Taking a Deal from 3X to 7X

Good afternoon, and thank you for hanging in this last part of the program. We started at this time on Tuesday afternoon, so here we are Thursday afternoon. There's been a lot of interaction and a lot of meeting and greeting, and on behalf of the 1,000 members of the Alliance of M&A Advisors, thank you for coming and being part of this this experience. We've, um, we're blessed with an extraordinary staff, wonderful sponsors, and most of all, it all happens because of independent M&A professionals like yourself that are willing to share, learn, and earn more together. So we're thrilled to have you as part of our community. We, we hope to be able to have you all join us in 6 months in Orlando, mid-January, the week of January 11th, and we want to keep this going, but we don't have to wait 6 months. It really, I think, is happening as we speak. I'm hearing of a lot of people making connections on the sell side, the buy side, projects, and that's really what this afternoon is all about, is doing more than just the traditional M&A activity. We started the M&A Association some 17 years ago, and it's grown from the initial 10 members now to over 1,000. And many people say that we should just stick to buy-sell activity and not get involved in other products and services that may be of help in the middle marketplace. And so we've got a bit of a divided opinion because people have said, well, Mike, your organization has limited time and resources, so there's plenty to do in just the lower middle market in terms of education and events and getting experts together. Why don't you spend more time helping us get found? Why doesn't the association become more well-known? And why don't you grow? And if you grow, then we all can do more together. So that's Another key part of what this afternoon is about, it's growth. We are growing the M&A Association. We've got new chapters. We have a very well-established foundation started in Europe, thanks in large part to Urs Brechtbecher and others who are working with him. We had a wonderful meeting here in Chicago a few weeks ago with the Hong Kong Trade Development Council. And thanks to Chris and Jackie and the Choi brothers, we are going to be expanding on the international front with a chapter in Hong Kong to service the Asia-Pacific area in 2016. So I've had people ask when the first meeting will be, and we haven't yet fixed the date, but we are very much committed to growth in terms of chapters The certification and training program, we've got 2 events this fall. We hope that for those of you that are not yet certified, about half of our 1,000 members are certified, so something to consider if that may be of benefit to you. And there's a long list of testimonials on why it could be of value to your efforts. But the M&A Association is thriving and will continue to grow. And yet one of the problems we've noticed over the years is that sadly, 9 times out of 10, when one of the independent M&A advisors goes out to visit a potential sell-side client, we've learned over the years, 90% of the time there's no engagement. There's no sale transaction that is even possible, largely because of some of what we've talked about in this this gap between what the seller, the private company, might like, want, or need in the way of sale value and reality. And most independent M&A professionals, when they have an hour or two meeting and you look at the situation and you do the initial assessment, most often, 9 times out of 10, the answer is, sorry, I can't help today. Goodbye, good luck, adios, I'll check in with you in a couple years. Now the reason I know that is true is because I did that for about a decade and a half myself. That was my role, and what I've come to realize is just as technology is changing and the marketplace is changing, maybe there's a better way. And that's really what this afternoon is all about, is we have identified some independent experts, that instead of just saying no, instead of just waiting for the right and ready transaction that is market ready today, what if for the 9 out of 10 that we say no to on the M&A advisor side, and for those of you from the private equity world, this gap is even more pronounced because we've learned over the years, most private equity investors will tell you, It's a numbers game, Mike, and we on average will do 1 out of about every 80 books, 1 out of about every 80 possibilities we look at. And I've said to them, well, gee, what happens to the other 79? And some of the people you will have met over the last couple of days, private equity investors, will look at you coldly and they say, well, Mike, I don't know, it wasn't a deal. Who cares? And so this is the reality of the M&A world. You all know it's true. And so this afternoon we're looking to be able to share some new thoughts, ideas, some innovative thinking, and it's all about creating more value. What if instead of saying no all the time, and it may be that we're never going to convert transaction experts into offering the best of these value growth profit improvement services, but maybe it's a different type of related professional, and maybe there's a way to collaborate and work together, in which case everybody is able to benefit. Now, some have said, you know, that's Pollyanna thinking and kumbaya and all that, Mike, it ain't gonna happen. But what's happening now is we're getting some momentum among people that think, my God, maybe this could happen. And one of the people that's done an extraordinary job over the past couple years, Ken Sanginario, with his Value Opportunity Profile, Ken himself made this same observation over many years that there ought to be a better way. And that's what we would ask your help with today is we want to make this a very informative, interactive session over the next few hours. We've got some top-notch professionals that are business owners, advisors, PhDs, authors, and most of all, they're willing to share. So in pulling this together, we want to get your thoughts and feedback because we think we've got a chance to do something very impactful for the private company marketplace, not just domestically, but globally, because we've learned that this is really the engine of job growth and prosperity. We know that during the Great Recession, the average larger company, the average company with revenues of $1 billion and up, got rid of 2,000 jobs during that 6-year Great Recession period, while the average middle market private company added 20 jobs. So we're now getting the attention of the regulators, the Congress itself. People are realizing that you're where it's at, which is why we're able to get the mayor and other congresspeople and such. Of course, I think it also helped too that our conference chair's brother was the chairman of the Democratic National Committee. Little things like that. Having government support for what we're doing is very important because it's important for our economy. So without any further delay, thank you for hanging in there. I think you're going to find this last part to be very meaningful and very helpful as you head back home and you figure out how to put all of this into motion. And one of the people that we've had, we've grown to build and learn much from Mary Lou and I were out on the West Coast in partnership with Thomson Reuters. One of our featured speakers for that program was Dr. Basil Peters, and so well done, and the work he's done, I think there's no better way to start off this afternoon, so please help us in welcoming Dr. Basil Peters.

Thanks, Mike. Good afternoon, ladies and gentlemen. The conference content committee wanted Kenneth Marks and I to talk about all the things that we can do, have done in our businesses, to take the value of a company we're selling from, say, 3x to 7x. Or in other words, how can we double the value, taking a little bit longer time horizon than some of us might just in the pure transactional end of the business. So I think that the— I just tested this thing and it worked a minute ago. I think the first step in dramatically increasing the value of a company you'd be selling is to hire a really good M&A advisor. I'm actually serious about that. I think that If you look at it over the entire life cycle, what company owners need is they need some good advice in that last stage of their company's operating history. And as I thought about this content, I thought, well, isn't that really the reason that you want to hire a good exit team, a good M&A advisor, a good value growth consultant? And another way to look at this is if you think about selling a company somewhere between 3x and 7x, Selling it for 3x is actually pretty easy. Selling it for 7x is a great deal harder. Selling it for 7x takes a lot of skill, strategy, and patience. This is a graph that I think about a lot and try and talk to our prospective clients about. And what I'm recognizing here is that in our industry, in this industry that facilitates exits, there are a range of qualities of intermediaries and advisors. And I think that it's pretty easy to accept that in any group of people, there's gonna be the people in the middle, there's gonna be a few that are exceptional, and then there's gonna be the bottom 50% that are below average. And I think what business owners underappreciate is that the ultimate end result when they sell their companies is significantly affected by the quality of the exit team that they end up working with. And I really believe, from watching what I've seen in the industry, from talking to many of my peers over a number of decades, I think that that range of outcome can easily be plus or minus 50% of the value of the business. That's about the 3x to 7x that the organizers wanted us to build a talk around. And that's a pretty big range when you think about this whole process just being the last couple of years of an organization's life, that it can all be affected plus or minus 50%, almost a factor of 2x, just on the quality of the exit team that comes together facilitate that transition. It's not the topic of this talk, but it's also interesting to me that if you look at what's happening in our marketplace, the range of fees that are charged actually varies over a much smaller range. So in the market, what I'm seeing is the difference between really good and the lower end of the range is probably only a couple of percentage points on the success fee. But the range in the outcome, I believe, is probably 25 times greater in a percentage basis. I think for most companies that we come across, most of those people that Mike talked about going to meet, there's quite a few ways that you could imagine increasing the final selling price. A full discussion of all the things that we could do, I think, should be a week-long workshop I was trying to twist Mike's arm earlier and thinking about whether we could put one of those together. But today we've got much less than an hour, so what I'm going to do is provide some highlights. Some of the ways that I believe that are generally applicable to almost any situation where we can help to move the price up are: number 1, to increase the growth rate; number 2, what I call structural value increases, Number 3, capitalizing on inefficient markets. Number 4, illuminating strategic value. Number 5, maintaining multiple bidders. And number 6, just the sales and negotiating skill of the team. Now those 6 factors kind of span that period of time that Mike was talking about. The first one takes the longest, the last one happens in the last few months. The biggest opportunity, I think, to increase the value of most companies is to increase the growth rate. And to understand that, I want to just take a minute and go over some material that most of you are going to be familiar with. And I'm sure that you all know that most valuation is based on a discounted future cash flow, and it also has to factor in things like the cost of capital and the imperfect predictability of the future earnings. I think an easier way to think about it is to imagine that buyers want to buy a business, they want to finance it entirely with debt, and then they want to have the business operate to pay that off in, say, 5 to 7 years. That's really an easier way, I think, to explain it, particularly to an owner. And I don't want to get into a bunch of math here, you probably can't even see these numbers, but what I've got up there is just a simple table showing what happens to the discounted future value of an income stream from a company In this case, the company's earning $1 million a year. I've projected it out for 10 years. Just use the math that's built into Excel to show what the discounted future value is of a business that's not growing, that's generating $1 million a year. And if you add those up, the bottom line there is just under $4 million. A little bit more than that 3x at the lower end of the range we're talking about. So if you've got a business generating $1 million, it's not growing, $4 million is kind of a fair price at an 18% discount factor. I know we could negotiate discount factors all day. We're not going to do that here, but just for comparison purposes, here's a similar company generating $1 million of EBITDA, but it's growing at 25% per year. And if you add those numbers up, that totals up to a little over $9 million. So what's interesting about that when you're thinking about how to help an owner increase the value is a million-dollar company not growing, it's worth about $4 million. That same million dollars growing at 25% is worth $9 million. Again, just pure math, not talking about any other change in the business. But that's double the value. That's right there, 3x to 6x, let's say. And another way that is familiar to a lot of people to think about this growth factor in valuation is the rules of thumb that people use in the public markets. I'm sure all of you have heard your advisors or thought to yourself that in the public markets, people often say that the P/E ratio of the stocks that you buy or own should be roughly equal to the growth rate. In other words, if you've got a company growing at 10% per year, a fair P/E might be 10. A company growing at 20% per year, just on a mathematical basis, deserves about double the valuation or a PE of about 20. And of course, there's other differences there because we're talking about after-tax earnings, we're talking about the difference between liquid and illiquid, but the same principles apply. So an easier way to think about that, I suggest, is to look at this graph, which is nothing more than the math behind the discounted future cash flow of any income-producing asset. But what's interesting here is if you go down to the lower left of that graph and at that zero growth rate, you see that it starts at about 4. So a company that's not growing, fairly valued at about 4 times earnings with this 18%. But look what happens when the growth rate increases just a little bit. You know, if you get up to, say, 25% growth rate, which is, again, it's a solid growth rate but not a spectacular one, the fair value's 9. But if you could grow that at 50%, now what's happened is, just, again, just math, The fair multiple is like 25x at 50%. And that's one of the things that drives the crazy valuations we see in the tech market, is a lot of these companies are growing at 50, 75, 100, or 300% per year. And that's why when we see some of these multiples, at first it kind of takes our breath away, but really it's all based on simple mathematical fundamentals. But that's a really big lever that we can apply at the early stages to change the value of a company. The— I don't know what the name for this is, you know, Mike and I have been talking about what this should be called for years, all of us have. I don't know whether it should be called exit planning, growth consulting, growth value. We're gonna figure that out one of these days, but there's a job here that's not normally part of the transactional organization. What I've found in the business that we've done is that many of the companies that we find who we hope are saleable really haven't maximized their growth rate. They're in that category that Mike was talking about, which is where you want to— you're tempted to say, well, I'll see you in a couple of years or three to see what's happened. In our firm, we've actually taken a bit of a different approach, and we've naturally wanted to help the business owners that we found were not quite ready. So I look back over the transactions that we've done for the last decade or so, and in about half the cases where we've completed exits, we've actually been involved in helping the company increase the growth rate. And the challenge with that is, and again, looking back over our own transaction history, is that takes a lot more time. Because even if you're efficient in doing that, you're gonna need at least several quarters of actual financial results to have a convincing demonstration to a buyer that you have established a higher growth rate. So that's, I think, one of the examples Mike was suggesting that he wanted us to be thinking about is, you know, how can we either expand our practices or work with other professionals to get these companies that we find that are good companies, but maybe haven't been as aggressive as they could have been, How can we help them grow faster? Another one of the things that I think should be done early on in every exit strategy planning session is to think about structural value increases. And these are often small tweaks in the corporate structure, and they can sometimes increase the selling price by 10 to 25%. Sometimes this is called financial engineering. And these can be balance sheet changes, they could be asset versus share sale strategies, they might be financing mechanisms, or even tweaks to the deal structure. Tax innovations, in some cases, can be a significant opportunity, depending on the structure of the company you're dealing with, and the jurisdictions across which you're dealing. International transactions bring a whole new layer of possibilities, in tax planning, and there's almost an uncountable number of things that you could do under the category of structural value increases, but in my experience, those can easily add millions of dollars to the final result and more than pay several times over for the professional fees that are involved. Another particular favorite of mine is capitalizing on inefficient markets. And I think that we, as a group of professionals, probably underappreciate just how inefficient the markets are that we operate in. And certainly, our prospective clients have very little appreciation for this. And what inefficient means when you talk about markets, what the economists are talking about when they describe inefficient, is a complex thing. But the short summary is that an inefficient market information is difficult to access. In other words, there's no transparency. The number of buyers, and especially the number of sellers, is limited. And these things tend to contribute to markets that are illiquid, which we all know firsthand because we recognize how difficult it is to facilitate a company transition. But they're also inefficient in matching price to fundamental value. And what's fascinating to me about this is that, unlike almost everything else in the financial world, there's an imbalance in the effect of this market inefficiency. And all of the market inefficiencies favor the seller, and none of them favor the buyer. And recognizing this provides an enormous capability to optimize the outcome for our client companies. And the flip side of this, and the part that breaks my heart, is that because on the buy side almost everybody there is a professional, buy side people are smart, they've probably done this a lot of times before, especially as an organization. A lot of times sellers, especially in what buyers call proprietary deal flow situations, end up having sellers leave millions of dollars on the table. And the saddest part to me is a lot of times they don't even know, because of these inefficiencies in the market, because of the imbalances between the capabilities on the buy and the sell side. Illuminating strategic value is perhaps one of the largest fundamental increases in the value that the financial intermediaries can provide. And in my view, it's not actually possible to create strategic value in the context of an exit or transitionary period. Even if you're taking the long view and looking at it over a 2, 3, even longer year period, I think that the fund— the strategic value actually has to be there or it's not there. I don't think you can create strategic value. You might be able to get a company to grow faster, you can probably restructure a company, but the strategic value is something that I think is either there or not. And the job of the professionals is to illuminate it. The job of the professionals is to have that strategic vision across multiple industries, multiple markets, and to find a situation where that particular company has a higher value to some class of buyers than to the general market. And this can be challenging. A lot of times, even when you think you understand where that strategic value is, communicating it can be a real challenge. And again, one of the areas that I think is a particularly fun part of the business that we do, one of the things that differentiates some of the really superb firms in our industry from people in the average. And of course, everybody in our business knows that there are a lot of opportunities to make the playing field more level for the sellers. By ensuring that companies don't end up completing a transaction based on an unsolicited offer or really a single bidder. And I think that every business should really strive to have multiple bidders to maximize the final selling price, but also to increase the probability of completion. Multiple bidders will ensure the transaction also closes sooner. And I think quite importantly and underappreciated is, it's the only way that I can imagine to demonstrate good governance in the case where there's more than one shareholder. There's also no question that selling and negotiating skill has an impact in the final selling price. And all of us who've run businesses know that, you know, selling a business, selling a company is just like any other sale that you might make, except that it's bigger and more complex. And I think that an outstanding sales capability in the exit team can easily increase that final price by 50%. And I've got a blog post up on my site that gets quite a bit of traffic about some of the case studies where we've actually had the ability to disclose some of the things that increased value by 50%. 'Cause the first reaction you usually get when you're talking to a business owner is, "Can you really increase the price by 50%? Is there really that much elasticity in the market?" And, you know, it's hard to describe to somebody who hasn't seen it. And I think most of our clients don't really appreciate where they actually ended up on that graph between that plus or minus 50% in value because they have no ability to put that number in perspective. But I've actually helped to make that happen quite a few times, and in the actual process, I think it's quite easy to see. It's quite easy, and I've even got a case study where one owner was brave enough to say on camera that when the first offer for their company came in and it was at their target price, he had an un— irresistible urge to grab his pen and sign the LOI. And my partner and I actually had to almost sit on him and not let him have anything that would write to help him appreciate that it was, it was too early to accept that first offer, even though it was at his target price. And part of the reason is that that growth planning that we'd done earlier was paying off quite nicely. The company was growing a little bit better than we expected. And in the end, what we did is we had 3 bidders, we walked the price up 48%. And that's one of those cases where we were able to talk about it. And so when you see that happen over and over again, you really do get an appreciation for that in this highly inefficient market that we operate in, there is probably, you know, a percentage of range that's influenceable just by how well the exit process is designed and executed. The challenge with this, and the challenge with learning about this, and perhaps the opportunity for the AMAA to help us all be better at this, is that in our industry, in my experience, about 80 to 90% of the time, the people involved in the transaction end up signing an NDA. And what that means is that we don't have a lot of case studies that we can use for helping to understand how we as an industry can do these things better. So we're all still learning in our own little companies where that NDA allows us to exchange information. And what is sad for me is that I know of many great stories, some of them were companies that we ourselves, in my little firm, sold, where we can't tell the story. And that to me is kind of heartbreaking because it's a lost opportunity for all of us to learn more about how we can do this and to increase the final outcome. I've been writing quite a bit about this on my blog. There's some resources up here. This PowerPoint should be available from the AMA download, or if not, just go to my site. I'm sure you can find these, or send me an email. I'll be happy to point you to them. I'm gonna hand it over now to Kenneth Marks, who's gonna do the second half of this module on increasing the price from 3x to 7x. 7X, and then if there's time, we'd be happy to answer some questions.

Good afternoon. This is a hard time. This is a difficult time slot, as many of you know, that if you've done the speaking, it's after lunch. It's 1:30, 2 o'clock. In fact, 2 o'clock, you know, everybody's— I see, you know, we need the coffee. Do we have enough coffee? Those kind of things. So I know it's a tough time slot. Basil, that was a great tee-up. I mean, we had not rehearsed this. We've actually corresponded and shared slides, but we had not had a chance to rehearse this, so I was sitting there thinking you've done a great job of teeing up to give me a chance to share kind of the next level of detail, so thank you. I have a firm called High Rock Partners. We are a strategic advisory firm, and we do quite a bit of M&A work, and so if we think about our business, it's about a third strategy work, about half buy-side and about half sell-side. So our buy-side clients, $100 million plus type buyers that are buying lower middle market companies. Our sell-side clients are clients that are usually $3 to $30 million. They're technology, they're B2B services, manufacturing distribution. And so I come at this looking at it pretty holistically, and I think that's one of the reasons Mike ask me to participate is that we do quite a bit of strategy work in helping clients think about what their alternatives are. So I want to share with you and kind of dovetail into what Basil teed up in the first 30 minutes. I want to share with you just some of the, the ways that we as a firm think about this idea of how do we help our clients significantly increase the value of their their companies. I've got a couple of different kind of buckets I want to talk about. The first one is, it's very high level, and as you think about that idea of growth, so I think that's really just the whole concept of, okay, that sounds great, how do I grow my business faster? As I've talked to many clients, if you're dealing in the lower middle market, as you know, a company for a number of years can sustain a 25 or 30 or 40% growth rate when the numbers are small. But as the numbers get bigger, it gets more and more difficult. And so what we found is, is in a very— and I'm gonna— I've got about a dozen slides I want to walk you through, maybe 15, that I want to touch on, uh, kind of an approach that we've used. And by the way, this— you were talking about a 1-week— we, we actually have a 3-hour, 3 or 4-hour workshop that we run for CEO groups. And so what I've done is I've taken about 20 minutes of that 3-hour workshop and tried to boil it down. And so what we tend to do is start with strategy because it is about— we found this whole idea of illuminating strategy, I like the way you've worded that, it's helping our clients to really get out of the weeds and think about what that growth strategy is for their company and what the strategic positioning is and why are they relevant to the marketplace. So we start with the strategic health of a business and we found that from that creates the opportunity to then think about some of the other fundamentals, as we'll call them. And so we think about what's the right management team that's in place to grow the business, to keep that growth rate going. Further, and we go through that thinking about the— as an output of that process comes who are the— what's the role of the owner founder, how is that business going to scale, and how should it be capitalized. And effectively what we're trying to do is bring alignment about for all these kind of fundamental areas of the business so that— and understand the strengths and the weaknesses and where that business is going. So let me give just a little bit of drill down on each one of these just to give a little color or character to it, if that's all right. When we talk about the strategic health of the company, we're talking about being able to articulate the growth strategy using the right strategic approach to be able to guide the way. It becomes effectively— we create something we call a filter, which helps make the decisions about what's right for the business moving forward and what's not. If you think about it, when we're talking about strategic health, we're really talking about understanding the secret sauce of that business, the unique business processes, the market position, positioning and how they really add value to their customers and what those customers are paying for. Particularly in a forward-looking, if you will, in the future horizon. From that we look at what's the right management team that actually is going to help grow that business. And this becomes a little difficult because if you think about it, reverse this, these are some of the things that if you're on the buy side, What are you looking at? And many times we're looking at— you think about it, the management team that has built the company to a certain stage is not necessarily the same management team that's going to be able to grow that business. And we find that in many cases, more and more cases, human capital, the management team, the leadership team, that's part of the value that a buyer is willing to pay for. And so if you have a management a team that is, for lack of a better word, legacy, and they're not positioned to grow that business forward, there's a big differentiation in value, likely, depending on the kind of deal you're doing. But there's a— we find more and more there's going to be a big distinction between the value of the company with the legacy team versus a growth-oriented, having the right players, use the Jim Collins, the right players in the right seats on the bus. Going through that process of understanding that and thinking about it is one of those fundamental steps. Now one of the things that ties with that is this idea of— and as I said, this doesn't really apply to you in the audience, but it applies to your client companies or your investments— and when I'm talking to CEOs, I give the example that, look, in my first business when I was in my 20s, I was the What's the problem with the growth of my company? I was this. I answered yes to all these. And I've got a whole series of how do you know when the owner founder is really part of the impediment of growing the company. But these are thought provokers effectively. But addressing the concentration issue around and the dependence on an owner or founder is a critical— one of those critical management components that can detract from the value of a deal significantly. It also— solving that problem of dependence actually can be addressed by thinking about the scalability of the company. So if you think about the systems, think about that, go back to the strategy and what's unique about the business and business processes and how do you grow that company, continuing to deliver good quality of either service or product, whatever it is that the company does, embedding the institutional knowledge in systems that are scalable and scalable on, I'm calling it, a disproportional basis to the rate of growth. We get, we use the term, I don't know what others call it, we call it operating leverage. By thinking through and having those investments in that scalability is something that solves a number of problems and provides the ability to sell forward the value. One of the fundamental things we try to do in the sales process is shift the conversation from trailing 12 months to the forward-looking. But it has to be credible. So many times we see forecast and we see things that just aren't credible numbers. We're going to take a business that's been lumpy for X number of years in earnings and has all these add-backs and has up and downs in revenues and all of a sudden the forward-looking forecast is perfect. How does that happen? We know the answer, right? It doesn't happen. And if you're on the buy side, you know it doesn't happen and you're not going to pay for that. But if you can really If you can really shift that conversation and you can do it credibly in the things we're talking about, these are the things that if you were a buyer that you would be thinking about doing if you're going to buy— want to buy a business at a lower multiple and improve it. These are the things that maybe if you're an investor, these are the things you might be doing. So what we talk to clients about is why do you wait to sell your business and let somebody else get the extra value? Why don't you do that yourself? So these are all some of the fundamental things that you have to address to accelerate the growth of that business in a real way. And what falls out of that is, which is pretty interesting, is what kind of capital is required to implement some of these changes. And in some cases you may find that creating an an exit is not a single event for a client. You may find that you can have a staged exit, which allows to de-risk and begin to shift and improve a company where maybe because of the current capital structure, whether it's you have partners that are kind of disagreements which won't allow the firm to invest at the levels and the rates and take the risk that the company needs to take because of certain owners. We find there's all kinds of issues within the ownership structures that kind of inhibit the ability of the company to grow. They also get in the way of doing a transaction easily and smoothly, and so addressing some of these fundamental— I'm going to call them capital formation issues— can be one of the things that can be— needs to be addressed up front before you go into a sale process. So in combination, we take these fundamentals and they give a framework to begin to identify some of the levers that you can pull to increase the value of the company. And it does directly relate to how do you increase that growth rate that we were just talking about. So that's one kind of overarching way to think about increasing the value, going from that 3x the 7x. Now I want to shift the conversation just slightly and try to take it into a few— a little more granular. You know, when we think about increasing the value of a company economically, I really think there are two fundamental ways to do that. One is, is how do we increase the return on invested capital? Well, there's only a couple of ways you can really increase the return on invested capital. Capital, and that has to do with you can take the capital you have and you can create more cash, positive future cash flow from it, or you can reduce the amount of capital that you actually deployed. So that's one way. And then the second way, fundamentally, if you think about the math around this, is that you can reduce the risk of the capital that you have invested. And so what does that mean in real terms? So I wanted to give you some examples. So on the left-hand side, how do we increase the return on invested capital? Well, these are some basic things you can do, but— and they do take time. One has to do with strategic position. Because that's going to affect the strategic position of the company and how it competes in the marketplace is going to affect the growth rate. Give you a couple examples. We talk about customer base. What we see many times that companies that have grown and they've grown kind of, I'm going to call it bootstrapped, they find themselves with a customer base that may not be very optimal. You have to think about the customer base from the eyes of the buyer. What customers are going to be attractive to the buyer as as they try to achieve the future cash flow. And many times you'll find that there are customers in the customer base that are not attractive customers. A way to think about it, for those that kind of do the— if you think about it in the transaction world, it's almost looking at the quality of earnings. And if you've been through the quality of earnings assessments, it's not just the economic measurements, but it's the quality of the revenues and the quality of the cash flows underlying it? Well, that comes from who are your customers and what are you selling to them and what's the pricing and how are you using the capacity that exists within the business. So you can look at those things and begin to figure out are there levers within there. You were talking about some of the financial engineering. One of the financial engineering places that we talk to clients about is working capital. 10 or 20%, if I think I think if Chris Bleas was here, he would tell you, and I know in the CEMA program we talk about this, you know, negotiating the working capital in a transaction, I can swing the deal many times 10 to 20% of the transaction value if I am good at negotiating working capital. And so what I find many owners will say, well, you know, because of the ease and my conservative nature, I've left working capital in the business and I have excess 'And I'm saying, guys, that's nice in concept, but when it gets to negotiating with a buyer, it's very difficult to overcome the historical trend of how much working capital you've used to run that business. And the best way to overcome that objection is to show that the business can run with less working capital or run more efficiently.' That— you can't do that in a very short timeframe. You need a number of quarters at least to actually tighten that working capital cycle. By the way, you may come back to, I have some of the wrong customers because I've got customers that are slow pay, and if I replace those with fast pay customers that can allow me to operate the business with less capital, that's going to increase the value of my company. So that's in the bucket that you had for called financial engineering. So those are things that— these are some of the levers you can be thinking about on the return on invested capital. The other is to reduce the risk. And I'd say the number one risk has to do, for lower middle market companies that I see, is concentrations. So we talked a minute ago about concentration in the owner founder. Too many— they really control the business, dominate it. They don't have a really well functioning management team. Another concentration, if you had that, you were probably thinking about is customer concentration. We see this all the time. You have a company that, you know, there's a question that it's at a certain level under customer concentration you have to ask, do I have a business or do I have a subsidiary of somebody else's business? We see the same thing on the supply side too. Depending on what business you're in, supplier concentration can be just as as detrimental to the value of the company as the other concentrations. And so I think looking at— if I had to throw a dart and say where am I going to make sure that I can de-risk the business, is around concentrations in these smaller companies. Obviously this is a broad generalization and there's all types of examples, but given the short timeframe I wanted to at least point to a couple of areas. And these begin to give you the ability to look at levers. And what we do really with when we talk about this workshop thing or doing a workshop, we'll take a— if you'll see, we'll take a P&L statement and we'll start to talk to the group and we'll have the CEOs work on their businesses and say, all right, where are the opportunities within my income income statement to begin to think about some of these levers and those two big buckets, return on invested capital and risk. Customers are one of those. One of the places I find very interesting is pricing. Pricing does take time, but it's interesting if you get the right customers with the right pricing, you can change growth rate and you can change risk of the business. So, and you can go through an entire exercise on the P&L and you can do the same thing with the balance sheet. The balance sheet, we get into the financial engineering, we get into make/buy decisions about should my business really be deploying capital doing the certain things it's doing or should I find a partner or outsource. Obviously these things take time to implement. So these are not what you're going to do in the 90 days that you've run up to a transaction. It's going to take longer, longer time. So if I try to bring this— and this is a slide I use with my clients, and this may sound a little cavalier, but I say— I talk to our clients and say, look, on the left-hand side of this, how do you bridge this valuation gap? How do you get a business that's easier to sell? If you're going to raise money, you're kind of addressing addressing the same questions. And I say if you are really happy with the valuation you're going to get from the business from the trailing 12 months, and we'll tweak the numbers a little bit, then you can go with what you've got today. And that's kind of the first bucket on the left. If you wanted to address some of the fundamentals and begin to tweak some of the obvious, we can increase the value of the company. And that's where we talk about 10, 20, 30, we can get a 50% pickup in the business. If you really want to change the whole negotiation and positioning of the company, we look for what we call a breakout strategy because we find from the buy side that once a buyer has bought into—no pun—has bought into, has an investment thesis and says, I like this business and I trust the management team and I want to buy this business. The next logical question is, how can I invest more to accelerate the growth of that business beyond what that team is currently envisioning? And if we can answer that question, we can shift the negotiations from purely being driven by trailing 12 to that future, that future what I'm going to call kind of geometric breakout strategy. And one of the examples One of the examples I use when we talk about the NDAs and proprietaries, I was the CEO and sold a technology company to Raytheon. I won't say too many details with the recording. But I can tell you that what we did is we shifted our strategy from selling black boxes to 3-letter agencies to selling systems. So we went from selling $25,000 and $50,000 black boxes to selling $1 to $5 million systems. And what we did is sold the company based on the right-hand side because we had proven that the market existed and that we could execute on the right-hand side. And that's kind of the essence of being able to make that real. You can't just talk about it. You can't just have the paper. You have to start evidencing the opportunity and validating it and showing the buyer that this is real. And that's where you can then accelerate, you can increase the multiples, you can move that way beyond the traditional metrics. But that takes time and takes planning and takes investment. We find that by moving from the left to the right, you actually generate additional cash flow by doing the things in the middle which give you the ability to invest, to prove and validate the things on the right. That takes time, but it's— that's kind of our thinking about how you really increase the multiples. Lastly, I want you to think about it from a transaction perspective, that we can do those things, but there are things we have to do to ease the transaction and to think about really optimizing for the after-tax cash. That's what our clients tend to care about on the sell side is the after-tax cash. So how do we optimize that? This falls into a couple of the different buckets that you mentioned in your slides earlier, but, you know, one of those that is so obvious, and I'm sure we have some CPAs in the room, is you have to have good financial information. It has to be accurate, it has to be timely, and it has to comply with GAAP. And if we don't have those fundamentals, we can't talk the language of a strategic buyer or a private equity buyer. We're negotiating in a— it's kind of like being a three-legged dog in a race. So you need good information. We probably all appreciate that. There are other things you can do, everything from contracts being assignable and making sure your contracts are in in order to making sure, believe it or not, particularly if you have intellectual property, that you have— you own the intellectual property, you can identify it, it's clean, it's not encumbered. Cleaning up those issues during a transaction process really risks the process and risks killing the deal by slowing it, putting impediments, and losing momentum. So these are things you really want to have your house house in order in advance, and they do affect the confidence of the buyer, which affects the value of the deal. And it may not come out in the number that's on the paper, but it will come out in the deal terms. And deal terms in the lower middle market are just as important as the valuation that you get from the dollar. So you have to couple those. To look at that realizable after-tax cash. And obviously there are things around taxes that we were talking about in optimization that you really need to address so that the take-home cash is real. I appreciate you guys giving us a few minutes. Hopefully this kind of gives you a little more insight or a few thought provokers as to how you may think about for your clients and how you may help them think forward in increasing the value of their companies. So I think that's really all I had.

Do we have time for a couple of questions? Yes, we do. Great. Anything. Wait. Questions for Kenneth or myself? You mentioned a workshop that you did.

Can you give me more information on that? I haven't done it publicly. I do it for CEO groups. I'd be happy to let you know next time I do one. Great. Other questions?

Did you write the book, Financing Growth?

I did. I was the lead author. What was the question? I was the lead author of a book called The Handbook of Financing Growth under the John Wiley's Finance Series. And this is a cheesy commercial, but we just did— what I just talked to you about is a real quick summary of a chapter that's going to come out in this book. It actually comes out next week. It's called Advances in Mergers and Acquisitions. It's a bit of an academic book, but we— my business partner and I wrote a chapter that is on this very topic of optimizing for M&A and growth.

So other questions? Wait, here comes the microphone. We're going to capture this better.

I thought your point about the financial metrics and return on capital is exactly the point. And all the bits and pieces of how you get to that number with, you know, turning over your assets and so forth, DuPont formula, those kind of things. But the thing that I find to be the most frustrating is where you have the— you know, I've got— I can think of numerous cases of, you know, the owner who they just keep way too much capital in there because they're They like not having the risk at night. They'd rather use, you know, they'd rather have $14 million of steel sitting around, which is 6 months' worth, rather than be out in their line. How do you approach those conversations? Because I have to tell you, I'm a complete failure.

It's not easy. I mean, in some cases you just can't change that mindset. I was fortunate enough in the JPS example that we sold to Raytheon where I was able to come in as the president. I don't do that anymore, but I came in as the president and was actually able to execute. I was able to take the reins and make those changes where the owners weren't willing to make those. I think that in a real answer though, if you can start small and show them the improvements, I think that's— it's getting some early wins, some small improvements, gaining confidence, you can build, you can work into it. Starting with big things are very tough, you know, people's behaviors and changes. I mean, that's— I wish I was— that's not my forte.

The way I explain it to business owners is I tell them that I can only get them 60 or 70 cents for each dollar of cash they leave in the business. So that kind of works. Well, that's an interesting, simpler way to explain playing the same game. That usually gets them motivated. Next thing you know, they're sweeping the cash out. This is operating much more efficiently.

Or actually, perhaps to both of you, how do you charge fees, and are they in any way contingent? Are you typically hourly? And then do you do the follow-on investment banking piece?

You want to go ahead? You know, we work in a fairly competitive industry, and there's a fairly— pretty well-established deal structure for how intermediaries work. So in our case, we charge a work fee. We don't usually screw around with that. It's always $50,000 in our firm. And then a success fee that has a sliding scale depending on the size of the transaction. And we just keep that simple and make it a linear percentage of the transaction value, just so it's easy to calculate. Are you talking about your performance improvement fee? Sorry, no. Um, in our firm, we bundle these things together. We are a premium M&A advisory firm. We charge a premium success fee. And quite frankly, I don't know how to charge for other things and get a return that is commensurate with the value being added. So we kind of lump it together.

I can give you a couple examples of how we've done it. And it depends on where we enter the relationship and at what time. We have done— we have convinced CEOs and we shared with them that, look, if we can increase EBITDA by $250,000, that's a $1.2 million increase in the value of your company. And so we have had performance fees in that performance improvement piece that are linked to increase in EBITDA. That's not very often, but we have done that. A lot of times I would say the more typical approach is is we will go in with some type of assessment based on why they call us or how we got engaged. And we'll basically— we're using the same tools, but we'll tailor the output for what their particular situation is. And we'll generally do an assessment, if you will, somewhere around $25,000. That's— and a lot of times it ends up being 3 or 4 months, 5 months at $5,000 to $7,000 $1,000 a month. We try to build in the first right to negotiate for the transaction work. We over time have found that it really doesn't matter what's in that document. If we build the trust with the client, we're going to be there as the trusted advisor, and many times there's follow-on work or there's some monitoring, so we will have kind of a some type of advisory relationship that may either have a monthly or quarterly fee to it. We look at that as— I don't want to say it's not a— it's more of covering our cost of doing business so that we're in the game and in the relationship with the client when they really have a transaction. That's how we really think about it. Maybe that's where they've been leaving money on the table in that process. Process. I don't know. I should ask my clients.

Yes. Some of the changes, improvements you suggested are quite obvious, common sense, but you still see so many companies not do that. The customer concentration, I mean, it's easier said than done, but working capital and things like that. But some of them a little more complicated, you know, they can add value to company, and this I've faced multiple times talking to prospective seller. We might get them ready to be sold 6 months, 4 months down the road, but there are some strategic decisions there to take. Maybe some relocation of a manufacturing facility, you know, signing a new 5-year lease, changing a supplier. Making some serious hiring decisions.

Yes.

And sometimes you think, hey, there will be a buyer here in the next 4 or 6 months. They might not like these changes enough. They might have different choice for location, or they won't agree with your hiring decisions. So how do you navigate those things? I mean, you might see improvements because of those decisions, but there could also be a downside for the buyer whether strategic or private equity, won't fully appreciate the changes?

Those are tough questions. I mean, it's not easy to provide advice to a CEO who's been running this business for a couple of decades and be sure that in the actual transaction you're not going to end up, as you suggested, creating a negative instead of a positive. So I don't know that there's a simple answer to your question. I think it's really an experience that you build in having seen what buyers actually want and then having the confidence to be able to look that CEO in the eye and say, yes, you should definitely do this, especially when it's that close to the actual transaction.

I'll give you what you can do, and we do— we try to do this. We have this thing we call an exit strategy evaluation. So what we're doing is we're looking at using what we know about transactions We're looking at the future value if they implement those changes and what the economics are going to look like. And we look at today's market data. We said, okay, if I have a company that is below the average as far as earnings, whatever the metrics are in that business, so if it happens to be gross margin is an important metric, or it happens to be, you know, net income or growth rate, we look at those and we say, Alright, is this really going to change this from a lower performing business to a higher performing? And what is the market paid for higher performing businesses in this industry now? And if you apply those to those future numbers, you say, okay, this is how this can look. You can build that and simulate and give some ranges of potential value and see if it makes sense. Because your question is really important, is, is, hey, I can do all these things, but at the end of the day Am I really going to be worth— is the after-tax cash really going to significantly change to me? The second part of your question, which was actually I think the first, is what if I don't want to make that investment? I mean, this is where it comes into play in today's market. We have private equity investors that will do minority investments, that will do recaps or will do partial exits. So you can say, well, look, Listen, here's what we can do. Take some of your money off the table. If I understand your personal ambitions with this business and what you're trying to do with this business in your— and I'm not— we don't get into financial planning on a personal level, but if we understand how they are thinking about this asset they own in the bigger picture, then maybe say, well, listen, we can shift the risk for you by— let's recap the business. Let's take a tranche of capital off, you go ahead and invest that outside, de-risk it some. At the same time, bring some new capital in and bring a partner that has a more aggressive risk profile. So there are a number of things you can do to begin to address that, but you have to think kind of broadly about the alternatives. It's not— it's a complex question. It's a good one.

Yes, good answer. I think we might be timing out here.

Oh wait, okay.

The processes you're speaking of require a fair amount of time on your part to implement. Yeah. Would you estimate the amount of time and say number of hours or workdays that it would take you to convert a company doing say $20 million in sales with an EBITDA of 15% to $30 million in sales and EBITDA of 20%? Are you looking at 100 hours, 500 hours, 1,000 hours, and over what period of time?

You talking about in fees? Are you talking about in— I'm talking time. Time. Hours?

Work hours. Number of hours. By whom?

By our firm? By your firm. Absolutely. There's two levels of hours in there. There's the assessment and the strategy piece, and then there's the execution piece and holding hands. The strategy and the hours for that, that is probably 100 hours, maybe 150 hours to think through the strategy and do that piece. The part about execution is wildly, varies wildly, and there's no single answer. I can't give you a single answer on that.

So that comes back to a question regarding fees. Right. Are you working on a two-fee system?

I'll tell you how we have a very simple, We don't work— we always get paid for our time on a monthly basis as a core concept to cover our cost. We don't do any contingency for the core cost. We do have performance fees on top of everything. In other words, even if we're getting paid, we do buy-side work, we're getting paid an hourly fee, but on top of the hourly fees on a monthly basis, we get a performance fee when they close the transaction. That's an example. We just don't do work on a monthly basis without getting paid.

But that's for the buyer. I'm thinking from the seller's side.

Seller's the same way. We don't do a fixed upfront retainer like most of the industry. We do a monthly retainer, and if it takes 6 months, 9 months, 2 years, we get paid through that period on a monthly basis. Thanks.

Would you help us thank Kenneth Marx and Basil Peters? Excellent material.