Articles & Presentations

When I sell my company, should I consider “rolling over equity” into the buyer’s company?

The Denver Post | BUSINESS

By GARY MILLER | | GEM Strategy Management

PUBLISHED:  June 23, 2019 at 6:00 am

It depends. It is no secret that this year and next may be the best time to sell your company. A lot of money is on the sidelines looking for investment opportunities and buyers are paying premiums for well run, privately held companies. Often, buyers offer business owners an opportunity to roll over a part of the purchase price proceeds into the buyer’s company.

Gary Miller

This is particularly true with many private equity (PE) firms who are searching for companies in the lower end of the middle market space. We see many private equity acquisitions and some add-on deals offering business owners what is referred to as rollover equity. Rollover equity arises when certain equity holders in the target company, including founders and key members of the management team roll a portion of their ownership stake over into the new equity capital structure put in place by the acquiring PE firm. In other words, they sell less than 100% of their interest with the balance becoming equity in the new capital structure.

Equity rollovers generally result in post-transaction ownership by the seller from 10% to 40%. In a 30% rollover, for example, the private equity firm would own 70% of the newly capitalized equity in the business with the seller “rolling” a proportionate amount of value to equate to 30% of the new equity. Most PE firms strongly prefer equity rollovers for seven reasons:

1. Asymmetric information benefits the Seller. The seller has more knowledge than the buyer since the owner has operated in his/her industry over many years. Buyers believe that the acquisition will be more successful with the sellers at the helm.
2. Confidence is built with the buyer. When the seller accepts an equity rollover, it signals confidence to private equity buyers that continuity will be assured, and the interests of the seller and buyer will be aligned.
3. Rollover equity incentivizes sellers to continue to grow the business. With “skin in the game” sellers provide buyers with some comfort that those who built the business are incentivized to continue to grow it since they retain an economic interest in the business.
4. Less capital is needed in the acquisition from the buyers. Since the sellers are investing some of their profits from the sale into the buyer’s business, less capital is needed from the buyers to buy the seller’s business.
5. Alignment between the parties provides the buyer to grow the business in a shorter period of time. This arrangement helps align the seller’s management team to align with the buyer’s management team’s growth objectives since the seller will continue to have “skin in the game” post-acquisition.
6. Seller receives major liquidity from the initial sale of their company. At the same time rolling over a portion of their equity allows them to participate in further upside — a “second bite at the apple” in a second sale by the PE firm.
7. Sellers rolling over equity can defer taxes. From a tax perspective, taxes can be deferred by sellers on the portion of the purchase price that is rolled over into the new capital structure from the seller.

How does an equity rollover work?

Owners contemplating an equity rollover often find themselves facing a new world in terms of capital sources and leverage. Most of our clients have a modest amount of bank debt and a single class of stock (perhaps split among several shareholders/members). Private equity capital structures typically consist of multiple tranches of debt (mezzanine, junior, and senior debt), or one large piece of “unitranche” debt. Also, the structure can include differing levels of liquidation preferences in the equity structure of the capital stack. The increased complexity of the capital stack and the different debt structures are not business characteristics many owners are experienced or comfortable with.


Equity rollovers offer substantial upside, and downside. For example, consider the hypothetical transaction involving an equity rollover with a PE firm. Two brothers jointly own a distribution business. They are considering a transaction with a private equity firm. The enterprise value of their company is $12 million; the outstanding debt is $1 million, and a $2 million equity rollover has been requested from the PE firm. After paying off the debt and reinvesting the $2 million, the brothers pocket $9 million. The new capital structure, post transaction, is 50% equity and 50% debt (a mixture of senior and mezzanine debt), with the PE firm owning 80% and the brothers owning 20% of the recapitalized company. Leverage is implicitly touted as a benefit to sellers considering an equity rollover. The argument is that when the business grows, debt is paid down, and the business is eventually sold to a strategic buyer for a higher price. In this example, the second transaction will yield $50 million for the business. All equity owners earn a return on their investment. In this case, the brothers parlayed their $2 million equity rollover into nearly $10 million.


Equity rollovers can also bring risk. PE investors generally operate with a more leveraged capital structure than family-owned firms or entrepreneurial firms. While added leverage boosts equity returns, risk increases as well. For the PE firm considering this business as one in a portfolio, the risk/return ratio might be more suitable to the buyers than to the sellers with this being their only investment.

PE firms love to promote success stories, particularly the instances where an owner made more on the second sale than in the initial sale. A seller doesn’t typically hear about the disasters. A seller considering a rollover should ask for the capital structure pro-formas, and detailed financial pro-formas the PE firm has created to support such a capital structure and financial projections.

For those considering a rollover, the following four questions should be asked:

  1. Taxes — Will the transaction enable a tax-deferred rollover?
  2. Corporate governance — What say does the seller have in ongoing strategic, operating, and financial decisions?
  3. References — How has the PE group behaved in partnership with previous sellers?
  4. Debt — Does the higher leverage require personal guarantees of the debt in what will most likely be a more leveraged business?

To roll or not to roll

Our clients are generally entrepreneurs or families who have built successful businesses over many years or decades. When they finally reach the difficult decision to sell, most sellers do not contemplate retaining a piece of the business. It is not because they have a negative view of the business, but because they have poured so much of their lives into their businesses that retaining any involvement — financially, operationally, or emotionally — conflicts with their decision to sell. Those owners should seek a strategic buyer who wants to own a 100% of their businesses.

For those owners rolling over equity need to fully appreciate that while they are partnering with the PE group “buying” their company, the seller’s influence over important decisions may be minimal. Compatibility with the new owner with regard to strategy, expectations, culture and performance metrics are important to asses before becoming partners. It is important to be comfortable with the decision-making rules of the governance agreement. Some PE firms expect a hidden form of return (fees) that often doesn’t show up until the deal is being documented:

  1. Management fees
  2. Finders fees
  3. Administrative fees
  4. Breakup fees
  5. Transaction fees
  6. Origination fees

All the fees above contribute to a skewing of the returns among the parties. PE firms will argue these expenses are non-recurring and therefore shouldn’t affect value in a future sale, but they are real cash expenses that alter the return profile of the two parties. Asking for a complete schedule of proposed fees earlier in the process will reduce unpleasant surprises further down the road.

Getting professional advice in advance and during discussions with PE firms or other strategic buyers is a must if you want to avoid disappointments down the road. So, the answer to the question, “Should I roll over equity in the buyer’s company”?

It depends.

Gary Miller is CEO of GEM Strategy Management, Inc., a M&A consulting firm that advises small and medium businesses throughout the U.S. and represents business owners on how to maximize the value 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 970-390-4441 or

Sooner or later you will probably want to sell your business

The Denver Post | BUSINESS

By GARY MILLER | | GEM Strategy Management

PUBLISHED: May 26, 2019 at 6:00 am

Every company will need a growth story.

Many business owners come to that point in their lives when they know it is time to sell their company. Whether their decision is due to health, fatigue, boredom, burnout or retirement, the fact remains they want out. At that point, the composite characteristics and attributes of each business paints a picture that is viewed by the business community, competitors, creditors, employees, suppliers, customers and potential buyers. That picture can tell a story of dynamic growth, sedentary stability, or decline. It should be the story of a thriving company culture, perceived opportunity, and growing enterprise value.

More often than not, owners are not prepared for the rigors of a robust due-diligence process brought on from potential buyers eager to hear the “success” story – causing many deals to fail. We advise clients to think like buyers and ask themselves . . . “what do buyers look for when buying a business”?

Gary Miller

When investors screen for and perform due diligence on businesses, they spend an inordinate amount of time analyzing the products or services, market size, competition, pricing dynamics, customer experience, financial history, proformas, and strength of the management team. They do this because these are the important factors that will help them preserve capital and earn an acceptable return on investment.

A strategic business plan including a growth plan need not be about “hockey stick” projections. In fact, it doesn’t necessarily mean getting bigger; rather, it means getting better. And, in that regard, every company should have a growth story showing the ability to analyze and overcome adversity and continue on a positive growth path.

In corporate finance language, getting better means improving the present value of future cash flows. The set of strategic actions should increase cash flows, extend their duration, and/or improve predictability. Changing the trajectory of these factors by making strategic decisions makes the business better.

Seven Actions that Improve Business Value

  1. Strengthening relationships with customers
  2. Diversifying suppliers
  3. Investing in technology to improve efficiency
  4. Putting redundant systems in place
  5. Making customer experiences easier, more efficient, and productive
  6. Accelerating new product or service offerings
  7. Expanding into new channels and geographies for growth or diversification.

Investing in a capable team, efficient processes, and systems that allow the business to operate independently of any one person further achieves the goals and improves the business value. The market place is dynamic, and competition makes it difficult, if not impossible, to generate superior returns on capital indefinitely unless owners and managers watch for growth opportunities.

Growth affects culture, opportunity and value

Orienting a business toward growth can empower the workforce and attract greater talent. Managers take direction from their owners and, without a directive or incentive to “think outside the box”, the future will look like the past. In our engagements, we often encourage owners to install retention plans that incentivize key employees to stay with the company through a transaction.

In almost every case, we find that aligning interests serves as a catalyst for new ideas and creates a sense of urgency. It is no surprise that cost savings are easier to find, and expansion opportunities become more attractive to managers when they perceive that owners are receptive to new ideas. Plus, it is more fun than just repeating yesterday, and that dynamic alone makes it more interesting to employees. Making this a priority ahead of, rather than during a transaction, can help the value accrue to the current owner rather than the new one.

Creating excitement for the future of the business has an added benefit. During the sale process, information is shared through statements of facts (i.e. memorandums, data sites, etc.) and through communication with management (i.e. management presentations). While it is important that the former is organized to position the business positively, the latter offers the best opportunity to form an emotional connection with the buyer. When managers have the opportunity to share their excitement in the future and can inspire a buyer’s confidence, the perception of risk decreases, and the perception of
value increases.

Regardless of how it is expressed, at the end of the day, value is a function of the perceived future cash flows of the business. To illustrate the impact of growth on valuation for example, if a business is growing at 2% annually, assuming $2.5 million in operating profit and a cost of capital of 10%, the discounted cash flow analysis implies an intrinsic value of $21.75 million. Growth in cash flow, either as a result of lower costs, increased prices, or greater volumes, drives values higher.

Developing the growth plan

A good growth plan will separate revenue growth into achievable actions that have been vetted through data and analysis. The plan might include current market penetration, product or service extensions, geographic expansion, complementary acquisitions, or potential price increases. The size of each opportunity and the likelihood of success will only be limited by competition, customer demand, and business infrastructure.

Given the limited resources of middle market or small businesses, the capability to size each opportunity accurately may not exist internally. Using a third party skilled at customizing market studies and consumer research to the specific needs of a business can give owners the valuable information needed to prioritize initiatives efficiently.

Likewise, the cost structure can be affected by focusing on and continuously monitoring the cost of growth. Revenue growth by definition will provide leverage on fixed costs, while pricing, the use of new technology, and process improvements can drive down variable costs. Combined, revenue growth and operational cost improvements drive greater future margins and higher value. Increasing shareholder value is never easy and there is generally no “silver bullet.”

Rather, success requires a combination of initiatives, and by breaking down each of these growth strategies into actions, the numbers or results can follow. Business planning is a dynamic process with no target end point.

Those organizations that prioritize continuous improvement and consistent growth will be best positioned to maximize shareholder value.

As you prepare to sell your business, remember what Rod Stewart said almost 50 years ago. “Every Picture Tells a Story”. As a business owner, you can determine how your business picture will look. The picture you paint will ultimately determine your business’s enterprise value.

Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or to buy companies and raise capital. He can be reached at 970-390-4441 or

How to retain employees during the labor shortage

The Denver Post |  BUSINESS


PUBLISHED : April 28, 2019 AT 6:00 AM | UPDATED: April 25, 2019 at 12:52 pm

America’s labor shortage is approaching epidemic proportions. Across the country, more jobs are available than workers to fill them. The unemployment rate has dropped to a nearly two-decade low. Businesses are complaining of worker shortages, arguing they could do more, sell more and build more if they could just find skilled employees.

According to the Department of Labor, at the end of January 2019, the U.S. economy had 7.6 million unfilled jobs, but only 6.5 million people who looking for work. It was the 11th straight month the number of job openings was higher than the number of job seekers. This shortage has translated into higher wages to retain and attract workers, which increases employers’ costs of doing business.

What can a business do to attract and keep skilled employees? In addition to paying competitive wages, many business owners are considering adding retention and performance programs for their most valuable employees. One such program is called a Phantom Stock Plan.

What is Phantom Stock?

A phantom stock program is a form of long-term incentives used by businesses to award employees for improved company value without actually giving away equity. As a result, no dilution occurs for shareholders. It is a type of deferred bonus offered to key employees, where the future payout is tied to appreciation in the equity or market value of the sponsoring company. The term “phantom stock” may be used broadly or narrowly since no formal or statutory definition of the term exists.

Some companies use the term phantom stock to denote any type of plan for which employees must wait until a future date to receive the promised financial value. More narrowly it indicates a plan that is intended to mirror restricted stock awards or stock option grants. In this usage, the sponsoring company creates certain units or “phantom shares” that may resemble actual stock. But actually, it is a commitment to pay the employees cash upon fulfillment of certain conditions such as duration of employment or growth in company value or both.

Phantom stock may also be known by such terms as phantom shares, simulated stock, shadow stock or synthetic equity. Participants in phantom stock plans are expected to view the company’s objectives through the same lens as the shareholders. These types of plans can help attract employees and retain and differentiate a company’s value proposition from its competition. Phantom shares do not result in owner equity dilution because actual stock is not being transferred to the participant.

Seven good reasons to consider a Phantom Stock Plan

  1. Phantom stock helps align goals between business owners and their key employees for growing the business. Most owners want great talent that thinks like an owner and can execute a business plan. If a company is
    focused on growth, employees are the most critical assets for this growth objective.
  2. Phantom stock helps create value by turning other long-term incentive plans into growth drivers.
  3. Phantom stock helps a company compete for employees who have the ability to be growth catalysts for businesses.
  4. Phantom stock plans can retain employees because employees must wait until a future date to receive the financial value of a promise given today.
  5. Phantom stock plans demonstrate fairness because they share value with those who help create it by protecting both the shareholder and the employee interests.
  6. Phantom stock plans are linked to the same business objectives as the owners.
  7. Phantom stock plans form long-term incentives used by businesses to award employees for improved company value. As a result, it is a type of deferred bonus where the future payout is tied to appreciation of the equity, or market value of the sponsoring company.

The term “phantom stock” may be used broadly or narrowly since there is no formal or statutory definition of the term. More narrowly it indicates a plan that is intended to mirror restricted stock awards, stock appreciate rights (SARs) or stock option grants. In this usage, the sponsoring company creates certain units or “phantom shares” that may resemble actual stock but are actually a commitment to pay the employees cash upon fulfillment of certain conditions such as duration of employment or growth goals of the company.

Types of Plans

In general terms, three types of phantom stock arrangements are available. They are not mutually exclusive; a company could have just one type or all three depending on its objectives.

1. Full Value Phantom Stock Plan is a deferred cash bonus arrangement that creates a similar result as a restricted stock plan. The sponsoring company determines a “phantom” stock price through an internal or external valuation of the company. Employees are awarded some number of phantom shares that carry specific terms and conditions. At some point, key employees will receive a cash payment equaling the value of the original shares plus appreciation of the stock.

For example, assume an employee receives 100 phantom shares with a starting price of $10. At a pre-determined future date, the company will calculate the value of the phantom stock and pay the employee the full value. Let’s assume that the share price appreciates to $18. The company will pay the employee $1,800 as a cash distribution. This $1,800 reward is taxed at ordinary income rates.

2. Performance Phantom Share Plan is a type of plan contains two distinct performance-based elements. First, employees must achieve certain pre-determined performance targets. If they do, they are awarded phantom shares. The number of shares may vary by employee and by the degree to which the targets were achieved. Financial targets might include such measures as Pre-tax Income, EBIT or EBITDA.

The second, performance element relates to the potential improvement in value that may come through phantom stock value appreciation. Once awarded, the phantom shares may still be subject to vesting schedules or other restrictions. The tax effect to employees is identical to that of full value phantom stock.

For example, let’s assume an employee receives 100 phantom stock options (PSOs) with a starting price of $10. At a pre-determined future date, the company will calculate the value of the phantom stock price and pay the employee any positive difference between the original price and the appreciated price. Assume the share price grows to $18 from $10. The company will pay the employee $800 (the increased value).

3. A Phantom Stock Option Plan, also known as a Stock Appreciation Rights (SARs) plan, is a deferred cash bonus program that creates a similar result as a stock option plan. As with the previous two plans, the sponsoring company determines a phantom stock price through an internal or external valuation of the company. Employees are awarded some number of phantom options that carry specific terms and conditions. Should the company phantom stock appreciate over time, employees will receive a cash payment equaling the difference between the original price and the appreciated price.

Most business owners and CEOs intrinsically understand the principle, “the more value you help create, the more reward you will receive”. They know that sharing value through long-term incentive plans is essential to capturing the loyalty and commitment of top achievers.

Fairness might best be summarized as follows: Successful companies share long-term value with high performers because it builds trust and confidence between ownership and its employees.

Regardless of which plan(s) are chosen, employers have the opportunity to eliminate or greatly reduce employee turnover among key personnel. The cost of adding these plans are minimal at best. The increase in performance and longevity of employees is self- liquidating when the cost of employee turnover and the increased profits and value added from incremental growth are analyzed.

Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or how to buy companies and raise capital. He can be reached at 970-390-4441 or

CEOs of small businesses must take active role in monitoring workplace behavior

The Denver Post | BUSINESS

By GARY MILLER | | GEM Strategy Management

POSTED:  March 24, 2019 at 6:00 am

A little over a year ago, I represented Paul who was selling his business to a strategic buyer from the west coast. His company had 47 employees, was 27 years old, and very profitable. Paul’s company served the food processing industry. The transaction process was going smoothly. The buyer was paying a significant premium for his business and Paul was on top of the world.

About two and half weeks before the closing of the transaction, Paul received notice that he, his company, and Roger, VP of sales, were being sued for sexual harassment. The complaint alleged that Roger, three years earlier, had begun sexually harassing one of his subordinates (Megan) at a sales meeting in Dallas. The complaint further alleged that, despite Megan’s rebuke of each of Roger’s advances, the harassment continued for the following two years, creating a hostile work environment for Megan. She finally left the company, without explanation, a year before it was put up for sale.

Paul was blindsided. He had no idea that Roger had been harassing Megan. However, Paul had been puzzled and disappointed when Megan, a rising star in the company, had resigned so suddenly.

Paul immediately contacted me and his law firm to explain the situation. We all agreed that Paul had to disclose the lawsuit to the buyer, since the lawsuit, now, was a potential liability to the buyer in the future. The closing was postponed until the buyer could decide whether to go through with the transaction. In the end, the buyer walked away.

Paul was now left with a company that would have to defend him and his company in a lawsuit, potentially dismiss his VP of sales, and start all over to find another buyer after the lawsuit was settled.

The subject of sexual misconduct in the work place is dominating mainstream conversations and board room agendas. This crime doesn’t just plague men and women who run large global enterprises, Fortune 500 behemoths, film studios, and media platforms. Small businesses, though not as newsworthy, are experiencing similar situations.

In the U.S., 43 percent of employees work in organizations with 50 or fewer people. It would be a mistake to think that a smaller workforce means a decreased chance of sexual harassment. In fact, a few characteristics make small firms more susceptible. For example, at a smaller firm, people may interact more frequently, and that proximity can provide repeated opportunities for harassment.

Also, many small firms, especially those with fewer than 30 people, do not have formal HR departments. The absence of HR means that CEOs must take more responsibility to keep current and design, communicate, and monitor rules regarding workplace behavior. Another challenge is that without an HR department, more incidents might go unreported, as in Paul’s company.

Aureus Asset Management studied 57 CEOs from small businesses. The majority (70 percent) said they are more worried now about sexual harassment affecting their employees and their businesses than they were a year ago. They attributed this heightened anxiety to high-profile cases and reverberations, coming to light, rather than on any specific incident within their companies.

They worried, and rightly so, that the existence of inappropriate behavior, lurking in the shadows, would damage their office culture leading to poor morale and productivity.

They realized that they must produce a clearly written harassment policy to protect both employees and the firm’s reputation. Twenty of the CEOs acknowledged that they too, are more aware of their own behavior today than in the past.

Small businesses do not actually need an HR department to root out and prevent sexual harassment if management is educated about the topic and:

  1. Looks for factors that lead to a toxic culture, such as having a predominantly male executive staff in power and being indifferent to allegations;
  2. Establishes clear policies (in writing) outlining what constitutes sexual harassment, which behaviors will not be tolerated, and what employees should do if they see or experience misconduct;
  3. Looks for potential signs of misbehavior such as: a. Touching others frequently; b. Women quitting more frequently than men; c. Telling inappropriate jokes continuously; and, d. Drinking too much at company events.
  4. Asks the alleged accused to take a leave of absence until the owner investigates the entire situation and seeks to resolve the problem internally. If seeking resolution internally is impossible, the owner should seek outside counsel.


Should the complaint be litigated, sexual harassment claims have two classifications:

  1. “Quid pro quo” harassment: for example, when a supervisor, or an employee in a position of power, demands sexual favors from a subordinate/worker either in exchange for a job benefit, like a promotion, a raise, or to avoid a job detriment, like getting fired or demoted.
  2. “Hostile work environment” harassment: for example, sexual conduct or behavior that interferes with an employee’s job performance or creates an intolerable work atmosphere. The offensive conduct, however, must be “pervasive” or common place.


For example, a single “dirty” joke told by a male worker at the water cooler probably doesn’t rise to the level of a hostile work environment. Telling such jokes around the office every day would.

Employers must investigate any sexual harassment claim brought to their attention. If an employee complains about sexual harassment by a co-worker or a supervisor, or even a customer, and management fails to investigate, the company can be liable under Title VII of the Civil Rights Act of 1964.

On the other hand, an employer is liable if one of the supervisors or managers takes adverse action against an employee, such as firing or refusing to promote the person because he or she refused the supervisor’s sexual advances.

How do you protect your employees and company?

The best thing is to have and follow a written sexual harassment policy, which should:

  • Define what constitutes sexual harassment, providing real-life examples;
  • Make clear that sexual harassment will not be tolerated in the work place;
  • State that all claims of harassment will be investigated;
  • Set forth an easy-to-use complaint procedure that designates at least two managers or supervisors to whom employees can address complaints as well as one person outside of management;
  • Require supervisors and managers to report any incidents of sexual harassment;
  • State the corrective or disciplinary measures to be taken for sexual harassment, up to and including discharging the harasser from his job.

Generally, a company will avoid liability under Title VII if it has and follows an anti- harassment policy. The policy must provide a complaint and investigation procedure, and the employee must take advantage of those procedures by following the established protocol. Not only does this protect employers who are dealing with harassment claims, it also discourages false claims from being waged.


Almost every CEO of a small company has concurrent goals to grow into a highly profitable business and to create a vibrant and desirable office environment. If a blind eye is turned toward sexual misconduct at work, high financial, reputational, and energy-sapping costs of dealing with a sexual harassment lawsuit will injure the company significantly.

Small businesses can prevent sexual harassment by establishing a healthy internal culture, which means listening, observing and encouraging an open, honest, dialogue among managers, supervisors and employees. The well-being of your employees, thus your company are at stake.

Paul is still fighting the lawsuit. Scores of thousands of dollars and hundreds of man hours have been spent in investigations, depositions, interrogatories, and attorney client meetings and conferences calls. All could have been avoided had Paul anticipated the potential for a sexual harassment situation.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. He can be reached at 970-390-4441 or



EBITDA: It’s important to understand it when selling your business

Denver Post | BUSINESS

BY GARY MILLER | | GEM Strategy Management

Posted: February 24, 2019 at 6:00am | Digital Edition

Most business owners have heard of EBITDA, (Earnings Before Interest, Taxes, Depreciation, Amortization), but don’t fully understand how it can affect the value of a company and the price buyers pay for a business. EBITDA is a financial calculation that measures the financial strength of a company. This calculation is often used by financial analysts, investors and potential buyers when valuing and analyzing potential acquisitions. It a meaningful measure of operating performance as it allows businesses and investors to more fully evaluate productivity, efficiency, and return on capital, without factoring in the impact of interest rates, asset bases, taxes and other operating costs.

By minimizing the non-operating effects that are unique to each company, EBITDA allows investors to focus on operating profitability as a singular measure of performance. Such analysis is particularly important when comparing similar companies across a single industry, or companies operating in different tax brackets.

Photo provided by Mark T. Osler

Gary Miller

EBITDA first came to prominence in the mid-1980s as leveraged buyout investors examined distressed companies that needed financial restructuring. They used EBITDA to calculate quickly whether these companies could pay back the interest on various financed deals. The use of EBITDA has since spread to a wide range of businesses. Its proponents argue that EBITDA offers a clearer reflection of operations by stripping out expenses that can obscure how the company is really performing.

EBITDA is calculated using the company’s income statement of net income (Total Revenue
Minus Total Expenses = Net Income) and adding back interest, taxes, depreciation and
amortization. It is important for business owners to understand this metric when selling their
businesses because many businesses are sold by a multiple of EBITDA (for example, a
business might sell for five times EBITDA).

However, EBITDA alone may not reflect the true value of a company. Therefore, a business owner should add back certain expenses that are categorized as discretionary, extraordinary, and non-recurring. This calculation is referred to as “adjusted” EBITDA or “normalized” EBITDA.

When combing through expense accounts looking for add-backs, keep some questions in mind: Were these expenses necessary for the operation of the business? Will a new owner incur these same expenses?

Below are some examples of typical add-backs for each category:

Discretionary: A primary discretionary expense is how much owners pay themselves in salaries and benefits (“perks”), including salaries and benefits paid to family members. It’s not unusual for business owners to pay excessive (i.e. well above market rate) salaries to both family members and longtime employees. “Perks” such as a personal car, entertainment, travel, life insurance policies, rent expense, or even sponsorship of your child’s little league team are purely discretionary. The amounts for these expenses should be adjusted to fair market or normal levels. Negative adjustments would include filling any gaps in the management ranks such as hiring a new CFO after the transaction is completed.

I recently met an antique dealer who traveled with his wife to Europe four to six times a year searching for antiques. Not surprisingly, the associated travel expenses were significant. Was this a legitimate business expense? Sure. Would it be necessary for a new owner to travel the same number of times with his wife to continue operating the business successfully? I doubt it.

Nonrecurring: These are one-time expenses, including moving expenses, cleanup and repairs from storm damage, purchasing new computer equipment etc. It’s reasonable to assume that these expenditures would not be incurred by a new owner.

While I am a firm believer in the EBITDA metric, buyers and sellers should be aware of the pitfalls of relying on EBITDA as the sole measure of a company’s operating performance. For example, if a company’s performance has varied in recent years, the time period for which EBITDA is calculated could significantly influence the implied multiple.

Consider a company that produced an EBITDA of $200,000 last year, has an EBITDA run-rate of $140,000 this year and is expected to produce EBITDA of $260,000 next year.  A 5x multiple would suggest values ranging from $700,000 to $1,800,000 – quite a wide range. So what EBITDA should you use? The proper EBITDA would be a current “normalized” level of EBITDA (which can require significant analysis to ascertain).

Another weakness of EBITDA is that it excludes “CAPEX (capital expenditures) and working capital requirements.” While EBITDA is often mistaken as a proxy for net cash flow, it is important to remember that EBITDA is not equal to net cash flow. “CAPEX” reduces a company’s net cash flow but is not factored into an EBITDA calculation since CAPEX does not hit the P&L statement. Also, as companies grow, higher levels of inventories, receivables, and other working capital assets are required to support higher revenue levels.

These investments are a use of future cash but are not reflected in EBITDA. Since most buyers look to future growth in cash flow, growth cannot be captured in a static EBITDA or an adjusted EBITDA calculation.

Often, multiples are assumed based on the expectations and experience of business owners and their advisers. While it is commonplace to hear about multiples of 5x to 10x, there are many industries where EBITDA multiples can be much higher or lower. Also, company-specific factors should influence the selection of an EBITDA multiple. Assessing the proper multiples of EBITDA requires in-depth analysis of companies within the same industry, geography, size (revenues, assets, employees), growth rates, margins and profitability.

While an EBITDA multiple can assist in developing a proxy for value, this should be done only after careful analysis of the factors above. In addition, the analysis should be supplemented with a comprehensive discounted cash flow analysis, which can reflect a company’s projected growth in revenues, profits and cash flows.

Finally, be prepared to defend any add-backs that you include in your adjusted EBITDA. Not surprising, discussions about add-backs with a buyer can become contentious. A savvy buyer will expect you to be able to justify each add-back and explain it in detail.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. He can be reached at 970-390-4441 or

Funding stages from startups to IPOs

The Denver Post | BUSINESS

by GARY MILLER | | GEM Strategy Management, Inc.

PUBLISHED: January 27, 2019 at 6:00 am | UPDATED: February 5, 2019 at 5:49 pm

Robert was well on his way growing his startup to a viable commercial enterprise thanks to his “Founders” financing among his family, friends and his own resources. However, like so many startups, Robert was running out of cash. While his customer base was steadily growing, his monthly expenses (“burn rate”) was exceeding his monthly revenues –- forcing him to use up capital faster than he had planned from his initial capital raise.

Robert realized that he needed to raise more capital to expand his operations and achieve his profitability goals. Robert is not alone. Successful startups need to raise capital through a series of external capital raise stages. Robert could potentially need five major capital raises, or more, to realize the full potential of his company. There are five major funding stages before you can plan on exiting through an IPO.

First — Founders Funding Stage

The earliest stage of funding in a new company comes so early in the process that it is not generally included among funding rounds. Known as Founders funding, this stage typically refers to the period in which a company’s founders are launching their operations. The most common funders are the founders themselves, as well as close friends, family and supporters.

Second –- Seed-Funding Round

Seed-funding is the first official equity/debt funding stage. It typically represents the first official money that a business venture raises. Think of “seed” funding as an analogy for planting a tree.

This early financial support is ideally the “seed” that will help to grow the tree (the business). Seed-funding helps a company to finance its first steps, including market research, product proto-types and proof of concept. With seed-funding, a company can fund its final product development, identify target markets and the team to complete these tasks.

Many potential investors include founders, friends, family, incubators, venture capital companies and “angel” investors. These groups tend to appreciate riskier ventures (startups with little proven track records). However, they expect either convertible debt or equity in the startup in exchange for their investments.

While seed-funding rounds vary significantly in the amount of capital they generate for a new company, it’s not uncommon for these rounds to generate from $200,000 to $2 million for the startup in question. Many startups raising seed capital are valued between $1.2 million to $6 million.

Third –- Series A Funding Round – “Optimization Stage”

Once a business has developed a track record (an established customer base, or consistent revenue streams), the founders may want to continue raising money to optimize their customer target markets, products and service offerings. In a Series A funding round, it is important to have a strong Strategic Business Plan for developing a business model that will generate long-term profits. Typically, Series A rounds raise approximately $2.5 million to $25 million or more due to the high-tech industry valuations.

Series A funding investors are looking for companies that can produce long-term profits and maintain both a competitive advantage and strong bench strength in its management ranks. Fewer than half of all successful seed-funded companies will attract the attention of Series A investors because of weaknesses in those three areas.

Fourth –- Series B Funding Round — “Building Stage”

Series B rounds are all about taking a successful business past the optimization stage to the next level — expanding its market reach. Companies that have gone through Founders, Seed and Series A funding rounds have developed substantial customer bases and have proven to the investment community, that they are prepared for success on a larger scale.

Building a successful product and growing a winning team requires quality talent. Such talent is responsible for bulking up business development, advertising, technology, and customer support. Success in these areas is critical in this stage.

Series B funding appears similar to Series A funding in terms of processes and key players. Series B funding is often led by many of the same players as in the earlier round, who include a lead anchor investor who helps draw in other investors. The difference between Series A investors and Series B investors is the addition of a new wave of venture capital firms or private equity firms that specialize in the “Building Stage” of funding.

Estimated capital raised in a Series B round tends to be between $25 million and $100 million or more. Valuations for these well-established companies varies between $100 million and $250 million or more.

Fifth –- Series C Funding Round –- “Scaling Stage”

Businesses that make it to a Series C funding stage are very successful. These companies look for more funding to help them develop new products, additional services, to expand into new markets, and to acquire other companies. In this stage of funding, investors inject significant capital focusing on “scaling” the company, growing it as quickly and as successfully as possible.

Investors’ expectations are to receive more than double their investments when they exit the firm. One of the fastest scaling strategies is M&A –- particularly acquisitions. This strategy can accelerate market reach by purchasing companies in North America, Europe and Asia.

Since Series C round companies typically have reached target customers coast to coast in the U.S., inorganic growth (buying companies) is less costly than organic growth (generating additional sales from existing customers) once an enterprise reaches critical mass.

Series C funding groups, hedge funds, investment banks, private equity firms and large secondary market groups become the major investors. They believe that the company is less risky, therefore more investors come to play.

Most commonly, a company will end its external equity funding with Series C funding. However, some companies can go on to Series D and even Series E rounds of funding. But, generally Series C funding rounds can generate hundreds of millions of dollars to scale globally. Many of these companies utilize Series C funding to help boost their valuations in anticipation of an IPO (Initial Public Offering). Companies at this stage enjoy valuations of $100 million or even into the billions.

Therefore, Series A, Series B, and Series C funding rounds, refer to growing a business through a progressive amount of funding rounds designed to focus on specific company objectives. Series A, B, and C funding rounds are merely stepping stones in the process of turning a successful startup into a commercially viable firm, potentially leading to an IPO.

The time it will take Robert to navigate these five funding stages (assuming he wants too and can attract investors for each round) is unpredictable. Some companies can be very successful after only a “seed” round or a Series A, or even sub-Series A1 or A 2 with smaller raises. But, for most entrepreneurs, they will need four or five large rounds of funding before they can reach for an IPO.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. He can be reached at 970-390-4441 or

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    2019 could be the best year ever for selling your business

    The Denver Post | BUSINESS

    by GARY MILLER | | GEM Strategy Management

    POSTED:  December 23, 2018 at 6:00 am

    Over the past several weeks, I’ve been asked by several business owners whether they should sell their businesses in 2019 or hold off until 2020 or 2021. I told them, “Do not wait.” One of the biggest mistakes business owners make is postponing the sale of their businesses in hopes of selling at a higher price some time in the future. More often than not, they mistime the market.

    No one can accurately predict with any degree of certainty what the market will look like in two to three years. Even today, some experts predict that we are headed for a recession sometime during 2019 through 2021.

    I do not believe the pessimists. The “Index of Leading Economic Indicators,” the best predictors of the fundamental strength of the economy, strongly suggests that at least in the short term, the next 12 months to 18 months, shy of a major geo-political event like 9/11, the economy will stay strong.

    As small- and- medium-sized businesses embrace a strengthening economy, there is another reason for entrepreneurs to be optimistic. It is a seller’s market. Some advisers say it’s the best market for mergers and acquisitions they have ever seen, certainly in recent years. Even small business owners who aren’t yet ready to retire are looking to take advantage of this robust M&A environment.

    In the Pepperdine Private Capital Market Study, business advisers state that seller sentiment hasn’t been this high in the past five years. My colleagues tell me many active buyers are working on multiple deals simultaneously, which has not been seen in past years –- or, at least, not at the volume we are seeing today in the lower-middle market.

    Separate research reported in Forbes Magazine confirmed those findings. According to Forbes, published a few months ago, nearly one-third of small business owners plan to sell their businesses within the next two years. The majority of business buyers –- 84 percent –- plan to buy in the next year.

    I am advising our clients, if their companies are prepared to go to market, sell now! You may not get another chance like this for another five to seven years. Valuations are high and buyers are paying premiums for well-run companies.

    However, business owners shouldn’t rush to sell their businesses simply because the market is strong. Analysts insist that to maximize value, business owners must prepare their business for sale before going to market. Buyers have become much more cautious and sophisticated in their due diligence processes since the Great Recession of 2008-2009.

    Today, 15 major areas that buyers look at closely when examining a company to purchase are the company’s:

    1. Historical financial statements and related financial metrics, as well as the reasonableness of the target’s financial projections of its future performance;
    2. Technology/intellectual property;
    3. Customer base, its concentration and sales pipeline;
    4. Strategic fit with the buyer’s organization (cultural);
    5. Contracts and commitments to suppliers, employees, contractors, lenders and senior management;
    6. Past, present and potential future litigation;
    7. Tax matters and understanding of any tax-loss carryforwards;
    8. Governance documents and general corporate matters;
    9. Overall operations and its cybersecurity protocols;
    10. Related party transactions;
    11. Regulatory filings and compliance issues;
    12. Production/sourcing/suppliers and related matters for products and services offered by the target company;
    13. Marketing and sales strategies and agreements related to the sales of the company’s products and services.
    14. Competitive landscape and market analysis of the industry sector the target company serves; and,
    15. SWOT (strengths, weaknesses, opportunities and threats) analysis.

    Because buyers will slice and dice numbers every way possible to understand the business and any problems, risks and opportunities going forward, sellers can prepare their companies by putting themselves through the same due diligence process as buyers do to shore up the “soft underbelly” of the companies. It is always better to identify any “warts” in a business before going to market, versus during a buyer’s due diligence process. No one likes surprises. If buyers discover problems during the due diligence review, that was not disclosed by the seller in advance, it will usually cost the seller significantly.

    I recommend to clients during the preparation to sell their businesses that they understand two major metrics about their businesses: (1) A valuation of their business conducted by an independent certified valuation firm so they don’t over price or underprice their businesses and, (2) A benchmarking study focusing on how they stack up against competitors in their industry. A comprehensive benchmarking study can focus on the due diligence items listed above. Both of these analyses and studies will point out key performance areas that are strong and/or could be problematic in the transaction process.

    One new issue that is hurting some sellers in closing their transactions is their inability to attract new talent and retain current employees in this environment of record-low unemployment. In a separate report from Wells Fargo and Gallup published a couple of months ago, nearly one-fifth of small business owners cited hiring new staff and retaining current employees as their biggest challenge. Some experts note that the struggle to hire new talent is squeezing businesses’ organic growth efforts, making companies less attractive to buyers.

    Given this current labor shortage environment, I am recommending to some of our clients that they consider inorganic growth (acquisition strategies) vs. organic growth only (build from within) as a part of their overall exit plan. A smart acquisition, such as purchasing a competitor’s well-run company, can add significant enterprise value, and therefore add significant shareholder value. In today’s market a solid acquisition, rolled up into your current company’s operations, can add more diversification, lower your risk profile and generate increased revenues and earnings.

    Regardless of which strategies are employed, now is a good time to plan your exit strategies and prepare your company for sale. I remind them that “a bird in hand is worth two in the bush.”

    Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or how to buy companies and raise capital. He can be reached at 970-390-4441 or

    Gary Miller: Benchmarking: a tool for small-and medium- sized businesses

    The Denver Post | BUSINESS


    Gary Miller: Benchmarking: A management tool for small – and medium – sized businesses

    Gary Miller, staff photo

    By GARY MILLER | | GEM Strategy Management

    PUBLISHED: November 25, 2018 at 6:00 am | UPDATED: November 26, 2018 at 3:18 pm

    Gary Miller writes a monthly column for The Denver Post.


    If you don’t know where you’re going you might not get there. – Yogi Berra


    Now that the mid-term elections are behind us and businesses are closing out the year, it’s time before lunging into 2019 for business owners to take a serious look at how their companies stack up against the competition. One management tool that large businesses have used for years is called “Benchmarking.” However, in the last few years, small- and medium-sized businesses are engaging in this management tool, as well.

    Benchmarking is a process for obtaining a measure –- a benchmark. It is a process designed to discover the best performance being achieved –- whether in a particular company, by a competitor or by an entirely different industry. This information can then be used to identify gaps in an organization’s processes, operations and financials in order to achieve a competitive advantage.

    Some of the more useful financial benchmarks involve: (1) gross operating and net profit margins; (2) sales and profitability trends; (3) inventory, accounts receivable, and accounts payable turnover; (4) salary and compensation data; (5) revenue and cost per employee; (6) marketing expense as a percent of revenue; and (7) revenue to fixed assets ratio.

    Suppose you learned from your benchmarking study that your gross profit margin is 3 percent lower than your competition. For every $1 million in annual revenue, that’s $30,000 a year that they’re making that you’re not. Is it because their prices are higher or their costs are lower? Does their sales mix include higher margin items that you don’t carry, but could? Do they have some sweetheart deal from their suppliers that you should know about? Do they spend that extra gross profit or does it fall to the bottom line? Finding answers to these questions, among others, could change your business strategies going forward.

    Another example of benchmarking is considering the metric of “wait time.” It does not matter whether waiting for a car repair at a dealership or making a deposit in a bank lobby, customers do not like waiting in long lines. Similarly, whether waiting on a telephone help line of a cable company or a favorite online retailer, customers do not want to remain on hold. They want their concerns addressed quickly and efficiently.

    The bottom line: Important information can be learned by going outside one’s own industry because many customer concerns are the same.

    Benchmarking is a difficult, time-consuming process. Most business owners engage a consulting firm that subscribes to various business databases of diverse industries and asks them to evaluate the problems found, recommend solutions, and measure results. However, some small-business owners prefer to take the time and learn for themselves.

    For best results:

    1. Use data from similar size companies and, where possible, within your own geographic area.
    2. Use a source that represents a large universe of inputs so that numbers are not skewed.
    3. Choose the industry group that best represents your business North American Industry Classification System.

    Below are 10 of the best sources for free or low cost financial data covering a wide range of industries.

    1. Your Industry Association may be the best source for consolidated industry data and financial benchmarks.
    2. The Internal Revenue Service Corporate Sourcebook offers summary balance sheets and income statement numbers for all industries by size of company.
    3. Annual Reports of Public Companies in your industry as well as the 10K and 10Qs provide rich information and often compares their performance with their industry’s overall performance. Also, very important information is often buried in the foot notes, so read them carefully. Though these companies may be larger than yours, their numbers can offer significant insights.
    4. The Bureau of Labor Statistics Labor Productivity and Costs shows output per hour and unit labor costs by industry.
    5. The Bureau of Labor Statistics Labor Pay and Benefits provides information on wages, earning, and benefits by geography, occupation, and industry.
    6. Bureau of Labor Statistics Labor Producer Price Index offers production costs trend data by industry.
    7. Department of Labor reports hours, wages and earnings reports by industry.
    8. Census Bureau Economic Census provides annual and trend data on sales, payroll, and number of employees by industry, product, and geography.
    9. Census Business Expense Survey reports sales, inventories, operating expenses, and gross margin by industry.
    10. Census Annual Survey of Manufacturers covers employment, plant hours, payroll, fringe benefits, capital expenditures, cost of materials, inventories and energy consumption.

    In addition, three other inexpensive sources of industry data that are useful for many business owners include:

    • Dun and Bradstreet offers individual company data on sales, employees, net worth, nature of financing, credit worthiness, balance sheet/income statement/ratio data, law suites, public filings, liens, and judgments.
    • The Risk Management Association offers benchmarking data on a business’s performance. This is one source that your bank probably uses to benchmark your business’s performance, so it’s well worth the cost.
    • offers easy access to financial information about public companies. It also provides the same research information as financial professionals use.


    No better evidence for the value of benchmarking exists than the Winter Olympic Games. When watching the games we repeatedly hear “the time to beat” as downhill skiers race for the finish line. That information drives skiers to shatter new records set just minutes before.

    In business, benchmarking your performance against that of your competitors can propel you to greatness, too. It can help you establish internal goals, pinpoint market opportunities, exploit competitors’ weaknesses, and create the kind of esprit de corps to unify and motivate your team.

    Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or how to buy companies and raise capital. He can be reached at 970-390-4441 or


    Should you consider a “structured earnout” when selling your business?

    The Denver Post | BUSINESS

     | | GEM Strategy Management


    A structured earnout is a portion of the purchase price of a business that is paid overtime at a later date contingent upon the acquired business achieving certain agreed to performance targets. Basically, the buyer agrees to pay at closing a certain percentage of the agreed to purchase price with the commitment to pay additional amounts (the earnout) to the seller if the acquired business achieves certain future revenues and profits.

    Photo provided by Mark T. Osler

    Gary Miller writes a monthly column for The Denver Post.

    Structured earnouts increase or decrease sharply depending on economic conditions. During the Great Recession, economic volatility made it more difficult to accurately project revenues and profits and tight borrowing conditions made it difficult to finance transactions. As a result, buyers and sellers increasingly relied on earnouts to consummate transactions.

    However, today buyers have regained confidence in the economy. Competition for quality investment opportunities has increased, creating a seller’s market for quality companies.

    Therefore, sellers of high-quality companies have become less willing to enter into earnout agreements. But, for those companies for sale whose financial performance is inconsistent, who have a concentrated customer base, or are operating in poor market environments, a structured earnout could be the best option for selling your company.

    Introduction to earnouts

    The purchase price of a business is determined by many factors including future cash flow, earnings, growth rates, among others –- topics that are major subjects of disagreements between sellers and buyers. These disagreements often reach an impasse during negotiations because of a gap in their expectations about the future performance of the business.

    The seller expects the price to reflect his/her projections on the potential future revenues and earnings. The buyer is reluctant to agree when the projections do not seem realistic. An earnout can help the parties bridge this gap and therefore complete the transaction.

    The parties need to agree on what those performance targets are –- financial and/or commercial.

    If they are financial, they can be set at the top of the P&L statements (e.g. gross revenues or net revenues), or at the bottom of the P&L statements (e.g. EBIT or EBITDA). If they are commercial (e.g. diversification of the customer base, or the launch of new products) milestones can be set to measure those commercial achievements during the earnout period. Most earnouts are a combination of both.

    Although earnouts are an excellent tool for bridging the gap between the parties’ expectations, they have become controversial due to the potential for future disputes. Many M&A practitioners (including this writer) question whether they are ultimately good for either party. There have been various court cases in connection with earnouts. Vice Chancellor Travis Laster of the Delaware Chancery Court famously observed in the Airborne Health case: “An earnout often converts today’s disagreement over price into tomorrow’s litigation over outcome.”

    Advantages of earnouts

    For a buyer, the advantages of using earnouts are hard to challenge. By deferring payment(s) of a portion of the purchase price and making it conditional on the achievement of certain performance targets, the buyer is actually transferring the risk of the uncertainty of future revenues to the seller. For a buyer, this is the most valuable benefit of an earnout, as it will only pay for those potential revenues/earnings when they are achieved. The frequency of payments and the earnout period are determined by the purchase agreement — usually paid on a quarterly or semiannual or annual basis over a one to three year time period.

    Another advantage for the buyer is to use the earnout as a tool to protect itself against misrepresentations or a breach of covenants by the seller. If at some point during the earnout period, the buyer makes a claim against the seller for misrepresentations, breach of covenants or other terms and conditions, the buyer may decide (depending on the purchase and sale agreement) to deduct the amount of its indemnity claim from any earnout payments due to the seller.

    Finally, earnouts can help a buyer retain key employees. For example, when the seller is also the CEO of the business, having an earnout would encourage him/her to remain with the company after the transaction closes. For the seller, remaining with the company would give more control and a strong personal incentive to do his/her best to meet the performance targets.

    Disadvantages of earnouts

    The biggest disadvantage of earnouts is the risk of post-transaction disputes. Typically, the disputes center the seller’s ability to achieve the earnout performance targets. More often than not, disputes arise when performance targets are not met because the buyer (at the shareholder level) makes certain management decisions that prevent the acquired business from achieving its performance targets.

    Structuring the earnout can be a serious challenge too. If the earnout is not tailored to or in alignment with the uniqueness of the business’s operations, complications followed by disputes can arise. Since each business operates differently, even when operating in the same space, special attention to operating details is required for a successful earnout structure.

    Although the risk of earnout disputes is difficult to eliminate, earnouts work best when a seller-CEO stays with the acquired company after the transaction closes because (1) a continuity of management practices will be in place; (2) the risk of disputes based on the seller’s lack of control over the company’s operations is reduced and, (3) the seller will be rewarded for his/her own performance rather than for the performance of a new management team brought in by the buyer.

    Most importantly then, one should think of an earnout as creating a partnership between seller and buyer. If an earnout is structured properly, the buyer and seller become partners, sharing in the upside and downside risk of a deal.

    Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. He can be reached at 970-390-4441 or

    Seven expectations if you sell your business to a private equity firm

    The Denver Post | BUSINESS

    By GARY MILLER | | GEM Strategy Management | He writes a monthly column for The Denver Post.

    POSTED: September 23, 2018, at 6:00 am


    Recently, Kevin and his board of directors asked me to join them in a discussion of how a private equity (PE) firm will value its business and what to expect in their examination of the company. A few weeks earlier, a PE firm had approached Kevin stating that they were interested in purchasing his company to expand its portfolio of similar companies. They wanted to know if Kevin was interested in selling his company.

    Kevin’s firm is 18 years old. Over the past three years, it has averaged $12 million in annual revenues and has averaged $2.1 million in earnings before interest, taxes, depreciation, and amortization. I gave Kevin and his board the following advice.

    1. The goal of a PE firm is the same as any other company — to make money. It looks for businesses that show clear growth potential in revenues and profits over the next three to five years.
    2. Typically, PE firms buy a majority interest in a company, leverage its networks and resources to help make the target more successful than it was before the purchase. Then, they ultimately resell the company for a profit — usually after three to five years. This process can be likened to someone buying a classic car, restoring it, and then selling it for a profit.
    3. PE firms determine a company’s true value through rigorous and dispassionate due diligence. A top-to-bottom examination of the company allows them to test their “going-in” assumptions against the facts. This examination provides a clear understanding of the business’ full potential and what it could be worth in the future. Such a tightly focused due diligence process builds an objective fact base by scrutinizing several factors that help answer the fundamental question: “Will this acquisition make money for investors”? Such scrutiny can help PE firms discover a compelling reason to pay more than another bidder — or throw up red flags putting the brakes on a flawed deal.
    4. The PE firm verifies the cost economics of an acquisition. Veteran acquirers know better than to rely on the target’s own financial statements. Often, the only way to determine a business’ stand-alone value is to strip away all accounting idiosyncrasies by sending a due-diligence team into the field. Often they rebuild the balance sheet, profit-and-loss and cash-flow statements. The team collects its own facts by digging deeply into such basics as The cost advantages of competitors over the target company; and, the best cost position the target could reasonably achieve.
    5. PE teams do not rely on what the target tells them about its customers; they approach the customers directly. They begin by drawing a map of the target’s market, sketching out its size, its growth rate, its products and customer segments; then it breaks down that information by geography. These steps allow the PE firm to develop a SWOTs (strengths, weaknesses, opportunities, and threats) analysis, comparing the target’s customer segments to its competitors’ customers segments, answering the following questions.
    • Has the target fully penetrated some customer segments but neglected others?


    • What is the target’s track record in retaining customers?


    • Where the target’s offerings could be adjusted or improved to grow sales and/or increase prices? And,


    • Can the target continue to grow faster than the market’s growth rate?


    1. The PE firm’s due diligence teams always examine the competition. They dig out information about business strategies, operating costs, finances, and technological sophistication. They examine pricing, market share, revenues and profits, products and customer segments by geography. Normally, PE firms have a deep understanding of industry data so they can benchmark the target and its competitors. This due-diligence process is a powerful tool for unmasking the target’s fatal flaws.
    2. PE firms take a long view, looking ahead to the time when they’ll be selling the company to another acquirer. With that in mind, the goal is to hit a three-to-five-year growth target, and build sustainable growth into the company’s DNA.

    What can business owners do to increase their company’s values?

    A business owner can emulate these same PE firm processes to increase his/her company’s value. Many owners know far less about the environments in which they operate than they think they do. As a result, they often don’t challenge their own conventional wisdom until it is brought to their attention by the potential acquirer. By then it’s too late to have maximized the company’s value.

    By digging deep into the data, owners can discover their company’s full potential and the underlying weaknesses that could make them less attractive as acquisition targets. By examining the factors that drive demand and measuring products and services against competitors, owners can identify performance gaps that need to be addressed.

    Looking at the broader picture owners should ask themselves:


    • What key initiatives will have the most impact on my company’s value in three to five years?


    • What are the customers’ future purchase behaviors, if we do nothing?


    • What technologies could disrupt my business?


    • What market changes could affect our market share?


    These questions are hard to answer. The key is to define the future business environment for the company. Owners need to see what the facts say about the company and what levers can be pulled to create more value for their companies.

    Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or to buy companies and raise capital. He can be reached at 970-390-4441 or