Think You're Exit Ready? Neil Schaffer's 1,000-Day Rule Will Change Your Mind

Bruce EckfeldtWelcome, everyone, to From Angel to Exit. I'm Bruce Eckfeldt, I'm your host. Our guest today is Neil Schaffer. Neil is CEO at Carlton Advisors. We're going to get into a bunch of things. He's done several different transactions, some really interesting ones, and we'll have a chance to talk through some of those learnings, differences, and experiences. Hopefully there will be some insights for earlier-stage companies looking to go through a transaction or exit at some point, or that are closer to a transaction: things they need to think about, be aware of, and maybe plan for a little. So I'm excited for the conversation and to hear the story. With all that, Neil, welcome to the program.

Neil SchafferBruce, thank you so much. Really happy to be here.

Bruce EckfeldtIt's a pleasure to have you on. Before we get into the specific deals and transactions you've been involved with, I'd love a little personal backstory. How did you get into business? What was your professional background? Give us a little of that.

Neil SchafferSure, happy to. I initially joined Price Waterhouse in their middle market practice in New York, directly out of undergraduate school, back in the day when there was such a thing as the Big Eight recruiting on campus, in my case at the business school at Binghamton University. I was at PW for about four years. It was an amazing education, and I realized I didn't want to grow up to be an audit partner, so I left and moved into a business career.

Bruce EckfeldtGood. I know you've been involved in multiple transactions. Give us a little overview of the world you've been in in terms of M&A and the nature of things, and then we can dig in more specifically.

Neil SchafferWhen I left PW, I was controller and then CFO of a paper distributor that was growing. They grew fivefold, from about $50 million to about $250 million of revenue, about two-thirds organic and about one-third as a result of acquisitions.

I left there after about eight years and joined a startup food manufacturing and marketing company. As I told you in the preview, we entered into three contracts to acquire three small brands, three small food manufacturers. Those contracts were contingent on financing, and the financing was contingent on taking the company public, because the acquisitions were going to be part cash and part public company stock. We completed those transactions, and we had a little bit of money left over. It was a very small deal. I think we raised $4 or $5 million in the aggregate.

We then identified a subsidiary of a large public company that was non-core to their business. We wanted to buy that company. The price was about $40 million, and we had about $1 million in the bank.

Bruce EckfeldtSo you were short 39.

Neil SchafferWith the help of some amazing investment bankers, we raised another round of equity and a sizable round of secured debt and completed that transaction. We went from being a $7 million company barely making a profit to about a $50 million company making a very substantial profit.

That was the beginning of a series of acquisitions, some of which I was involved with and some of which happened after I left the company, that evolved into the company being about $2 billion of revenue and about $2 billion of market cap. So that was a very exciting moment in time. It burned me out. I lasted about three and a half or four years, and I burned out.

Bruce EckfeldtProbably a little stress.

Neil SchafferThen there were a number of other adventures along the way, a couple of mostly mid-market companies, a couple of which I started as a co-founder. I've started two consulting practices. All of my commercial businesses have been companies I've either joined or co-founded.

Bruce EckfeldtGot it. When it comes to these deals, do you consider yourself a strategic expert, a financial expert? What's your expertise, or your perspective going into these M&A opportunities, in terms of how you analyze them, where you see the opportunities, and how you evaluate them? Give me a sense of your mindset.

Neil SchafferOther than with the food company, which was intended to be an acquisition roll-up vehicle, all of the other M&A transactions have been strategic in nature. They've been oriented toward wanting to grow faster, knowing that geographic expansion, business line expansion, or partnerships, particularly with technology and software providers where we can figure out rev shares, are mechanisms to bring capabilities into my company or bring my company into other geographic areas. Very often that's by acquiring players already in that region, rather than planting the flag ourselves. So they've tended to be strategic or opportunistic in that way.

On the exit side, I think a couple of things have been at play. One is that for companies that take on capital, where previously they've been running the company, going for product-market fit, and funding it internally, taking outside capital is when I think entrepreneurs begin to consider an exit. That's been the trigger for most of my businesses and most of my clients' businesses. You can bootstrap your way and think about the long-term success of a company. As soon as you take outside capital, you have to start thinking about how you're going to return that capital, with a profit, to the people who entrusted you with their money.

Bruce EckfeldtExactly. When do they get their money back?

Neil SchafferThe other thing, particularly with companies that haven't taken significant equity, is really looking at the market and business you're in and determining whether you think you're at or nearing a peak of the business cycle, whether your company's cycle or the external macro cycle. If you think you're approaching a peak, there's still some gas and some growth left in the tank, and you'll hit that peak in a year, and you think the next cycle peak is going to be five, seven, 10 years down the road, if you can see that far, you may decide that heading into that peak is the time to exit your company.

Bruce EckfeldtI think that's a good point, and a lot of founders fail to appreciate how significant it is. The moment you're dealing with outside money, you're dealing with some kind of time frame for the return of that money. When you raise capital or do a transaction, being able to tell some kind of story, to have a plan for how that entity is going to get their money back, is going to be part of their interest in the deal. I can have great financials, but if the investor doesn't see a window or opportunity for a later transaction that gets them their money back, it's going to be a hard deal to close.

What's your approach on the sell side? Let's start there. How do you create that story, the model that says, "Buyer, this is a great company, and this is how and when you could realize a return on your investment if you do this transaction"?

Neil SchafferIn terms of selling equity, I think the narrative is a strategic narrative around the vision of the business's arc of progress. You have a sense of where you are on the S-curve. Capital is required to enable you to realize that vision and execute that plan. Absent capital, you either won't get there or you'll get there too slowly.

You make the case that the market is ripe, you're ready, and the thing that's missing is fuel in the tank to accelerate. You've built the engine and it can go fast, but if you want to accelerate, you need fuel. You make the case that a certain amount of fuel will let you get to scale and get the flywheel turning, if it's an early-stage company. Once the flywheel is turning, you face different decisions. Do you want to be at stasis? Do you want the flywheel turning at 25 miles an hour? Do you want it to go faster? Do you want it to move into a different domain? What do you need to have happen?

So have a vision of what you expect the company's trajectory to be per plan, to the extent plans are met, which rarely happens. Man plans, God laughs. But have a point of view and a really clear vision, and be able to articulate: "We're going to do this with capital. We're going to attain this result. And when we do, we'll have an option before us." Success brings options. The option will be: is it worth exiting?

Bruce EckfeldtExactly.

Neil SchafferDo you have a view of a moment in time and a maturity of the company where your financials and operations look like X? And who in your marketplace wants X? Because I think most private companies maximize exit value by selling to strategic buyers. I think they maximize value, not just economic value for themselves and their investors, but also emotional and psychic value for the team, if the team believes they can continue doing what they're doing, if they really believe in the mission, within the context of a larger organization that can support a bigger execution of that vision.

A lot of companies shouldn't necessarily plan on an unlimited life on their own. In theory, perpetual corporations are a nice concept. But in reality, you may find that your greatest success comes from attaching yourself to a larger entity that gives you more throw weight.

Bruce EckfeldtI'm a big believer that everything has natural cycles. Every business is going to go through some kind of journey, and there will be changes or transactions at different points. The only constant is change. Do you, and if so how, think about these plans differently when it's more of a financial transaction versus a strategic exit? Financial meaning, "I'm basically looking for money. I have a plan and a vision for the future, and I just need cash, or powder, to get there. It's pretty much contained in the business I have. I just need more fuel to push it." Versus strategic, saying, "We're a piece that, if put into the right puzzle, could really complete things." Do you think about those strategies differently when you're taking a company to market?

Neil SchafferI think they're two parts of the same story. When you're selling equity in exchange for the fuel needed to execute the next relatively short part of the journey, it's probably about two years, because normally you should raise more than one year and less than three years of fuel. Ideally, by the end of that second year, you should be positioned to be cash-flow break-even or better and self-sustaining, or very clearly arriving at a place where you're more attractive for more capital at a higher valuation, because you've accomplished things that suggest you deserve more capital to take it to the next level, and that this management team should take it there.

In my opinion, financials don't drive a company's business and strategy. They're a reflection of operations. You have to be very careful not to let the tail wag the dog. Financials are downstream from every action that takes place in the business. They're a picture.

To me, the important part of financial analysis is that history does tend to go in a circle. There are a lot of lessons to learn, not only from your own financial experience but from those around you, others in your market, and others outside it. Financial planning and analysis is really the important part, in my opinion, along with having really good-quality financial information. I see a lot of companies, big and small, that don't do a very good job of examining the treasure trove of their own data.

Bruce EckfeldtYou mentioned some equity and some debt plays earlier. How do you look at the differences between raising capital on the equity side or the debt side? Are there situations where you lean one way or the other, or trade-offs you think about? "We need capital to scale. What should we be doing?" What are your heuristics?

Neil SchafferSure. I think it starts with capital availability in the macro environment. When I started Carlton Advisors a year ago, I looked at the environment we were in and decided I generally wasn't going to focus on startups and early-stage companies. Access to capital has been limited. Both debt and equity have become relatively expensive over the past couple of years. It isn't flowing. There's too much dry powder sitting there.

So the environment now is that companies' innovation budget, marketing budget, and R&D budget are actually inside their own business. Part of the pitch has been: run a better business. You need your innovation budget, but you have to be growing your own revenue, earnings, and cash flow. By doing so, when the capital window opens, you'll be very attractive to investors, because you've had to sharpen your pencil and really run a better business.

Given a choice, if I have a business with earnings and cash flow, I would normally choose to raise debt capital rather than equity capital. For one thing, it's less expensive. I also think it requires more discipline from the management team and the company, because that money needs to be repaid on a regular basis, not at some potential payday at the end of the day. It creates a different environment for the company.

Bruce EckfeldtIn terms of the transactions, you told the story of the big one you did and being burned out after a few years. What do you advise companies on when they're thinking about a transaction? What do they need to do to be prepared, practically, emotionally, strategically, financially? What's on your checklist of "Don't think about doing a transaction until these things are true or in place"?

Neil SchafferGreat question. I attack them separately, but the emotional question is probably the first issue. What do you, the CEO, the business owner, the executive team, all want as a result of this transaction? Do you want to leave? Do you want to stay? Do you want to be bigger? Do you want to be part of a bigger team? Do you want to play golf? What do you want to do?

And have you really thought through what not working means, losing the social network represented by your team, your customers, your vendors, your advisors? Have you thought all the way through not having those people in your life every single day? There are a lot of issues there.

Bruce EckfeldtThere's the flip side too: what's it going to be like to be with your husband or wife a lot more? It changes your world.

Neil SchafferThat's exactly right. Your immediate, true, physical social network changes radically. So it's about sensitizing people to that and forcing them to ask and answer the hard questions: what do they want to do with their time, their life, their money, if they actually have money coming out of the business and liquidity from the cash that's been trapped inside a private company? Now what?

But setting that aside, let's say you get to a place where you have someone who likely won't experience seller's remorse.

Bruce EckfeldtOr sabotage deals.

Neil SchafferThen you're on to what makes you attractive to a buyer. What makes you attractive to a buyer is different from what makes you and your product attractive to a customer. It's a different environment, because the buyer is fundamentally buying one thing: the probability of future cash flow. And that probability is a function of risk.

Bruce EckfeldtTell me more.

Neil SchafferThey want to know that cash flow is highly probable rather than risky. Getting positioned there means not every decision has to run through the CEO. You have to have enough depth in the organization. Do you have a good team? Do you have the right people in the right seats? Do you have time to refresh that team? What's your timing around exiting the company? Have you really thought through the preparation?

The other thing is that if you wish to leave, having a team in place is really important. If the leadership team intends to leave and wants to create an environment where the rest of the team, the leadership as well as the associates and staff, all have a role post-transaction, how do you ensure that?

Bruce EckfeldtThat could potentially lead to a very different type of deal, or to certain kinds of buyers.

Neil SchafferThat's exactly right. Then there's the challenge of documenting playbooks and SOPs. You have to pour out the knowledge. I work with clients to create a knowledge base. Bruce, you have a ton of information in your head, and it can't stay in your head.

Bruce EckfeldtThey're not buying your head. They're buying the company.

Neil SchafferAnd if that's what you're selling, you won't command a premium price, and you won't be able to leave. Now you go from founder-entrepreneur to having to say, "Mother, may I?" because you don't own a controlling interest in the equity any longer. You're not in charge, but you're still there.

Bruce EckfeldtYou're going to get hurt on valuation, and your retention is going to be bad.

Neil SchafferI think that realization tends to get a fair number of people to take the actions they should take to prepare their company for sale, if they're actually committed to selling. It's a bit of a wake-up call. Selling a company is a bit of an art form. The steps to prepare are pretty well understood in the market. There's exit planning expertise in the market. And it takes a few years.

Bruce EckfeldtPractically, what time frame do you typically like to see in terms of having enough runway to do the prep work?

Neil SchafferIt's a thousand-day journey. I think it's really three years. Three years makes it sound a little easier to tolerate, but it's actually one step after another for a thousand days.

Bruce EckfeldtI did the math really quickly. A thousand days. Yeah, that's three years.

Neil SchafferAnd by the way, break it down into one- or two-month sprints, or 90-day sprints, where you really pay attention to the five or seven things that are going to drive the most value in the company. Financial performance is only one of those things. But if financial performance matters, moving your business up and to the right and showing consistent improvement in financial metrics may in and of itself take three years, because buyers normally want to see three years in the can and a good forecast going forward.

Bruce EckfeldtI'm curious whether you see a difference here. I tease apart valuation and buyability. I know it's subtle: the things that drive a number versus the things that enable the actual transaction. What do you look for that actually helps the deal get done?

Neil SchafferThat's a great question. I think buyability is truly a function of both competitive advantage and company culture. Those are the two things most buyers really look at. Can I replicate your business without buying you? If I can't, then do you have the right kinds of people and, if you will, the right ethic to fit into my organization?

Again, I'm thinking about a strategic buyer. Financial buyers tend to look at businesses a bit differently. They'll look more at the competitive advantage and the staying power and sustainability of the business, because they'll allow the culture to be what it is. If it's been successful, they're not going to try to weld that culture into a different or larger entity where there might be tension.

Bruce EckfeldtI find strategic sales fascinating. Financial sales aren't necessarily easy, but they're more straightforward. You look at the financials, do your forecast, and have some kind of plan: "If I inject this capital, what do we do with it? What do the margins look like as we grow?" It's somewhat contained. With a strategic, I've been involved in a couple of cases where it wasn't even super clear why they were buying the company. Only post-transaction did it become clear: "Oh, I see. You've got this other product you can sell into our market," or "You want to leverage this into all these other customers." When you're selling and looking at a strategic opportunity, how do you evaluate the buyer's view of your value, which may not be super clear or may be complicated, so you can negotiate, have a good sense of where you should land, and not leave money on the table?

Neil SchafferI think it starts with: don't assume anything. If you're dealing with a strategic buyer, you have a wonderful opportunity to build relationships and have a dialogue with them, to gain some clarity about why they want what you do, what you own, or what capabilities you have. Why is that a force multiplier for them? One plus one has to equal more than two in their mind. How much more than two? Why does it equal more than two? "Tell me what you intend to do with my capabilities. How do we take my capabilities and add them to yours to do something neither of us is doing today? What's your vision for your business, and how do we fit?"

If you get good and reasonably honest answers to those questions, you can make a better case for value and valuation. If someone tells me their intention is to use my capability to enhance their product, to raise price, to go to new markets, or to sell more things to existing customers, for argument's sake, where the cost of acquisition is near zero, that's very, very powerful, because now I can model it. Now I have enough information to go back into my Excel models and represent what my business plus their business should look like, and then make a case for the valuation of what I'm bringing to the table.

Bruce EckfeldtI tend to pay attention to the questions they ask early in the process, and I'll often probe a little on the question, because sometimes they really don't want to tell you much. They're trying to keep their cards close to the chest. But there are often tells in the questions: the way they ask, what kind of information they want. You start to get some insight: "Okay, they're really curious about these customers in this part of the market. I wonder what's going on here." You can sniff some of that out, because there's always a little bit of a dance.

Neil Schaffer100%. That's why I said if you can get them to be reasonably honest. They're negotiating from the very beginning, and they're going to be guarded in what they tell you.

Bruce EckfeldtI'm curious what you've run into on the deal side: things that have complicated deals, derailed deals, hurt valuations, or just made things more dramatic than they needed to be. What typically comes up that's somewhat avoidable?

Neil SchafferI think valuation and negotiating terms are always challenging, and they're two different things. A long while ago I had a CEO whose point of view was really interesting to me. He said, "Your price, my terms." He was very clear that the terms are very often more important than the price. So negotiating deal points is a challenge on almost every deal.

As a CEO or CFO representing the company in a sale, you're on stage the whole time, and you have to be very sensitive to the fact that everything you say can and will be used against you. Every number that goes on a page is carved in granite. So you have to be very, very circumspect about what you share and how committed you are to the information.

You have to be very responsive to the deal, knowing that you don't have a life during the final stretch. It can be very, very demanding for everybody. You have to be diplomatic with bad lawyers and deal with drained people all around you, who very often become impediments even if they don't mean to be. It feels like they're doing it on purpose.

And I have had professional service providers show up at or around closing, when there's lots of money on the table, and throw down unexpected, ridiculous invoices. "I want to grab some money while it's on the table." We didn't necessarily agree to any of this, but they're there, and there's the potential for them to impede progress at the end as well. I've seen that happen once.

Bruce EckfeldtI'm curious to flip to the acquiring side. You mentioned acquiring for growth and geographic expansion. When you look at growing a company through acquisition, what are you typically looking to do with those expansions? Is it primarily financial? Strategic? Customer base? Geography? What are the factors that come up when you think about inorganic expansion?

Neil SchafferTo me, it's strictly strategic. There will usually be a goal or an intended outcome: being able to serve more customers in a different geography, bringing in different capabilities, having more pricing power by adding capabilities I don't have today. Customers are asking for things I could sell, but I need capabilities I don't quite have right now. So very often it's really being driven by the market. Then, obviously, downstream there are financial implications of that growth and expansion. But it tends to be driven by the business plan. If the business plan says, "Our plan is to be a nationwide service provider," or "a nationwide product company," or "to have 50% market penetration in five states," but right now I'm only in one small town, then if that's the plan, what do you need to do to get there?

Bruce EckfeldtHow do you evaluate an individual opportunity from a risk and culture point of view? It's easy to look at a website and see their services and think, "We could bring them in. That would complement the other things we're doing. We see their client list. We could sell to them." There are a lot of surface-level synergies. But digging under the covers, how do you figure out how viable or complicated the deal is going to be, and how does that drive the transaction process, the offer, or the decision about whether to do the acquisition? How do you get under the hood a little?

Neil SchafferMost of the transactions I've been involved with for acquisition-based growth have been either in my area of business or so closely aligned and adjacent to it, in the actual product or service I'm delivering or the geography. Even if it's a different geography, I'm very clear that I'm acquiring an extension of my company in order to move into that geography. So sometimes you're really valuing the other entity's market penetration, reputation, quality of team, net promoter score. How well regarded is this company? You'll know, because they're your competitors or they're adjacent in some way.

It's interesting. When I talk to clients about acquisitions, frequently I don't come from their industry. Sometimes yes, often no. But they should know whom they want to buy and who should buy them. If they're really embedded in their business and they know their business, customers, market, and product, they know whom they admire. "Whom do you want to buy, or sell to?" Very often, in a conversation about whom you want to sell your company to, the place to start is: "If you could, whom would you buy?"

It's like a brainstorming session about what you'd like to do tomorrow and how you want to grow. Very often the best way to facilitate that is to ask, "What are you doing today that you shouldn't be doing? What have you been doing that you shouldn't do tomorrow?" Start peeling away the things you're doing and brainstorm what not to do. After you get past that, flip the coin: "Okay, what should we do?"

Bruce EckfeldtI want to cover this from both sides. How do you create a market, or a situation where you're really going to get the best opportunity? I run into a lot of founders who come to me and say, "I just got this offer from this company, and we're trying to evaluate whether to take it." I ask, "Okay, what other offers have you gotten?" And typically the answer is none. "Okay, so what are we doing?" How do you make sure you're really looking at all the options, getting all the potential buyers to the table, and creating a reasonably competitive scenario so you get the best options? What does that process look like?

Neil SchafferFor purposes of selling your company, there are a couple of things. One, I recommend that companies consistently and constantly be on the lookout for what they want to buy, and for what they'd want in exchange for selling: that ideal state. Make it part of your strategic planning, at least your quarterly planning process. Not monthly necessarily, but make it an active and ongoing part of your thinking. "If I could, whom would I buy? If I could, to whom would I sell?"

Then work that into your financial models, because it will force you to know what your comparables are and to pay attention to what deals are getting done in your market. Talk to business brokers. Talk to M&A people. Have regular, informal valuations done at least once a year. If you look like a viable client today, or an exceptional company that could be a viable client in the future, investment bankers will be happy to engage and give you some insight. "Back of the napkin, your business looks like it's worth six times EBITDA. And by the way, if you get it from $7 million of revenue to $10 million, that multiple will go from six to seven just because you're larger."

Make this part of your periodic planning process. Don't just think about your own budgets and sales and what you're going to do. Look outside your company and maintain clarity about what's happening in your market, what deals are being done, and the trends. Are valuations going up or down? If the norm is six and someone went off at nine, find out why. Do your best to get underneath what caused that company to get a 40% better valuation.

Bruce EckfeldtExactly. There's a story there. My philosophy is that you want to have a plan for operating the business forever but be ready to sell at any time. I always say a buyer is going to want a plan for the business, so you'd better have one to be able to sell to the buyer. They may want to change it. But if you don't have a plan for where the business is going to be in three to five years, the buyer is going to have to come up with one, and it may not be a good one. You want to be able to tell a story.

And I think your point about thinking about this regularly, quarterly or semiannually, is key. "If we got an offer, what offer would we need to be willing to sell? Where is the market going? What's been happening in the market?" And the other one: if this market is peaking a bit, we either need to get more aggressive about doing a transaction in the next year or two, before we're on the other side, or we need to commit to being in this for the next seven to 10 years. Because if we're going through a down cycle, the last thing you want to do is try to sell in a down cycle. You want to get through it and get to the next peak.

Neil SchafferI also think that if you believe in your business, and you really want to be in it through that next down cycle and up cycle, because you love your business and want to stay, then you should plan, if you have the capital or can raise it, to opportunistically buy your competitors during the down cycle. Some of them will be ready to sell. Some will get frustrated. Some will say, "Dear, I missed the peak, but I still want out because I'm done."

Making this part of at least your quarterly planning cycle has to be done with a certain amount of rigor. It has to be something you're not just playing with, doing wishful thinking. There's real investigation that needs to be done. You really need to keep your ear to the ground. And I think it helps your business as well, because it forces you to think clearly about what's happening in your market and in the larger market: not just your own market, but the macro business cycle in general.

Bruce EckfeldtGreat insights. Neil, we're going to hit time here. I want to give you the opportunity: if people want to find out more about you and the work you do, what's the best way to get that information?

Neil Schafferneil@carltonadvisorsllc.com, or the website. I'm happy to respond to direct inquiries via email. That's probably the best way. The website is informative, but I really prefer dialogue, getting the opportunity to learn what business owners have in mind, what their key problems are, and whether I might be able to be helpful.

Bruce EckfeldtAwesome. I'll make sure that information is in the show notes so people can get it. Neil, thank you so much for taking the time today. It's been a pleasure.

Neil SchafferFantastic. My pleasure. I've enjoyed it a lot. Thanks.