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The Art of the Small Deal



By
02/27/2006

By Michael Kreiter 


Small deals in the $2 million to $3 million range are different from the headline-grabbing mega-deals. Small transactions are much more difficult to value because it's tougher for buyers to predict return on investment. Valuation approaches, usually based on earnings multiples that seem etched in stone for the big-dollar deals simply don't apply in small transactions. Small-title companies are more difficult to sell because there is generally a much smaller pool of potential buyers. And once a buyer and seller do come to terms, closing the small deal is dicier because different sets of business, emotional, and cultural values often come into play.

Valuing

If there is a rule of thumb, or "formula"for valuing magazine properties, it is simply this: strategic buyers expect to get their money back in five years or less, financial buyers expect an annual return of 20 percent or more (after debt service) and figure on a 3-5 year exit.

How does this translate into a valuation of your property? With the caveat that all of the conventional valuation schemes don't apply to small deals, we can nonetheless begin with this rough approach: average your EBITDA (earnings before interest, taxes, depreciation and amortization) over three years, recast the numbers to add back cash flow the buyer would gain through scale, and multiply by six. That number should also equate to between 75 percent and 150 percent of gross revenues.

Using this approach, let's say your magazine averaged $1 million a year in sales over three years, with a bottom line average of $100,000, after all salaries and expenses. We are able (in this theoretical exercise) to add back $75,000 in expenses that would not carry over to the buyer (often general and administrative costs) and recast our earnings to $175,000. Six times that amount is $1.05 million;right at one-times sales.

Certainly, legions of magazines have sold for more and less than is reflected in this approach. In the grander scheme of things, small magazine properties sell for what a limited pool of buyers is willing to pay. There are, however, conditions that can decidedly lower a publication's value to the buyer:

ユ Weak or negative cash flow
ユ Poor market position (i.e., third or fourth book in the field)
ユ Limited distribution (i.e., regional)
ユ Frequency less than twelve time per year
ユ Field too competitive
ユ Little or no competition
ユ New or start-up
ユ Stagnant or low-growth market served

These factors can influence values to varying degrees, but the "kiss of death" is suspending publication or missing an issue. In this scenario, value plummets and buyers;if any can be found;are wary.

Timing

The best time to sell is when you choose to and, ideally, are fulfilling your prearranged exit strategy. This suggests that advance planning is one key to realizing top dollar. Sellers succeed by focusing on strategic buyers who have the most to gain in terms of increased market dominance and crossover ad sales opportunities. Often, these strategic prospects are your direct competitors, or at least peripheral competitors. Matching the profile of a perfect seller will help you command the highest price when it's time to divest:
ユ Strong cash flow (15-25 percent) with room for improvement under the buyer's banner
ユ Market leader, in pages, dollars, readership, editorial quality
ユ Steady history of page, dollar, and profit growth, with no "hockey stick" anomalies
ユ Meticulous business and financial records, including monthly P&Ls, balance sheets, ad page and market share histories, budgets, forecasts, etc. Note: financial records based on the accrual system of accounting are much easier to work with during a sale
ユ Readership in a stable, growing market with a large universe of potential advertisers (ideally, 1,000 or more companies) and an audience with heavy and frequent purchasing needs
ユ Audited circulation with high one-year and renewal rates, and accurate "expires" and deferred subscription liability reporting for paid circulations
ユ Focused distribution with high ad rates and CPMs and a history of sticking to the rate card
ユ Profitable brand extensions
ユ Compensation levels and expenses in line with;or slightly higher than;industry standards
ユ One owner/shareholder, who is flexible and recognizes the buyer's need to earn a realistic ROI on the transaction
ユ A clean corporate charter (ideally, S Corp. or LLC, because C Corp. asset sales involve a harsh tax consequence)

Now let's put the show on the other foot and examine the characteristics of the "perfect buyer":

ユ Offers a fair price and pays all-cash at closing
ユ Respects the seller's emotional and business culture
ユ Protects the confidentiality of the transaction, from beginning to end
ユ Negotiates in a spirit of trust and good faith
ユ Makes good on all promises and warrants
ユ Doesn't attempt to change price/terms in mid-stream
ユ Prepares evenhanded purchase agreement and related documents (non-compete and consulting agreements, etc.)
ユ Is flexible and accommodating
ユ Completes due diligence and closing quickly and discreetly

If you're on the buyer side of the fence, the best time to make an acquisition is when:

ユ Your existing titles are at or near full potential
ユ The acquisition enhances your market position
ユ The acquisition complements other titles in the house
ユ There are opportunities for cost-sharing and other economies of scale
ユ You have adequate cash flow and reserves to fund the transition

"Perfect buyers" and "perfect sellers" may exist only in the realm of the theoretical, but certain practices by both parties can help transactions from falling apart before closing:

ユ Once negotiations have begun, maintain business as usual
ユ Expect delays
ユ Prepare, prepare, prepare
ユ Appoint cooperative attorneys and accountants who are focused on completing the transaction
ユ Respond promptly to requests made by either party
ユ To the extent possible, sellers should make sure there are no material changes in sales, spending, circulation, or market presence during negotiations. Sellers who become bogged down during the transaction can let business slide prior to closing, with disastrous results
ユ Buyers should make sure financing or cash requirements are lined up well in advance
ユ Both parties should operate in a spirit of full disclosure. Nothing derails a delicate deal like an unwelcome surprise, a skeleton discovered in the corporate closet

Certain uncontrollable events can affect the transaction;a key employee dies or quits, market conditions shift abruptly;but, generally speaking, a deal that proceeds in a spirit of cooperation and free from surprises will result in a deal well done.

Michael D. Kreiter is director at W.B. Grimes & Co., a Gaithersburg, Maryland-based investment firm for the media industry. He can be reached at mkreiter@kc.rr.com.

By
02/27/2006







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