BTS Header Logo

3 vs. 9 Times Earnings

This week in Built to Sell News, we’re covering:

  • Why some E&Y partners got offered 9 times earnings while some got just 3
  • Insisting on cash vs. rolling equity
  • Why 44% of earn-out deals are now tied to EBITDA
  • Inside the mind of an acquirer of 45 businesses (listen now)
  • A trophy Porsche
  • Happy people at Angry Birds
  • How to lose $235 million

Last week, Ernst & Young cancelled plans to break the firm into two businesses. While the deal is dead, the sordid details of the proposed split provide insight into the inner workings of the usually secretive partnership and provide entrepreneurs with a rare glimpse into the relative value of cash and shares in an M&A transaction.

The failed proposal called for splitting E&Y into a slower growth audit business and a faster-growing consulting company. The Wall Street Journal reported that E&Y partners based in the United States, staying with the audit business, were set to receive a cash windfall of roughly three times their annual compensation in return for giving up their share of the consulting business.

The partners’ moving to the swashbuckling new consulting business were set to receive shares in the new entity equivalent to nine times their annual compensation paid out over five years. Given the average E&Y partner earned $850,000 last year according to the Journal, the equity stake in the consulting company represented life-changing money for the consulting company partners — on paper.

🏧 Selling Your Business: Insisting on Cash vs. Rolling Equity

What’s going on here? Why would the audit guys get a measly three times earnings while the consulting folks commanded nine? The consulting partners were going to get triple the audit partners payout because they were being asked to accept their compensation in relatively risky shares in the consulting business with a five-year hold back. A consulting company has limited hard assets so the entire value of the business is goodwill — easily eroded by an errant partner or by selling bad advice.  In other words, the consulting partners were taking more risk and waiting longer for their money.

A similar principle will apply when selling your business. Most owners prefer to receive 100% of their sale proceeds at closing, but if you insist on all of your money up front, expect to get a lot less for your business than if you are willing to take some risk and get paid out over time as your company hits milestones in the future. 

🧠 Inside the Mind of an Acquirer of 45 Businesses (including 3 former guests)

For example, this week on Built to Sell Radio, John Warrillow interviewed Kevin McArdle, who runs Big Band Software, a holding company for software businesses. McArdle has acquired 45 businesses, including three former Built to Sell Radio guests (Laura RoederHow to Make Your Email List Worth 7-Figures, Arvid Kahl and Danielle Simpson – How to Scratch Your Itch, and Tyler Tringas – A Small Giant Makes a Great Exit), so we wanted to understand how he thinks about the value of a business.

Unlike most private equity groups who pay a multiple of revenue for a SaaS company, McArdle told John he typically values the businesses he buys between 4 and 10 times EBITDA. The difference is McArdle usually pays 100% upfront, whereas most private equity buyers insist the seller rolls a portion (usually at least a third) of their sale proceeds into equity in a new entity the PE firm creates when they buy a business (i.e. “rolling equity”).

📈 44% of Earnout Deals Now Tied To EBITDA

As the economy has worsened over the last year, private equity groups are even more likely to force sellers to take some risk. According to an upcoming study from SRS Acquiom, 18% of M&A deals involving PE buyers in 2022 had earnouts, up from 15% in the previous year. Among these deals, 44% had earnout provisions tied to EBITDA growth last year, compared with only 10% in 2021.

When you decide to sell your business, think deeply about the time value of money and where you want to sit on the risk/reward curve. Insist on cash and you can expect to get a lot less than if you’re willing to take some of your proceeds in shares and get paid out over time.

🌷 Spring Clean Up

Spring is here and if you’re tidying up messes inside your company, create Standard Operating Procedures for your employees to follow. Download our free guide to SOPs here.

📽️ Clip-of-the-Week

In this clip, Kevin McArdle explains that while his offers may sometimes be lower than other private equity buyers, his all-cash offers are often more appealing to entrepreneurs who prefer immediate cash instead of having to roll equity.

🏆 The Trophy: How to Commemorate Your Win

Kelby Zorgdrager, the founder of DevelopIntelligence, has certainly enjoyed the fruits of his labor since selling his business. He treated himself to not just one, but two trophies: a stunning lake house on Lake Macatawa in Michigan and a Porsche Cayenne Turbo. You can hear the emotion in his voice as he describes these purchases to John at the 1:06:07 mark of the episode. 

  📣 Quote of the Week

“As private equity deal financing gets harder, sellers are granting favorable deal terms to buyers, such as deferred or performance-based payment, in order to close transactions”.

– Madeline Shi – Pitchbook

📈 Recent Deals

  • Rovio, the creator of the popular mobile game Angry Birds, has been offered a deal to be acquired by Sega for an estimated valuation of $776 million.
  • Dan Snyder has agreed to sell the NFL’s Washington Commanders to billionaire investor Josh Harris for a record-breaking sum of $6 billion. Snyder bought the team in 1999 for $800 million. 
  • Walmart has sold men’s clothing company Bonobos for $75 million, marking a significant loss of $235 million compared to its 2017 purchase price.

We’re always on the lookout for inspiring entrepreneurs to feature on Built to Sell Radio, and we need your help to find them. To nominate a founder, head here.

(Was this newsletter forwarded to you? Sign up here.)

Colin Morgan, Executive Producer of Built to Sell Radio

John Warrillow, Host of Built to Sell Radio

Daphne Parsekian, Copy Editor

Denis Labataglia, Audio Engineer

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

BTS Footer Logo

Build, Accelerate and Harvest the Value of Your Company

© All Rights Reserved | Built To Sell