Utilizing M&A for Partner Buyouts

Mike Harvath  00:07

Hello and welcome to this week’s Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. For those of you that tune in regularly, and even for those of you that don’t revenue, rocket is the world premier growth strategy and M&A advisor to tech enabled services companies with me today are my partners, Matt Lockhart and Ryan Barnett. Welcome guys.

Matt Lockhart  00:34

Thanks. Mike fired up. We have released three new opportunities to the market here in the past you know, week or so. And that is, that’s great news for our clients, but I think it’s also great news for the market in general. I think, you know, harkening back to a year ago, that wasn’t the case, but let’s go. Let’s make it happen. Ryan, what’s going on?

Ryan Barnett  01:04

Yeah, no. Thanks for the intro, Mike and Matt. And it’s always room to celebrate. We closed a few deals too. Our clients closed a few, both on the buy side, and it’s time to celebrate at the time. Same time, no rest for the wicked as we as we launch again. If you have any questions about mergers and acquisitions in the tech enabled services space, or you’re thinking about buying a company or selling your own company, this is the podcast for you, and I’d really encourage you to check out Revenue Rocket, revenuerocket.com/current-deals if you’re interested in any of the companies that we represent. Give a flavor of who we work with today. You know, in this podcast, we talk about topics that are near and dear to our heart, as well as things that we see in everyday environments and something we oftentimes see. And this is really a case, and with the tech services companies are partner related businesses. And I in this case, when I say partner, I mean two or three individuals that have come together to form a partnership agreement in which they found a company or have equity in a company, and they operate the company as a partner. And oftentimes, partnerships change. People evolve, the interest change, maybe even things like retirement come into play. And there’s a natural course in which one partner or more may emerge, another partner may depart. And what we want to talk about today is, is a merger or an acquisition, a method to help facilitate a change within the partnerships and what to look for and and such. So Mike, why don’t you just get us going, we’ve worked with lots of partners, and tell us, tell us a little bit about the importance of a partnership and what that means for founding a company, and what it means to a potential suitor if you’re looking to sell.

Mike Harvath  03:02

Yeah, you know, these are good and interesting topics, right? And I think in particular, what’s important to know is when a partnership comes together and where the place are, where the partners are, when they decide to join forces and either start a business or come into a business as a partnership, or when they determine it’s time for them to exit the partnership, can all be different, and things change right while you’re developing and growing a business as a partner in that business, and that’s okay. There’s no judgment about that. There’s it is what it is. And I think, you know, it does take a village to build a great company. Oftentimes, it takes a great partnership with people with different skills that all bring their own individual superpowers, if you will, to the table. But what you should know is, you know, partnerships are hard, right? They’re hard to maintain, whether that’s a partnership around a business or a spousal you know your spouse relationships, or you know any other partnerships that you may be involved in, they require care and feeding, and they require some governance, particularly in a business partnership around a document called a shareholders agreement or an operating agreement, I would just take this time to plug to make sure that all of our listeners have those agreements updated and that they’re clear as to how to bring on a new partner or exit an existing partner without drama or ambiguity. That will make it much, much easier for you to be able to transition the partnership to others. For those that might be ready to retire or decide they want to move on or start another business, or maybe the superpower they brought to the business isn’t a super anymore, because of things that may have changed in their life, it could be any number of things individually, personally or professionally. And so those agreements have to be in order, in order for you to bring people in and out of the partnership smoothly. But, but beyond that, you know, you can use M&A as a vehicle to sort of change the cap table in the business. We’ll talk more about that in a minute. But with that, back to you. Ryan,

Matt Lockhart  05:21

Well, I was going to jump in, Mike, I really like your analogy to, you know, a marriage. Now, let’s write, let’s face facts, that a marriage is much more important, right? But, and, and, I guess some marriages may be defined by documents. But where it does equate is that you know, having a regular check in in terms of of you know, the party’s goals and desires and is is healthy, regardless of whether or not M&A is on the table. That being said. And we’ve talked about this before, in in past podcasts that you know when it’s time, it’s time, right? And you know when there’s an individual owner of a business, maybe a founder of a business, etc, etc. It’s really about that individual’s time when there’s a partnership, be it with two partners or three partners, you know, four partners, right? That you know, people may be on different timelines, and that’s okay, right for people to be on different timelines. And so I think that’s a, you know, one of the first recognitions is that a you people may just have different goals and desires and objectives

Ryan Barnett  06:56

When moving on from a partnership is something that that it can be established and can be done. It can be done in the right way. I think oftentimes, or we see, we see great partnerships. Sometimes we see a non operated partnership in which there’s a member that it just isn’t in the business, but still has the equity stake. We see that quite often now the times there’s partners that perhaps have a contentious relationship and can move on just because they don’t work together. Sometimes it companies evolve and people evolve and and it’s, it’s common to come to a place where you need to say, hey, let’s do, do a little something. Or what are some options for moving away from a partnership, I guess. And that’s really my next question is, is, if you think about the world we’re in and we see these partnerships, what are some options that a partner, that someone can have in removing a partner from a business and in continuing on, Mike, why don’t you get us started there?

Mike Harvath  08:02

Yeah, so you know, certainly you can. And back to my point about an operating agreement, you can exercise sort of the rights in an operating agreement if a partner wants out. And that gives, if an operating agreement is authored properly, with your lawyer and your counsel, you can, you can exit a partner in an orderly fashion, in a way that fairly values the business and remunerates them accordingly for that value if they own equity, as is the case with most partners. The other option, of course, is that you know transitioning the cap table of the bigger conversation, whether you’re contemplating selling the business, and that may give you enough liquidity in the business to exit the partnership. You may exit as a as a partner, as well as, let’s say, another partner in the business. Or, you know, certainly there’s options where as a partner, if someone wants to exit, you can use a recapitalization, we call it our liquidity event, to help you exit that partner, but then you stay on as a managing partner in the new entity, or as part of the new entity, and play a role. We have recorded many podcasts about selling in or selling out. In this case, it would be one partner sells out. If there’s a case of two partners, or maybe more than one, if there’s multiple partners, and a partner sells in and continues on with the with the entity moving forward, remuneration and consideration and value and terms are all sort of interwoven in this discussion and should align to the objectives of the individual partner. And, you know, again, probably portends that you need a good advisor to help you with that, so that everybody kind of gets their fair shake and can navigate, you know, the ins and outs of the of the offer the suitor or buyer or recapitalization partner, as well as terms for each one of the partners equity based on their own individual requirements.

Matt Lockhart  10:15

You know, Mike, when you use the term recapitalization partner, oftentimes, you know, I think of that as being a financial buyer, right? Call it a, you know, maybe a private equity firm. And where it’s it’s very natural for those private equity firms to look for one or all of the partners to continue forward, but whoever is going to continue forward that they continue to have an interest in the business, a stock interest in the business, and that’s, you know, I think that’s a super viable means, you know, I also, I mean, let’s face it, you you could just sell out to a strategic partner and sell all of the interest in the business, and one partner can say, look, I want to continue forward and have an employment agreement. And, and you could manage things that way. And, or, you know, even as in a strategic you know acquisition, there is oftentimes, you know, opportunities for one or more partners to have an interest in the new strategic acquirer. So I was thinking about that in the context of recapitalization.

Ryan Barnett  11:42

And Matt, the brings up a question to me, is, when a buyer is evaluating the company that has a multiple partnerships, do they have to care about the what that cap table looks like, and do they in the case in which you have where there’d like to be some person staying on a person leaving or a person. We’ve seen these scenarios on the buy side, we say quite often, does the buyer need to worry about the equity of the company? Let’s say, or is an earn out pin to one person versus another? Help me understand when, help me understand that it’s something just don’t, don’t understand.

Matt Lockhart  12:28

Yeah, no, I think that, you know, I think everyone will love this. It depends. It is, it is situational dependent it, it’s in sort of backing up. You look at the readiness of a firm, and as we advise our clients, becoming ready to to sort of maximize the value that you’ve created in a firm is not a, you know, two week process or a two month process, right? There’s, there’s stages that you know, demonstrate the maturity of a firm and the value of a firm and and if, if too much of a firm is dependent upon one individual or two individuals, right then there could be challenges right in, in executing an acquisition that is most desirable, you know, to to all parties. So but do they care? They they they buyers certainly will care. They certainly will want to understand. But then the next is, okay, what are these shareholders doing? What is the ability for these shareholders to step away from the business? And then, you know, why is there that ability? What has been created? What is the structure and the team that has been created, you know, behind a firm now? Well, mature firms have thought about this. They’ve created succession plans. They’ve started to execute those succession plans so that the partners, right can demonstrate their overall, you know, capability, and that it’s really a team that is driving the business forward, not any one individual shareholder.

Ryan Barnett  14:36

Yeah, I think that’s a, it’s a, it’s a great and it’s great, great segue. And I think I’ve got so many questions here on this, I’ll try to narrow in a few. If, if you get to a point in which you have a partner and you’re looking at a buyout a partner, and one partner is perhaps moving on, it seems like the value of the company has to be in play. Here it’s i. And to understand what the shares are, or what the value might be worth. Mike, how do, how do business owners come to an agreement of that value?

Mike Harvath  15:12

Well, I think by using credible outside counsel and advisors, is how they get there. And I’ll emphasize, you know, credible. Credible are people that do valuations and or advise firms like yours in your space, and have a track record for doing so with integrity and expertise, not arm’s length, sort of valuation shops or ones that don’t understand the space, or, more importantly, someone achieving a valuation that’s not specifically designed to value equity and support of either a partner buyout or a wholesale sale of the business. Why that’s critically important is because there’s a variety of reasons and sources for getting business valuation, everything from someone to who can kind of look at a multiple, and they sort of swag an estimate and think that an estimate is the same as evaluation, to going to a insurance company who may do an evaluation of your business pursuant to buying key man insurance, to, you know, ensure the value of the equity that any individual partner or group of partners might own to a bank that might do a valuation pursuant to lending support of lending to looking at, you know, A variety of other reasons, it’s important that if partners are to come together on a partner buyout or a liquidity event, that they get a independent valuation of the business supported by people who know the space and have relevant comps and experience in the space to advise them on what is the real value of the equity, and what options do you have as it relates to either selling all the equity or some of the equity, or, you know, doing a recapitalization, or even one partner buying out another, using some leverage to do that. There’s all kinds of the options. But it all starts with quantum, one version of the truth, right, the ability to understand value and be able to respond to value and to offers. Right? It may be that the partnership agrees that they want to go to market and run a sell side process, you know, with a firm like revenue rocket, where we can maximize value in the open market, where we get competition to kind of, you know, for lack of a better term, run the number up, right? Run get valuation. Competition creates optimized offers, typically in the sale of a business. And so that might be the objective. So I think in the end, you’d need to start with a baseline of what the heck is this business worth? And then what are the objectives of the owners? And then align and coal ask for best possible outcome. And oftentimes all roads there lead to a relevant and competent advisor who can help you figure out your options.

Ryan Barnett  18:19

Yeah, well said, figuring out that value, I think, is critical the market will bear. So if you have a an agreement here, and you’re looking to perhaps exit a partner gearing that exit, that’s going to help determine real market value compared to theoretical market value. And I want to go back to something, Matt, you were touching up, and I just want you to dig in that tiny bit more, which is you’d mentioned the continuity of the firm and the if a buyer is evaluating a partner that leaves, or if there’s The party. I just want to help me understand, buyers are going to ask a lot of questions about the continuity, or what that partner did, and what should sellers be what should sellers be aware of, and how should they position someone who’s leaving as far as their roles responsibilities, especially if there’s a perhaps an add back attached to that person’s salary? Yeah, well,

Matt Lockhart  19:22

I think it goes back to, you know what I was saying, where you have executed, and it’s not full succession, right? Because the the finality of succession is somebody leaves, right? But you’ve, you’ve, you’ve executed the preparation for that. You know, you put people around you. You’ve put great people around you who are have decision making ability that are demonstrating that they are growing the business and managing the business. Whatever aspect of that business that a particular shareholder is is responsible for, and that, you know, that’s just good business overall, right? But in particular, and if a buyer is looking at that, they are going to say, Okay, what has been done? When was that done? How? How was that done? And if it’s like, hey, we hired somebody six weeks ago who is doing x right? Well, then they’re going to, then they’re going to look at it probably a little bit more critically, rather than, okay, I used to say, you know, many partners, right? And let’s think about it in the context of a founder led business, and one individual was responsible for sales, and this individual was a rain maker, and he also maintained all of the customer relationships, or the most important customer relationships, and and he did that because he really loved those relationships. He really liked that’s what he personally got satisfaction from. And then all of a sudden, for whatever reason, whatever event, that individual was, you know, looking to exit the business, and he hadn’t built an organization around him. He hadn’t hired sales leaders, right? He hadn’t built a go to market engine and an account management engine. Well, then a buyer is going to go, Well, wait. A second, there’s a whole bunch of risk in relation to that particular individual leaving the business and and they’re going to, you know, they’re going to assess that risk as to whether or not they can go forward with an opportunity. And then also they’re going to value the business and associate that risk to it, right? So it’s just this is this sort of goes back to, you know what I was saying earlier, that it’s important to continually be checking in with your partners, where yet, how you feeling? Right? What’s your timing? All right? Where’s your excitement, right? All of those things related to the business. So that if there is an indication by one partner or the other that they’re starting to think about their timeline, planning can be done and action can be taken and look, we’ve advised the numerous clients through these activities, and so it’s very doable. It just, it’s just better to be open and be planful.

Ryan Barnett  22:57

Yeah, I think you did. That’s great. We’ve got a lot of this subject. Is there any case studies Matt or Mike, either on a really successful exit agreement, or any horror stories that might help kind of punctuate this, or anything that you’ve seen that might help someone relate to the audience on the situation?

Mike Harvath  23:23

Yeah well, how much time do we have, Ryan? I’m joking a little bit, but there certainly this can be an area of contention for people. We even have entrepreneurs that say they won’t enter into partnerships because they’re just too hard to manage. I’m not in that camp. I think partners bring great value and great skills that individual leaders, as you as entrepreneurs may not have, right? And I’m not the only one that believes that. I mean, if you are looking around and listen to anyone who’s built, you know, you call them serial entrepreneurs, or entrepreneurs that that have built, you know, great companies over time. They’ll talk a lot about, you know, how the group of people come together, that the team of people, of leaders, come together to do great things together that they can’t necessarily do a part. But I will add that, you know, it is critically important to have alignment in your partnership, and more importantly, have a governance structure in your partnership that will allow you to bring in and exit partners as a firm continues to grow and evolve, and as I mentioned earlier in this podcast, it has to do with the shareholder agreement or operating agreement. Vagueness in that agreement can create a lot of consternation. I’ve seen it. I’ve had experience where we’ve had to be or introduce ourselves in new engagements, where we become a deal facilitator to help you know, navigate that those waters, if those documents aren’t clear, pursuant to either a partner buyout or an. Partner coming in, or, you know, exiting and or a wholesale exit of all the partners. So you know, if there’s any battle cry here, for those of you are listening, and for those of you that have partners, do make sure that those documents are aligned, and that should give you a great baseline for your ability to at least help start a dialog with your partners, for those that may want to exit and or start a dialog about how to have a much more broader exit. That is fair enough, global all parties.

Ryan Barnett  25:42

Sounds good. I appreciate that. You know what I heard, Matt and Mike here today. Whereas, as I said, first of all, having an operating agreement in place, shareholding agreement is critical. So work with a lawyer to draft that up, make sure that is something that you’ll have sustaining going to have it’s going to have all sorts of things that will help you operate together and have a partnership. If you do have an exit, you’ll have an appropriate exit plan. I heard that there’s options for for having partnerships go out from from a partner buyout all the way through having the firm acquired and and someone departing, you’ll be responsible for any debt associated with that, or any kind of if you’re any debts associated is typically going to be a cash free, debt free transaction. So just be prepared to clear off your debt you may take on in the case that you do have a a partnership that does require some kind of financing, I heard that M and A can be a great option for this. So if there are funds or recapitalization that it can be in place, there are, there are buyers that are happy to work with under companies that perhaps have one person staying and one person leaving, or or both both departing, really, where it depends on that buyer. I heard that it’s important to have continuity within your your teams, and to make sure that if someone is departing, to understand the full impact that they have the company, so any potential suitors will understand where they need to replace and I heard that if you’re you’re going through any kind of partnership that needs changing or funding evaluation is critical, and you need to use a third party firm to get that run done, right? Matt, I’ll turn over to you for any last thoughts and take over to Mike to close us out.

Matt Lockhart  27:36

Well, thanks, Ryan. I mean, I think great topic. Thank you, Ryan. If it’s this situation or any other situation related to creating the greatest amount of value in your firm, we would love to chat. I think that’s the way we’ll close it out again. We’re super excited if you’re listening I’m sure you’ve seen something from Revenue Rocket related to our new listings. If you haven’t give us a call, we’d be excited to talk to you about those. And we’re pretty fired up to be this busy towards the end of the summer. So speaks well to a good end of the year here for all of us. Mike?

Mike Harvath  28:21

Thanks, Matt. Thanks, Ryan, and with that, we’ll tie a ribbon on it for this week’s Shoot the Moon podcast. Encourage all of you guys to tune in next week while we unpack further, hopefully interesting topics to you on M&A and growth strategy for your tech enabled services company, make it a great week. Take care.