BUILDING CREDIBILITY FOR BUSINESS OWNERSHIP: 4th article in the series of M&A


Credibility is an intangible but essential ingredient in making a successful business deal. According to Webster’s dictionary, to be credible is to be “worthy of trust” or “believable.”  In business, it refers to the belief and perception of other people that you are able to do the things you propose to do. There is no scientific way to measure credibility or to assure that others believe in you.  However, there are a number of tips outlined in this chapter to help increase the likelihood that others will take you seriously in a business deal.

 

General Qualities that Contribute to Credibility

Display of integrity, pragmatism, interpersonal skills, professionalism and ability all contribute toward your credibility. 

 

Integrity. Integrity refers to sincerity or honesty–that you mean what you say.  A business person of integrity addresses the issues openly and directly. People feel that they can trust you and rely on your word.  They do not fear that you will do something underhanded when their backs are turned.

Pragmatism This is another quality that contributes toward a credible image.  A pragmatic person understands the issues and is realistic.

Interpersonal skills Interpersonal skills can also contribute to your credibility.  These skills involve your ability to communicate clearly with others and to be considerate of others.

Professionalism How do you come across as professional?  Be thorough in any detail you handle.  Find out as much as you can about the companies and industries you plan to deal with so that you will appear knowledgeable.  A person who approaches an issue with intelligence, analysis, and calmness is  viewed as professional or objective in demeanor. Such demeanor generates respect and trust by others.

Knowledge of the acquisition process Beyond your knowledge of the specific companies and industries, it is important that you convey knowledge of the acquisition process.  You must convey the sense that you can handle all the complexities of managing the deal, from financing, to due diligence and closing. Your advance preparation in researching the industry and type of company you plan to buy all increase the likelihood that people will view you as having what it takes to close the deal.   In short, people have to believe that you are able to do the deal.

Your educational background and work experience Formal education and work experience also contribute to your image. Others probably weigh your education more heavily in assessing your ability if you are younger. As you get older, work experience typically matters more.

Experience may be in a wide variety of business or technical professions, with engineering, sales, or finance being especially helpful. Any experience you may have working with banks is also helpful, even for a past personal loan such as a home mortgage.

Having an initial plan Having a clear idea about what you want to do also builds confidence in others that you are able to complete the deal.  A good written business plan is also very helpful.

Your business associates The credibility of each of your business associates–investors, bankers, consultants or employees– rubs off on your own image, for better or for worse.   Especially if you are young, finding more seasoned members of the team can be very helpful in building credibility and in increasing the odds of your success.  Be especially careful to look into the backgrounds of strangers. You do not want to ruin your own reputation by dealing with unscrupulous individuals, either as investors, lenders, employees or business partners.

Credibility for a particular venture Credibility also varies depending upon the particular business venture you are embarking upon.  Experience in one industry may or may not carry over fully into another industry. If you have experience in the manufacturing sector, for instance, you may still have to re-establish yourself in the service sector.  Or if you have experience building diversified conglomerates in related industries, you may still have to establish credibility for success in building a portfolio for a holding company.

Credibility is Important in Deal-Making

A credible image is essential at each stage in the deal-making process and for each group you may work with.  For instance, in the early stages of searching for a company, credibility must be established with a banker so that you can obtain a letter of understanding, a document that indicates that a bank is willing to deal with you if you find the right company.  The letter of understanding, in turn,  helps you to obtain credibility with the broker community, which you need in order to obtain the lead flow to find the right deal.  If you need other investors to raise sufficient capital for the deal, credibility is also essential with that group.

Credibility with the seller is also important.  Whereas in real estate, a seller often has a contractual obligation with a listing broker to sell his or her property if a full price, cash, non-contingent offer is presented, such requirements are rare in the sale of most businesses.  Sellers have been known to refuse a sale to a higher bidder.  Purchase of a company is a fairly complicated and drawn-out process.  A seller is likely to back out of a deal or refuse to enter into one, at all, with a buyer that he or she does not trust. Where an investment banker screens initial prospects, you may not even have the opportunity to learn about or bid on a company unless the banker feels you are a legitimate buyer.

Finally, at later stages in the deal-making process, you will need to be viewed as trustworthy and believable by prospective employees.  Otherwise the value of the company you

are purchasing may seriously erode before you even have a chance to take over, due to a drop in productivity or increased turnover of valued employees.

Credibility and the Banker

Establishing credibility with the banker is often a prerequisite for establishing credibility with other parties.  When you have established credibility with a bank, it will often provide you will a letter of understanding which can be shown to the broker, seller or others to show that a bank is likely to lend you money needed to close the deal.  Although the bank is unlikely to provide you with a blanket approval, it will often provide such a letter on a deal by deal basis.  This allows you to say, to the seller, for instance, that he or she can call John Doe, at First Bank to personally verify the relationship.

This was done when J.P. Industries was founded.  Founder and author Psarouthakis spoke with representatives from a couple of investment banks and came to an understanding on a deal by deal basis. They gave permission to use their name in the brochure that J.P. Industries distributed to business brokers and potential sellers.

The banker is likely to consider the following issues in considering your credibility:

1)      How serious are you about the business deal?

2)      What are your qualifications for running the business?

3)      What are your strategic thoughts? How are you going to be equally or more successful than the present owner of the company?

4)      How much equity is available?

5)      Who are the equity investors?  Are you alone or are there others?

6)      Do you have an initial business plan?; and

7)      Do you have a plan for paying off the loan?

 

How serious you are about business ownership

One way to establish the seriousness of your intent is the amount of effort you are expending toward your new venture.  In general, bankers and others assume that you are more serious about the project if you are working at it full time.  This is not to say that you must quit your present job to get a loan, but it does contribute to a banker’s opinion of how serious you are about the project.  A banker is likely to view you differently if you have two years’ of income saved up and are planning to look for companies full-time than if you are simply between jobs or you are still working at your present job.

If you do plan to quit your job, you must plan for this step very carefully.  You should be ready to live on savings for up to two years until you have made the transition to your new company.  You also need to make plans with your family so that they are prepared and willing to make the appropriate sacrifices.

 

 

 

Your business qualifications for running the business

Though not necessary, it is helpful to have an M.B.A. (Master’s of Business Administration.  During the acquisition process, having the M.B.A. does have some impact.  With or without the M.B.A., it is important to have good advisors.  Your familiarity with the industry is also very important, not only to the banker but to the seller too.  Many sellers feel uncomfortable with the “whiz kid” from Wall Street, and would often rather deal with someone with past operating experience in the same or a related industry.

 

Your strategic thoughts.

 

The banker will also want to know what you plan to do with your company.  Do you know how you are going to improve value of the company and what you plan to do with the company in the long run? Why do you feel that an investment in this industry is a good move at this time and what changes will you make to assure that your company will be successful.  Strategy doesn’t need to be complicated but it should be clearly thought out and communicated, preferably in a written business plan.

 

The amount of equity available

Bankers frequently inform all those that will listen that they are not in the equity business. They expect a significant percentage of the transaction will be covered by equity investment by you or other investors. The rule of thumb varies from year to year, and decade to decade, and industry to industry. For instance, in manufacturing, today, a typical ratio is three dollars of debt to one dollar of equity depending upon the degree to which the loan can be secured by tangible assets within the company.  Although much more highly leveraged acquisitions, with ratios as high as ten or twelve, have been supported by banks in the past, their high failure rate has made most banks more cautious.  The ratio will vary from bank to bank, and also from industry to industry, typically being much lower for a service-type business lacking lacks inventory or other assets to secure the loan.

The other equity investors, if any

Your investment group can contribute substantially to your credibility with the banker, seller, brokers and others.  If someone with wealth has made a significant investment in your project, this definitely contributes to your credibility.

 

Your initial business plan

Adequate attention to development of an initial business plan will assist in building credibility with the banker. The banker wants to be sure you have a clear idea what type of company you are looking for, what you are going to do with that company once you buy it (fix it up for resale, create a group of companies, etc.) and how you are going to go about finding the right

company and making the deal (how you will find the leads, who will assist you in screening the right candidates, how you will carry out due diligence, and so forth). Once you identify the specific company you plan to buy, you will then need to prepare a more detailed plan for that company.

 

Your plan to pay off the loan

The banker will want to know how you plan to pay off the loan.  For instance, do you plan to go public, sell the company, or simply pay off the loan from cash flow?  The banker wants to know what they will get in return for the risk they are taking.   

 

The extent to which the loan can be secured

You don’t necessarily have to be an executive from a Fortune 500 company to get a bank loan.  the bank will evaluate the assets of the company you plan to purchase.  As alluded to earlier, a banker will feel more comfortable lending to you if you have some way of securing the debt, whether with personal assets, assets from your existing business, if you have one, or assets of the company that you plan to purchase.

Credibility and the Investor

Many of the same issues described already that contribute to credibility for the banker and seller, are also likely to pertain to the investor.  In addition, the investor will want to know the exit strategy for his or her investment, which may or may not be the same plan as for the banker. For instance, if you take the company public, this might be way to pay off both the banker and investor.  Or you may plan to pay the investor with a high level of dividend distribution of earnings.

 

Credibility and the Broker

Companies are bought and sold in a very unique way, compared with any other industry.  There are few publicly available places to find out about which businesses are for sale, because it is usually not in a company’s best interest to advertise broadly that it is on the market. Existing customers, suppliers and employees may become apprehensive about a potential change in ownership.  And some leads are only developed by brokers after it becomes evident that a potential buyer might be interested in a particular firm.  Many companies are sold each year that their owners had not even considered selling, at the outset but after hard work by a broker, and expressed interest by a buyer, eventually a deal was made. Brokers do not pursue such leads for a buyer unless they feel that the buyer is serious and capable of following through with the purchase.

Some general factors related to credibility concern your educational background, your advisors and experience.  If you have an M.B.A., good advisors and familiarity with the industry you are going into, you are likely to establish credibility more easily with brokers as well as with other groups.

Credibility with the banker also helps you to establish credibility with the broker community.  Obtaining a letter of understanding from the banker can be very useful in establishing that credibility.  Thus, all the issues related to credibility with the banker, apply here as well.

Credibility and the Seller

The seller has to feel that you can make the deal.  Five things are important to the seller in determining credibility:

1)      Can you finance the deal?

2)      How serious are you about making a deal?

3)      Do you know how to make the deal?

4)      Will you treat employees fairly?

5)      Do you plan to retain the integrity of the original business?

Your ability to finance the deal

Generally the seller doesn’t want to wait a year while you find the money. The rare seller will give you six months to find the money.  Most sellers realize you may not have the cash in the bank but they want to feel comfortable that having made the deal, you can get access to the money almost immediately.  You need to assure the seller that you have serious money sources subject to the deal. Then he will be comfortable dealing with you because the financing is obviously there.  You should develop a strong relationship and obtain a letter of understanding from at least one bank early on in your search.  You also need to line up whichever equity sources you might require.

 

How serious you are about making a deal

How serious you are about making the deal is often determined by others by the commitment you have made to the search.  In addition to having the funds required, awareness of the time and effort involved is important for credibility not only with the seller but with business brokers.  Whether fairly interpreted or not, most in the deal-making business will take a buyer less seriously who is still working at a full-time job, or who comes across as being “between jobs” and just looking around.  Making a deal is a demanding process that requires full time attention to see through in a reasonable amount of time. You need to plan for as much as eighteen months to two years to see a search through from beginning to end.  About one year is to find the right company. Figure another six to ten months to complete the acquisition process once you find the right company.

 

 

Your knowledge of the deal-making process

Making the right deal requires knowledge of the different business functions, including marketing, finance accounting, legal and operational aspects of the business, as well as technical aspects related to the particular industry.  In addition you will need all the specific deal-making skills, including evaluating, pricing, valuing, and negotiating the possible deal as well as closing the final deal.

Your likely treatment of employees

Your perceived treatment of future employees is often a concern in the family business, especially where many employees have worked in the company for many years.

Your long term plans for the company

Many sellers, especially the owner of a private company who has spent a lifetime building the business, wants to feel that you are not planning to hack up the company into pieces as soon as you have bought it. These same sellers may be concerned about whether you plan to move the company to another city or otherwise destroy the identity or integrity of the original business.  These concerns are likely to be less for the large conglomerate selling off a division.  However, to the extent it might impact employee relations at the remaining company, it can still be important.

Credibility with Other Groups

The issue of credibility with customers and suppliers is not as critical as it is with the aforementioned groups, at least in the early stages, and for larger companies.  However, it may be of concern in small companies.  The customer will be concerned with the continuity of services.  Suppliers are concerns that they are going to lose you.

The employee issue, although not at issue early on in the negotiations, can be very important in later stages. When the owner changes, people may feel a great degree of uncertainty.  Uncertainty creates insecurities and insecurities can create low productivity.  You may lose your good people before the deal closes.  So you need to move quickly even during the due diligence phase, as the rumor of a possible sale of the company spreads among employees.  You also need to relate with employees so that they can begin to know you. It is important to communicate who you are, why you bought the company, and in broad terms, what you plan to do with the company.

Credibility with the public can be a factor, especially with a large publicly held company.  They will want to know your plans for the company as well, especially plans that will dramatically increase or decrease the number of jobs that your company provides the local community.  Plant closings, expansions or other abrupt changes in employment levels will be of great concern.

Main Reference: “How to Acquire the Right Business”

John Psarouthakis & Lorraine Uhlaner

Published by Xlibris, 2009

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