Blog No. 6: Egos and Taxes

Several years ago, I saw a classic 1967 Ford Mustang Convertible parked on the street. It was red with black leather interior. It had been (mostly) restored, and looked amazing. There was a for-sale sign on the window with a phone number. So, I called it.

“Tell me about the car,” I told the man on the other end of the line. I didn’t say: “How much are you looking for?” which would have saved me a lot of time and anguish. Instead, I spent the next day test driving the car, looking at the car, having my mechanic check out the car, reading blue book reports on value, etc. In short, doing due diligence.

“I want $30,000 for my red convertible “baby,” the owner told me.

“But it’s got damage on the rear, needs a valve job, and a new muffler. It’s worth maybe $9,000 in its current state,” I told him. “That’s what the blue book says. That’s what the market says. So that’s my offer.”

Now, in fairness, he’d invested a lot of time and money into this project. And, in reality, he probably had at least $20,000 overall into the car. So, in effect, he was under water on his “baby.” But he didn’t want to admit that. He “had” to get $30,000 for it.

“The price is $30,000 take it or leave it,” the man told me.

“Well my offer is $9,000, I said.

“Forget it,” he said. “I’m insulted.”

As it turns out, this story is a pretty good metaphor for much of my career.

I’ve spent a lot of time over the last 35 years engaged in various M&A conversations, as a buyer, seller or intermediary investor. In fact, at last count I’ve done 55 deals in my business career.

And inevitably, it has often fallen upon me to tell sellers their “baby” is ugly. Their companies aren’t worth what they’ve told themselves, or worse, their investors, shareholders or family accountants. By convincing themselves their life’s work is worth more than it actually is, they often are frustrated, unhappy, or just plain pissed off when they finally get a dose of reality, no matter how gently it is presented.

Simple economics tells you that free markets are just that, free. Buyers and sellers will eventually reach a transaction price --- for whatever the market will bear. Valuation multiples in some industries vary wildly. Some remain fairly static. Emotion can be a factor, but overall, cooler heads usually prevail, and a good deal is one in which --- and I firmly believe this --- both parties have sacrificed something to close the transaction. Give and take. It’s the American way.

In my career, since leaving the newspaper business in 1982, I’ve looked at hundreds of deals: Media companies, technology companies, services businesses, government contractors, manufacturers, printers, Hollywood production companies, PR firms, ad agencies, book publishers, a myriad of internet businesses, phone companies, restaurants, bars, commercial real estate properties, residential apartments, insurance agencies, a rocket manufacturer, even a company that make dishes for satellite transmissions.

I used to tell Joan Beitel, my long-time business colleague: “You’ve got to drop a lot of lines in the water to catch a fish.” And believe you me; I’ve got filing cabinets filled with dead “fish.”

“You really should clean those files out,” Joan would say about once a quarter. ‘Those deals are dead.”

Looking at companies is what I do. I assess their value, and then decide if it’s worth buying or selling, and if so, what the return on investment would be and how long it would take. Then we try to finance the deals and make them happen.

Some of these deals have been winners (ROLM, N.E.T., Intergraph, AOL, IXL, Disney.com, Intercom) and some have been losers (NetNoir, Rainmaker, NFL.com, The Laurel Brigade). But overall, when the day is done, we’re further ahead than we were before we entered the game --- so no complaints.

Today my consulting company is looking at various deals and companies. And I’m working with several clients:

  • In December I was engaged on the buy side as a finder to help a “Private Equity” client find some quality companies to add to their technology portfolio.

  • I’m also working with two different “Family Offices” about a similar buy-side arrangement, albeit in the media space.

  • And, I’ve been consulting with a regional media group about an equity re-capitalization and restructuring following a brutal financial downturn in their industry segment.

Now, the P/E buyers are very successful. They are savvy, use the standard five methods of valuation --- discount cash flow, revenue multiple, EBITDA multiple, backlog and black shoals --- to determine their purchase price point. Comps of similar deals are readily available and well documented. You can argue all day long with P/E firms, but they’re smart, disciplined, and connected. In the end they will stick to their price and not go above it. As I said, smart.

For these buyers, I found a great small company that fit perfectly into their strategic vision. It is growing, does work in their sweet spot, and has a good management team that could help drive business development for the larger asset they would bolt the target company onto.

Now, the owner of the selling company contacted me. He told me he is 75 and would like to retire; in short, he’s looking for a good home for his company. A company he built from scratch to $25 million over the last 11 years. The company is modestly profitable, and has a good reputation.

“I want to make sure my people are taken care of,” the seller said.

The buyers are honorable people whom I greatly respect, I told him.

“Well, I’m very interested. How long would it take?” he said.

Well, let’s do some preliminary due diligence first, and then we’ll see where we are before I bring this to my clients, I told him.

So we spent several days together, going through his books, meeting with his key personnel, and visiting his offices. Indeed, I met his entire headquarters staff through this process.

In the end, after talking with my P/E clients, I gave him a range of what they might be willing to pay for his company.

“I’m not going to sell for that,” he said. “This company is worth a lot more than that. And besides, after taxes, I’ll make even less.”

I politely showed him how the EBITDA model worked, how comps backed up the math, and then used three of the five proven valuation models to verify that the buyer’s purchase price range was fair and legitimate.

A few weeks after Christmas, he said, “I’m no longer interested in selling at this time. I’m going to grow my business further. I’m going to wait at least a year.”

I reminded him that my buyers were ready to go. They were well funded, and good people. “These guys are professional, serious businessmen. If you walk away now, they may not be back,” I said.

“I understand that. But, well, I’m insulted,” said this 75-year-old seller. “If they want to buy my company, they’ll need to pay 4X what you’ve quoted me. No deal otherwise. I’ll just keep working.”

And that was that. No amount of logic, mathematical computation, comps or other honest input was going to change his mind.

In effect, he had convinced himself his “baby” was worth 4X market value. And nothing on this earth was going to get him to the table. Essentially, his ego wouldn’t let him admit that his company was actually worth one quarter of what he thought it should be worth.

Another client this week is working on a re-capitalization of the equity structure of his 160-plus year old media company. But, like many old media companies, he’s got a substantial amount of debt and old assets on his books. So, the valuation models are tough in his case. While he has some substantial tax loss carry forwards for potential investors to utilize, getting to a realistic valuation number that doesn’t so dilute him and his family has been very tough.

“It’s my family’s business. It’s worth substantially more than so-called third party experts are telling me,” he said. “This is really hard, but I’m not going to give it away.”

Unlike the first company above, this second seller could use the cash. So, while it’s a great blow to his ego, the reality is at some point soon, he’s going to have to come to grips with a smaller valuation than he has promised his family. Or, he can fold up his tent, and go out of business.

“Listen man, I don’t enjoy telling guys their baby is ugly,” I said. “But the valuation models don’t lie. The market may be brutal, but it’s reality. What are you going to do?”

He looked at me and said, “I don’t know, but I have to have majority control. I can’t be a minority owner of my family’s business. Your valuation is an insult. I can’t do this.”

Hey, as I said, I’ve looked at hundreds of these.

In August, an old friend who has a PR firm in Washington called to say she was ready to sell her company. She’s 64 years old, divorced, and has a large home overlooking the Potomac River.

We met for breakfast at the Georgetown Four Seasons Hotel. I told her based upon the revenues and profits of her business, after plugging them into the valuation models, her business was worth in a range of only so much.

“Well, I think we can do that,” she said. “I’m bored, and pretty tired. Do you have a buyer in mind?”

As a matter of fact, I have two buyers in mind, I told her. “But, you do understand what they’ll most likely offer you for your company, right?” I asked.

I’ll move the story along, five months later; she turned down the very same market value I detailed for her in August for her 29-year-old company. “I need three times what they’re offering,” she said. “I can’t afford to sell at that price. I’m going to keep working. I’m insulted.”

I guess I should have learned after 35 years that you get slapped a lot before somebody finally says yes.

But what always surprises me, every single time, is how the realities of the market have no bearing whatsoever on what people think their baby is worth.

Will these three companies eventually sell their businesses? Perhaps. Or their estate attorneys will liquidate them at a fraction of their value in probate after they’re gone or the businesses close. Indeed, many businesses close because of tax consequences post-sale, leaving their heirs a huge hassle.

In the end, it’s about egos and taxes. Some things never change.

Oh yeah, and the guy with the Red ’67 Mustang? It’s still in his garage. But now he wants $50,000 for it.

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