The investor is interested. Now what? Sign papers, pop the
champagne? Unfortunately, its not that easy. The term sheet is to
be prepared and after some negotiation, hopefully signed. The due
diligence will commence and then leading to the final agreements.
Let’s take a breather recap on the path taken to obtaining
private equity funding. The chart below provides a useful picture:
Source: Money Magnet by Jacoline Loewen
Let’s be honest - selling shares in your business can be
infuriating, especially when you think what is wonderful and
valuable about your business often gets pushed aside and ignored.
The valuation process, as the fund runs a very critical eye
over your company, is much like a house makeover show where
potential buyers waltz around, making rude comments about
the purple kitchen and Great Aunt Susan’s china hanging on the
wall. Before the owners can splutter a word of protest, they are
marched through the place with the bossy host who points out
those piles of CDs that should have been thrown away, the two
rooms that could be one, the sooty fireplace, the sink stained with
dripping taps, the peeling paint and red carpet with stains from
the dog muddy walks. The owners are whisked away, the experts
race in and before you can say “Bob’s your uncle,” they rip out
that carpet, add a new coat of paint and new lights. Perhaps a
call to Got-Junk? And a gang of helpers cart off old paperbacks
and children’s clothing piled in the garage. You get the picture.
Finally, presto - those same rude buyers are perking up in interest,
particularly if they bump into another buyer admiring the fresh feel
of the place—then things get really hot.
You too, want to have your business looking its best and
presenting itself in a shiny way to a few, select buyers. Auctions
(showing your company to many buyers) are popular and may get
you the highest price but caveat-emptor. You are seeking a long
term relationship, not offloading property, so pick who you want
as a partner and make price a secondary priority.
How the Investor Values Your Business
By now you have satisfied all requests for investment
proposals, presentations, strategy documents and financial
information from the investors. What’s the next step? You now have
got to be prepared for some discussion sessions around valuation.
The investor has to commit to how much money he is willing
to invest, as well as how much of the company they will want to
own. Stay calm. There will undoubtedly be a significant element
of the rocket science stuff – hardcore math and accounting
formulae. However, there is also a healthy dose of subjectivity
including the strength of the management team, market share
of your products, threat of competition, technology risk and the
extent and nature of your capital requirements. These issues will
not only be reflected in the overall valuation of the company, but
also influence how many board seats the investor will require. The
end result of this leg of the process will be a tug of war debate
as to how much of the company you are willing to give up to the
investor and also what risk terms you are able to live with over the
ensuing “partnership” period.
When buying a house, you want to know what features
will ensure protection of value for the property. Likewise, if
you understand the math for private equity investors, you will
understand how they assign value to your business. How much
will they help you in developing your business? Much like the
example of buying a house, the bids vary depending on who is
making an offer and what they judge to be of value. Investors
have reasons too. Imagine you have a house and now you are
going to share that investment with a private equity investor. Do
you and your partner want it to suit your Owner Controlled goals
or is it for investment and resale? Then, what return do you want?
The three variables for private equity in deciding valuation or how
much to pay for a business can be explained using a house example:
• Growth—you rely on holding the house and getting a return
because the neighbourhood went up in value. This is “Buy, fix
and sell” method.
The Win/ Win Deal
By Jacoline Loewen, EMDA Director, Director of Crosbie & Company Inc.