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Private Equity
Angel Investing: A look from Both Perspectives…
Interest in Angel Investing from both investors and the entrepreneurs who need the money is at an all-time high. Many of the participants from both camps are relative neophytes at the process.
Here is a list of common pitfalls that can plague both Angels and Entrepreneurs.
Miss-Matched Expectations & Goal Alignment: Angel investing is a type of marriage and we all are aware of the poor statistics related to marriage success rates. The following bullet points mostly reference unaligned expectations by all parties involved.
Risk Appetite: If the Entrepreneur’s company is little more than an idea with zero to little sales, the capital received from the Angel needs to be “flyer” money- i.e. if it doesn’t come back, no one’s life is ruined. What people think their risk appetite is and what they can really stomach (a 50% stock portfolio drop in one year for example) needs to be fleshed out in black and white.
Management Styles: Does the Entrepreneur just want the capital and then be left alone? Does the Angel’s capital come with the expectation of being part of every decision big or small? I know of numerous examples where Angels and their Entrepreneurs are NO longer on speaking terms because the right questions and leadership parameters did not get asked before funding. An honest review done by a competent third party with no skin in the game is highly recommended.
Exit Strategy (or lack thereof): When is the day a company should start Exit Planning? The day the company is created. Bankers Advocate is in the Exit Strategy business and we see time and time again that a concise and flexible plan needs created and constantly updated. Time is not your friend and all contingencies need to be discussed. If the Entrepreneur expects to run the company forever and the Angel Investor is expecting a liquidity event in 3-5 years that and other differences need to be worked out. A viable Exit plan that all stakeholders agree on needs formulated.
Single Investor or Angel Group? For the Entrepreneur to receive monies/expertise from a group versus an individual is highly desirable but not always doable. As they say, beggars can’t be choosers. However, the skill sets a group can bring and the group dynamics of multiple Angel’s can help temper the idiosyncrasies of a single investor.
Candid Answers to Tough Questions: This point is squarely directed at the Entrepreneur. You will be asked many tough, smart, and insightful questions. Your answer should never be a guess. I would recommend multiple roll-playing sessions with your advisers to fully vette your presentation. Audiences can tell when you are just winging it and all credibility is quickly lost.
In summation, both those in need of and the suppliers of capital need to ask honest and sometimes humbling questions of themselves. The right research done before the check is cashed can save a tremendous amount of grief and frustration later.
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What is a Hypothetical Appraisal and why would you Need One?
Whenever we take on a new Exiting client, we get a 3rd party business appraisal done by a reputable company (one that the banks will take, hold up in court, etc.). We also utilize a business appraisal in our targeted search program for Entering Clients. Our website is chock full of good reasons to get one. Occasionally in addition to a regular or enterprise appraisal, we use a Hypothetical Appraisal. From the American Society of Appraisers (ASA) website, here is the definition:
A hypothetical appraisal is an appraisal based on assumed conditions which are contrary to fact or which are improbable of realization or consummation. The Society takes the position that there are legitimate uses for some hypothetical appraisals, but that it is improper and unethical to issue a hypothetical appraisal report unless (1) the value is clearly labeled as hypothetical (2) the legitimate purpose for which the appraisal was made is stated, and (3) the conditions which were assumed contrary to fact are set forth. A hypothetical appraisal showing the value of a company which it is proposed to form by merging two existing companies would he deemed to serve a legitimate purpose. On the other hand, a hypothetical appraisal of a projected apartment house, based on an assumed rent schedule which is so much above the market that it is practically impossible for it to be realized, would not serve any legitimate purpose and its issuance might well lead to the defrauding of some unwary investor.
So from this you can see why we sometimes utilize a hypothetical appraisal. If your business will be purchased by an individual or financial buyer who hopes to run it, grow it and earn a nice living after debt coverage; a hypothetical appraisal is probably not right for you. If your business is large enough or unique enough that it will add immediate synergies to a strategic buyer like a PEG or larger company, then it make sense.
Warning! There are unscrupulous companies who try to get $40,000 or more from business owners selling them on the merits of purchasing a hypothetical appraisal. They will dangle their roster of strategic and international buyers as a lure. Please use some common sense. If the size of your business or its lack of uniqueness would not entice these larger buyers, don’t be fooled. These companies are in the business to sell appraisals for $40k, not to sell your business. A reasonable appraisal will be a fraction of that price. See this INC article for details.
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How is the Credit Crunch affecting Smaller M&A Deals?
I get asked by potential Exiting Clients how the tighter lending environment is affecting the market for their company. It results in a credit crunch, which is is a decline in lending activity. Here are a couple of things that I could see happening in the marketplace:
Deals are still getting done- Fairly priced companies under $10 million are moving nicely. It seems the smaller the deal, the less radical the lender requirement changes. However, getting deals financed is still tougher than it was a year ago and Buyers must “line up” correctly for the bank.
Private Equity has moved “Down Stream”- PEG’s (Private Equity Groups) have funds that must be employed and they are looking at smaller deals than they have historically done in the past. These smaller deals are typically easier to get funded.
Due Diligence: Slower and Pricier- Because of stricter lending requirements and Potential Buyers being more gun shy, due diligence can be drawn out and more expensive for both sides. This alone is a good reason to get a reputable third-party appraisal and pre-financing in place. Cleaner books and records will help your business stand out and reduce transaction costs.
More Corporate Buyers- With the big company layoffs and turmoil, more middle management types are looking to leave the corporate world and build their own economic engine. While always strong, I have seen an uptick in these types of buyers.
The International Buyers are Coming- There have always been foreign buyers looking for businesses in the US. However, with the strength of their home currency versus the USD, this has accelerated. I have been asked to give seminars in Canada and Great Britain to potential buyers who can also use buying a US business as a vehicle to get a visa.
Despite the credit crunch, you can see this is still a fine time to Exit Business Ownership. Whether the Prime Rate is 20% or 5%, the proper steps still need to be taken before your business is brought to market.
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