you change your behavior very much, because here's the only thing I'll say. If I totally misread the value of the business and it's much higher. Then it may justify investing more of my resources in running a more robust process.

But you don't put that out there when you're the deal what you're asking for.

No, no, no. But I'm saying if I put out the material thinking I'm probably getting 5 million bucks for this business, and a bunch of people come back and start to give me body language around valuation at 40 million, 50 million, then I'm going to pivot and I'm going to run a much more rigorous process because I want to extract that value. Getting 10% more on a $5 million deal is not worth it. Getting 10% more on a$50 million deal is worth it. I have never seen that happen. In my experience, when you're divesting a subscale business, the bid ask spread is no one wants this thing or a few people are somewhat interested. Because the reality is, if it's a rock star business, it's not getting divested. It's very rare that you see a 400% growth business get divested. These businesses are usually, if you're generous, a diamond in the rough. If you're not generous, a falling knife. It's very rare that you get way more interest than you thought. Actually, the reverse problem is usually the case that we go out thinking, yeah, there's probably 10 people out there that are going to be pretty seriously interested. And the first eight we talk to go, nah, don't want to look at it. That's the more common problem is, wow, do we just have a busted deal here?

Yeah. Is there a dumpster for those deals?

Yeah, well, the dumpster is shut down.

Shut down, wind down, which is horrible.

For a whole bunch of reasons.

Not good for Morel. What's the hardest part of selling a small business?

Unit one for a corporate development officer is not running a rigorous process. We have all been wired with best practice. We've all spent hours watching M and A Science and learning the way to do this. There's something in our wiring that makes it very uncomfortable to not pursue best practice. But you have to understand the juice isn't worth the squeeze. That for something that's really small, you have to apply the right amount of resource. Given the size of the thing, given the impact of the business, and given the fact that it's a divestiture. Acquisitions and divestitures, it's like the difference in puts and calls. An acquisition has infinite potential upside. A divestiture does not. You can make some. There's some benefit to Those ongoing commercial relationships. But for the most part, a divestiture is about stopping the pain and getting a small amount of cash on the balance sheet. The first thing that's really uncomfortable is saying I'm going to do this. I'm not going to think about it as doing it in a half assed way. I'm going to think about it as doing it in an efficient way. It's appropriate to the size of it. The second one is a cultural thing. In companies where divestitures are viewed as failures, they're viewed as failures by the businesses. And somehow corp dev officers often don't get the credit that they deserve for doing an effective divestiture. Your path to promotion is not covered in effective divestitures. Nobody goes, that's the person we're going to promote to vice president or to svp. I think those are the two things that are particularly tough about divestitures. But what I like about them is it really is an opportunity to create value. It's just value in a way that people don't want to see. Stopping the pain. I put a band aid on my daughter's ankle this morning. Stopping the pain is of great value.

That's really good. Can we go off record but still be on record?

Sure. Of course.

I'm really interested in buying one of these carve outs. Man, you got me fired up. Talk me through it. How can I work my way into one of these companies? Find a corporate person like you used to be.

Remember, there is a dark side to these. These are not, as a general matter, rock star businesses. I know.

I like Harry deals.

Okay.

That was my background.

Yeah. As long as you recognize that they're.

Hairy deals, you got to work harder on them. Just put a little disclaimer. You work harder at them.

Yep.

But they can be really rewarding if you know what you're doing. Absolutely don't know what you're doing. They could even worse.

That's right. The first thing is that self awareness that says this is a dusty hairy deal. I'm going to have to do a lot of work on it. The second step is figure out where you're the natural buyer. You want to be a better buyer than everybody else who is out there. It's in a space that's natural for you. Because if you're a strategic buyer, because you have lots of synergies, because you understand the dynamics of the business. So it'll be easy for you to take it over, it'll be easy for you to integrate it. These are all things that are going to make you a more natural buyer, which has a couple of benefits. The first one is it means that the corporate's more likely to reach back out to you if you put yourself on their radar. If I'm a corp dev officer in a software company and a guy who only runs professional services companies calls me and they may say they're interested in my assets, I don't see how they're going to be successful. So I think that's going to be either a looky loo or somebody who bails at the last minute. Number one, be the natural buyer for the asset. Number two, do the market intel, find out the assets that are struggling assets. Because generally speaking, by the time a corp dev officer has been asked to divest a business, the business has been an ugly stepchild for a while. It should be common knowledge within the company and you want to try to get in early because once the corp dev officer has the asset, they're going to move fast. If they follow my guidance, they're going to move super fast and they're going to try to get the process done quickly. They're not going to call 50 potential buyers. They're going to go because remember the conversation we had earlier, the goal is not to touch every potential buyer and get the maximum value. The goal is to go to the five or ten most natural buyers and just get a deal done. Being out in the market, talking to corp dev officers who look at your existing business and go, oh yeah, I can see why is probably as good a way as any. And then there's a matter of luck, right place, right time because these assets come up for sale when they come up for sale. The one other thing I'll say is there is no harm in asking to extract an asset. If you know of a business inside of a large corporate and it's not officially for sale, but you've heard rumors that it's not getting growth funding, they put it in a basement somewhere, it's sort of being treated like an unwanted asset. There's no harm in reaching out to the corp dev officer and saying hey, I know you have this business. I think it would be a great fit. I don't know if you guys have considered selling it. I'm trying to stimulate that conversation.

Okay, so the sourcing part, there's a lot of what you described of bottoms up, like really doing some market research identifying these businesses which you can absolutely do a third party database and Google, Google, LinkedIn. Other I was curious about is top down where if I know there's a large player in the space and they have tons of business lines which it's hard to sometimes get familiar with other business lines. But I reach out to the corp dev and saying, hey, just curious if you got some little thing you want. No, that's probably not the best way you can.

And if you have a close enough relationship, maybe they'll tell you it's kind.

Of like the friend of the business where.

Yeah, but the reality is the corp deb officer doesn't want to focus on divestitures until a divestiture is needed. That's not what they want their day job to be.

Need to come in with a bit of an investment thesis.

I think that's right. And I think the most important thing, and frankly this is what we do. It's a core part of our strategy is you have to communicate to the seller and to the corp dev officer. I understand your business, I understand your constraints. I want this asset and I'm going to make it the best result for you. So that's something that we do to differentiate ourselves from all other buyers. Why should you deal with us? You should deal with us because we already know how to create a deal that optimizes for a corporate seller. The only thing better than having a buyer who is willing to do all the stuff that I just listed, be flexible on the reps and warranties, take care of the employees, take care of the is a buyer who comes in. And you don't have to tell them any of that. They already know it. When I show up to a corporate development officer, I go, I've been in your chair. I know how to structure a deal that will optimize for you how to get what you need and get what I need. And the likelihood of the deal getting done fast, clean and it actually closing is way higher with me than it is with other people. There's a reason why you would want to sell to me. It's a thing you want to get rid of and you're going to get a good outcome. That last part is I'm not going to waste your time. This isn't going to all blow up on you because for a small deal, the failed deal is a horrible outcome.

Let's role play this out. CEO of M& A Science we have one of our business lines, the data room product called Firm Room. And this is a really profitable business for us because we carved it out of our deal room product and made a standalone data room. But this market is very fragmented. There's probably 100 data room providers out there. There's some really old ones, very stagnant business that are privately owned. But I've also found some corporations, I remember Nasdaq used to have their own data room. I think they actually built it in house, had this thing in the market for two, three years, and this thing, nowhere in sight, is going to be a competitive business model that they'd want to. They probably realize that we got to kill this thing. I think they just shut it down. But that would have been a good one.

And there what I would have done is I would have gone to them proactively and said, I think that I am a better home for your data room product. And here's the benefit to you of doing that. Deal and purchase price should not even. It either shouldn't be on the list or it should be relatively minor point. Because in the grand scheme of things, does Nasdaq care about a few million dollars for a purchase price? No. But saying we can then provide a white label NASDAQ product that you can still deliver. We can cross sell other NASDAQ services. I don't know if this is the right answer. You'd have to research them. But putting together a conceptual package that says if NASDAQ sells this data room business to me, here are all the revenue streams and cost savings that are going to flow to Nasdaq and brand benefits that are going to benefit you. The mistake people often do is go to a corporate and go, I want to buy that little business for $5 million. And frankly, the corporate's reaction, it's the same reaction as if I said to you, I want to buy that pen from you for 3 cents. I don't care one way or the other. I'm not even going to bother having a negotiation with you over 3 cents. It's too silly to me.

What's my pitch?

So I think your pitch is again, not knowing Nasdaq that well, you've sold a bunch of customers on this. You don't want to run this business. It's not a core to your business. Sell it to me. I will take care of your customers. They won't be mad at you. I will offer you a white label product. So if you think you can still sell this, you get all the benefit of selling it without running anything. And it'll be a better quality product than the one. Because right now you have this product that you're really not paying that much attention to. I'm a market leader. So if you're selling a white label Nasdaq version of my product. It's going to be a really good product. You could also sell the adjacent products that I have. We can talk about white labeling them. I will not cut this kind of a deal with any of your direct competitors. And I'd throw in the transition services stuff. I'm going to need some transition services from you and of course, or some glad to pay generous price that will run through your P and L. You're too young maybe to remember this, but the old ads. This is your brain. This is your brain on drugs. This is what you have now. A little subscale business that's not strategic, that's sort of an annoyance, but that puts you at risk with your customers because when you sell it to a big customer, then you're beholden to them. The new scenario is you don't have to worry about any of that. You still get all the benefit of providing this to your customers, maybe even more benefit other services. Your customers are happy, you're getting more revenue and you're getting much higher margin. You don't have to maintain this weird little technology that you don't really understand. Doesn't that sound better than that?

Focus on the business impact that you would make.

Yeah, exactly. Remember that for them, if you think about the order of importance, the lowest importance is balance sheet. For something this small, P and L is more important. And in some cases customer relationships, brand and market presence are even more important than small, than P and L impact. Try to focus on those top two things, not only because they care more about them, but because you care more about the bottom thing. Get them all hyped up on the top thing. Go. In order to have all this great stuff, we of course are going to have to talk about a very reasonable purchase price. And at the end of the day, they'll be fine with it. They won't care.

Complementary versus competitive. This example is actually competitive. For going after another data room product. Complementary. It makes sense. We don't go too far from our core, but hey, this seems like a good part of the strategy. We'd acquire the business pretty straightforward. A lot of conversation we have in MI Sciences around those scenarios. If it's competitive, where most of them realistically are tech stacks, probably 10, 20 years older, outdated, clunky, much better product.

But that's fine. Buying revenue, buying customers, buying brand, buying employees. There are lots of things that you can be buying in that deal. Even if you're going to retire the.

Tech you do that still is okay. You can still be upfront about it and say, hey, we can run this, provide a better experience.

In fact, I mean, without insulting them. You're saying exactly what you're saying, which is when we migrate your customers over to our platform, they'll be getting a better experience. This is what we do for a living. This is not what you guys do for a living. So we're going to give them a market leading experience either for the customers that you already sold the product to so they'll be happy or. Or for customers you're going to continue to sell this to if you want to do a white label deal with us. People are smart. They understand if they don't have market leading tech, the person who built the tech may not want to hear that. But the person you're talking to, the corporate development officer, the division leader, doesn't have an emotional entanglement with their tech stack. They just want the best thing for the business.

I'm fired up. I want to go talk to some strategics in the industry.

There are good assets out there. People focus on acquisitions, but not all acquisitions turn out well. Some acquisitions are big and come with multiple parts. And maybe you like nine out of the ten parts, but not the tenth part. But inevitably there are a large number of assets that haven't found their home.

When it comes to negotiating terms with these large corporations. Yeah, doing earn out owner financing. Oh yeah, Equity.

Yeah. You have to be careful because some of them will be willing to own a minority stake in a third party business. Some of them just philosophically will not want that complexity. But you can absolutely talk to them about earnouts. Some are comfortable with it, some are not. But again, remember, they don't have a balance sheet problem. The treasury accounts probably have a billion dollars in cash. They don't need your $4 million. It just gets put on the pile. Yeah, you can definitely do that. Or the other way to do it is pay very generously for things over time. So my TSA expenses, I'm not going to negotiate with you. They're going to end up being $3 million higher than they would have otherwise been. But it's $1 million a year for three years. But then I'm going to push hard on the purchase price. Effectively what you've done is a little bit of seller financing.

How does it impact taxes? Everybody rolls their eyes. If I bring anything about taxes?

No, no. If you think about it, as long as all the accounts are valid, and I'll leave that up to a cpa. It lowers your purchase price, so it does lower your basis. But it also increases your losses or reduces your profitability. So it's running more money through both parties, P and ls, and less through their balance sheets. For the large corporate. I don't think it matters. It's so comically small. They're not thinking about the taxation. Exactly.

Exactly. This has been good.

Yeah, good.

What's the craziest thing you've seen in M and A?

Apropos you've asked me this question a number of times. I've given you different answers. But apropos this topic, I saw a deal. It was a 8 million revenue business unit of a much larger company. It was about break even. They decided it was off strategy. They wanted to sell it and they really wanted to sell it. Unfortunately, they had a couple of different failed sale processes. Buyer went pretty far down the line, then decided no. But they still had buyers that were interested, but they reached an internal decision. And this goes to the point I made early in this conversation that the noise and distraction associated with the sale process was too much. Even in the face of having buyers at the table that wanted to due diligence and negotiate, they just shut it down. They just fired everybody. You and I sit here going, wow, 8 million revenue tech business that's got some significant value to it. But in their eyes, the distraction factor of continuing a sale process that had been bumpy and hadn't achieved anything. It was worth it for them to take $0 and pay out maybe a million dollars in severance to just stop the pain. It's the case study for why there is this opportunity with subscale divestitures to create value by bringing the right two people together at the right time.

How would you save that deal?

I'm not sure if there's a way of saving that deal other than getting the buyer front and center with them earlier in the process before they reach the decision that they were just going to shut down. Because once a company reaches a decision like that, they're just going to do it. The wheels go in motion and everybody runs. So I think the only way of saving that would have been for the buyer who wouldn't have ended up walking away to get into the process early enough and turn it into a successful process.

I would have gotten the jet, I would have and spending some T and E on the corporate card and said, hey, let's discuss this over a few drinks.

Yeah, that's part of the problem with this is that on a small deal, the problem is nobody wants to spend any time on it. That corp dev team. This was probably their fifth priority behind four really important acquisitions. And so at some point they said, you know what? This has been going round and round. We're not getting anywhere.

They got fed up.

They got fed up.

Done.

Yeah. And it was too small. I go back to the pen analogy. If that pen stops writing, you might lick it. Try it again, you might tap it on the desk. But at some point relatively soon, you're just going to throw that pen in the garbage and move on. In the grand scheme of Kisan Patel, it's just a crappy little pen.

Wow. I'm going to start looking for more pens in the dumpster.

Yeah.

Michael, thank you so much for the time today. I enjoyed this conversation. You helped me become a better M and A scientist.

Thanks, Kisan.

Those of you still with us, we got a little extra bonus conversation towards the end. Till next time, here's to the deal.

Foreign.

Thank you for taking the time to explore the world of M and A with our podcast. We love hearing feedback. Tag us on a LinkedIn post, add a review on Apple Podcasts. We'd love to hear from you. If you need help standing up an M and A function or optimizing one that you already have, we're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email, Kisan K I S o n a science.com or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter. Again, that's mascience.com here's to the deal. Views and opinions expressed on M and A Science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual. This podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.