Birds and the Bees About
Choosing Your M&A Investment Banker

Birds and the Bees

If you are new to the game, heads up

Founder-owners of middle market companies usually only sell a company once in their life. The rainmakers at investment banks – the “closers” in Glengarry Glen Ross lingo – are skilled at getting new engagements. They pitch one deal after the next. They are polished at making a business owner believe that they are – and will continue to be – their banker. This is financial slight-of-hand to be aware of. Ask them if they will be your day-to-day contact during the life of the deal and watch their reaction and response.

The asymmetry in transaction experience between business owners and street-smart investment bankers leaves the owner vulnerable to the bait-and-switch gamesmanship of “closers”. Let’s lay out some of truths to be aware of before you give you heart to one of them.

Investment bankers only get paid for transactions that they either source or close. Bankers get paid a percentage of the value of their deals, not the firm’s deals. Since teams do not share their success fees with other teams, the financial motivation is to work on one’s own transactions and not assist other teams’ members due to the scarcity of time and other resources. It’s actually worse than just a lack of cooperation. Outperforming the guy next to them is their best path to partner. Because of that, bankers look left, then right, and then work to see that these interlopers are gone. Inter-team assistance is virtually non-existent as a result.

Rainmakers are motivated to sign up as many engagements as possible, not analyze companies. They want velocity, the quickest possible turnover so that they maximize their bonus. They have a financial incentive to get an acceptable price, not the highest price. The latter requires that they really roll up their sleeves and understand how your company will fit with each prospective buyer. That requires a lot of work. It also requires the next ingredient.

The vast majority of investment bankers have never been on the buy-side. They have never had to put together a set of financial projections they were held accountable for, never been involved in merger integration, never hired a CEO, and never had to turnaround a company. It’s hard to give sound advice if you’ve never actually been there, done that.

The person pitching you likely has not done any financial analysis for decades. Bankers that have survived at medium and larger firms are now managing people and client relationships. Their analytical skills have atrophied and they are dependant of the skills assigned to them out of the analyst pool. That makes for a quilt-work of the analytics the firm puts forth, and buyers see it. Their work is not integrated. Sections and paragraphs don’t fit together, and the reader is left to integrate the work themselves rather than being let to an inevitable favorable conclusion. Its like reading a version of The Old Man and the Sea where each chapter was written by a different college team rather than Ernest Hemingway. Its one of those things that hard to define, but you know it when you see it.

If your company is at or below the average size for an investment bank, they will assign junior people to your deal team to give them experience. Unless you are on the upper-end of the bank’s size range and value, you are likely to get “B” and “C” team talent. Being a Guinea pig or analyst trainer is not in your best interest. To get the best outcome, find a bank that specializes not just in your industry, but your size category. PE firms are very specific about the size of deals they will pursue. You need a bank that fits with your company’s size and the investment criteria range for the PEGs that match. The lowest end of the middle starts at $0.5mm in EBITDA and runs to about $2mm. Most lower middle market PE firm start at $2-3mm in EBITDA and run to perhaps $10mm. The majority are looking for double-digit EBITDA margins, so revenue expectations for this segment are roughly $10mm to $100mm. The middle of the middle market starts at roughly $10mm in EBITDA. Revenues at that point are $100mm and go up to $500mm where the upper middle market starts and our interest ends. Once a company hits $200mm in sales or better, it starts to have divisions that require separate diligence and pricing by the banker. Here is where a larger bank comes into play. Below this, it doesn’t help you. Each of these segments is distinct, with it own multiples that buyers are willing to pay due to the separate issues found in each size category. Typical EBITDA multiples paid increase as size increases. As a result, you can’t directly compare the EBITDA multiples paid for companies of different sizes. If your banker does so without adjusting for size, he is either incompetent or you are being mislead.

Bankers covet their buy-side relationships and resist sharing that relationship with other deal teams. Selling a company requires that they market the transaction to buyers where there is a fit. Also, bankers manage these buy-side relationships and have material relationship equity in them that they work hard to maintain. Try to sell a company to the wrong set of prospective buyers and they will put you on their spam list, stop picking up the phone, and terminate your hard-earned relationship. Because of the damage that can be done to a buy-side relationship, relationship bankers do not provide access to their buy-side clients unless it is in their personal interest. Bankers invest a significant amount of time and energy in developing their equity in these relationships. They simply do not permit access without a strong financial incentive, and then, provide access only with direct involvement and protection of the buy-side client.

Companies sell for different multiples depending on their size. This is because the smaller the company, the more numerous the likely weaknesses. These weaknesses include dependence on the owner, customer concentration, smaller geographic footprint, fewer deliverables or products, and a general absence of sophisticated talent acquisition and succession planning. When your banker shows you multiples for companies that are vastly different in size without an appropriate caveat, you are being conned.

Bankers will try to tell you your company is worth more than it really is to win the engagement. Every business owner wants to be told their business is worth a fortune. But a valuation in a pitch is worth exactly what you paid for it. Nothing. The banker has not conducted due diligence. They have barely scratched the surface at the time of the pitch. The hard truth is that even once a good banker has finished doing all their analysis and completed writing the information memorandum, they have still not completed due diligence. Only after the buyer completes their due diligence is the entire truth known. As a result, the earlier you are from that point, the wider the range needs to be to take into account all the possible outcomes.

All that matters is your deal team, not the firm. Think Seal Team, not Army Reserves. A smaller well trained, fast moving team will beat out a slower, larger, less well trained force. Due to the incentive comp, the only deal experience that matters, including industry experience, is that which belongs to your team members. Banks operate in discrete silos. If your banker tries to impress you with all the deals that his firm has done, ask him which ones he was the primary banker for. Watch the pupils dilate. Also, beware the bait-and-switch rainmaker. His job is business development. The more senior he is in the firm, the more likely he will not do any work on your deal after the engagement letter is signed. How important is experience? Entire investment banks have been created by a single rainmaker leaving a bulge-bracket firm with a deal team. Evercore, Greenhill and Moelis come to mind.

Lifetime experience matters. There is a reason that 35 year-olds aren’t running investment banks. They just don’t have the deal experience, credibility, and relationships that give them access to buyers. They can be good at running a group of analysts, but that is where it stops. As far as doing the negotiations in transactions, this is the purview of senior bankers. A good senior banker can just sense the situation. More junior people simply miss the queues. There are just too many tricks to the trade, and too many ways that a sophisticated buyer can take advantage of a first-time seller and less-than-senior team. Younger bankers operate out of their firm’s three-ring binder. This helps junior bankers, and they do well with plain vanilla, but if you need creativity and innovation, you need to find someone that has exhibited this during their career. Buyers are motivated to take advantage of color-by-number bankers, and whoever has the greater experience and creativity will win the day. Sun Tzu knew this well.

Most lower middle-market firms close relatively few transactions, and that is a good thing if you have “A” team talent and they are focused on you. The relatively small average number of transactions per firm (2-3)1 is due to the small number of team members needed to optimize the execution of the sale process of a lower middle-market company, from $2mm to $20mm in EBITDA. A deal team size of four is all that is needed. This includes one senior banker and his analysts and intermediate members. A full-time senior banker guides the team and, hopefully, is the ultimate analyst, writer, marketer, daily contact and deal guy. Experience counts, which leads us to our next point.

Investment banks are much like large law firms. Your corporate lawyer is really independent of the firm. The firm simply provides infrastructure. If your corporate attorney seeks counsel from another of the firm’s attorneys, that attorney bills for his time. As a result, attorneys operate within distinct and separate silos with your attorney working with his associates. Investment banking is the same. There are fairly famous examples of investment banks sprouting up virtually overnight due to a well-connected and regarded investment banker leaving a bulge-bracket firm with a deal team and setting up shop. Evercore and Greenhill are examples. Oh, and like the law firm, if you find that your attorney’s associates are the ones returning your calls, you’ve been assigned to the “B” team.

It is for these reasons we consider ourselves unique. We started on the buy-side. We were held accountable for our projections and ultimate outcome. WE had to compare projections to actual results for the life of the deal (doing this for a decade was a painful but enlightening experience). We had to fix our own problems. We sweated and worried and worked like madmen if things went South like they did in 1991. This pain caused learning that is irreplaceable. You cannot have empathy if you have not experienced the same pain. We have.

As a small firm that originated on the buy-side, we see things from your – and the buyers – point of view in a way other firms just can’t. We do our own projections using all past history and current competitor and industry information available, just like the buyer will. We personally possess control over each and every relationship with our buy-side clients. We do not have to consult with anyone before having contact with them. We personally control our human resources and dedicate them to a single transaction during the sale process rather than having them work on numerous transactions simultaneously. Unlike other firms which assign the work of a transaction to numerous low level analysts and then attempt to integrate the individual disparate parts, a senior banker conducts all analytical work and conducts all writing to ensure both accuracy and consistency in our work. We use our analysts solely for research, information acquisition, and formatting. Having been on the buy-side, we know what can go wrong. We’ve felt what you’ve felt. And having been there, part of our goal is to see you gain from the learning we’ve already paid for.


1. Pepperdine University Private Capital Markets Study

When to Sell Your Company

Playing cards

You have to know when to hold ’em and know when to fold ’em

The decision to sell your company is normally much more of a personal decision than an economic one. Owners need to have a personal reason to sell, like having something else they would rather do, like spend time with family, engage in a hobby, or address health issues.

Once an owner firsts thinks about selling, the next step is to think about factors unique to your company, the economy, changing technology, and your personal goals. Has it reached $5 million or more in sales? If so, it’s in the strike zone of many acquirors. If it’s still young and small, it has substantial risk, and you may be better off growing it to a size that diversifies the customer base and permits the creation of infrastructure so that a larger pool of buyers are attracted.

Where is your company on its growth and risk curve? Sometimes it makes sense to wait until growth starts to taper, so you can maximize profitability. Buyers will focus on a narrow range of EBITDA multiples that they will apply to your earnings based upon the size of your company. It’s important to get profitability as high as possible so that both numbers are at their highest possible level.

Then there is the health of the economy. Selling a company in 2009, or during any recession, isn’t the right timing. You always want to sell when credit is available to buyers, and your operating results are favorable. Market stability, measured by VIX, indicates a time of market calm.

Then there are your personal goals. Is there more you want to achieve from a personal gratification standpoint? Most of us entrepreneurs own our own companies because we have a passion. As long as that passion is in place, our health is good, we have balance in our life, have at least some wealth outside the company, and we don’t need the value inherent in the company for other personal or business reasons, then we should continue to enjoy what we do. The only caveat to that is if we really aren’t maximizing the value of the company and it would be worth more to someone else. Those situations do occur, and occur commonly.

The increasing rate of change in the world can blindside us, require us to re-engineer the company, or require skills, knowledge, or scale we don’t possess. Hiring the right talent goes a long way in bringing in fresh ideas. The entrepreneurs that survive long-term hire people smarter than themselves. Startups go through transitions, and if we’ve been fortunate enough to grow the company, there comes a time when we can’t do it all ourselves. To maximize the value of our companies, we have to make it self-sustaining, and able to live without us.

One of the best statements I’ve heard about raising children is that the goal isn’t to raise a good child. The goal is to raise a good adult. To do that requires that they can live without us, and many of us, at some level, are reluctant to let go. The same holds for our companies. If the company is dependent on us, it can’t possibly be at its best. Many private equity groups shy away from buying companies held solely by the founder. The PEGs have found that the founder holds on too tight.

We know an entrepreneur who has started and sold three companies and is now acquiring his fourth and fifth. The first three were ready to be harvested for one reason or another. The first two had started to see their growth and opportunities flatten out. The third met with changing industry conditions and he knew he was too small to compete, and he didn’t have the resources to make the acquisitions necessary to have the economies of scale to survive. So now he’s reinvesting in businesses with more defendable niches.

The easiest decision to make in the world of investment is the buy decision. The hardest is the sell decision. The exit planning process should start as soon as your company is operating successfully. When things have been really good, its hard to make the sell decision. But that is the best time to cash in your chips. Too many owners sell under duress, in the midst of a recession under very bad conditions. I’ve seen them walk away with nothing but a release of their personal guarantee where they could have retired a few years earlier quite wealthy.

Try to be as dispassionate about the sell decision as possible, and know that there are always other businesses you can reinvest in or other passions to pursue if the market is telling you its time to sell.

To learn more, write us at or click here

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

When to Sell Your Company?
Before the Recession of 2017/18

Economic experion periods

Our current expansion is well past middle-age and now eligible to join AARP

We’ve started to ask ourselves when the next recession will start. Our observation is that the M&A multiples are at – or a bit past – theirs prime for this business cycle. Also, banks seem to be having more credit problems. There is a rumbling among them that suggests they think it’s time to curtail the hell-for-leather business development mania that has been running its course the last several years.

It’s clear that our current economic expansion is past its prime and is now eligible to join AARP. At 80 months old, it exceeds the post WWII average of 60 months, as measured from the end of the previous recession.

Our sense is that 2016 will be okay, and so any recession must be in 2017 or later. In looking around the world, China is suffering a minor – if not larger – meltdown, putting downward pressure on commodity prices. As a result, all commodity related companies are marking-to-market their inventory, or kicking the can down the road by flowing above market cost-of-goods sold through their income statements thus deflating earnings. On the bright side, the consumer is the direct beneficiary. John and Jane Doe will put less dollars’ worth of gas in their car this summer and have more to spend on everything from eating out to taking a summer vacation. That’s why we think 2016 will be okay.

But we’ve also looked at CAPEX in O&G E&P; it’s down a third, and will lead to higher gas prices within 24 months, maybe less. Fracking wells play out in 18 months or so, so lower supply is looming. So, we looked at the length between the post WWII recessions, and extrapolated out our current expansion through this time in 2017, and then 2018.

Here’s the conclusion we drew based on some Kentucky Windage and simple observation: we look like we might have another 12 and 24 months of modest growth. If we avoid a downturn for another 24 months, our expansion will be 104 months old. This will lag only 1st place winner of 120 months, and be nearly tied for 2nd place contestant at 106 months. This will still place it in the top 25 percentile of expansions.

We noted that the expansion that preceded the Great Recession was 73 months long (5th place), and we are at 80 now. We didn’t find that much of a comfort. The second longest post-war expansion was 106 months but it was followed by the stagflationary 1973-75 recession. This was a period of economic stagnation and high inflation in much of the Western world during the 1970s, which put an end to the general post-World War II economic boom. Again, we found little comfort in this.

While it’s possible that the Fed has found an anecdote to gravity, we have started to model a recession in 2018. In fact, we’ve almost started to hope for one. If we somehow eclipse the 120 month leader, we’ve begun to wonder what price we will pay.

© Pegasus Intellectual Capital Solutions

When to Sell Your Company?

Watch the VIX 1

VIX vs commercial lending

Going to market is like going to sea: do it while its calm

At some point, most business owners will ask themselves “When should I sell my company?”. This is important. Timing matters.

One of the articles I read recently was entitled “Banks Ride Business World’s M&A Wave”. That my caught my eye in addition to another, seemingly unrelated, article: “Fear Index Off Lows as Volatility Spikes”. My immediate thought was that mergers and acquisitions lending will fall in the near future.


It’s no secret that leveraged buyouts are big business with banks. Many of the larger banks have specialized groups, variously named, that handle the private equity groups that are behind much of the leveraged buyout lending. And there are of course the strategic buyers – every day companies – that also play in this market too. Both are plenty smart. Certainly smart enough to know when it’s time take risk and when it’s time to avoid it.


Our belief is that M&A lending has picked up because certainty has improved. What everyone had been looking has been some semblance of stability. The VIX option on the CBOE (domiciled here in our hometown, Chicago), is one of our favorite things to watch. Recently we looked for research regarding the relationship between stock market volatility and commercial lending activity. We didn’t find anything useful.


So we downloaded historical data on the VIX – the measure of statistical volatility of the S&P 500 – and Federal Reserve data on commercial lending activity to businesses (non-financial). Our work seems to indicate fairly clearly that a lack of volatility drives business lending activity. That should not be a surprise to anyone. The reason, we think, is quite simple: businesses hate uncertainty. That includes private equity groups, regular companies and Chief Credit Officers of the banks.


When the world looks uncertain, people don’t take risk. Buying a company is risky. Sales can fall by dramatic amounts (as they did in 2009) and you can lose your entire investment. The take-away for a business owner is that they should sell their company during a period of calm in the market. This will be an emotionally difficult decision for many business owners to sell, because who wants to get out when things are going well?


I know of too many owners who rode through the good times just to be forced to sell during bad times. Falling sales and faster falling EBITDA, covenant defaults, and forbearance agreements all cause serious damage to the market value of a company. Selling under duress is the worst of situations. About all you could add to that is failing health of the owner, and I have seen that as well. We sometimes see mourning families with all their net worth locked up in a leaderless company. Avoiding this is part of exit planning.


When you can, sit down with a piece of paper and write out when you intend to sell your company. What are the markers? I would suggest that you are still in good health, maybe 5-7 years from your intended retirement, your business is stable or positive, and banks are lending. You’ve achieved what you want from a personal gratification standpoint. And I would add at the end, the stock markets have low volatility as measured by the VIX.

You can see a current chart of the VIX here


If you’d like to learn more about mergers and acquisitions or exit planning, contact us at

(1) This article written in February 2013. In 2016, Harvard Law School published an article “The Real Effects of Uncertainty on Merger Activity” which confirmed our thesis about using the VIX as an indicator of market stability in predicting M&A activity

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

Preparing Your Company for Sale

Preparing a Company for Sale

Before hitting the launch button, go through the checklist

Preparing a company for sale – the M&A processexit planning – entails a fairly extensive list of things that need to be done and considered. The process should start several years in advance of the sale process.

Among the many issues are:

– Succession planning, talent acquisition, training and talent retention

– Process review

– Diversification of risk

You will appreciate that most companies are purchased by private equity firms. To receive the highest possible price for your company, you need to be viewed as a platform company instead of an add-on. To be an attractive platform company, your company needs to have reached a stage where it sustains itself. It has Human Capital, Structural Capital and Relational Capital.

Put another way, it has good people, depth on the bench, and a process for recruiting, training and retaining them.  It has internal processes that reflect an in depth understanding of the business in all respects including a strategy and a vision that extends out 5-10 years.  And it has good or great customer and vendor relationships.  In the absence of this self-sustainability, the buyer is really just buying your customer relationships, or technology, or some other part of the whole.

You – the current owner/operator – need to be expendable. Who is your replacement? Potential buyers want to know the company will survive once you leave. That requires talent acquisition, training, talent retention and succession planning. One of the challenges entrepreneurs have is letting go of the reins and bringing in someone that is their equal (or more than their equal). You need to have a real management team in place, with cross training of all your staff. There should be two people or more that know every job.

Preparing a company for sale should begin about a year or two year ahead of marketing the company for sale. Start with a review of all internal processes needs to be conducted. This is part of the due diligence a buyer will go through. They prospective buyers will ask themselves “Is the company as efficient and effective as it can possibly be using best practices and current technology?. If the company were being designed from the ground up today, is this the way you would put it together?” If not, look into the steps that can be taken in the next year or two and reflected in the financial statements the following year. Have you integrated current technology into your business processes? Software that increases efficiency is generally a good investment, even in the short-run. Related to this is where technology is headed, and whether the company has reviewed its strategic marketing plan to reflect the changing competitive landscape.

Diversification of your customer base is increasingly important given the rate of change in technology. Sales concentrations impair sales price and are an impediment to raising capital, as lenders are concerned about both uncollectable accounts receivable and unabsorbed overhead. One of the things that’s hard to predict is how changing technology will affect your customers. If you were dependent on Borders Book, or currently, Best Buy, anyone would rightfully be concerned about the outlook for your company. The best thing you can do is diversify your customer base, and watch the stock price of your customers. If they are public, watch their public competitors’ stock prices, and make this monitoring an integral part of your CFO’s job. There should be a natural tension between your CFO and Sales. If there isn’t, you don’t have balance.

These are some of the first things to think about in the process of preparing a company for sale.  Exit planning is a job on top of your job, and we assume you are already fully employed.  Talking to us when you being the process achieves two related goals.  First, completing your exit plan.  Second, we increase our knowledge of the company to a level where we can market it with greatest effectiveness.   To learn more, contact us.

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Raising Capital and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

To Sell Your Business, Start With The End in Mind

Golden path

The path to wealth requires that you build a company that other’s want to buy… and pay a lot for.

The world of mergers and acquisitions is filled with sale transactions of middle market and lower middle market companies at prices well below what the companies would have been worth had the owner operated it with the intention to sell it from the beginning. Entrepreneurs make innumerable decisions along the way that did not maximize the value of the company in the eyes of its potential purchasers.


Decisions regarding choice of target market, customer concentration, R&D spending, hiring, compensation, succession planning, and systems are made that are expedient, easy, cheap or that simply didn’t look forward to a time when the owner would step down. Had the sale of the company always been planned for, most owners would have made certain decisions differently and worked to position the company as a leader in its field, ready to become a platform company for a private equity firm that could grow it through acquisition, using its structure as the foundation upon which they would build.


Regardless of how rational we believe we are, humans are subject to the whims of emotion. A recent article “Shopping Your Science”, Kuchner, Marc, The Scientist, April 2012 – outlined research that showed that people make purchase decisions using primitive pleasure and pain centers in our brain. With current brain scanning technology, we can see the center of the brain that lights up when an attractive object is shown to them. We can also see the pain center light up when a high price is shown. But comparing the size of the pleasure center with the pain center, researchers could predict whether the subject was inclined to purchase the object. What they concluded, is that all decisions, even purchase decisions, are emotional.


We can extend this pleasure-to-pain ratio to financial decisions by PEGs. If we have not prepared a company for sale, they perceive pain in the remaking of the company, with the associated uncertainty, effort, and stress that go into rebuilding the company.

One of the things we have learned in mergers and acquisitions is that it is very difficult to transfer the culture of one company to another as outlined in the article “Acculturation in Mergers and Acquisitions”, Nahavandi, Afsaneh, and Ali R. Malekzadeh, Academy of Management Review 13.1 (1988): 79-90. The “culture” is the way the company thinks, its values, how it does things, how it collaborates, who it hires, how it rewards. It is the summation of all of its attributes. Thus, those innumerable decisions that went into building your company are the determinants of your company’s culture. Its your secret sauce.


The culture of your company is the glue that binds it all together. If the company has critical mass, the culture endures after you are gone. Once established and codified in your Human Capital (HR), Relational Capital (sales/customers/suppliers). and operations policies and procedures, your culture continues after you exit. This is the part of the company that entrepreneurs commonly don’t build and the part of Enterprise Value they don’t obtain upon sale. Instead, entrepreneurs commonly sell the value of their customer relationships (Relational Capital), and likely they have pulled in some talented people, but have not created depth on the bench with succession plans for each key person, or created a talent acquisition and talent retention infrastructure that self-perpetuates. As a result, a PEG has a lot of work to do before the company becomes a real platform upon which they can grow both organically and through acquisition.


The question is, if succession planning and the creation of a self-sustaining culture are so important to the creation of the enterprise value of the company, why don’t entrepreneurs focus on it more intensely? The answer, of course, lies in the murky world of psychology.


Psychology is more important to mergers and acquisitions and exit planning that most entrepreneurs grasp. Humans are averse to certain thoughts, and among those are the aging process, failing health and death. Intellectually, we understand that we will get old, have health problems, and pass. But understanding something intellectually is not the same thing as understanding something emotionally. Our minds and our hearts often do not understand each other, even if they attempt to communicate, which they commonly don ‘t.


We have seen privately held business owners never plan for their retirement or hire and train their successor for taking the helm of the company. The consequence is often deleterious if not disastrous to the value of the company and those whom depend on the owner. “Key man risk” is all too common and is fundamentally a failure to conduct succession planning, which is central to building a company of enduring value.


The solution to maximizing the value of your company in a mergers and acquisitions transaction lies in conducting appropriate exit planning. By this we mean turning the company into a self-perpetuating going-concern. We do not mean tax planning for yourself or your estate, or anything unrelated to the company. Our focus is entirely on creating shareholder value. Taxes are high class problem we let other firms worry about.


If your company is established, regardless of how small or large it is, you will benefit from planning for your own succession and conducting exit planning. To learn more, contact us.

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

Maximize Shareholder Value,
Prepare for New Technology

First Digital Camera

The first digital camera, invented in 1975 by Kodak

The year 2012 has seen two famous companies collide with the Knowledge Era.  Kodak was dropped from the Dow Jones average in 2004 and filed for bankruptcy in January 2012.  In March 2012, The Encyclopedia Britannica announced it would no longer produce a print version.


But Apple, once on its knees, is the most valuable company in the world.  As late as March 2003, its stock price was a meager $7.01 compared to its recent close at $542.83.  In March of 2003, Kodak was trading at about $28.00, compared to its recent price of $0.21.


So why the difference in fates?


We can all blame Gordon Moore, the Intel engineer, and Moore’s Law:  integrated circuit speed doubles every year (now 18 months).  Some of us understood it, and some of us didn’t.


You may rightfully ask, what does this have to do with me?  The answer is, if you are a business owner, an understanding how Moore’s Law will affect your business will affect the value in a mergers and acquisitions transaction and in your ability to raise capital.  It will also determine your resistance to financial distress.


In 1975, Steven J. Sasson, one of Kodak’s research scientists, developed the first working model of the digital camera.  It was met with doubts and questions from management.  Moore’s Law was understood by Sasson, and he projected that in 20 years the technology would exist to create a digital camera with the storage and resolution that would make it a viable competitor to film.


But Kodak management couldn’t envision how consumers would use and share photos on their TV.  The TV, or course, was the only viewing device for a digital photo of the era.  And the TV was hampered by its own problems with resolution.  High definition and 1080P were concepts yet to be created.  Besides, Kodak saw themselves as inventing and selling coatings for films.


A line from Kodak’s internal report sums it up“The camera described in this report represents a first attempt demonstrating a photographic system which may, with improvements in technology, substantially impact the way pictures will be taken in the future.” But, as they now acknowledge, they had no idea.



Playback device and TV  for the first digital camera

The playback device for the first digital camera: the TV. Its all executive management could envision.

Kodak had made two critical mistakes. Had they avoided one or the other, they might be prospering today.

– They put the digital camera and its patents back in the Warehouse of Lost Knowledge and promptly forgot it was there, just like the Arc of the Covenant being rolled back in the government warehouse in that unforgettable scene from the 1981 film “Raiders of the Lost Arc.”

– They defined themselves incorrectly: Fuji Film was in a very similar situation as Kodak. So why did they not meet the same fate? It defined itself differently. In its culture, it made chemical coatings, not film. It simply transitioned to coating other products, and used the same research engine.

Arc of Knowledge

And the first digital camera – and its patents – were rolled back into the warehouse of lost knowledge.


Encyclopedia Britannica had advance warning that it needed to change.  Encyclopedias first came out on CD in the early 1990’s, and CD’s could be searched.  But salesmen ran the company, and without their sales commissions for selling a print edition, they couldn’t see what other business model would benefit them personally.  And so the company has become a shadow of its former self compared to the free and collaborative Wikipedia.


But what about Apple?


When Steve Jobs first initiated the R&D to develop the iPad, the technology didn’t exist.  But Jobs foresaw that Moore’s Law would bring integrated circuit size and cost down to the place where he could make his wafer thin device technologically possible and economically affordable.  By the time R&D was completed, integrated circuit size and cost had shrunk to a fraction of its former self, and a star was borne.  Now the retailer Kohl’s plans to dispense with its cash registers and use only iPads due to their far greater number of applications.


Neither Kodak or Encyclopedia Britannica could see that the world was changing and would obsolete their way of delivering solutions to their customers.  The customer needs still existed, of course.  But the way of satisfying them are hardly recognizable.  Photos and videos are taken from one’s cell phone, sent by text message to friends and family and uploaded to YouTube and Facebook.  All information is at your fingertips at Wikipedia, which is one of the most visited, collaborative, and authoritative sites on the internet.


Things will get tougher in the next twenty years as the exponential improvement described by Moore’s law ultimately leads to the possibility of a technological singularity: a period where progress in technology occurs almost instantly.


A technological singularity is the theoretical emergence of greater-than-human superintelligence through technological means.  Since the capabilities of such intelligence would be difficult for an unaided human mind to comprehend, the occurrence of a technological singularity is seen as an intellectual event horizon, beyond which events cannot be predicted or understood.

Graph of computing power

Computing speed will eventually collide with the rest of the corporate world.


Proponents of the singularity typically state that an “intelligence explosion”, where superintelligences design successive generations of increasingly powerful minds, might occur very quickly and might not stop until the agent’s cognitive abilities greatly surpass that of any human.


So, if Kodak had a hard time as early as 2004, and Encyclopedia Britannica started to struggle in the mid-1990’s, what exactly is going to happen to the rest of the corporate world and how do they prepare for it?


Corporations need to create off-site tech groups in Silicon Valley or in the Biotech world to protect their creative people from any corporate culture that prevents a rethinking of how things are done and why they are done a certain way.  The creative, contrarian people are hard to manage by definition, and our Human Capital departments will need to make a place – a protected place – for them in the corporate environment.


Companies will need to white-board virtually constantly.  When they wake up in the morning, the first thing they will need to ask is what changed overnight.  They will need to create challenger teams that do nothing but come up with ways to obsolete and defeat everything the company does now, much the way Top Gun uses experts in our enemy’s methods and equipment to attempt to defeat our best pilots.


Collaboration will become more important than ever.  No one person, or a single board or executive team will be able to assimilate all the information necessary to stay abreast of the changes unfolding.  Corporate cultures will need to be designed to provide for the fluid exchange of information in all directions.


Whereas information has historically only traveled upwards in our Command and Control corporate cultures, those that survive will ensure that knowledge is exchanged downwards and sideways.  This will run counter to the cultures of many companies, and the a Human Capital function will need to select for people that have the willingness and ability to share information freely and not control it.


In the world of finance, those companies that disclose that they are preparing for the future (without giving away their secrets) will enjoy a lower cost of capital,  higher stock prices, have an easier time capital raising, enjoy higher mergers and acquisitions values and, and avoid financial distress.


As a result of all of this, the the Human Capital function in companies will become more important than ever.  The selection and training of informed, collaborative people that freely  share information will be central to a company’s ability to survive and prosper in an environment where progress in technology occurs almost instantly. To learn more, contact us

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

Increasing Your Company’s Value:
It’s About Long Term Vision – and Helping Others


Shareholder Value Maximization is about long term value creation, not short term results, and that means investing in Intellectual Capital.

Maximizing the value of our company is about helping others, not just ourselves. The net worth of a business owner increases right along with the value of his company. With greater wealth, we can best help those around us, in addition to ourselves. So, it’s not just about money. It’s also about maximizing our ability to help others.


Focusing on the long term is much like educating our children. What you’ve already done for your children is what needs to be done for your company. Children don’t provide any meaningful output for at least the first 18 years of their life, and commonly 22 to 26. All that time and money during this quarter century is spent preparing a child for the workforce and life. His or her lifetime earnings and life satisfaction are dependent on this period of investment in their future. We are investing in human capital via training and education.


There are metrics that are proxies for how our children are doing during their first 18 years: their grades, number of intimate friends (an indicator of social skills), and participation in social activities including sports. These metrics give us an idea of how the child is doing and what their prospects are for the future, long before we start to measure their income and net worth. We can think of those as key performance indicators for measuring Intellectual Capital (the value of a company above the value of its tangible assets) and its creation. The time we spend with our child coaching them – guiding them – in known in our business as “Knowledge Management”, or the process of constant learning and improvement  known as Kaizen in Japan.


Real shareholder value maximization is about the creation of long-term value. We study this in our work on Intellectual Capital. Research and Development – as but one example – is expensed on the income statement and reduces reported income. In reality, it increases the value of the company over the long run because it increases the company’s new products, or cost reductions. The use of GAAP accounting does not accurately reflect the accretion of value due to the R&D activities. Public companies attempt to make disclosures, but analysts are still challenged on knowing how to use the data. The investment in acquiring and training people is expensed from an accounting standpoint, when I reality is and asset that yields great returns.


Since our firm works predominantly with private companies, you would think that the owners always look out into the future and try to build the most value over the long term. That is not always the case. There are occasions where we see an absence of investment in talent acquisition, talent retention, and succession planning. Nothing destroys the value of a privately held business like losing its key man. Owners must acquire and retain their successor.


A lack of investment in Human Capital shows itself with an absence of job descriptions, a lack of performance reviews, and an absence of any of linkage to key performance indicators. This is paramount to flying in the dark without instrumentation, and it can have potentially fatal consequences.


We also see a lack of investment in keeping up to date with the technology of the industry. Few things stay the same in this world, given the rate of technological change. There needs to be a process for staying abreast of industry and technological changes.


This is barely scratching the surface of the issues that go into the subject. The time and effort invested  in working towards the goal of maximizing shareholder value provide their own rewards in both the capital raising process, and in the exit planning phase of the mergers and acquisitions process when the owner decides to transition out of the company. If, however, the owner transfers ownership and operations to the next generation, the effort put into maximizing shareholder value becomes more apparent. These would include constantly looking for ways to improve the company, periodically re-engineering the company, re-accessing the customers and market segments the company serves, and reviewing its supply chain.


The challenge for the privately held business owner is that they get comfortable with their performance and stop having new ideas integrated into his process that can take the company to the next level. That is where we can help. To learn more, contact us

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

Selling Your Company:
Finding Your Special Sauce


To Maximize Shareholder Value, Find Your Special Sauce

At some point, most business owners will ask “How do I sell my business?”. And “How do I prepare my business for sale?” The earlier these questions are answered, the greater the wealth that the owner will accumulate over their life.

The vast majority of businesses are sold once in a lifetime. And many aren’t even sold then, and span generations. As a business owner, when you sell your company, you are venturing into an area where your experience is limited. There are exceptions, but for the majority of owners of middle market companies, a sale is a once-in-a-lifetime experience, and you are at the disadvantage.


By comparison, the buyers are experts, and it is their business to buy businesses. This creates a disparity of knowledge and understanding about what what makes a company an attractive acquisition candidate (aside from a disparity in skill in the M&A process). The challenge to the business owner is that he/she doesn’t actually know what the buyers want. They likely know the market for their products very well, but they commonly don’t really know the market for their company.


Try thinking about your company as a consumer product, like a hamburger. There are other competing product offerings – hamburgers – on the market, each with their own attributes: size, flavor, texture, type of bun, condiments, weight of the beef patty, packaging, price and experience consistency. Has your company been positioned to attract customers? That is, is the design of your hamburger specifically addressing the needs of your consumer based upon market research?


Depending on whether your company was developed with an exit in mind, the sale process might be measured in single-digit months if it is well prepared, or measured in years if it needs repositioning. If its poorly positioned, it could also end up as a liquidation. Which direction the exit takes depends whether the company was created to attract buyers.


Here are a few attributes financial buyers look for:

1) The company runs itself

2) It’s scalable

3) It has a defensible niche or other competitive advantage


Companies that run themselves have good management that are independent of the owner. A marker of this is whether the owner can go on vacation without worrying about what is going on back home. To do this, the company needs a sales manager and top salesman, neither of which are the owner. The company has a head of operations that is grooming their own successor. And it has strong financial management capable of standing its ground against the VP of Sales (and the owner).


A company that runs itself has invested in its people and processes. Policies and procedures are codified. It has systems, controls, and key performance indicators that are compared regularly to actual results. There are best practices that have been put in writing. Training is passed from more senior to less senior people, and jobs are cross-trained.  The company is not dependent on any one person.


A company that runs itself has a long-term plan. The plan determines – by default – the company’s priorities and activities in the short term and medium term. The energies of the company are focused and used efficiently, since they are not wasted due to conflicting goals. The long-term plan also matters because financial buyers will own the company for about 7 years, and will sell it to someone else that may own it even longer. As a result, the buyer is looking out at least 14 years, because he is going to be facing his own buyer in 7 years. That is the vision the company has to try to take into account in forming its strategic plan. In addition, the company has stayed abreast of technology and other industry developments, because 15  years is a long time and getting behind the curve can be quite fatal.


Scaleable companies are lean and have a flexible design that permits growth without a requisite increase in costs. The systems, training programs, and sales effort can be ramped up and result in an increase in EBITDA margins. The company has a management team that can handle growth as-is, or it has a system to efficiently train and expand its human capital.


Companies with a defensible niche know their customer, their competitors, their suppliers, their industry, and most importantly, themselves. They have thoughtfully analyzed their own profitability, where they make their highest margins, where they can obtain the greatest return on capital, where the long term growth of the market will come from, and how they will position themselves for it. The company has created itself around a unique capability, and it’s not quite like any other company in this regard. This is their special sauce, and buyers seek acquisitions that have one.


If you don’t sell your company to a financial buyer, then it’s even more important to have a special sauce. Strategic buyers are interested in that certain indescribable something, je ne sais quoi. It may be a technology, process, knowledge, market, or something else altogether.  It is certainly a form of Intellectual Capital.  That is a certainty because tangible assets can be acquired anywhere.


The special sauce of one company was its new product development process. The company had been in workout at two banks in a row, and had a nearly valueless equity position. As a last attempt to survive, it brought in a new president who transformed it. But the key was that he put in place a new product development model that eliminated the bottom one-third of their products every year and created a new third. Not only did this create variety for the consumer, it allowed greater pricing strength with his distributors. In just a few years, the equity value of the company went from virtually zero to $40 million when it was sold to a strategic buyer who valued it as much for its new product development model as for the rest of its attributes.


The takeaway is that you need to know what prospective buyers of your company want, and then create a special aspect of your company to meet their needs. You need to do that with your company just like you do in creating the deliverables for your own customers. To learn more about exit planning and mergers and acquisitions, contact us.

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

See also: Preparing a Company for Sale


Selling Your Company Yourself?

Mission Impossible Mouse Trap

It can be done, but it is not for the unaware…


A question I hear often from privately held business owners is “Why do I need anyone to help me sell my company? I already have buyers wanting to buy it now.” The answer is related to an imbalance in experience, information and human resources. The outcome is that owners get less if they sell their companies themselves, according to recent research by Fairfield University

Think about selling your house. This is generally the most valuable asset for any household, and the second most valuable for a privately held business owner. I have had people offer to buy my house. Thus, like the privately-held business owner, I have interested buyers. But do I believe for a moment that this is the best price I can possibly receive? If I listed the house with a real estate broker, what are the odds that one of these people would end up being the high bidder? I think the odds are low. And, how do I run the rest of my life while I prepare my house for sale and go through the very time consuming process of talking to and negotiating with buyers?

Selling a house is very, very simple compared to selling a company. You can benchmark a house based on comparable transactions, whereas no two companies are alike in any similar way. Companies have liability issues, potential litigation, customer concentration, product concentration, HR issues, succession management issues, and technology risks. The due diligence lists of sophisticated buyers is in the order of 35 pages long. Here is what one looks like: M&A checklist The buyer’s due diligence team will include their attorneys, accountants, and their lenders with their field auditors. I regularly see buyer’s due diligence costs total $350,000 for a middle-market company.

Obtaining fair market value requires (1) a professional description of the asset from the buyer’s standpoint, and (2) contacting sufficient potential buyers to assure that you have competition and statistical reliability that you have canvassed the market. Private equity firms make a living by contacting business owners and negotiating one-off deals. Strategic acquirors do the same thing and commonly want just a brand, product formulation, process, or customer base and are unwilling to pay for the infrastructure and other valuable intangibles you have created. Sell to one of these buyers and you are selling just part of your company’s value.

Private equity firms and larger strategic investors are professional buyers. They have internal or retained legal counsel specializing in mergers and acquisitions, databases of recent M&A transactions that they can use as comparables, a staff of analysts gifted in industry and economic research, and the ability to marshal internal human resources to simply force an outcome through superior effort.

Privately held business owners are most often first-time sellers. Compared to PE firms, this is a profound inequity. The business owner has a full-time job running their company. The sale process is very time consuming. Putting together the historical financial information, formation papers, customer and supplier information, historical data on sales by SKU by customer, information on tangible assets… the due diligence list goes on ad nauseum at times. Do this by yourself and prepare to be overwhelmed.

The business owner will be holding down two jobs: running their company and selling their company. Business owners are fully-employed just running their company. The buyer has the advantage of superior knowledge, superior human resources, and the ability to wear down the seller over time. The buyer will request what seems like a never-ending stream of information, and will emphasize and drill-down into the ever-present weaknesses of the company as a detriment to value. In time, the buyer will fatigue the seller. The seller would like to cancel the transaction, but is now too tired to start the sale process all over again. The buyer generally wins this battle.

There are numerous ways for a privately held business owner to get less than they deserve. A few include a lack of competition in the bidding process, liabilities which must be assumed by the seller, assets which are not included in the sale (both tangible and intangible, i.e. intellectual capital), tax liabilities, potential future liabilities, post-closing working capital adjustments, and the list goes on.

An M&A professional will protect the seller from being distracted from day-to-day management and becoming fatigued. The investment banker will assist in organizing due diligence materials ahead of time, and ensure that enough potential buyers are contacted to assure that the odds are low of any higher prices being unidentified. The investment banker will protect the seller from obscure but potentially deleterious provisions in the purchase and sale agreement including post-closing items. The investment banker will protect the seller from obscure but potentially deleterious provisions in the purchase and sale agreement including post-closing items.

The challenge is that we don’t know what we don’t know. To counter that, talk to business owners that have sold their company. Chat with an experienced M&A attorney both for advice and referrals to business owners who have sold. Learn as much about the process and what to expect as you can. Then decide for yourself.

By Charles Smith

Charles Smith is the founder and Managing Partner of Pegasus Intellectual Capital Solutions, a Chicago based boutique investment bank engaged in mergers and acquisitions, capital raising, and restructuring and workouts. PegasusICS is the creator of the Intellectual Capital AuditTM, a methodology to identify how knowledge is used within a company how it creates wealth, and how it affects corporate governance. The firm was voted 2013 Boutique Investment Bank of the Year by Acquisition Finance Magazine. You can learn more by clicking here.


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International Trade:
A Key to Maximizing Value

Trade has grown dramatically in international importance

Trade has grown dramatically in international importance

International trade has become increasingly important over the last several decades. Trade as a percent of global GDP has steadily risen from 20% of global GDP in the early 1970’s to just 50% of global GDP today. One’s first reaction might be that service providers can stop reading now, because only goods – physical products, raw materials, etc. – are exported or imported. Not so.


U.S. exports of services have escalated dramatically.

U.S. exports of services have escalated dramatically.

The fascinating part of the story is that the increase in trade also involves services. Unless a business is looking overseas or across borders for both sourcing and selling, it may be missing out on opportunities for growth or cost reductions.


Commercial construction – one of the seemingly most local of businesses – is even a candidate for international trade. I learned of this when an attorney at a Chinese firm approached me about introducing their client – a giant Chinese construction firm – to U.S. construction companies to joint venture on U.S. construction projects. As it turned out, the Chinese government had given cheap loans to their industry, and they were now using this as leverage to provide financing for commercial and municipal construction projects in the U.S.


One common misconception is that only larger companies import and export. One company I know makes high precision parts using highly specialized materials. Their secret sauce is their chemistry. They manufacture and ship one specialized product to one of the most famous luxury product manufacturers in Europe. They do this and still obtain 20% EBITDA margins. They also source some of their supplies from inland China. How big are they? About $5 million in sales. This is all possible due to the Internet.


The Internet also makes ecommerce possible. But many business owners believe that only consumer products are sold on-line. Yet one company I know has been very effective at selling industrial products on I understand why. Finding industrial goods in small quantities or that are very specialized or infrequently purchased can be difficult and time consuming. Local suppliers are commonly set up to service only much larger orders. Google search, and EBay makes ecommerce possible.


If you have a unique product that is high-value relative to shipping costs, the world is your oyster. Ecommerce eliminates borders, and eliminates your geographic limitations, subject only to shipping costs. As a hobbyist, I needed a very specific diameter of pipe with a very specific wall thickness. I found exactly what I needed, in aluminum, on Amazon for about $57. It probably cost the manufacturer a few dollars. I could care less, because it saved me so much time looking fruitlessly locally.


With Internet search at our fingertips, accounting services, banking services, call centers, software programming, engineering, design, graphic arts, and IT are all bought and sold internationally. And, by the way, so are investment banking services including cross-border mergers and acquisitions, and capital raising. If you want to learn more, contact us

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at


The Many Flavors of Company Buyers

Ice cream sundae with many flavors

Some flavors are simply better than others

Company owners are commonly bombarded with unsolicited expressions of interest in buying their company. Some are real and some are not. Some are very good guys. Most of the rest are decent people, but money is a weakness for many, one of the seven deadly sins. That leads to the rest. How do you know who is who?

The world has changed in the last 35 years. In 1979, when I started my career, Private Equity Groups (PEGs) didn’t really exist, certainly not in the middle-market or lower middle-market. When they did emerge, they were called buyout firms, or LBO funds or LBO firms. They used financial engineering , primarily financial leverage, to get their required return on investment. And then there were the asset sales that broke the company up into parts to reduce debt quickly. Those days are long gone. The low hanging fruit of yore – the under-managed company – has long since disappeared. The increasing efficiency of the large corporate and middle market is forcing PEGs to look at smaller companies and focus on operating skills rather than financial engineering.

Today we see PEGs, Family Offices, Strategic Acquirors, Fundless Sponsors, Pension Funds, and international strategic acquirors all as possible buyers for companies. Even within each of these categories, there are a number of varieties.

PEGs have segmented into industry/sector specializations, control versus minority position, and active versus passive management. There are funds that specialize in minority, typically passive, positions. We see a growing specialization in Oil & Gas, Healthcare, IT, Technology, and Agribusiness/Food segments. New specializations sprout up with alacrity, such as funds focused on companies in the Sustainable/Cleantech space. PEGs use OPM (other people’s money) and have roughly a 7-year time horizon before they will resell the companies they acquire.

In addition to their equity funds, many PEGs now often have pure debt funds and debt-with-warrants funds that permit recapitalizations of companies where the owner wants to take cash off the table but not cash out. These funds sprouted up to offer a high fixed yield to investors in the post-financial crisis period. The debt funds usually have a 5-year period before they exit. Most funds are guys in white hats, but some wear black hats, and use the debt as a call option on the stock of the company or its assets. It’s important to know who is who.

Family Offices are invisible to many. They prefer it that way. From the outside, they may look like any other PEG. They are high net worth families with assets in the hundreds of millions or billions of dollars and manage their wealth much like a PEG would, except it is their money. These families usually created their wealth building a company that was sold at some point in the past. They oft times have valuable skill sets to bring to the table, and have longer time horizons over which they invest, sometimes infinite. Most family offices are nice people, but it is very uncommon for them to reach out to a company owner themselves.

Strategic Investors can be broken into two categories: you direct competitors and everyone else. Competitors commonly want to steal your trade secrets: customer lists, manufacturing processes, or some other secret sauce. If they don’t want to steal your trade secrets, they want to steal your people, or something else you have. Unless you have built the Chinese Wall in your sector, their only goal is to put you out of business. If you have built the Chinese Wall of your sector, don’t let them through the gates.

Non-competitors are usually large companies looking to sell into your customer base, use your products to sell into their distribution systems, or some other strategic reason. If the non-competitors are large, as in a billion in sales and publicly traded, they may offer the highest sale price.

Large Strategic Investors’ scale creates safety through diversification of products, customers, geographic markets, and management. When they acquire your company, they usually fold you in, eliminate your corporate overhead, and get a positive bump in their stock price. The best of these buyers are experts at what they do, buy companies regularly and understand merger integration. If they don’t, it is best to be cautious.

Fundless Sponsors are a bit of an odd duck, and quite likely to call or write to you to buy your business. A Fundless Sponsor is someone that does not have their own capital to invest. They have to raise capital for every deal they do, and are rarely the people that will run the deal or the company. The control party is the one with the actual equity in hand. The universal truth is that Fundless Sponsors are looking to buy a company off-market and below market value. Some Fundless Sponsors are very professional, but some are not, and can waste a lot of people’s time and money in the sale process.

Some Fundless Sponsors paint themselves as either a PEG or an investment bank. If they position themselves as the former, they are deceitful. If they position themselves as the later, they have conflicts of interest. If you work with a good investment bank, there is no need to work with a Fundless Sponsor, as it is far more productive to take the transaction straight to the ultimate acquirors. A good investment bank does not buy companies or have a fund. That is a red flag, and a huge conflict of interest.

Pension Funds have started to do direct investing in recent years. Traditionally, they have invested in the funds that PEGs operate. Some Pension Funds are huge, such as CalPERS (California Public Employees’ Pension System), and very long term in their approach. Pensions are nearly universally good guys, but to date, I have never heard of one calling or writing a privately held business owner to acquire it.

International companies can be attractive acquirors, particularly if you have a customer list or distribution system that helps them access the US market without having to build it themselves. Sometimes they want your technology. The way they do business is dependent on their culture and business culture, and they are many times so different from those of US companies that we may as well be from different planets.

Regardless of who wants to buy your company, it’s important to remember they are professional acquirors, have dozens of deals under their belts, and want to buy you for less than you are worth. Getting someone in your corner evens the odds, and permits the creates the kind of competition that brings results.

Position Your Company
for Sale as a Platform

Building Columns

You must build a solid foundation if you want to sell your company as a platform company.

If you want to sell your company, be sure that it is viewed as a platform company by private equity groups. PEGs commonly view an acquisition in a new industry or space as a “platform” company. That is, they intend for the company to grow organically and have add-on or tuck-in acquisitions to create synergies. At the time of the acquisition of a platform, the PEG does not have an existing portfolio company to combine with it that would yield synergies. You want that platform company to be yours.

Platform companies stand in contrast to “add-on” or “tuck-in” acquisitions where synergies to an existing portfolio company are believed to exist. Estimates vary across sources, but add-ons constitute roughly 40-50% of PE buyout activity, making it critical for business owners who are thinking of taking a private equity investment to understand some of the strategic implications of both views. Add-on and tuck-in acquisitions are usually considerably smaller companies so as to not dilute the culture of the platform. Add-ons and tuck-ins are acquired for lower EBITDA multiples. Think 3x.

In academia, Platform companies are those that involve not only one company’s technology or service but also an ecosystem of complements to it that are usually produced by a variety of businesses. As a result, becoming a platform leader requires different business and technology strategies than those needed to launch a successful stand-alone product. There are two fundamental approaches to building platform leadership – “coring” and “tipping.” If you really want to make a lot of money, position yourself as a platform company that uses a coring or tipping strategy.

“Coring” is using a set of techniques to create a platform by making a technology “core” to a particular technological system and market. When pursuing a coring strategy, would-be platform leaders think about issues such as how to make it easy for third parties to provide add-ons to the technology and how to encourage third-party companies to create complementary innovations. Examples of successful coring include Google in Internet search and Qualcomm in wireless technology. “Tipping” is the set of activities that helps a company “tip” a market toward its platform rather than some other potential one. Examples of tipping include Linux’s growth in the market for Web server operating systems. Another tipping strategy is for a company to bundle features from an adjacent market into its existing platform. This is referred to as “tipping across markets.”

In common usage of the term, PEGs conisder platform companies to be those which have sufficient economies of scale, and talent acquisition, talent management, and succession planning capabilities upon which it can effieciently add add-on or tuck-in acquisitions. PEGs seek to acquire companies that they can grow or improve (or both) with a view toward eventual sale. In terms of growth, the financial sponsor will usually acquire a platform company in a particular industry and then seek to add additional companies to the platform through acquisition. These add-ons may be competitors of the original platform company or may be businesses with some link to it, but they will be added with the goal of increasing the overall revenues and earnings of the platform investment.

PEGs spend a great deal of time developing strategic plans and an investment case for a new platform to determine why they are buying a business and how they will generate an attractive return. This analysis is usually even more comprehensive for businesses that are new to a PEG. For add-on acquisitions, PEGs sometimes lean more on the expertise of its relevant portfolio company’s management to determine the fit, synergies and strategic benefits of a transaction. That is why the talent acquisition, talent management and succession planning are so important.

For new platforms, PEGs require that the company not only be self-sustaining, but be scaleable. The ability to grow the company is the rationale behind the deal, and it defines how the PEG will create value through things like capital infusions, operating partners and future add-on acquisitions. The PEG seeks avenues of growth to maximize value of the investment. For new platforms, PEGs focus on issues including industry attractiveness, the opportunities for growth, the self-sufficiency and scalability of the target, and and whether the PEG can add value in the acquisitions process.

To be self-sufficient and scaleable, the target must be able to prosper without any one individual. Customers must be “owned’ by the company, not one person, and certainly not the current owner. Critical processes must be mapped, and the organization must be in a highly efficient.

If you are a business owner, ensure that you have created a company that can prosper without you, that is self-sustaining, and has the talent in place to take it to the next level without you. That is your path to greatest wealth.

To learn more, contact us.

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at

Increasing Your Company’s Value With Benchmarking

Common Sized Income Statement

If you don’t know where you are, how can you know where you are headed?

Benchmarking your company against your industry peers helps you identify your strengths and weaknesses. It points you in the direction to increase the value of your company.

Benchmarking your company using common-sized income statements and balance sheets is the single most important you can do to understand the value and salability of your company. We use common-sized financial statements in all our engagements, including M&A, valuation, capital raising and turnarounds. They quickly tell us where a company ranks compared to competitors.

“Common-sizing” is taking a financial statement and putting the number in percentages. In the case of the income statement, you take each line item and cast it as a percentage of sales. In this way, you can see at a glance how each expense category compares to sales. By putting your data year-by-year, you can easily detect changes and trends. Graphing the data makes the changes all that more clear. With this in hand, you can determine if you have a competitive advantage or disadvantage.

“Competitive Advantage” is technically defined as a 2 point advantage in EBITDA margin (Earnings Before Interest, Taxes, and Depreciation as a percentage of sales) compared to industry averages, e.g. 10% versus 8% industry average. There are vast differences in the EBITDA margins of companies, and between the various industries and company sizes. You always want to compare yourself to your industry. You may or may not want to compare yourself to just companies of your comparable size, as you are usually competing against the largest players unless you have geographical – or other – barriers to entry.

Your EBITDA margin advantage (or disadvantage) tells us where a company would fall in the comparable sales transaction EBITDA multiple observations, ceterus paribus. If a company’s industry comps show that companies in its space have fetched multiples of 4-10x EBITDA with an average of 6x, and the company’s EBITDA margins are 2 points better than industry average, we expect that this company would sell at the high end of the EBITDA multiple range.

This outcome results in a higher sale price at any given nominal dollar EBITDA level. Keeping an EBITDA margin advantage is mission critical if you want a good sale price. The buyer can ill afford to scale up a company that is just average, or worse, below average. It only makes sense to scale up a company that is superior to its peers.

Common Sized Income Statement

Benchmarking goes well beyond the income statement, however. We use common sized income statements to look at working capital efficiency. Here, we calculate receivables, inventory, payables and accruals as a percent of sales. If we see rising percentages over time, it is a cause for alarm. We saw this trend prior to the financial crisis in the building products sector. The underlying cause was the slowing of payments by home builders to their suppliers.

Common Sized Income Statement

An out of control working capital increase that makes growth infeasible.

We also saw a disconcerting increase in working capital utilization by a manufacturer in the building products space. The long term trends indicated that continued revenue growth would not be financeable and that the company was headed towards a liquidity problem. This company listened to us, and accepted an offer to be acquired by a much larger competitor.

Working Capital effect on revolver outstandings Graph

Revolver availability tapped out due to unconstrained increases in working capital.

The challenge in using common-sizing is interpreting the results. There are commonly more than one possible interpretation, and it takes experience and use of other data to determine the underlying causes. As but one example, lower EBITDA margins over time, combined with rising working capital as a percent of sales could indicate an increasingly competitive pricing environment, or a company’s willful easing of pricing and sales terms to capture market share. If EBITDA margins continue to be above industry average, the later interpretation is a positive. If EBITDA margins are at or below industry average, this would be considered a negative and would negatively impact company value.

Common Sized Income Statement

A common sized balance sheet

You can use benchmarking to determine both your competiveness and salability, as well as a diagnostic tool to determine what needs to be changed (or not changed) about your company If your EBITDA margin is below industry average, common-sizing will quickly point to problems in your cost structure. After that, a re-engineering project is called for to ensure your supply chain is optimally designed.

One word of caution is in order. Your cost accounting and financial accounting have to be very good. Costs have to be accurately allocated. If you have multiple products, costs have to be allocated to each product. We commonly find that the quality of financial data of companies without audits is inadequate to make meaningful decisions. A re-engineering of the accounting and finance functions then become the first order of business. Without high quality cost accounting and financial accounting information, we are just flying blind.

If you are interested in benchmarking your own company or want to learn more about benchmarking using common-sized financial statements, please contact

Shareholder Value
Managing Talent is the Key

Man pulling shirt open like Superman

Talent acquisition, talent management and succession planning are the keys to the ultimate creation of Human Capital and Shareholder Value Maximization.


The creation of enterprise value, the key to shareholder value maximization, is primarily dependent on the creation of Human Capital.  That has been my conclusion for some time, and according to Andrew McKenna, Chairman of McDonald’s Corporation, whom I heard speak this Tuesday, it seems to be his opinion too.


Mr. McKenna identified three key roles for the board of directors:  Succession planning, talent acquisition and talent management.  Without these, an enterprise has no viable future.  With these, in time it will build the Structural Capital and Relational Capital it needs to prosper.


Lower middle market companies commonly suffer from a key man (or woman) issue.  This is really just a lack of succession planning.  To build a valuable enterprise, we must hire, train, and nurture our successors.


In his first job, Mr. McKenna went to his boss to resign.  His boss asked why.  Mr. McKenna said he wanted to start his own company.  His boss asked what kind.  McKenna said, the same as yours, I’m going to be your competitor.  His boss asked who was going to finance it.  McKenna said he thought he could find financing.  His boss said, let me finance it.  McKenna asked why.  His boss said, I want you to be successful so you can buy my company.  And thus began Andrew McKenna’s rise in the corporate world.


A failure to build your company to a size that is self-sustaining isn’t an easy thing to do.  But dental practices do something different but similar all the time.  During his or her career, a dentist builds Relational Capital, as well as some Structural Capital (the office, systems, assistants, equipment, etc).


But the dentist is the talent, and when selling a practice, a new, talented dentist is sought out by the current practitioner to acquire all or part of his practice over time, thus harvesting some of the inherent Relational Capital built up over a career of quality work.  Since the buyer must be successful, the seller must seek out talent, manage it, and in the process set up his successor and buyer. In so doing, he maximizes the value of his company in the sale process, as it is sold over time.


The maximization of the enterprise value affects everything else: the ability to raise capital, the value in mergers and acquisitions, and the resistance to financial distress.  It is common for an entrepreneur to be either the key salesperson or an inventor with a technical background.  Neither tends to focus on their succession plan.


So, regardless if you are the head of one of the largest enterprises in the world, or the smallest, the same principles apply.  Talent acquisition, talent management, and succession management are the keys to value creation. To learn more, contact us

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at




Why Human Capital Should be a Line Function

McDonald's Golden Arches

What is this logo worth? And how did it get to be so valuable?

Enterprise Value is the total unlevered value of the firm. For publicly traded companies, mathematically it is the market value of the stock plus the value of debt. If you subtract from enterprise value the market value of its tangible assets, what you have left is the market’s appraisal of the total value of the intangible assets. That is what has come to be called Intellectual Capital, and we abbreviate it as IC.


IC is further divided into three components: Human Capital, Structural Capital and Relational Capital.


– Human Capital comes and goes everyday, either up and down the elevator, or into and out of the parking lot.


– Structural Capital is all the stuff the Humans have to work with: processes, systems, databases, infrastructure, intellectual property, your Six Sigma program, your talent acquisition program, training programs, that sort of thing.


– Relational Capital is made up of your relationships with your customers, suppliers, and depending on your industry, perhaps government or regulators.


When we look at a company like Google, or Facebook, you can see quite easily that there was some person or persons that started it all, and the company grew from there. It is all about a person or group that had a vision or idea, and they hired and motivated other like-minded souls, and voilà, they became a force to be reckoned with.


It’s a bit harder to see this effect when you look at an established company, like McDonald’s. McDonald’s is by many standards a relatively young company. It was 1948 before the first hamburger was sold, and 1955 before Ray Kroc joined the company. It’s market cap as of today was $94.4 billion, and its enterprise value was $107.9 billion. The book value of its tangible assets comes to just $29.0 billion. That’s just 27% of enterprise value, leaving the other 73% to Intellectual Capital.


For fun, let’s compare that to Navistar, the old International Harvester. Their market cap was $1.45 billion today, their debt was $4.4 billion, bringing their EV to $5.86 billion. That compares to tangible assets of $10.5 billion. Navistar’s IC is a negative $4.64 billion. You can see that a lot of the investment in tangible assets has been wasted. It suggests a huge Human Capital, Structural Capital or Relational Capital problem. We don’t see the same thing at Deere or Cat, so we know its not the industry.


Back to McDonald’s, while this extra value isn’t all attributable to the company’s current workforce, it is all due to the company’s current and past workforce. Ray Kroc obviously gets credit for some part of that, but when you try to account for the fact that the company’s earnings and revenue have grown at 9% a year for the last three years, you have to believe that something has been institutionalized.


What we are looking at Human Capital that has been converted into Structural Capital and Relational Capital over the years. The company now has a way of doing things (Structural Capital), a brand (Structural Capital), and a brand cache with its customers (Relational Capital). It also has an awesome supply chain (Structural Capital) with its suppliers (Relational Capital), and impeccable quality control (Structural Capital) and marketing (Structural Capital). But it all began with the Humans at an earlier time that precedes the current employees tenor.


So here is the point: Human Resources – HR – is a staff function almost everywhere, and a backwater in many companies. Yet, arguably, it is the single most important driver of shareholder value. Why isn’t it a line function?


The argument I hear is that the performance of HR is too hard to measure. I disagree. My belief is that the performance of HR is measured over too short of period of time and based upon non-measurable criteria, much as the rest of corporate America measures most everything. If it didn’t occur this quarter or this year, it just doesn’t matter.


That is, we believe, misguided.


Companies love to promote and move people and not hold them accountable for their past decisions. I have argued in the past that banking is the poster child of this. They reward salesmen based upon their loan production in the last quarter or year, while the performance cycle should be over the business cycle. By the time the economy turns down, many of these ‘top’ salesmen are in different jobs or functions and not accountable for their decisions.


This should be changed. Compensation should match the period over which real performance is measurable.


It takes at least two years for someone to grow into their job. And long after that the decisions that HR makes effects their motivation and performance. Things like training.


HR’s job is to get the best people possible into the value-creating jobs. They are also responsible for the training, measurement, compensation, perks and all else that goes into rewarding employees for good work.


Large companies need to start to focus on the HR function and bring it into the line as a real partner. Smaller companies will find that they need to outsource certain skills. But still, the buck stops at the top.


And speaking of the top, smaller companies commonly suffer from what has been called a “key man issue”. A key man issue is simply a failure to hire and train a successor, whether due to an absence of scale or inclination. Its presence is a huge deduction from the enterprise value of the company. If a business owner wants to really maximize the value of his company, he has to prepare for his own departure, whether through sale, death or other means. He has to define what his company’s secret sauce is, what its seven secret ingredients are, and ensure they survive his passing. That is, if he values his wealth.


Resistance to HR being a line function will be felt from all sides. HR people will not want to feel the heat of the kitchen. If so, they aren’t the heat resistant type and will need to be replaced. Managers won’t want to relinquish control of hiring and compensation decisions. I would suggest that they either have the wrong person in HR or the manager needs to become his own HR person. The later is the logical decision in a smaller company, with outsourced HR as a resource.


In the Knowledge Era, Human Resources should be made a line function, staffed with very talented people that take on the responsibility for the company’s future. The senior HR person should report directly to the President, and no one else. Together, they should be the two most important people at the board meeting.


How important is Human Capital? Important enough that Goldman Sachs no longer has an HR department. It’s the Human Capital department, as is ours.

To learn more, contact us

by Charles Smith

Mr. Smith is the founder of Pegasus Intellectual Capital Solutions, a boutique investment bank specializing in mergers and acquisitions, Capital Raising and restructuring and workouts. The firm is an innovator in the use of Intellectual Capital Audit for pre-closing due diligence and in turnarounds. Charles can be reached at