Will appear on Buy-Side pages – RECENT BUYER ARTICLES

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 4

M&A buyers are still active in the midst of this uncertain business environment. However, they are mindful of added risks caused by COVID-19.

These are some financial questions that are likely to come up in future due diligence in light of COVID-19:

  1. Did the business utilize any government relief, debt deferrals, or rent reductions?
  2. In terms of government relief, was the business accurately entitled to that relief and did they meet requirements for debt forgiveness?
  3. Did the business take on new debt that would impact the viability of an acquisition?
  4. Are revised financial projections reasonable?
  5. What is the financial condition of the business’s key customers?
  6. Are there risks to collecting on accounts receivable?
  7. What is the seller doing, if anything, to reduce or renegotiate operating expenses?

Business owners looking to sell soon should review their current practices now, so they’re prepared to address buyer concerns.

Read our previous posts on coronavirus era M&A due diligence:

For further information or to discuss a current M&A need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Petaluma, California office.

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 3

M&A buyers are still active in the midst of this uncertain business environment. However, they are mindful of added risks caused by COVID-19.

These are some contract-related questions that are likely to come up in future due diligence in light of COVID-19:

  1. Did the business default on any third-party agreements?
  2. What are the termination rights on key contracts?
  3. Are counterparties adhering to their contract obligationss?
  4. Were terms modified or waived in a way that would impact future enforcement, force majeure, or other provisions that would enable termination or suspension of an agreement?
  5. What ongoing challenges and risks will the business face due to non-performance?

Business owners should review their current practices now, so they’re prepared to address buyer concerns.

Read Part 1 and Part 2 of this series on coronavirus era M&A due diligence.

For further information or to discuss a current M&A need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Petaluma, California office.

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 1

M&A buyers are still active in the midst of uncertainty. However, as you would expect, they are mindful of added risks caused by COVID-19.

Talent-related questions that may come up in future due diligence due to COVID-19:

  1. Did layoffs or other cuts impact the business’s ability to retain key employees?
  2. Did the business comply with state and federal laws related to layoffs and furloughs?
  3. How is employee health and well-being managed?
  4. Are policies and practices sufficient to protect employee safety?
  5. Do employees have the ability to work remotely – without frustrating workarounds?
  6. How well does company culture support engagement and accountability in a remote environment?

For further information on business sales, mergers and acquisitions in the midst of coronavirus or to discuss a current need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

Methods of Selling Distressed Businesses

As most companies transition from survival to rebuild mode in the second half of this year, some will become financially distressed and the owners will want to move on. Fortunately, for the shareholders and creditors of these companies, there is an active market for distressed business assets. Distressed businesses can be attractive acquisition targets for strategic buyers, and sellers can optimize financial outcomes through a proactive M&A sale process.

Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. (Source: Wikipedia)

Distressed business sales range from simple out-of-court transfers of a company’s tangible and intangible assets, to highly structured and expensive bankruptcy proceedings.

Four Routes to Selling the Assets of a Financially Distressed Business

  1. Sale of assets (Asset Purchase Agreement), where lenders and certain creditors may be asked to forgive or discount outstanding debts
  2. Secured party short sale under Article 9 of the Uniform Commercial Code
  3. Asset sale in an Assignment for the Benefit of Creditors
  4. Section 363 asset sale in a Chapter 11 or Chapter 7 bankruptcy

Selecting the appropriate method is case-specific and involves a number of considerations, including:  (i) the particular assets involved; (ii) the seller’s runway and the speed of consummating a transaction; (iii) the cost of the process; (iv) privacy concerns; (v) the cooperation of secured creditors and ability or need to sell assets free and clear of liens; (vi) buyer protections afforded; (vii) exposure to subsequent challenges and liability (i.e., fraudulent conveyance or successor liability claims); and (viii) which process will most likely maximize value to shareholders. Choosing the most effective method requires careful analysis of facts and circumstances and understanding of alternatives.

If your company is facing financial distress, the sooner you get help and take action the better. When financial distress is severe and on a path to insolvency, an attorney with specialized expertise in complex workouts, restructurings and bankruptcy must be consulted early on.


Al Statz is President and founder of Exit Strategies Group, a leading California-based M&A advisory firm with decades of experience selling companies in all market conditions. For further information, or if you are interested in exploring the potential sale or acquisition of a distressed business, contact Al Statz at 707-781-8580 to discuss your needs, circumstances and options, confidentially. 

Business Values May Not Decline

A recent survey of M&A advisors and business brokers showed that of all small and medium businesses on the market at the end of Q1, about 35% had closed (temporarily at least), 40% were operating at partial capacity, 4% had benefited, and 21% remained unaffected by COVID-19. Not surprisingly, advisors indicated that 46% of lower middle market deals were delayed at the end of Q1 and 11% had been cancelled altogether. For deal cancellations, 25% were attributed to sellers pulling out, 46% due to buyers backing out, and 12% due to changes in bank financing.

For business owners, the COVID-19 pandemic was like getting punched between the eyes. It knocked people down. And even when they could stand up again, their head was still spinning. But now, we’re starting to see the cobwebs clear.

Advisors like us saw an instant drop in buy-side activity in March. We had some new buyer conversations in April, but nothing solid. By early June, though, we started to see a resurgence.

Affect on Valuations

The question now, as buyers move forward with acquisition plans, is what will happen with business valuations?

For those businesses that remained fully active, their valuations will likely stay solid. Even businesses that partially closed or were negatively affected may find that valuations remain consistent. Businesses that were essential or able to pivot to an online or contactless model will be attractive to buyers.

And while declining cash flows typically do impact business values, we may see special considerations granted for the pandemic. Most businesses trade on a multiple of “normalized” historical cash flow or EBITDA. Normalizing financials includes making adjustments for one-time and unusual events. As buyers and lenders evaluate your business, they may accept normalization adjustments due to COVID-19, after your business recovers.

Affect on Deal Structures

In terms of deal structures, though, sellers who want to receive full value for their businesses should be prepared to carry more risk. Buyers will be seeking more of the purchase consideration in the form of seller financing, earn outs, or equity rollover.  Here’s what that might look like for sellers:

Seller financing. 

Seller financing can bridge a buyer’s resources with the value they see in your business. Essentially, it’s a loan from you, typically structured with monthly payments over a number of years.

In the past year, seller financing has hovered between 10-15% for Main Street deals, and 6% or less for deals over $5 million, per the Market Pulse Survey. The more perceived risk (e.g., COVID-19 closures and declines), the more seller financing buyers tend to request. So, we expect we’ll see these numbers climb in the year ahead.

Earnouts.

An earnout is a commitment by the buyer to pay you a certain amount of money tied to future business performance after a sale. If the business meets certain benchmarks, you receive additional value.  An earnout is a way of sharing risk.

Equity rollovers.

In an equity rollover, the seller maintains an ownership stake in the business. They roll a portion of their equity into the new capital structure in lieu of cash proceeds.

Rollovers are common with financial buyers, such as private equity groups. These buyers generally acquire businesses with the intention of holding them for five to seven years before reselling at a profit. Financial buyers often want sellers to receive a portion of their consideration as equity. It’s part of their financing model and it demonstrates the seller’s faith in the business.

Rolling over some of your equity gives you get a second bite at the apple when the business sells again. If the new owner successfully grows the business, that minority stake could be worth as much or more than your original sale.

Deal structures will also be driven by lending activity in the months ahead. If lenders pull back, both buyers and sellers will be motivated to reach alternative financing arrangements.

For further information on M&A market conditions or to discuss a current need, contact Al Statz, 707-781-8580.

M&A Advisor Tip: SBA debt relief incentivizes buyers

SBA debt relief is is a big incentive for buyers to move ahead with small business acquisitions right now.

The SBA will pay six months of principal, interest, and any associated fees that borrowers owe for all current … as well as new 7(a), 504, and microloans disbursed prior to September 27, 2020.

As an added incentive, SBA lenders have the authority to defer loan payments for six months. That means some buyers could acquire a new business and have almost a full year free of loan payments.

For further information on this topic, or selling a business, or financing a transaction, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

Market Pulse Survey: Deal Cancellations due to COVID-19

M&A advisors saw many of their business sale/acquisition deals delayed, put on hold or cancelled in March 2020 as a result of the COVID-19 Pandemic.  Who was cancelling these deals?  The following chart shows the results of this survey question from the latest Market Pulse Survey.

Presented by IBBA, M&A Source & in partnership with Pepperdine University

“Deal activity is always expected to constrict during times of uncertainty. Both sellers and buyers are being conservative right now, taking a wait-and-see approach,” said Scott Bushkie, managing partner, Cornerstone Business Services. “Once we have some clarity on when businesses will be allowed to reopen and in what capacity, some deals will continue to move forward.”

“For many business owners who had already put their businesses on the market, this is a temporary pause,” Bushkie continued. “Owners who were burned out or near retirement will still be looking to exit their business. The nature of that exit will look different now, but once you get so close to the finish line, it can be difficult to envision holding out for much longer.”


For further information on M&A market conditions, or to discuss a current business sale, acquisition or valuation need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

Valuing a Business in Bankruptcy

Bob BatesAccording to data collected by the U.S. Bankruptcy Courts, business bankruptcies declined from 60,750 (or 4% of total filings) in 2009, just after the 2008 financial meltdown to approximately 22,750 in 2019 (or approximately 3%).[1]  With overwhelming challenges ahead as a result of the Coronavirus Pandemic, the question is not if these filings will go up over the next 12 months but by how much.

Before I dig into valuing a business in bankruptcy, let’s review the relevant “chapters” of the U.S. Bankruptcy Code. These “filings” are as follows;

  • Chapter 7 – a liquidation proceeding where assets are sold by a trustee to repay unsecured creditors and, in the case of a business filing, the Company ceases operation[2];
  • Chapter 11 – a reorganization where a Company (as well as individuals) negotiate a plan with its creditors to pay a portion of the amount outstanding while remaining in business.[3]

What is Value in a Bankruptcy?

The U.S. Bankruptcy Code defines “insolvent” as

“…financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation…”[4].

It is at this time, when a business is insolvent, that an appraiser comes in to determine the value of the Company’s assets. However, there is no definition of value in the U.S. Bankruptcy Code, only the guidance that;

“Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.”[5]

The value of the Company depends on the type of filing and the recovery plan if the company is to survive as a going concern. In a Chapter 7 filing, the asset value is based on a liquidation approach (orderly or forced) based on the expected timing set forth by a bankruptcy trustee. In a Chapter 11 filing, the value is based on a going concern approach, also dependent on the proposed timing, but tied to a financial and operational plan for reorganization that impacts the capital structure of the business.

Valuing a Business in Chapter 11 as a Going Concern

Under a Chapter 11 reorganization, the approval of a reorganization plan depends on whether the parties can negotiate a favorable outcome for the Company (or debtor) and the unsecured creditors. When this path to resolution fails, the U.S. Bankruptcy Court needs to rule on this insolvency and whether the reorganization plan proposed suggests that the value of the business is less than its liabilities. While this plan may include the sale of assets, subsidiaries or other court-mandated transactions, it always assumes that the Company will continue as a going concern that requires a valuation.

For example, in a recent court case, a valuation expert for the debtor concluded that the value of the business burdened with $317 million of debt was between $180 million and $220 million (midpoint of $200 million) while the expert for the unsecured creditors’ expert pegged the value between $335 million to $445 million (midpoint of $390 million). In effect, the unsecured creditors concluded that the business was solvent and that they are responsible for 100% of the liabilities of the business. The Court determined that both experts were highly qualified and used the same valuation methods and weightings. The differences came down to their selection of comparable companies. The final decision agreed with the debtor’s expert and the plan was approved and the terms “crammed down” to the unsecured creditors who had to take a haircut on the amount owed to them.[6]

Other key components or potential issues faced by an expert in valuing a business in bankruptcy include;

  • Forecast – The appraiser needs to determine the strength of the forecast in a proposed reorganization plan and whether a management-prepared projection shows bias towards a low case scenario.
  • Diligence – In court cases, either side will hire appraisers to determine the value of the Company as a result of the reorganization plan. This adversarial situation reinforces the importance of the appraisers’ diligence and strong support for key assumptions and inputs.
  • Comparables – As noted above, the question of comparability is key in the defense of the value determined using a market approach. Comparing a small niche software company to Google lacks, among other things, strength based on size, business model and portfolio of revenue streams. There is also a question as to how actively traded companies compare to a bankrupt company with inactive or no recent trading history.
  • New Debt – Determination of the interest rates available to the debtor and changes in the capital structure are key in determining the Company’s risk profile before and after the reorganization plan. Also important is the assumption of potential balloon payments and the need for asset sales or refinancing when these payments are due.
  • Hindsight – The court will accept a “known or knowable rule” but discourages the use of hindsight which may lead to bias.
  • Taxes – A consideration of the debtor’s tax situation including the possible utilization of NOLs and a change in ownership after the reorganization.

A Small Business in Bankruptcy

The above example underscores a frequent adage of appraisers that a big company is much easier to value than a smaller one. Whether it’s the lack of detailed financial information or the presence of operating agreements that may trigger a specific approach to and allocation of enterprise value, small businesses are almost always an extension of the individual owner operator and therefore always unique. In particular, professional service businesses in bankruptcy (such as an electrical contractor or a barber shop) may lack the ability to realize value, especially in Chapter 7 filings, for intangible assets that will remain with the business owner. Additionally, a market approach requires the use of different datasets that compare control transactions as opposed to publicly traded companies. Otherwise, the same issues above apply but with limited financial and management resources, a full detailed plan and forecast may not be part of an appraiser’s available information.

Unfortunately, the current health and economic crisis will likely cause an uptick in business bankruptcies and situations where appraisers need to determine value in unique and distressed situations.

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, ownership transfer, strategic and bankruptcy purposes. If you’d like help in this regard or have any related questions, you can reach  Bob Bates, CPA, CVA, CFE at 508-331-8815 or bbates@exitstrategiesgroup.com.


[1] https://www.uscourts.gov/report-name/bankruptcy-filings

[2] https://www.usbankruptcycode.org/chapter-7-liquidation/

[3] https://www.usbankruptcycode.org/chapter-11-reorganization/

[4] https://www.usbankruptcycode.org/chapter-1/section-101-definitions/

[5] https://www.usbankruptcycode.org/chapter-5-creditors-the-debtor-and-the-estate/subchapter-i-creditors-and-claims/section-506-determination-of-secured-status/

[6] https://www.bvresources.com/articles/bvwire/bankruptcy-court-highlights-comparables-selection-in-assessing-experts-valuations

The Value of a Sell-Side M&A Advisor to Buyers

Al StatzStrategic and financial buyers often tell me how they appreciate the value that experienced, ethical and professional sell-side M&A advisors (a.k.a. business intermediaries, investment bankers, or business brokers) bring to a deal; even when that advisor represents the seller!

As a buyer, you can expect a sell-side M&A advisor to help by compiling, analyzing and serving up relevant business information, by bringing transparency to the process, by facilitating the process, by introducing funding sources and other resources, by anticipating and solving problems, and by being an unemotional conduit between you and the seller. The advisor will have an effective and transparent process for selling the business, and you will understand what that process is.

When you acquire a business through an experienced professional sell-side M&A advisor, here is how you benefit at each stage of the process:

  1. Confidentiality — Maintaining confidentiality is in your best interest as a potential owner, and the advisor’s sale process is designed to protect sensitive information. It starts with the advisor supplying an NDA on reasonable/market terms that is normally ready to sign.
  2. Screening — A good advisor will ask about your acquisition criteria and funding plans, and communicate the seller’s needs and expectations. They will make their own assessment of fit and confirm both parties’ commitment to moving forward in the process. When they don’t think the fit is right, they will tell you to avoid wasting everyone’s time.
  3. Discovery — You will receive a Confidential Information Memorandum (CIM)* with a detailed narrative and important facts and figures on the target company. The M&A advisor wants you to be able to make an informed and dependable decision; and therefore strives for accuracy, transparency and balance in the information presented. After you absorb the CIM, the intermediary will have answers to many of your follow up questions.
  4. Management Meeting — A seasoned intermediary makes site visits and management meetings more productive by establishing desired outcomes for the parties, co-developing an agenda, helping the seller prepare, facilitating important conversations, and following up post-event.
  5. LOI Negotiation — Based on my experience and feedback from transaction attorneys, letters of intent that are negotiated with the involvement of a seasoned M&A advisor tend to be clearer on economic deal points and stronger with respect to contingencies, process and time frames. They result in less renegotiation and are more likely to close.
  6. Due Diligence — The intermediary will set up and maintain a data room and help everyone organize, schedule and facilitate this phase; which saves you time and aggravation.
  7. Financing — The advisor can liaise with (and introduce) debt and equity capital providers. They can compile and summarize information for the application process. Their knowledge of what these parties need, and what they will and won’t do, helps them anticipate and resolve issues that arise and save you valuable time.
  8. Closing — A good M&A advisor works closely with the parties, their attorneys and CPA’s and other specialists throughout the acquisition process. They have great project management skills and attend to numerous details, anticipate and resolve roadblocks, and quarterback various activities to keep the process moving to a successful and timely closing, which is in everyone’s interest.

The bottom line is that professional and experienced sell-side M&A advisors save buyers time, effort and transaction costs, and increase the likelihood of getting from LOI to the closing table. Of course they will also make sure you pay a fair price.

* A CIM analyzes a company’s financial statements and covers its history, customers and markets, operations, personnel, facilities, key contracts, fixed assets, intangible assets, strategic relationships, competition, industry dynamics, growth opportunities, projections, and more.

For further information on the services of an M&A advisor on the sell-side or buy-side, contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com.

 

‘No Shop’ Protects Buyer Investment in M&A

A no shop provision is an important part of M&A transactions. Also known as an exclusivity clause, a no shop clause prohibits the seller from sharing information or negotiating with other would-be buyers for a specified time frame.

Prior to this, the seller is negotiating with several buyers. The goal is to entertain multiple offers and figure out which buyer will ultimately provide the best deal for the seller.

Once the seller has identified their preferred buyer, both parties sign a letter of intent (LOI). At this point the buyer will begin more comprehensive due diligence to validate their assumptions and make sure the business is everything they believed it to be.

Due diligence is an intense process that could include FBI background checks, equipment appraisals, environmental studies, and more. Some buyer groups conduct industry studies or hire a consultant to call the business’s customers under the guise of a confidential customer satisfaction survey.

Financial due diligence will be a massive focus, of course. Securing a quality of earnings report could cost anywhere from $15,000 to $150,000, depending on the size and complexity of the target acquisition.

Then there’s the necessary legal fees. The buyer’s attorney will draft the asset or stock purchase agreement. This takes the framework of the LOI (typically five to seven pages) and puts it into comprehensive legalese (approximately 50 to 70 pages).

I’ve seen attorney fees as low as $15,000 for a small, routine deal and as high as $250,000 for a lower middle market acquisition (average range $30,000 to $50,000). Private equity firms, which make up a major buyer category, are not shy about spending fees to make sure they have the necessary protections in an acquisition.

At the end of the day, it might not be uncommon for the buyer to spend $100,000 to $500,000 in total transaction costs. That’s why most buyer groups are adamant that they get a no shop provision for 30 to 90 days.

That exclusivity period is the protection they have, ensuring that if they’re going to spend time and money going down this path, the seller is not going to negotiate the deal out from under them and sell to another group.

From a seller’s standpoint, a no shop period can help limit buyer’s remorse or post-deal litigation. If multiple buyers are trying to be the first to the closing table, buyers might skimp on due diligence. Rushing due diligence can lead to unexpected discoveries after the deal is closed, and that can lead to conflict and litigation.

Conversely, long no shop periods are not in the seller’s best interest as there is always a risk that a deal will fall through in due diligence. A shorter no shop period gives sellers a better chance of recapturing interest from a competing buyer if the transaction is terminated.

For further information on exclusivity and other common deal provisions, contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com.