5.Network Network Network. A great way to improve your chances of successfully purchasing a business at a good price is to have an entree into a business that is not formally for sale. What I mean when I say that business is not formally for sale is that owner has decided that he wants to exit and has shared that information with a few close advisors, but has not engaged services of an M&A firm or advertised on one of popular Business for Sale Web Sites. Put word out to your network of professionals, industry sources, trade associations, vendors and suppliers, etc. Utilize same preparation as described above and hand out your materials. Your banker, your lawyer, your financial planner and all of their associates are great sources of businesses for sale. Remember, if you do not establish your credibility with them in your preparation, they will not risk their credibility with another client through an ill-advised introduction. The good news from this approach is that you may be able to purchase a good business at a bidder of one price without price pressure from other buyers. If that seller’s trusted advisor brings you in, chances of this happening improve significantly.

6.How serious are you? Lots of individual buyers will pay a broker or intermediary a success fee based on a percentage of purchase price. The most serious buyers, however, pay buy side engagement fees as well. This is a fee usually ranging from $2,000 to $7,500 per month paid to M&A professional to formally search for you outside of networking only approach they would take for no engagement fees. Corporations in acquisition mode almost always operate this way. The benefit to this approach is that intermediary will expand universe of candidates to those companies that fit your buying criteria that are not for sale. It is a lot of work to compile databases and try to break through difficult barriers to reach an owner that was not contemplating a sale and convincing him to entertain this process. Our objective is to buy his company as only competitor. If we can do that, transaction price will generally be 20% below a business that is formally for sale, represented by a professional, and getting many interested buyers. Saving you $1 Million on purchase of a $5 Million business certainly will justify any monthly fees and success fees an M&A professional would charge. The corollary to this is if you are a business seller, and you do not engage a professional, you most likely will leave that 20% premium on table.

Most individual buyers are engaged in buying process with either no current income or very limited consulting income. In other words, buying a business is their full time job. While one operates in buying mode, they are working for no income. The longer that buying process takes, greater erosion of their financial resources. It is in buyer’s interest to not only purchase right business at right price, but to compress amount of time it takes to complete process. Implementing one or several of these recommendations should help you buy smarter and faster.

8.The improving market provides both seller and buyer growth leverage. When negotiating earnout component, buyers will be very generous in future compensation if acquired company exceeds their projections. Projections that look very aggressive for seller with their pre-merger resources, suddenly become quite attainable as part of a new company entering a period of growth. An example might look like this: Oracle acquires a small software Company B that has developed Oracle conversion and integration software tools. Last year Company B had sales of $8 million and EBITDA of $1 million. Company B had grown by 20% per year. The purchase transaction was structured to provide Company B $8 million of Oracle stock and $2 million cash at close plus an earnout that would pay Company B a % of $1 million a year for next 3 years based on their achieving a 30% compound growth rate in sales. If Company B hit sales of $10.4, $13.52, and $17.58 million respectively for next 3 years, they would collect another $3 million in transaction value. The seller now expands his client base from 200 to 100,000 installed accounts and his sales force from 4 to 5,000. Those targets should be very easy to hit. If these targets are met, buyer easily finances earnout with extra profit.

9.The window of opportunity in technology area opens and closes very quickly. An earnout structure can allow both buyer and seller to benefit. If smaller company has developed a winning technology, they usually have a short period of time to establish a lead in market. If they are addressing a compelling technology gap, odds are that companies both large and small are developing their own solution simultaneously. The seller wants to develop potential of product and achieve sales numbers to drive up company’s selling price. They do not have distribution channels, resources, or time to compete with a larger company with a similar solution looking to establish industry standard. A larger acquiring company recognizes this first mover advantage and is willing to pay a buy versus build premium to reduce their time to market. The seller wants a large premium while buyer is not willing to pay full value for projections with stock and cash at close. The solution: an earnout for seller that handsomely rewards him for meeting those projections. He gets resources and distribution capability of buyer so product can reach standard setting critical mass before another large company can knock it off. The buyer gets to market quicker and achieves first mover advantage while incurring only a portion of risk of new product development and introduction.

10.You never can forget about taxes. Earnouts provide a vehicle to defer and reduce seller’s tax liability. Be sure to discuss your potential deal structure and tax consequences with your advisors before final negotiations begin. A properly structured earnout could save you significant tax dollars.

Smaller technology companies have many characteristics that make them good candidates for earnouts in sale transactions: 1. High growth rates, 2. Earnings not supportive of maximum valuations, 3. Limited window of opportunity to achieve meaningful market penetration, 4. Buyers less willing to pay for future potential entirely at sale closing and 5. A valuation expectation far greater than those supported by buyers. It really comes down to how confident seller is in performance of his company in post sale environment. If earnout targets are reasonably attainable and earnout compensates him for at risk portion of transaction value, a seller can significantly improve likelihood of a sale closing and transaction value.