Figuring out the appropriate exit point from your small business--assuming you want one--is tricky enough. What's harder is getting your company in shape for a sale.
Most businesses get stuck at a growth inflection point, where they are doing well enough, but not really growing. Taking the next step requires putting new systems in place and, often, additional management.
I recently profiled the sale of Accurate Group, a once-sleepy residential mortgage-services company purchased by Evolution Capital, a boutique private-equity firm, in 2009 and sold three years later for more than 10 times the original sale price.
Its three-year growth trajectory has a lot of things to teach entrepreneurs who may be curious about what they need to do to be attractive to a potential buyer, whether that's another business, or in Accurate's case, to a second private-equity firm.
Evolution was in the business of finding diamonds in the rough. In Accurate, it had spotted a number of essential factors for all the businesses it bought: It was in a promising industry--real estate servicing; it had a unique technology that set it apart, it was not capital-intensive, and it had healthy cash flow, which meant the company could unlock its own growth.
The primary goal that Evolution's managing partners Brendan Anderson and Jeff Kadlic had when they acquired Accurate, which was doing business primarily in North Carolina at the time, was to turn it into a national company.
"Real estate is always changing hands, and you don’t have to own or invest in it" to profit from it, Jeff Kadlic, a managing partner and founder of Evolution says.
Accurate had a system called Magellan, which could keep track of the high-volume transactions of thousands of appraisers, underwriters, title searchers, and closing agents involved in mortgage transactions. It could keep track of the paper-intensive workflow, quickly allowing the company to fulfill and close orders.
There were fewer than 10 licenses for the system software out there. Paul Doman, whom Anderson and Kadlic brought on to lead the company because of his expertise in the market and familiarity with Accurate's owner, knew that with the right coders he could build it out and give it a proprietary spin.
After 20 years in banking and mortgage services, many of those spent at First American Financial Corp., one of the largest mortgage-transaction services companies in the U.S., Doman was eager to try his hand as an entrepreneur. He'd managed to turn a sleepy home-equity unit at First American into a $100 million enterprise with 500 employees, in just a few years. And now, at 51, the time was ripe.
"[Magellan] was created for[a residential mortgage services] type of business, but we knew we could enhance it greatly to meet Accurate's needs," Doman says.
Magellan also made Accurate's service "sticky," meaning it required any bank that used it to install it in its back office, which required several months of work. So there'd also be little incentive to unhook once it was in and working properly. And that meant ongoing revenues from customers.
A Big, Fragmented Market
And though real-estate transaction services is also a highly fragmented market, amounting to about $17 billion in the U.S., Accurate had less than one percent of that. So there was huge potential to grow by leading or taking business away from competitors.
For their part, Kadlic and Anderson saw how Accurate had the potential to generate cash, and lots of it, in disparate economic cycles. Facing new regulations from the Dodd-Frank Wall Street reform act to legislation passed as part of the Economic Recovery and Reinvestment Act, the residential mortgage industry had seen its rules rewritten. What's more, large banks that had dominated the industry were exiting it, and regional banks were eager to outsource these more complex and time-consuming parts of their mortgage division to an audit-worthy partner, while they returned to their main line of work, which was lending money to consumers.
The 100-Day Plan
Anderson and Kadlic had learned in previous deals that it was important to establish a 100-day plan before the ink had even dried on the sale papers or employees and managers would resort to their old ideas about running the business. So for every company they bought, they created a day-by-day road map detailing infrastructure and organizational changes, as well as sales and revenue milestones. Anderson and Kadlic had seen many companies fail to grow simply because they hadn't put into place adequate management, structure and accounting controls.
"The bidding process that goes on with investment bankers is so overwhelming, it is not until after the dust settles that [employees] know what the new book says," Kadlic says. "With small companies, the only advantage is to move fast, so we start from day one and run fast and hard."
One of the hardest parts of the process is engaging with each potential buyer. It requires management to put together a book-length presentation digging deeply into the company's financials, customers, and prospects. Additionally, top management must also engage with each potential investment group individually. That means wining and dining them at costly dinners, as well as in full-day management presentations to talk about the company.
Accurate's management team had to do this twelve separate times in the span of about six weeks, all while continuing to ramp up growth and pushing to beat the company's quarterly numbers.
As a first order of business, Evolution and Doman moved headquarters from Charlotte to Cleveland, to keep a close watch on it. Then Doman hired an eight-person management team that would help Accurate grow and scale. In addition to Doman, who had acquired a 15% share in the company, Accurate picked up some of his best managers from First American, including its chief information officer, its president of valuations, and an executive in charge of business and strategy.
Next it rescued Magellan, the crown jewel of the sale, from its precarious perch in Charlotte, where it sat on a server under a blue tarp that caught the rain when it leaked through the ceiling during bad storms and was cooled by a hastily-installed air conditioner and a rotating fan. Doman located a hardened data center in Charlotte where it would be protected from hackers as well as rainstorms and stuck it there.
Investing in Management and Infrastructure
In its first year of ownership, Evolution ploughed close to $1 million into salaries and infrastructure upgrades that would allow the company to grow as it expanded into other states. The funds came from the company's free cash--about $350,000 annually, but growing rapidly in the first year.
That included hiring two of the original programmers who had designed Magellan and putting a new chief information officer in charge. For this task, Doman chose Mike Cullen. He was a tech savant and guru software engineer sometimes called "Mozart" because of his technical wizardry building systems. He had more than 21 years of experience designing real-estate transaction software, and Doman had worked with him at First American.
The next step was to go out and sell the company's services like crazy in an attempt to take Accurate national. Doman boosted the sales staff from one national representative to eight, and they went on an aggressive hunt for new business. They succeeded in bringing on some impressive regional clients. The first big win was Northwest Savings Bank, in Warren, Pennsylvania, which brought Accurate about $750,000 in annual revenue.
In 2009, it also brought on First American as a customer, which also added hundreds of thousands of dollars more to revenue.
Although Accurate's first year under new management was strong enough, the capital expenditures took a bite out of EBITDA. But by year two, the investments started paying off. By the end of 2010, it had connected Magellan to three more regional bank customers, and EBITDA had crept up to $1.8 million. By 2011, with the wins of five more regional banks, EBITDA had jumped to nearly $3 million, or 10 times what it had been when the team bought Accurate Group.
"Not only were we generating positive cash flow, but it was consistent, reoccurring revenue," Doman says. "We had built a business that could then strategically invest in new things like sales people to help our growth and systems to give us scale."
By mid-year 2012, the year that Evolution sold the company, free cash had leapt to nearly $5 million, and by the end of the year to $8 million, with capital expenditures sinking to a mere $50,000. Within 16 months, Accurate had reached the point where major private-equity investors would be interested in purchasing the company, according to investment bank Edgeview Capital Partners, which Evolution hired to solicit interest and execute the sale.
"That is the magic marker in the lending community, and investors know they can put more leverage on a business to help with equity returns," says Derek Beres, Edgeview's managing partner.
A few months later, an even larger private-equity firm ABS Capital based in Baltimore would purchase the company for $55 million of equity and an undisclosed amount of debt.
"Investors need to feel like they connected with you at a higher level [during the sale process], like they can make money with this team,"Kadlic says. "And what you are looking for is the true believers."