Articles & Presentations

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


    Should I buy my father’s business?

    The Denver Post | BUSINESS

    POSTED: August 26, 2018, at 6:00 AM

    By GARY MILLER | | GEM Strategy Management, Inc.

    Last month, Bill and Mary, owners of a successful hardware distribution company, came to see me about selling their business to their son.  Bill Jr. had worked for them for the past four years and was doing an excellent job. He left a promising career to return home after Bill Sr. had a heart attack.  Several of Bill and Mary’s children worked in the business as well but had not expressed any interest in purchasing the company.

    I asked them if Bill Jr. was really interested in taking over the family business and was he ready to lead the company. They weren’t sure if he wanted to buy the business now.  As I listened to them, I decided that I should discuss the situation with Bill Jr. privately. They agreed.  After spending time with him, it was clear the Bill Jr. was interested in buying his father’s business but had not seriously considered purchasing it now.

    This is the advice I gave him.

    I told him that there is no single path to taking over a family business.  More importantly, if he is interested in purchasing the business now, he needs to know how to proceed smoothly. It is wise to take a cautious approach that recognizes the family’s unique personalities, values, and interpersonal relationships since it is his family.

    First, Bill Jr. will need to consider the ramifications of taking over the family business. I advised him to take some time to review his career goals and personal life. Since Bill Jr. was in his mid-30’s, he may want the chance to define himself and his career outside of the family business.

    Second, Bill Jr. will need to review the benefits and risks involved in purchasing the business.  He should secure the advice of a trusted mentor and a business consultant. There is a range of benefits that come with taking over the family business. You are:

    • Maintaining the family legacy.
    • Getting an established business with a modern infrastructure.
    • Getting the existing talent and knowledge of longtime employees.
    • Getting a profitable business with strong cash flow.
    • Getting a business with a solid customer base.

    However, Bill Jr. needs to recognize potential risks, as well. I recommended that he take some time to consider the various risks. Questions he should ask himself are:

    • Is there potential for infighting among family members about the buyout?
    • How will he finance and pay for the purchase of the business?
    • Is the cash flow enough to pay the payments to his parents?
    • Is the initial financial investment economically viable?
    • Are there long-term growth opportunities for the business?
    • Does he have the right skill sets and leadership style for the company culture?
    • Will the existing customers and employees stay with the business if Bill Jr. takes over?

    Third, I advised him to secure a professional opinion of value from an independent, certified valuation firm. Often, family members will either under or overestimate the value of their business. Without an independent valuation, family feuds can erupt. A certified valuation will help determine whether it is a good business decision to purchase the business and, if so, how much should Bill Jr. pay for it.

    Fourth, Bill Jr. should make a holistic decision. Taking the benefits, risks, current financials, family dynamics and his own career into account, make the decision that is right for him.  His advisors should make sure that Bill Jr’s considerations are relevant, thoughtful and logical.

    Fifth, assuming Bill Jr. decides to purchase the business, he should be cautious in how he proceeds with the purchase. Nerves can become raw and tense during the transaction process.  To keep things under control, it’s best to take a slow approach and not be too aggressive because either could spark negative reactions among family members.

    Sixth, Bill Jr. should develop his own business relationships instead of relying on his parents’ or other family members’ relationships — lawyers, accountants, and consultants. It is advised that each participant in a family business transaction should have their own legal counsel. Bill Jr. will want to follow an arm’s length transaction process as if he were buying a company other than the family business. By using an arm’s length transaction process, he can minimize “family drama”. For example, avoid deciding on a purchase price around the dinner table or with a handshake on a family vacation. Hire a law firm with transaction experience to draw up the definitive purchase agreement and an M&A consultant to help negotiate price, terms and conditions, representations and warranties of the purchase. In addition, Bill Jr. should develop a clear communication and transition plan that addresses the transition of leadership from his father to himself.

    Seventh, he should use his unique talents and leadership style instead of trying to run the business like his father. However, he should respect family rules and precedents.

    Finally, I told him to be sensitive. When taking over the family business, remember that the last generation may be very attached to what they’ve built.  Whether the business was a start-up or they took it over from a previous owner, they have spent a great portion of their lives building a successful company. Just as starting a business takes a great deal of energy, taking over a family-owned business can be just as taxing — and surprisingly emotional, too.

    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


    An unsolicited offer for your business. Wow! What do I do now?

    The Denver Post | BUSINESS

    POSTED: July 22, 2018 at 6:00 am

    By GARY MILLER | | GEM Strategy Management, Inc.


     Most business owners know that merger and acquisition (M&A) activity is very robust.


    According to Deloitte LLP, in The state of the deal, M&A trends 2018 report,
    “Corporations and private equity firms foresee an acceleration of M&A in 2018 – both in
    the number of deals and the size of those transactions”. For business owners, this is
    good news. However, this flurry of deal activity results in unsolicited offers for many
    small business owners. That is what happened to Joe, the owner of a small
    manufacturing firm.

    Joe called me wondering what to do since he had received an unsolicited offer to buy
    his business. The buyer was willing to pay him three times annual revenues, plus his
    net assets on an earn-out basis over the next three years. In addition, there were no
    non-compete clauses in the offer. However, the purchase price had to be supported by
    an independent, certified valuation.

    Photo provided by Mark T. Osler

    Gary Miller, GEM Strategy Management Inc. He writes a monthly column for The Denver Post.

    On its surface, this deal seems workable. However, Joe was caught off guard since he had not seriously considered selling his business.  He didn’t know what to do. Following is the advice I gave him.

    First, be careful about how much information you divulge to the person representing the
    buyer. Request a signed confidentiality agreement from the potential buyer. A genuine
    buyer will not balk at this request. Consider if the offer is coming from a legitimate
    potential buyer or from a buyer with ulterior motives, such as acquiring intelligence
    about your business and its customers. It is critical to conduct proper due diligence
    up front to understand the suitor’s motivations and whether to engage.

    Second, take time to consider whether or not you want to sell your business now. Many
    owners wait to begin thinking about selling their businesses until their businesses are
    declining or they have been hit with unexpected major events, such as divorces, severe
    illnesses or deaths in the family, or losses of key employees, large customers or key
    suppliers. As a result, owners react, by making emotional decisions rather than strategic
    ones. Owners, who plan ahead, are more likely to extract higher values for their
    businesses when they are highly profitable and positioned for strong growth.

    Third, if you are interested in selling your business, seek help immediately from
    professional M&A advisors. They bring professional experience and expertise and
    provide significant value by helping you understand all of your options and help you avoid making emotional or irrational decisions. Know that you are at a disadvantage, to begin with, since most buyers, who tender unsolicited offers, have made other acquisitions. They are sophisticated and come with M&A advisors who are strong
    negotiators. Generally, most business owners who receive unsolicited offers haven’t
    taken the time to prepare their companies for sale. As a result, they often leave money
    on the table which is just what potential buyers are counting on.

    Fourth, consider whether you have enough capital to continue to grow your business
    and stay competitive. Seeking external capital or recapitalizing by selling a minority or
    majority interest in your business could be a better option than an outright sale of all of
    your business.

    Fifth, look at the market you serve. Consider both the short-term and the long-term
    prospects for a promising future. You may find, while business is good now, the long-
    term prospects are going to be challenging due to emerging trends or new displacement
    technologies that could threaten your current business model.

    on a few customers or suppliers? Generally, if over half of your business revenues come from 10 to 15 percent of your customer base, you have a concentration of risk. Buyers will not pay top dollar for businesses if they feel threatened by this concentration of risk.

    Sixth,  many times unsolicited offers come from so-called “private investment search
    firms”. These are firms, formed by a group of investors, who promise to fund a potential
    acquisition if the right deal comes across their platform. The investors hire a fund
    manager to seek out potentially good deals. Once the fund manager has found a
    potential target and gone through the transaction process with the seller except for
    drafting the definitive purchase agreement, he goes back to the investors and tries to
    “sell” the deal. All too often, one or more of the so-called investors balk at the deal and
    the potential transaction falls apart. In the meantime, weeks or even months have
    passed leaving the owner empty-handed after spending countless hours, energy and
    money trying to get the deal closed. The message is obvious –owners should vet the
    potential suitor to ensure the search fund has been fully funded and has the financial
    capacity to acquire your business.

    Finally, identify what methodologies the potential buyers are relying upon to value your
    business. This is critical for business owners looking to maximize value. Price is
    generally based on a multiple of some form of normalized earnings/revenues.

    Therefore, higher adjusted earnings equate to higher purchases prices.

    Most business owners need help to sort through the intricacies of selling their
    businesses. It is wise to consult qualified advisors such as M&A consultants, transaction
    attorneys, accountants, and wealth managers.

    Joe did just and wound up closing the deal of a lifetime.

    Gary Miller is Founder & CEO of GEM Strategy Management Inc., and M&A consulting firm, advising 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


    Ignoring tax issues before the deal is struck is a big mistake

    The Denver Post | BUSINESS

    POSTED;  June 24, 2018, at 6:00 am


    Many business owners put tax issues on the “back burner” when selling their companies. Ignoring tax considerations, until after the deal is struck, is a big mistake and can put you in an adverse negotiating position, even if the letter of intent (LOI) or term sheet (TS) is “nonbinding.”

    Sellers should not agree on any aspects of a deal until they meet with a competent tax adviser who can explain how much they will wind up with on an “after-tax” basis. Seven major tax questions should be considered before finalizing a deal.

    1. What type of entity do you use to conduct your business?
      Is your business is a sole proprietorship, partnership, limited liability company (“LLC”) or S corporation? These corporate structures are considered “pass-through” entities and will provide you with the most flexibility in negotiating the sale of your business. Your flexibility may be limited, however, if you conduct your business through a C corporation. The possibility of “double taxation” may arise at the corporate and shareholder levels.
    2. Is a tax-free/deferred deal possible?
      Most sales of businesses are completed in the form of taxable transactions. However, it may be possible to complete a transaction on a “tax-free/deferred” basis, if you exchange S corporation or C corporation stock for the corporate stock of the buyer. This assumes that the complicated tax-free reorganization provisions of the Internal Revenue Code are met.
    3. Are you selling assets or stock?
      It is important to know whether your deal is or can be structured as an asset or stock sale prior to agreeing to the price, terms and conditions of the transaction. In general, buyers prefer purchasing assets because (i) they can obtain a “step-up” in the basis of the assets resulting in enhanced future tax deductions, and (ii) there is little or no risk that they will assume any unknown seller liabilities. Sellers, on the other hand, wish to sell stock to obtain long-term capital gain tax treatment on the sale.

    A seller holding stock in a C corporation (or an S corporation subject to the 10-year, built-in gains tax rules) may be forced to sell stock because an asset sale would be subjected to a double tax at the corporate and shareholder levels. In addition, the seller is often required to give extensive representations and warranties to the buyer and to indemnify the buyer for liabilities that are not expressly assumed.

    1. How will you allocate the purchase price?
      When selling business assets, it is critical that sellers and buyers reach agreement on the allocation of the total purchase price to the specific assets acquired. Both buyer and seller file an IRS Form 8594 to memorialize their agreed allocation.

    When considering the purchase price allocation, you need to determine if you operate your business on a cash or accrual basis; then separate the assets into their various asset classes, such as: cash, accounts receivable, inventory, equipment, real property, intellectual property and other intangibles.

    1. Can earn-outs/contingency payments work for you?
      When a buyer and seller cannot agree on a specific purchase price, the seller and buyer may agree to an “earn-out” sale structure, and/or contingent payments. The buyer pays the seller an amount upfront and additional earn-outs or contingent payments if certain milestones are met in later years.
    2. What state and local tax issues are you facing?
      In addition to federal income tax, a significant state and local income tax burden may be imposed on the seller as a result of the transaction. When an asset sale is involved, taxes may be owed in those states where the company has sales, assets, or payroll, and where it has apportioned income in the past. Many states do not provide for any long-term capital gain tax rates, so a sale that qualifies for long-term capital gain taxation for federal purposes may be subject to ordinary income state rates.

    Stock sales are generally taxed in the seller’s state of residency even if the company conducts business in other states.

    Also, state sales and use taxes must be considered in any transaction. Stock transactions are usually not subject to sales, use or transfer taxes, but some states impose a stamp tax on the transfer of stock. Asset sales, on the other hand, need to be carefully analyzed to determine whether sales or use tax might apply.

    1. Should presale estate planning be considered?
      If one of your goals is to move a portion of the value of the business to future generations or charities, estate planning should be done at an early stage, when your company values are low (at least six months in advance of verbal negotiations and/or receipt of a TS or LOI). It may be much more difficult and expensive to simply sell the company and then attempt to move after-
      tax proceeds from the sale to the children, grandchildren or charities at a later date.

    Conclusion: Before deciding to sell your business, work with a qualified tax adviser who can help you understand the tax complexities of various sales structures. Above all, do not enter into any substantive negotiations with a buyer until you have identified the transaction structure that best minimizes your tax burden.

    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


    Half of all business sales fall apart during due diligence.

    The Denver Post | BUSINESS

    Here’s how to avoid it.

    By Gary Miller | Gem Strategy Management

    POSTED:  June 3, 2018 at 6:00 am

    When a seller tries to hide facts, or doesn’t disclose them to buyers and they are uncovered during due diligence, say goodbye to the deal. According to Forbes, “approximately half of all deals fall apart during the formal due diligence stage, and one of the most common reasons this happens is due to the buyers uncovering  issues which the sellers didn’t disclose earlier.” These situations are never pretty. Accusations are made, lawsuits follow, buyers lose their investments, sellers forfeit any earn-outs and face “financial claw backs” and businesses deteriorates rapidly. Nobody wins. These situations are all too common and in most cases should never happen.

    Think about it. You spend years building a successful business. You decide to sell, spend time trying to find a qualified buyer to sign an LOI (letter of intent to purchase your company) and begin negotiations, only to have your potential deal fall apart because of undisclosed items arising during the due diligence process. So what can you do about it? Below are four “musts” for successful deal making.

    First, don’t rush to go to market. Rushing to market can be caused by age, illness, burnout, divorce, legal problems, partner squabbles and myriad other reasons. But, in spite of these reasons, rushing to market could significantly impact your ability to get an optimal deal for your company. Going to market unprepared is a recipe for disaster. Since most business owners will only sell a company once in their lives, it’s a good idea to engage a professional M&A adviser to help prepare for the transaction process in general and the due diligence process in particular.

    Second, prepare for the buyers’ due diligence process. Prepare for intense buyer scrutiny.  Far too often business owners simply do not do their homework prior to the process and pay the price in the end when their deal falls apart. If a seller is not prepared in advance, due diligence can drag on for weeks; and, often, if it does, buyers get cold feet and move on to other, more attractive opportunities. Have an adviser create a typical due diligence check list and put you through the rigor of answering questions that could arise.

    Third, disclose, disclose, disclose. Throughout the discussions, negotiations and the due diligence review between a buyer and seller, credibility is being tested. In your discussions with the buyer, explain your challenges before they find them; understanding them will allow the buyer to get comfortable with your business. Disclosing the challenges actually builds trust and credibility. As long as the parties deal honestly with each other, trust builds. But, if either side tries to hide material information that surfaces during due diligence, trust will be shattered. The cardinal rule of deal making, during the due diligence process, is disclose all material information.

    For example, in a transaction involving a moving and storage company, a large percentage of the company’s revenue came from a single government contract. The buyer wanted to read the master contract between the company and the government agency to be sure it was transferrable as the seller had represented. However, the seller knew it was not really transferable and would have to be reviewed by the government agency because of change of ownership. He figured he could convince the buyer to buy the company’s stock instead of the company’s assets after the buyer was emotionally invested in getting the deal done. Wrong strategy. The buyer agreed to complete all other components of due diligence and would review the contract afterwards. Sure enough, the buyer discovered that the contract was not transferable and could only continue with an entirely different deal structure complicated by tax issues and potential liabilities. The buyer felt mislead and the deal disintegrated.

    Remember, the goal is to sell the business. Disclosing the good and the bad about the business, warts and all, is just prudent deal making.

    Fourth, think like a buyer. Look at your business as if you were a buyer. Ask yourself, what would I need to know about this company if I were buying it?  What are its strengths and weaknesses?

    A great exercise for sellers is to put together a list of everything that worries them about their own business – those that keep them up at night. Then, detail potential solutions to each problem that can mitigate a buyer’s concern. For example, if the business has some old equipment, the seller can be proactive and have a spreadsheet ready that details replacement costs and financing options along with the potential improved efficiencies that will contribute to the bottom line.

    Despite the dismal statistics of failed deals, transparency between the parties is the key to success. When a buyer wants to buy and a seller wants to sell, and the parties like and trust each other, they will find a way to get the deal done.

    Gary Miller is CEO of GEM Strategy Management Inc., based in Greenwood Village, which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. | 970.390.4441