Before you sell your company, or merge with another company, there are some things you need to think through. Our guest on this edition of “Deal Talk” shares five rules that he says could help you make the right choice, whether you’re considering a strategic M&A deal to grow your business or an outright sale to exit your business altogether. James Lewis is a business consultant and former executive at CVS Health, who worked to acquire a number of small businesses for the company. That background combined with his own entrepreneurial experience gives him a unique perspective with insight that all business owners can learn from.
If it ain't going to make something better then use your time and effort to do something else for your business.
- James Lewis
Jeff: Jim, you have yourself one heck of a resume and I knew this because I've been on your LinkedIn profile page and it's always fun to go to someone's LinkedIn profile because I think that professionals now more than at any time in LinkedIn's history are really using LinkedIn to their advantage. And your profile is there for everybody to see. Tell us a little bit about your current work with SCORE and where you were before that, and kind of how you're qualified as an expert in the area of M&A and some of the things that you've seen.
Jim: Great, no problem. I volunteer for SCORE at this point in my life. It's an organization that was formed in the later, middle 60s. Actually it was part of the SBA at that time. But we're about 11,000, 12,000, 13,000 volunteers across the nation. I think we operate out of 320-330 chapters, and our mission is to help small businesses with whatever their issues are. A lot of startup work, a lot of expansion work. And in cases that where we're getting to a lot of mergers and acquisitions are around exit planning. So our services are all free to the small business person, and we mentor as well as consult. I've done a couple of exit planning, and in that exit planning activities we talk about mergers and acquisitions. The reason I can do that is because I started a couple of small companies back before the turn of the century. And in one of those companies we actually looked at a merger and I can talk in more detail about that later. But we did quite a bit of activity around merging with another company. And then when I entered corporate America I became the vice president of a couple of small business units within the large corporate entity. And particularly one of those companies that eventually folded in to CVS Health, a company by the name of Advanced CVS, as the IT component I did a lot of acquiring of small businesses. Disease management company, ... which was a company that ran test for different drug companies, etc. And at one point we actually started from scratch a specialty pharmacy unit, that company. And I was very, very involved in those activities. I learned a lot.
Jeff: You and I have talked a little bit before our show today, Jim. This is a program as you already know that is really focused on helping business owners either maintain the value of their companies or certainly improve it. Ideally that's what we'd like to do, the latter. I noticed you have the five rules which include two never does, two always do, and one maybe do with caution. The first one that kind of jumps out at me and it's obvious it's number one, never do a merger unless it improves your business, and preferably, that's the key underscore, preferably, both businesses. Tell us about that.
Jim: It really should be part of your plans and goals. You really don't have any reason to do a merger unless it improves the business. It's like all the other rules. It's very simple and straightforward. If it ain't going to make something better then use your time and effort to do something else for your business. It would really be great if you can take two companies and you merge them together, and they both become better than the two or separately. In a lot of cases that's not hard to do. If you take a well known merger that I think most of us have heard about is Disney and Pixar. That merger improved both of those companies drastically. They became a bigger, better, and stronger company merged, than they were deeply together.
It really should be part of your plans and goals. You really don't have any reason to do a merger unless it improves the business.
Jeff: I would say that one merger that I can think of that probably did not go so well might be that of Mercedes Benz and Chrysler several years ago.
Jim: Oh yeah, that merger actually I would say probably violated our rule two, which we haven't discussed yet, more than it did rule one. That merger, even though it didn't bring both companies to their knees, it didn't improve either company.
Jeff: No, it didn't. Let's go on to rule number two, never buy another business as a defensive strategy, and this goes back to what we just talked about with regard to Chrysler and Mercedes Benz just a moment ago.
Jim: Yeah. I think when you believe that your only alternative to defending off a competitor is to merge with them, and I know there's an old adage out there that if you can't beat them join them. In this particular case that set you up for failure. Not that it's never worked because it has, but to look at a defensive strategy and think that you're going to be able to defend yourself from a competitor by merging with them probably overshadows most of the other reasons, the good reasons, to merge with companies. Just as a rule of thumb, if you're going to set-up a defensive strategy and that defensive strategy includes merging with your competition I think you're looking at it the wrong way.
If you're going to set-up a defensive strategy and that defensive strategy includes merging with your competition I think you're looking at it the wrong way.
Jeff: Rule number three, always allocate time and resources to do a in-depth due diligence. This is something we preach often on Deal Talk and we've had a number of attorneys and CPAs talk to us about this one.
Jim: Yeah, in fact there's an argument to be made that this should be rule number one. The best thing around this rule is that you shouldn't believe anything, or as a famous president once said, "Trust but verify." If you can't get your CPA to look at the books of the company that you're looking at then you've got issues right off the bat. If you can't get your attorney to verify all the contracts that may either part of the merger and or that are created out of the merger because you're going to have to create a buy-sell agreement and your attorney has to be involved with that. So if you can't spend the proper amount of time, the proper amount of effort by both your team, and I look at your accountant, and your attorney as a part of your team. And then if you can't put your own boots on the floor do tours look at the company that you're merging with, have them visit your operations sector, then you're probably going to miss something and either paid too much or do a merger that really doesn't make sense for some things that are hidden either in the books or the contracts that they've obligated themselves to, or something along those lines. So the due diligence, it takes time, it takes effort, it takes expertise, but it's well worth it in the long run.
Jeff: I think that's really important, and in this particular day and age we hear that word transparency thrown around an awful lot. But you know something, it is really critical that if you're working with or attempting to work with a company that that company, that organization, needs to be transparent, and you need to be transparent with them when the time comes. It's time to work that due diligence process which could take several months, it could take longer than that in fact. If you're not able to share documentation or information that would help assist in that M&A activity in order to consummate or complete the deal and there's nothing but posturing or there's hesitation on either side, there's reason to be concerned there and you may be wasting too much valuable time. You're listening to Deal Talk, my name is Jeff Allen and I'm visiting with Mr. Jim Lewis. He's a retired vice president of Specialty Pharmacy and Health Management Information Technology at CVS Health, and we're talking about the five important rules that every business owner needs to observe and really live by when it comes to making consideration for doing a transaction with another company, whether you are on the buying or the selling end. We've talked about never do a merger unless it improves your business, and preferably both businesses. Never buy another business as a defensive strategy. Always allocate time and resources to do an in-depth due diligence. The next one, number four is always structure an earn-out. Jim, I think it would probably be a good idea for those people tuned in today to listen to this program, maybe they're a young business owner just starting out an entrepreneur who doesn't know what an earn-out is. It might be best to talk about what that is before we talk about structuring an earn-out.
Jim: Okay. An earn-out is a vehicle by which in the definition of the contractual buy of another business, the owner of the businesses being acquired gets paid upfront only a portion of what was agreed to be paid for that company. The rest of it comes as a matter of a product from the fact that what is being generated over the next year, or maybe even three years is in fact true to what that business was projected to do prior to the merger. A lot of cases what happens is it gets defined by primarily future gross sales. So if you had a company that you thought was going to do a $10 million over the next three years, then the earn-out would be some portion of that $10 million actually being realized. And maybe you got different percentages at different levels up until you hit that $10 million mark. But part of the purchase prices then is an earn-out.
So the due diligence, it takes time, it takes effort, it takes expertise, but it's well worth it in the long run.
Jeff: Okay. And you say to always structure an earn-out then when you're looking at acquisition.
Jim: Yeah, and I realize that it's not always possible, but any merger or any purchase that I would be involved in, would have to have an earn-out. The people that I'm dealing with, the people that are selling me their business, they obviously in the due diligence, have reason to believe that this is a ongoing venture, and over time it's going to produce a profit for me as a buyer. I need them to have a little skin in the game. Even if they're not actively going to manage that unit within a larger corporate structure, they should be held accountable for the numbers that they projected. And accountability attached to a buy-out, purchase price is the strongest way I know how to do that.
Jeff: Your fifth and final rule here before we go to a break: only with extreme caution consider a hostile take over. So for those folks who maybe are listening, maybe you represent a larger firm or you own a large company, this might be more applicable to you particularly if it's a publicly traded company perhaps. Jim, talk to us a little bit about this one.
Jim: The reason that one's out there primarily is because to do a hostile take over you basically have to break the other four rules. It's hard to do due diligence with the owner or a small business who is going to be taken over in a hostile bid. The books aren't going to be opened, the contracts are tough to look at. Very seldom will you ever be able to actually get your feet on the floor of the company that you're going to do it. So the due diligence gets kind of thrown out the window. And also it's tough to really evaluate whether this merger is going to improve both businesses because more than likely at least the bought company, is Bob and I going to be improved in any way, shape, or form?
I need them to have a little skin in the game. Even if they're not actively going to manage that unit within a larger corporate structure, they should be held accountable for the numbers that they projected.
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Jim: Yeah, that's one that we lived with at the company prior to being acquired by CVS Health, advanced PCS. The bottom line of all that is it particularly around earn-outs. The combining or the folding in of a business to your own company doesn't allow you to keep the two businesses separate and or to identify, and this is probably the important part about it, identify and measure the synergies that you created with the merger so that you can tell whether in fact in a short period of time or whether it's going to take a long time for you to realize the benefits of that merger. So if you set it up as a division within your company, if you're the acquiring company. And even to the point of maybe hiring or leveraging the person's business that you bought, his or her management of that division within your company. It's clean, it's close, you keep it within your own corporation or your own company. And it allows you to not only measure but then to see the real progress that all of the hard work of getting these two companies merged together would create as far as a going forward entity.
Jeff: And it's nice and clean, it keeps things separate, but you're able to take and keep a tight focus on each. And I think that's really important, Jim. And also important, identifying stakeholders and measuring their successes with the merger. Talk a little bit about that and what you mean.
Jim: That's another biggy, and that's something that probably gets overlooked a lot though. I don't think so much today as maybe 10, 15 years ago but you have to realize that you and the business owner that you're merging with are not the only ones involved. Each entity has the stakeholders to satisfy, namely the employees, and that's big. If you can't get the employees on board and agree with the merger then you're going to lose productivity at the very, very least, maybe even get some back slashes. But they're a stakeholder and they should be considered in the merger and some of the policies, procedures, and organization around the merger should take into account those employees, particularly if there's any intellectual property that's invested in a certain group of employees, or one or two individuals. Another stakeholder is of course the families. Mergers and acquisitions have a way of upsetting people’s security. And security is directly attached to the family units that those people are associated with. And so there's actually a small stakeholder equity if you will in the families around the people that are involved in the merger. And so taking it into consideration, treating those people right, maybe even throw in some party to celebrate the merger or something along those lines, including family manner in a picnic or something along those lines is very valuable. Of course you have stakeholders that are lenders. Those people have to be satisfied that their loans are going to get paid up in some way, shape, or form and so you need to consider that.
Customers have a way of leaving companies when they get merged if they think that the merged company isn't going to treat them or be as good to them as the single entity prior to the merger. Take that into consideration. Build policies, procedures, and activities around retaining that customer base because without it of course the combined company won't be as good as the two separate companies. Some mergers have partners, even silent partners. Some of them have stockholders. I have a client who hasn't even incorporated yet as an LLC but they have issued, and I guess I would call it the rights to purchase stock when they go public to vendors. In other words this is a company that had to have an application developed on an iPhone or an iPad. And the people who did the development, another client by the way, but the people who are doing the development instead of taking pay, took the rights to purchase the stock of the company that they were developing the application for. Those people, if that company ever gets merged, or is subject to an acquisition of any way, shape, or form, those people are drastically affected, because of the number of shares that they hold that they have a right to purchase. So there's going to have to be some legal documents drawn up. There's going to be some consideration for with those people. It's not only the people who had bought and the people who are buying, but also maybe even some stockholders in that way, shape, or form.
And so taking it into consideration, treating those people right, maybe even throw in some party to celebrate the merger or something along those lines, including family manner in a picnic or something along those lines is very valuable
Jeff: In that last example you just cited, Jim, who would be the one to point the finger at in terms of advising those employees what they should have done? And we talked about essentially picking up that stock. Who probably, more than likely, was the one to advise them that that was the thing to do?
Jim: Well, quite frankly, that agreement came though a brain storming session that I had with the company that needed the application development, and didn't have the cash or the resource to be able to acquire such a large asset. Another client who is looking for additional business decided that he liked the company so much that he was willing to develop the software, and instead of getting paid cash would take the rights to purchase stock. And it's a legitimate, legal transaction, and can be very beneficial to both parties. Like I said, if that company ends up being a target for a merger then the software development company is going to have to be part of that merger discussion, and that should all come out in due diligence. The attorneys of both companies should be involved because it could get very tricky. And legal consideration should be made during that merger.
Jeff: Very good. I wanted to ask you, Jim, have you ever seen or been part of a situation where maybe an acquisition did not happen when it looked like maybe it would, and it actually ended up working out for the best that it didn't go?
Jim: Great question. My first company which I had a couple of subchapter S corporations back in the 80s. One of my first companies was an IT company that did custom turnkey systems for small businesses. We developed the software, we put together the hardware. We actually had a consulting company on the side to do modifications to the software and everything, but it was a company that didn't generate a lot of cash flow. We had a lot of money tied up in creating the products that we could use for our customization of small businesses. Eventually we ran into trouble because we didn't have the cash flow to expand or grow. We went to look for solutions. One of the solutions was the fact that there was a company who acquired used computer hardware off of lease, put together a computer room and sold computer time. They build out every 30 days and so consequently they had some pretty good cash flow. They depreciated their equipment very quickly. And so the cash flow of that operation was really great. And it looked like if we could merge as two companies, we would solve both problems. We would have a feeder to a high-end customization product for small businesses, and a way in which small business could get into computerizing their back offices etc. without having to go out and acquire a lot of hardware and a lot of software. Once again thinking back in the 80s we didn't have the possibilities that we've got today. But in the due diligence of doing that merger it became extremely apparent that we were trying to merge two companies that wouldn't be much different than Wal-Mart and Neiman Marcus today. The cultures didn't come together. One company had a culture where they were high-end. They hand-held their customers. They were very interrelated with those customers because it created the entire computerized systems for the small businesses. But the other company was, “We've got computer time. You want to buy it? Come in, bring your own computer operator in, run your own software, we're just selling time.” They didn't have any relationship with the customers. They also did things with bailing wire and band aids because the bottom line is that when their equipment and stuff were either outdated or broke down, they just called the scrap dealer. And the other company's products, you had to keep them up-to-date, you had to keep them current, you had to implement new technology, etc. It was a bad mix of two different cultures and two different ways of doing business. Bottom line is, that merger fell through. If we had went through with that merger we would have probably have ruined both businesses. The way it is, both businesses survived and were very good afterwards.
Jeff: Ended up working out in kind of an odd way. Jim, we're running out of time. I have to ask you though, for those business owners who may be in your part of the country, Fort Worth, Texas, that area out there, who would be interested in speaking with you and chatting with you about their own particular situations and how you might be able to help them with their exit strategies. How can they reach you at SCORE?
Jim: We have a website. It's fortworth.score.org, and most of our information is on that. We have an office in Fort Worth and a number of branch offices throughout the Metroplex here in Texas. You'll find all that information on that website. My background and credentials as you know are on LinkedIn. My LinkedIn account is jamesdlewis, or if you're a Facebook person which I am not, but we've got a Facebook page, it's _fw for Forth Worth.
Bottom line is, that merger fell through. If we had went through with that merger we would have probably have ruined both businesses. The way it is, both businesses survived and were very good afterwards.
Jeff: Jim Lewis, we thank you so much for being available, sir. it's been a pleasure to have you on this edition of Deal Talk and hopefully we can catch up with you again another time.
Jim: Very good, thank you, Jeff.
Jeff: Jim Lewis, retired vice president at CVS, and now a certified mentor with SCORE at Fort Worth, Texas has been my guest today.
Deal Talk has been presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one call Morgan & Westfield at 888-693-7834 or visit morganandwestfield.com. And for more valuable information and insight from our growing list of small business experts, make sure to join us again right here to Deal Talk. I'm Jeff Allen, thanks again for listening and we'll talk again soon.