Running a business is hard. Running a business while working through the exit process can be impossible unless you know what to expect and have strong partners in your corner, yet most brands underestimate the value that their fulfillment provider can bring to the due diligence process.
What it Takes to Exit
In the era of free money and wild valuations it was difficult to really understand what it took for a brand to exit as the rationale seemed to be everywhere. There were several examples of unprofitable, but fast growing companies selling for 9 or 10 figures only to have that value written down or the company shuttered altogether a few years later. A silver lining of the austerity going on in the funding ecosystem today is that the playbook and criteria for what it takes to exit has been simplified and fundamentals are beginning to take hold once again.
There are 3 requirements that a brand needs in order to prepare for an exit and maximize their outcome.
Profitability is a Baseline Expectation
In today’s environment a brand hoping to be acquired needs to be profitable. Revenue for the most part has become a vanity metric- an important one, but still a vanity metric. We are seeing more and more deals valued at a multiple of EBITDA vs revenue. A business is only as good as it’s ability to generate profit for an acquirer and they aren’t as interested doing the hard work themselves in making a business profitable after they acquire it and certainly don’t want to put more money into the business after the acquisition just to keep it afloat.
Your Acquirer Wants More Than Just a Business
Brands hoping to exit need to have some sort of unique capability that an acquirer will find attractive that separates them from other potential acquisitions they could make. The idea is that this “plus one” capability needs to be something that the acquirer finds value in and would try to implement or copy across their existing businesses. For some brands this might be an exclusive distribution or manufacturing deal, a robust content engine, patents, expertise in a particular digital channel, or a community that you’ve nurtured.
Paying Too Much for Shipping?
Learn how Willow saved 50% on shipping and labor costs by reformatting their packaging and kitting.
Leave Your Acquirer a Few Easy Wins
Lastly the secret to getting a higher multiple for your exit is in the ability to have an easy win ready for the acquirer to capitalize on once you’re integrated. You have to keep in mind that acquirers are made up of people, as well, who in some cases are sticking their necks out deciding to purchase your brand. You want them to feel good and look really smart about paying lots of money for your company and you need to create an easy to see runway for how they might be able to significantly grow your business after the acquisition.
For example, if you’re not already in Walmart or Target and the acquirer has strong relationships there, that could become a layup for them to essentially double your revenue. Other common easy wins that I see include international expansion, product extensions, or other sales channel expansion. A lot of times creating an easy win later means intentionally not doing something now in order to save that lever for a future date. If you’ve already launched in these channels then you’ll be valued off of actual performance instead of “what could be.” The challenge for any CEO is to understand the fewest number of levers that need to be pulled in order to reach the right level exit velocity.
Getting Through the Due Diligence Process
During the due diligence process you’ll have an outside consultant or senior supply chain leader evaluate your supply chain. It’s very rare that supply chain capabilities or “synergies” are a significant factor in the deal rationale and so their purpose is to try to find skeletons in order to find liabilities or risks that will either kill a deal or would need to be addressed shortly after the acquisition is made. Here are some common “gotchas” that an acquirer will look for during the due diligence process.
1. Contracts
The first key area that an acquirer will look at are your contracts, so make sure you have all of your agreements up to date and easily accessible. Acquirers want to know that you first have a contract for each of your key suppliers. They’ll then evaluate those agreements from a commercial and legal perspective to make sure that you have the proper IP and liability protections and don’t have any weird terms in there like a 10 year agreement with your 3PL or something like that.
2. Operational Controls
Next, the acquirer is likely going to look at the controls in your supply chain, specifically around inventory. They will want to know how often your do cycle counts and what the variability has been between them over time. One common “gotcha” that they will look for is unproductive inventory in the form of unprocessed returns, slow moving inventory, or inventory that is expired or within 6-9 months of expiration. To pass this section in the future, start working today to implement strong protocols to track and purge this kind of inventory.
3. Data Integrity
The next stop on the due diligence tour is usually around your data flows and data integrity. The acquirer will specifically be looking for examples where your data isn’t normalized, isn’t connected, or where you require manual intervention to process things. These things on their own are yellow flags, but ultimately ladder up to a huge potential red flag if you don’t have strong data integrity. One of the things that we do at Izba that helps speed up the due diligence process and instills confidence in data integrity is creating a process flow map that shows the entire system a brand is currently using and which way the data flows.
4. Your Team
As part of the due diligence process the acquirer is going to get to know your operations team. While the primary focus is on assessing the business, a secondary goal is to evaluate the talent on the team. They will essentially categorize people into three buckets: those that seem like they have a real chance to progress at the acquirer, those who could have a long career at the acquirer at the right level, and those who should probably be exited from the business within the first 6 to 12 months post deal. While each acquirer is going to evaluate things differently, the first threshold is how well they know the aspect of the business that they are responsible for. If your head of fulfillment can’t tell you how many orders you ship each day or what parcel products you’re using then that’s a problem.
5. Your Partners
The last major element that an acquirer is going to dig into is the partners that you’ve chosen. This is probably the single biggest potential risk to the supply chain that they will look to understand. If you’re working with a partner who is inconsistent in their performance or on dubious financial footing then the acquirer will most likely have to factor in the cost of unwinding that relationship into the deal rationale.
Your supply chain partners should expect to be visited and interviewed by the acquirer who will try to get a sense of the quality of their operation and understand their financial strength. You can make the due diligence process faster and more favorable by holding regular QBRs and using tools like Capabl to measure the performance of your partners.
Your 3PL as a Strategic Asset in preparing for an Exit
If an exit is in your plans in the next few years, make sure that your operations and partner selection reflect that. While there are thousands of fulfillment partners out there, there are some, like DCL, who acquirers have prior experience with and which may add credibility to your overall supply chain decisions. Above all, make sure that you find someone who will be an active participant in your exit well before the due diligence process. Here’s what I mean by that:
The best fulfillment partners won’t just endure the due diligence process, but will actively embrace it. They’ve been around the block before and know exactly what documentation, security protocols, financials, and interviews a large company would be interested in and help guide you through that process.
The best fulfillment partners aren’t just a node in your data architecture but the hub that helps tp connect all of your sales channels and distribution channels into a normalized structure. They should be able to be your source of truth when it comes to inventory accuracy, costs to service your business, and product catalog.
The best fulfillment partners aren’t just holding your inventory but are actively helping you manage it. They are proactive in identifying slow moving SKUs, products approaching expiration dates, or returns that need processed and are pushing you for a resolution so that you’re more operationally sound and present well during the diligence process.
The best fulfillment partners aren’t looking to lock you up just because of a contract but retain you because of how integrated they are in your business. They see the due diligence process not as something that is happening to you or the potential loss of a client, but an opportunity to share their value with the acquirer and win more business in the future.
Aaron Alpeter is the founder of Izba– a supply chain consulting firm that helps brands prepare to exit and helps acquirers integrate those acquisitions. He also co-hosts the “Ecommerce on Tap” podcast where each week they take a well known startup, tell their founding story, reverse engineer their supply chain, and discuss their exit opportunities.
Need a Reliable 3PL?
We’ve been in business for over 40 years. Let us know how we can help your company grow.
Tags: Articles About Value Added Services, Expert Advice & Tips
