Posts made in August 2019

Know when to walk away from a deal


By GARY MILLER | | GEM Strategy Management, Inc.

POSTED:  August 25, 2019 at 6:00

It was about 4:30 on a Friday afternoon when Matt, the owner of a furniture distribution company, was anxiously awaiting a response to his counter offer from Tom, a potential buyer. Tom had until 5 p.m. to respond.

Tom had sent Matt a fourth revision to a Letter of Intent a week earlier. Up to now, negotiations had been tough. The deal terms and conditions in the last LOI weren’t much better than the previous LOI, but Matt was still hopeful that most of their differences could be worked out. The biggest stumbling block was the purchase price. Tom had offered $2.8 million for Matt’s company – $1.7 million lower than Matt had expected. Earlier in the year, Matt had sought an outside, independent valuation firm to provide him with a certified Opinion of Value. The valuation firm stated that the fair-market value of the firm was $4.5 million.

Gary Miller

Matt was beginning to sense that this deal may not close. He was nervous because only 30 minutes were left before his response to Tom’s last LOI would expire. From a deal standpoint, it was technically dead if Tom didn’t respond by the deadline.

Matt didn’t know what to do. Should he call to inquire if Tom was going to meet the deadline? Or, should he just wait it out and see what happens? So far, Matt and his advisers had spent a lot of time, money and effort to get this far in the negotiations and yet it seemed that little progress had been made. It appeared to Matt that every time the two parties got together, the negotiations felt like a “beat down.” Yet, Matt thought that he “just needed to keep moving forward” – that, in the end, the deal would work out.

In reality, chasing a bad deal, whether from the seller’s or buyer’s point of view, rarely works out, even if the transaction closes. The result of a bad deal closing usually results in a costly mistake. According to a Harvard Business Review report, the failure rate for mergers and acquisitions sits between 70 and 90 percent.Therefore, one of the most powerful pieces of knowledge is knowing when to walk away from a deal. Below are six rules that Matt should have followed when negotiating with Tom.

Establish your “walk-away number” before negotiations begin

Think through the purchase price and the terms and conditions carefully before the transactions process begins and stick to it throughout the negotiating process. “Walk away” simply means the time and place when it no longer makes sense to continue the negotiations. For example, one deal structure that a buyer may propose is called an “earn-out.” Earn-outs favor the buyer far more extensively than the seller. Earn-outs are generally used more during poor economic conditions. If a buyer insists on an earn-out structure in today’s market, that is a red flag and it may be time to “walk away.”

Think like a buyer

Write down what you think is fair — and what is not — before the heat of the moment takes over. If you do this in the context of thinking like a buyer, seeing your thoughts in black and white often tempers your demands. Next, develop the rationale to support what you think is fair. If you do this, you’ll know when deal terms and conditions are going too far out of the range of acceptability and when the deal structure and price is unfair.

Develop the Best Alternative to a Negotiated Agreement (BATNA)

BATNA is a concept developed at Harvard’s negotiation school. Think about what alternative you have if your deal goes south. What will you do if this negotiation doesn’t work out? In the simplest terms know how strong and likely your “Plan B” is. I have a simple saying the drives this point home: “The person that can’t walk away loses.” If you aren’t ready to leave the negotiation table, you are going to lose.

Keep an eye on your walk-away number during the negotiation process

As you get into the negotiation process, always look back to that “walk away number” that you set before the negotiations began. Are we still in the bounds of a possible agreement or is it time to consider leaving the negotiations? How far have we gotten to our goals versus how close we are to the walk away number?

Matt, our furniture distributor, felt compelled to “keep on going” to put this deal together, even though all the signs of a bad deal were there. But he didn’t have a walk away number or a Plan B alternative to move on and find another potential buyer that will be able to justify Matt’s $4.5 million purchase price.

Know when you are acting on emotion

Selling your business is one of the most emotional times in a business owner’s life. It is almost always a one-time event, so it is important to keep emotions in check. The problem is that emotions often come in to play while negotiating and cause owners to push hard for the deal. We have to get that “win”. When emotions take over, both sellers and buyers often strike bad deals.

Reassess, if it doesn’t feel right

If you are in the middle of negotiations and it just doesn’t feel right, it probably isn’t. So, if it doesn’t feel right, think about why you are feeling that way. Write down the reasons and ask yourself, “Am I uncertain about closing this transaction because I lack confidence, or do I actually see legitimate red flags?”

Many studies have shown how perceptive human beings are. Ignoring these perceptions and feelings in a deal will not help you in the long run. Believe in your intuition. Trust that “little voice” inside you. If you see the wrong things preventing the transaction process from moving forward, then back out and start over again with a new prospective buyer. It’s a big world out there and plenty of buyers are looking to buy well run companies. It’s OK to walk away.

Matt did not get a call from Tom on that late Friday afternoon. When Matt and Tom did connect, Tom informed Matt that unless he could agree to his purchase price, he could not go through with the deal. In the end, Tom increased the purchase price by another $200,000 stating that was his final offer. Matt accepted the deal believing that he had no alternative. In fact, Matt didn’t.

Matt falls in that group of business owners who are dissatisfied with the sale of their businesses. According to Gold Family Wealth, more than 50 percent of sellers are dissatisfied with their post-sales results — especially the financial results (including the valuation, the agreed-upon sale price, the tax hit and the residual proceeds).

Having a “walk away number” and an alternative Plan B is key to knowing when to walk away from a deal.

Gary Miller is CEO of GEM Strategy Management, Inc., a M&A consulting firm that advises small and medium sized businesses throughout the U.S. He represents business owners when selling their companies or buying companies and raising capital. He is a frequent keynote speaker at conferences and workshops on mergers and acquisitions. Reach Gary at 303.409.7740 or

Know what capital structure is and how to use it to grow your business

The Denver Post

By GARY MILLER | | GEM Strategy Management

POSTED;  August 7, 2019 at 12:31 pm | Gary Miller writes a monthly column for The Denver Post.

Today, many small business owners are trying to sell or grow their businesses in this booming economy. But, more often than not, growth capital is required to achieve an owners’ growth goals. Because of the regulatory environment, many banks are reluctant or cannot lend what their customers need. Therefore, owners have to look for alternative sources of capital. The problem is, many owners aren’t knowledgeable about capital structure and how to use it to meet their goals.

Why is it important to understand a company’s capital structure?

By design, the capital structure reflects all of the firm’s equity and debt obligations. It shows each type of obligation as a slice of what’s called the “Capital Stack”. This stack is ranked by increasing risk, increasing cost and decreasing priority in a liquidation event (e.g., bankruptcy).  For small corporations and pass through entities (LLCs, S-corps etc.), the capital stack is as simple as owners’ common stock/membership interests and senior debt from their local bank.

For large corporations, the capital stack typically consists of senior debt, followed by subordinated debt, followed by hybrid securities, followed by preferred equity (preferred stock) and last, common equity (common stock).

The capital stack is effectively an overview of all the claims that different players have on the business. Debt owners hold these claims in the form of lump sums of cash owed to them (i.e., the principal and interest payments). The equity owners hold these claims in the form of access to a certain percentage of a firm’s future profits.

The capital stack is heavily analyzed when determining how risky it is to loan money to a business. Specifically, capital providers look at the proportional weighting of different types of financing used to fund the company’s operations.

For example, a higher percentage of debt in the capital structure means increased fixed obligations. More fixed obligations result in less operating buffer and greater risk. And greater risk means higher financing costs to compensate lenders for that risk. Consequently, all else equal, getting additional funding for a business with a debt-heavy capital structure is more expensive than getting that same funding for a business with an equity-heavy capital structure.

Medium- and small-business owners are seeking mezzanine financing

Today, many small to medium size business owners are looking into mezzanine financing to achieve their specific goals when bank debt or other senior debt is no longer an option. Mezzanine financing serves as a means to an end. It is not used as permanent capital, but instead, used as a solution-oriented capital that performs a specific purpose and can later be replaced with a more permanent source of capital.

What is mezzanine financing?

Mezzanine financing is a form of junior debt that sits between senior debt financing and equity financing in the capital stack. It is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in a company in case of default. It helps bridge the gap between debt and equity financing and is one of the highest-risk forms of debt.  It is subordinate to senior debt, but senior to common equity.

Mezzanine financing is more expensive than senior debt but cheaper than equity.  It is also the last stop along the capital structure where owners can raise substantial amounts of liquidity without selling a large stake in their companies. Mezzanine financing rates range between 12% to 20% per year.

Often, mezzanine debt has embedded equity instruments attached, known as warrants, which increase the value of the subordinated debt. It is frequently associated with acquisitions and buyouts.

Mezzanine financing can be a useful addition to a company’s balance sheet because it is a source of “patient” capital financing that requires interest-only payments, with no required principal amortization payments before maturity. During the life of the mezzanine financing commitment, a company has time to recover from the significant “event” that drove the initial financing need – be it an acquisition, shareholder buy-outs, growth financing, or other capital needs.

Mezzanine financing provides incremental leverage to facilitate a wide variety of uses. Eight of these are:

  1. Recapitalizations involve raising new capital to restructure the debt and equity mix on a company’s balance sheet. Mezzanine financing is used in this scenario, especially when owners want to achieve partial liquidity and maintain control of their businesses. For example, mezzanine financing can be used in situations where a group of shareholders are seeking partial or full liquidity, while other shareholders seek to remain actively involved in the business.
  2. Leveraged buyouts often use mezzanine financing by purchasing shareholders’ interests, such as a private equity funds or other institutional groups, to maximize their available borrowing capacity at the time of the purchase. Leveraged buyouts are typically completed by companies looking to raise large amounts of capital to support an ownership transition or significant growth event.
  3. Management buyouts also use mezzanine financing when a management team buys out the current owners, such as private equity or other investors, and gain control of the business. Therefore, this allows the management team to determine the direction of the company.
  4. Growth capital is obtained through mezzanine financing to help companies achieve their goals for organic growth, such as significant capital expenditures or constructing a large facility. Mezzanine financing is also used to enter new markets by developing new products and/or subsidiaries.
  5. Acquisitions are often funded by mezzanine financing where companies purchase other businesses with the goal of growing and responding to customers’ needs more quickly.
  6. Shareholder buyouts often use mezzanine financing for family-owned businesses that in order to increase their ownership stake, want to repurchase shares that may have fallen out of the hands of the family or from particular family members.
  7. Refinancings are commonly achieved by using mezzanine financing to pay off or replace existing debt to take advantage of lower interest rates and/or access better terms. Refinancing, using mezzanine financing, adds flexibility to a company’s debt capital structure, better preparing them to seize opportunities like acquisitions and shareholder buyouts.
  8. Balance sheet restructurings often add mezzanine financing to a company’s balance sheet. Doing so can optimize their debt capital structure, helping to fulfill debt requirements for transactions such as acquisitions and management buyouts, while giving the company time to recover from those expenses. It can also satisfy a senior lender’s requirement for a junior capital raise or create additional senior debt capacity for a business.

Mezzanine capital providers are now moving “downstream” into the lower middle-market and small businesses for companies that need raise capital beyond senior debt. Mezzanine capital fulfills an immediate need that supports the continuing success of the business.

Gary Miller is CEO of GEM Strategy Management Inc., a M&A consulting firm that advises small and medium sized businesses throughout the U.S. He represents business owners when selling their companies or buying companies and raising capital. He is a frequent keynote speaker at conferences and workshops on mergers and acquisitions. Reach Gary at 303.409.7740 or