Addison Adams - 3 Structures for the Sale of Your Business (D1118)

Welcome to the Exit Coach Radio show, the show for baby boomer business owners who are looking for cutting edge information as they plan their 3 to 10 year business succession and exit. Every week we interview top professional advisors for their best tips, strategies, and precautions so you can be well planned. And don't miss our one minute exit coach. Tip of the day on exit coachradio.com. And now here's your host, the exit coach, Bill Black. Welcome back everyone. With me now is Addison Adams. Welcome to the show, Addison. Thank you very much, Bill. It's a pleasure to be here. Well, it's our pleasure because we're gonna talk about legal issues around growing your business, and we've talked a bit about this. Topic on the phone and I was fascinated by some of the things we're going to cover, but first tell us a little bit about your background, your, your personal story. What's happened in your life to bring you to here where you are today? Sure, well, I am a native Californian born in Los Angeles and was a finance and real estate undergrad in college and then went to law school down in San Diego and Worked for a couple of years at a large class action complex litigation law firm and did that here in Orange County and then joined another firm doing similar work, getting experience also in intellectual property and labor matters and then for the past 14 years, my work has been primarily corporate transactional mergers and acquisitions and and corporate finance for emerging growth companies. So you've seen a lot of situations over the years, especially in the M&A and corporate transactions world. Absolutely we're very much pride ourselves on being entrepreneurial on our clients' behalf to help them understand and weigh the different importances of essentially risk that they are accepting to take as part of growing their business. So when clients come to you, they're thinking along the lines of, I want to get into a debt transaction or an equity transaction of some kind, either go public or raise money to grow. or things along those lines, and you have the background and the abilities to tell them, OK, well, let's talk about the pros and cons of each of the different types of transactions, correct? Absolutely. And that's where they come to you for guidance in those areas. Is that a typical situation for you or have they gone? you said you already work with companies that have already gone. What's a typical, most of the spectrum are startup companies with no revenue. Or the revenues are in the 1 or $5 million.10 million range up to about $100 million. This is the focus of my firm and of of my specific practice, which means that for the most part they don't have any in-house general counsel. They may have an in-house attorney that's very specific to their exact product, that's churning out perhaps a customer agreement or a specific type of license, depending on what their product or service is, but they don't have a generalist that's able to come in. And help with any kind of a labor dispute or distribution matter and certainly not the expertise to handle a corporate finance transaction. And by that what I mean is primarily that refers to an investor coming in to write a check or a group of investors to buy equity. The company. Do you find that a lot of people are so grateful that somebody's going to write a check that that they don't think through a lot of the situations? I mean, do you see a lot of messes in those situations or obviously you'd rather have people come to you before someone wants to invest and be prepared for that kind of a situation. That's exactly right, and that's actually a role that I play for a lot of the earlier stage startup companies is giving them advice early on in the process and also being available for quick questions as they go through the effort of trying to find capital and more importantly grow their business into something that's no longer an idea, it's actually turned into revenues and then when an opportunity comes along, there's no time. Lost getting up to speed on what the business is and what the needs are. So from the point of view of, I think, being prepared for that, having an attorney such as myself in the Rolodex and you know, ready to be activated at a moment's notice is very important and it can be very helpful to just in terms of any day to day legal needs that come up. Are there any particular industries that you specialize in or is it across the board with your firm? We do a fair amount. Of entertainment companies and interactive media, online websites, e-commerce, and manufacturing and distribution and tech, of course, and software. So the main areas for particularly for the going public transactions tends to be patent heavy tech related industries. A lot of intellectual property involved and that has its own specialties. So the question about whether there can be a rush to accept as soon as it's offered to you and of course that depends very much on the status of the company, whether it's a startup that's living off of savings are there or whether it's already an established business that's cash flow positive and has much more. Time and resources and options available. So the first thing that I think any business owner that's looking to grow their business needs to evaluate if they're wanting to raise capital in order to grow their business is to assess whether they'd be interested in raising debt or raising equity or raising some combination of that. That's a great place for a break. We're going to come back right after this commercial and talk about that. I'm talking with Addison Adams. We'll be right back. Hi everybody, this is Spike Reel with the Exit coach. Business owners, can you name the eight key value drivers that you and your manager should be focusing on to increase the value of your business? Introducing the Sellability score index. Visit our website and answer 25 questions about your business, and you will instantly receive your sellability score, showing you how well you stack up in the 8 value driver areas. It's a great management tool. It's absolutely free for our listeners. Just visit exitcoachradio.com and click get my Sellability score. Well, let's go back and, uh, wrap up our discussion of going public here, and I, I, I want to, ah, I want to interject here. I'm gonna call him in about 4 or 5 years and we're ready to take this platform public here. I, I, we now know who the attorney is we should talk to here. There you go. Well, absolutely you need a specialist in this particular area, so I'm talking with Addison Adams, and Addison, before the break we talked about some of the pros and cons of raising. whether debt or equity, what can you tell us about that? Well, the first thing I think to really think about is if you as a business owner can grow the company without raising capital and just self-funding it, then you of course are giving yourself the majority of the upside. However, if you have a risky company, a startup idea that you believe will be highly successful, but you know that there's some Risk that it may or may not work out, then the wise thing for you to do, even if you have all the money you need to invest in it, would be to distribute some of that risk and bring in some partners. In that case, you would be interested in equity investors because you don't want to take on the added risk of being forced to pay back the debt if things don't work out on the business venture. And so in that scenario that can be very, very wise, even though you're giving up some of the upside. If the if the business needs capital to grow, then bringing in that capital and getting the business grown is is the right thing to do, even if you're giving up even a significant amount of ownership of the company in order to do so. I like to say that it's better to own a slice of the watermelon than all of the grape. It's a good visual. Yes, and of course bringing in the capital, if that's what's needed is something that needs, you know, that should get done and needs to get done because just to follow the metaphor, you'd hate to see your grape die on the vine. Conversely, if the business obviously is able to borrow debt because it has assets that will interest a lender or it has a history of profitability, then the risk of it not being able to pay off that debt is less and The opportunity to grow the business and hold all the equity in the owner's hands instead of sharing it gives the owner more of the upside on the eventual exit down the road. I see. OK, so now when we talk about raising capital by equity, there are many ways to go, right? When is a company the right size to consider an IPO or a public offering, or what are the alternatives to that for different sizes of company? Well, my focus again is at the smaller end of the business spectrum, the sub $100 million revenue companies, and for them, the main thing about going public is going to be, there's a lot of costs involved with going public, not only in the cost of the experts, the lawyers and the accountants that also you need to train your management on the on how to be public and how to be careful about disclosures and insider trading and all of these requirements that are involved. So you want to make sure going public is going to be successful in the long run for your company, and in order for that to happen, what you need is to have both the capital to handle it after you're public, as well as a growth plan, a growth strategy that will justify being public, because if you're a small company, even a startup company, you can go public as a method to gain access to capital, and this is something that I work on quite a bit. However, the business, the product, the service, it needs. To be something that has a growth story attached, a large market, a disruptive technology, and so what we see is that for smaller companies it either falls into the category of patent heavy, intellectual property heavy business or it may be something that's more traditional, like a distributor or manufacturer or traditional business that has big plans to grow by acquisition. Maybe it's a regional player in California. to just expand and roll out nationwide and then worldwide and going public is thought that can help raise large amounts of cash to buy these other smaller competitors and also potentially use their public stock as a currency to buy the other competitors in lieu of cash and then fold them into a larger operation. You've got to go from small to big in order for it to make sense as a public company. Is there a number you can assign to that revenues wise when Somebody's gotten to the area where it even starts to make sense and below that it doesn't make sense at all. We did an IPO last month for a company that has no revenues but has a huge patent portfolio. It was a smaller size IPO of $15 million and a great team around it and a great idea. This company could grow into a huge company if and when the product gets commercialized, it will be a large market. But of course there's a risk that it won't work out. And circumstantial based on the fact pattern and the growth projections as you mentioned, right? Correct. And I, I would say that if you're not relying on a huge patent library, then you'd want to have north of 100 million in revenues in order to for it to make sense to do an IPO. OK, well that's that's something our listeners can hang their hat on, I guess it's not for the small. What about private equity or transactions along those lines? You all handle those types of things. as well as right for the smaller investor that needs equity, would that be another avenue that they would take a look at if they weren't big enough to go public? Yes, bringing in partners from angel investors or from private equity funds. Now typically private equity funds will come in as the acquisition and buy your whole business or buy a whole division of your business. It's rare that they would take a minority position and so that is where you'd be looking more at angel investors and and. Venture capital sources of capital in terms of equity and of course friends and family that you can find friends and family. Christmas is coming, so maybe. So tell us, you know, in the last couple of minutes we have, do you have any tips or ideas or precautions that our listeners should think about as they prepare their businesses for growth? Anything that comes to the top of your mind that they should be thinking about? Absolutely. OK. In the sale of a company, you are in a very cooperative process with the other side. If you're the seller of the business and the buyer is coming in and evaluating whether to buy your business, there needs to be a high level of trust there, a trust that you are not only being open and honest about your business and what you know about it, but also credibility that you know what you're talking about and that when you Hand over your financial statements, for example, they're clean, they're correct, um, they're complete, and they're not misleading, preferably they're audited and not only currently audited, but going back several years, and this is so that there is a confidence that comes in from the point of view of the buyer. A tip that I would have is try to look at it from the buyer's point of view and assess your business. Now in terms of what is the driving value in your business, is it a patent portfolio or is it a customer list? Is it access to certain markets? Are you in a niche? Are there barriers to entry and whatever that is, make sure that you can protect that and deliver it as part of the sale and talk to an advisor about how to go about doing that to make sure that it's ready. Some of the Smaller things that can be focused on in terms of tips and tricks is in order to make the sale process go smoother, you wanna have, of course, clean books and records. You also wanna have access to all your material contracts. As you go through entering into contracts, think about. Assignment clauses in there and make sure that you have the right to assign your material contracts to a buyer, particularly in the event of a sale of a business. A lot of times customers, large customers might want to restrict that because they want to make sure they have a consent right on who they're doing business with. If you can try to avoid that so that you have the right to sell your business without asking that third party for approval. So make sure that you can transfer freely in advance before you find out that you can't at some point down the road because that could hold up the sale. What else do you have? An idea here is to also look at your business not only from the value point of view, but from the risk point of view. What is it about your business that is likely to make a are nervous that they might get sued for something about your business after the sale. So if you're selling products, a buyer will be worried about product liability. If you're selling those products to the general public, then the buyer will be worried about false advertising and basically consumer class action claims for misleading labeling if it's a food product, for example, on the patent side. They'll be worried about potential claims for infringement from a prior owner of an infringed patent. So to the extent you can speak with a patent lawyer and make sure you've done the research on the prior art and you've got some confidence, then that's going to not only give comfort to the buyer, but it will give comfort to you if and when you're asked to give a weapon warranty that there is no infringement being caused by your own patents that you're selling. And so identifying areas of concern now is a great thing to do in order to start getting the blocks in place so that you're ready to deliver the business. So when they, when should someone get in touch with you? Is it the answer is now the best was 5 years ago and the second is. I, I think that's actually it's, it's absolutely correct because you should be running your business. In a way to not, you know, of course you need to maximize the value of the business, try to get it in a manner that it can run on its own without you, assuming your idea of selling it is to actually leave and make sure that you're running it professionally and properly, and that can be tricky even for larger companies, but especially for smaller business owners, smaller companies running it in a way where the owner and the managers are all being constantly trained and constantly updated on. How to run it in a best practices way is critical, and talking to an M&A attorney such as myself, talking to and having a good auditor that's familiar with these types of transactions and knows how to do financial due diligence so they can help you survive that scrutiny when the time comes, having insurance, everything needs to be in place and should be analyzed right away, especially if someone's listening to your program. That suggests that they've got an idea of selling their business within the foreseeable horizon. Addison, this is a fascinating interview. Thank you so much for joining me, and I hope our listeners were paying attention. I hope you'll come back and join us again sometime soon. Thank you. I would love to. Thank you very much, Bill. Well, my friends, that's going to do it for our show today. I want to thank you for listening in. I hope you've learned a thing or two that will help you in some way with your future planning. Thank you for listening to Exit Coach Radio. Time is precious and so are our pets, so time with our pets is extra precious. That's why we started Dutch. Dutch provides 24/7 access to licensed vets with unlimited virtual visits and follow-ups for up to 5 pets. You can message a vet at any time and schedule a video visit the same day. Our vets can even prescribe medication for many ailments, and shipping is always free. 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