There is no single way to do a deal.  There isn’t a “Right” way.  There are several wrong ways but not really a clear cut right way.  The right way is the way whatever is fair to both sides and meets both of their needs. 

The percentage of revenue model is one that I like a lot and when Lee’s bought a company called Marthedal in Fresno California, it was a perfect example of one that was executed well and worked for both parties.

Whenever I talk to people about tuck-ins, I talk about looking at them as a form of customer acquisition.  When The owner of Marthedal called me, lets call him Jim because I haven’t asked for his permission to use his name, he was looking to get out so that he could move to Texas and pursue other business interests.  He was a great guy and had been in the Fresno area for a long time.  He had bought the company from the Marthedal family.  I believe that he was an employee for them originally.  He bought it from the Marthedal family after the founder had passed away. 

By the way, this is a good time to make a public service announcement here.  I acquired Lee’s after a death in the Lee family. Marthedal sold after a death in the Marthedal family.  In both cases, people had passed away way earlier than expected.  If you don’t have a succession plan and a contingency plan for your business, you should probably look at getting one as soon as possible.  Luckily, in both cases with Lee’s, and with Marthedal, things worked out for both of those families.  At any rate, when I talked to Jim, he wasn’t emotionally tied to the company which was great and is always helpful when negotiating a deal.  You can focus on the numbers at that point and leave the emotion out of it.  I also started by asking why he was looking to get out and that’s when I found out about Texas and all the information about the previous owners that I mentioned above.  When going into deals, it is good to remember that you have two ears and one mouth and it helps to use them proportionately.  Ask and listen way more than you speak.  In many cases, they will come out and ask for something and you don’t think you can provide it.  That’s fine.  Don’t come out and say “well I can’t do that.”  Instead, sit quietly, think for a second about what they said, and then ask your next question.  

You are getting information at this stage and not closing the deal and getting them to sign on the dotted line.  Jim talked about some numbers and they seemed out of range but he was reasonable.  I listened to what he wanted to do, what his situation was with his family, what his goals were and things like that.  I started to realize that what he really wanted was to make sure to not let down Ms. Marthedal, whom he had bought the company from, and he also wanted to pursue his dreams down in Texas which prevented him from being able to stay with the company.

The company was small.  It was a couple million in revenue.  I got off the phone with Jim, thought about it, and realized that a percentage-of-revenue deal would be perfect.  I made sure that I had a plan all put together before calling him back.

When doing deals you need to have the mentality of a salesman.  In sales, a confused person never signs.  One of the best things you can do, if you are in a meeting or on the phone with the other side, is to get off and spend a minute or a day, or a week, or a month, depending on the deal, to make sure to think through the whole thing and get your own thoughts in order.  Make sure that you have a clear plan that doesn’t confuse them and is simple to understand.  It has to clearly demonstrate what you are going to do and how you are going to do it and how it benefits them.

I called him back and said Jim, I am not sure what kind of revenue I can get out of your company.  Your financials are pretty good but to get a clear accounting, we would have to do a due diligence period that could take time and money and you need to move to Texas soon. I think I have a plan though that you will like and it makes sure you get fairly compensated.  

I won’t divulge their profits but lets say that it was around 5% to make this easy to understand.  I said “Jim, you make 5% profit per year on all the revenue coming in today and you have to work all year for it.  I will buy your company and pay you 10% of all the revenue that your company generates for the next 2 years.  I will forward your phone number to my ServiceTitan account and that way we will be able to track every dollar that your phone number generates and I will even give you a user name and password to my ServiceTItan account so you can verify it. The payments will work this way.  I will pay you 100,000 dollars up front to make the deal happen so that I have skin in the game.  At the end of the first year, I will check the total revenue that your company number brought in and then pay you your 10% minus the 100K that I paid up front. So, my 100k go towards the first payment.  Then after the second year, I will check it again and pay you 10% of the second year as well.

Jim loved the idea because it was clear and it paid him fairly and he could head out to Texas.  The deal was done 2 weeks later.  I went to his office, signed the final docs in his office early that morning and he had called an entire company meeting and scheduled it for right after the signing.  I walked out of the signing and right into a company wide meeting to make the announcement. 

When you are making an announcement to the employees make sure to make it about what is in it for the employees.  They don’t want to sit and listen to someone pontificate about themselves.  We talked about the benefits plan and how Lee’s pays for college tuition for every employee and how excited we were to have them all on our team.  

The Marthedal deal worked well and both parties came out happy.  A lot of HVAC and plumbing companies like to have their cost of marketing for the year below 10% of their revenue.  What some do not think about is that its a blended cost. Your existing customers will probably use you again, as long as you are a decent company, and the cost to get them to use you again should be very low.  Acquiring a new customer usually costs much more than 10%.  It is usually 15% to 25% as a percentage of revenue depending on what service you are providing.  Then, for the year, between new customer acquisition and existing customer sales, your blended average will be below 10%.

So, if my normal cost of acquiring a new customer can be 20% and with an acquisition, I am guaranteed to only pay 10%, I am getting a deal.  In Jim’s case, he got more profit for two years than he normally would have gotten running his company and he didn’t have to be there to do it.  Plus, in addition to the new customers, I was able to get the vans, the trucks, the talented employees and everything that you don’t get when you are just marketing to new customers. 

NOTE: The only name or dollar figure in this article that I didn’t change was the name of the company acquired. Marthedal was the name of the company.  The rest was changed for confidentiality reasons. The method and reasoning behind the way the deal was done is accurate to explain how to do a percentage of revenue deal.  Also, the part about Texas and pursuing other interests is accurate as well because, well Texas is awesome.