Will appear on Buy-Side pages – RECENT BUYER ARTICLES

M&A Advisor Tip: ESG Diligence on the Rise in M&A

Companies that are able to showcase their Environmental, Social and corporate Governance (ESG) capabilities stand to gain a competitive advantage and make themselves more attractive to potential acquirers.

ESG issues cover a wide range of corporate practices that could include everything from environmental stewardship, health and safety policies, employee well-being, community support, to corporate culture issues.

In recent research from Datasite, 84% of dealmakers rated ESG as an “important/very important” M&A due diligence consideration. And 78% have terminated M&A discussions due to concerns about a target company’s ESG credentials.

We are definitely seeing buyers pay greater attention to environmental, social and corporate governance issues in our sell-side M&A engagements. From a buyer perspective, misalignment in these areas reduces valuation and increases integration challenges and costs. As a result, we are incorporating more ESG analysis into our company valuations and exit planning assessments, and making more of these types of disclosures in our offering memorandums.


For advice on exit planning or selling a business, contact Al Statz in Exit Strategies Group’s Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.  Exit Strategies Group is a partner in the Cornerstone International Alliance.

 

Due Diligence: Essential Step in Every Successful Business Acquisition

When purchasing a business the due diligence stage allows the buyer to verify  information pertaining to the business in order to determine whether to proceed with the purchase. The due diligence period also permits the buyer to determine if there are any barriers or risks associated with the transaction. Accordingly, the transaction closing is usually conditioned upon the due diligence stage being completed successfully.

While there are many operational, legal and financial components of due diligence, some less talked about ones are: the seller’s due diligence of the buyer, the buyer’s due diligence of the seller, including the reason for sale.

Some M&A advisors claim the reason for sale is immaterial-my colleague recently saw a sale listing citing ‘their mother’s ailing health’ as a reason for sale. He quipped that the reason for sale didn’t need to be examined as much as that the business needed to be analyzed. Was the multiple justified? Was it a good fit for the buyer? But just like anything else for sale, if the business is so good or profitable, why doesn’t the seller just keep it? Are they retiring? Could they gift it to a relative, if there is someone in their family who would be a good operator?

It may be good for a buyer to understand who the seller is. What is their background? Have they operated or sold other businesses successfully? What has happened with the other sales-were the new owners able to get a good deal? Is the seller a serial entrepreneur or can they not execute? Did the numbers add up? Did the financial projections/trends continue or was there some element of exaggeration or fraud? Some businesses are dependent on the seller’s special skill or knowledge. In the hands of a new buyer they may not be as successful. Then the buyer has wasted his money.

Most due diligence investigations are performed by the buyer, but in certain circumstances the seller will also conduct searches and other due diligence on the buyer. For instance, if there will be seller financing or seller will be receiving shares as part of the purchase price the seller may wish to conduct their own due diligence. Whatever consideration isn’t received at closing is worth less-like the old saying ‘a bird in hand is worth two in the bush’.

The due diligence stage also provides the buyer with information to assist with the negotiation of the main agreement. The results of the due diligence may cause the buyer to request that specific representations and warranties be set out in the definitive agreement, or that certain additional indemnities be given by the seller, or even that the purchase price be adjusted.

If you are purchasing a business, it critical to ensure that the due diligence associated with the purchase is conducted in a complete and thorough manner. The due diligence stage, if conducted properly, should provide the buyer with a complete understanding of what he or she is buying and an analysis of any risks associated with what is being purchased, so that the transaction may be completed without any unpleasant surprises.


Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, ownership transfer, strategic and other purposes. If you’d like help in this regard or have any related questions, you can reach Bob Bates, CPA, CVA, CFE at (415) 793-7777 or bbates@exitstrategiesgroup.com.

Key Deal Terms – Fall 2020

GF Data collects and publishes proprietary business valuation, volume, leverage and key deal term data contributed by over 200 lower-middle market private equity groups and other M&A deal sponsors.  Two of the acquisition deal terms that they monitor are the survival period¹ on general reps and warranties and the cap on indemnification² against breaches of general reps and warranties.   The following table shows these limits for deals in the $10 million to $25 million enterprise value range.

The indemnity cap in the first six months of this year across all industries was 10.0% of the purchase price, well below the 17.1% average from 2015 to present.  The indemnification period was 20.8%, up slightly from the 2015-to-present average of 18.8%.

  1. Indemnification cap refers to the general indemnification provided by the seller to the buyer against breaches of reps and warranties. This does not include carveouts for specific issues or items. For example, parties often agree that the general cap will not apply in the event of fraud.
  2. Survival period refers to the period after closing during which a buyer may assert a breach of the reps and warranties against seller. Again, this does not include carveouts. For example, exposure on tax, environmental, and ERISA issues often exceeds the general survival period.

For assistance with selling a lower middle market business, contact Al Statz in Exit Strategies Group’s Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.  Exit Strategies Group, Inc. is a partner in the Cornerstone International Alliance.

Plan Your 2021 Comeback with a Strategic Acquisition

Business owners tend to think more seriously about selling when things aren’t as much fun as they used to be. Running a business in the COVID era is anything but fun, and owners are being particularly responsive to acquisition inquiries right now.

Proactive Acquisition Searches

When growing through acquisition, companies can be reactive or proactive. In a reactive strategy, the buyer takes phone calls and watches open market listings for appropriate opportunities to appear. This is a slow process, and buyers often settle for something “close enough” rather than an ideal fit. Proactive buyers work with M&A advisors to build proprietary deal flow. The advisor conducts a disciplined search that targets passive sellers, i.e. owners who would consider selling if the right opportunity came along, but who haven’t listed their businesses on the open market.

Current Supply and Demand

Companies in reactive acquisition mode may be surprised by the level of competition in the acquisition market. COVID has shaken business confidence which is why there are so few quality companies going to market right now. If fact, conditions are similar to the residential housing market. Too few sellers are listing, which means houses are selling fast, above asking prices. In the current M&A market, strong businesses (particularly those relatively unaffected by the pandemic) are finding that lack of supply to be working in their favor.

The Search Process

  • In a proactive acquisition process, the critical first step is to define your strategy. An M&A advisor will  drill into your business model, strengths and weaknesses, culture and revenue streams to help you define your ideal target. What sort of acquisition will create a “one plus one equals three” outcome for your business?
  • From there, your M&A search team generates a list of potential targets. Typically this involves in-depth database searches as well as their own network sources. As a client, you review and approve this list before outreach begins.
  • Next, your M&A team begins a disciplined outreach strategy to generate seller interest. The goal is to bring multiple opportunities to the table at the same time so you have choices and negotiating leverage. You’ll view executive summaries of each opportunity and move into management presentations with a short list of sellers. When the strategy is clear and response has been good, it can take 60 to 90 days to reach this point.
  • Once you’ve identified your prime target, the next step is to negotiate a Letter of Intent (LOI) with the seller. An LOI is a written expression of a buyer and seller’s intent to enter into a transaction. The LOI includes non-binding terms such as purchase price, deal structure, indemnification, management arrangements, timeline, and key closing conditions. Completing an acquisition can be costly and time consuming, so you want to take time to carefully define LOI terms before you spend more time and resources on an acquisition. The LOI phase typically takes 2-4 weeks.
  • At this point in the process, you have not yet done comprehensive due diligence. Due diligence can take another 60 to 90 days before investigations are completed and definitive agreement terms are settled.

All together, a proactive acquisition process often takes 5 to 8 months. Roughly half of that time is spent building and narrowing a pipeline of opportunities and the other half is spent in negotiations and due diligence.

The Takeaway

If acquisition is part of your 2021 growth plan, start now. Assemble your team, refine your strategy, and run a proactive acquisition process. Waiting around for deals to appear will likely produce limited choices, heavy competition and no results.

For more information on the acquisition search process or to discuss your acquisition strategy, confidentially, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Sonoma County, California office. Exit Strategies Group is a partner of Cornerstone International Alliance.

Get to know your buyer: Conducting Seller Due Diligence

Adam Wiskind, CBIAs a business owner selling your company, prospective buyers will perform due diligence on you and your company.  But you should also conduct thorough due diligence on the prospective buyer.

When a buyer conducts due diligence on a company, they want to know that the company’s operations, finances, HR, environmental and legal matters (etc., etc.) are in order.

When a seller of a small business conducts due diligence on a buyer, they want to know that the buyer, whether a corporation or an individual, has:

  • the financial wherewithal to acquire the company
  • the legal standing to own it, and
  • the character and business acumen to successfully operate it.

Banks or other financial institutions lending money to a buyer for an acquisition will conduct their own due diligence on a buyer.  However, sellers shouldn’t rely on the bank’s due diligence process because they have their own timing, protocols, and criteria that may not align with the seller’s interests.

Some sellers focus their process principally on financial due diligence, believing that once the company is sold that they needn’t be concerned that the buyer can effectively manage it.  This approach is shortsighted even for business owners that are not concerned with their legacy.  Many transactions tie the post-sale business performance to the seller’s proceeds through an earn-out or a seller’s note.  If business performance suffers under the buyer’s direction, the seller loses too.  Even with a 100% pay out at the close of the transaction, when the seller has no post-sale financial interest, they may face legal risks if the buyer whose company is not performing contends that the seller misrepresented the business opportunity.

Minimally the objective of financial due diligence is to determine that a buyer prospect can qualify for acquisition financing and has sufficient capital for a down payment.  Regardless of whether the seller is financing part of the purchase or not – a credit check is a standard tool for evaluating a buyer’s credit worthiness and financial capacity.  A buyer should comfortably have access to at least 10% of the transaction amount in liquid funds (preferably more than 20%) plus sufficient working capital for day to day operations and a reserve.  Lastly, a seller that extends a loan to the buyer should ensure that the buyer has sufficient personal collateral available, in case of default.  It should be noted if a bank or other lending institution is involved that they will likely take a superior position on the available collateral.

The seller’s due diligence process should also explore whether the buyer has the character, capacity and legal standing to operate the business successfully.  The specific matters to be investigated depend on the type of business being sold and its management needs.  A seller should at least understand the buyer’s general business management experience and their experience within the specific business industry.

Below is a list of other areas to explore.  Rather than simply providing a due diligence list for the buyer to respond to, a savvy seller may want to interview a buyer to get in-depth answers:

  1. Does the buyer have the authority to acquire the company?
  2. Does the buyer face or have they faced any legal issues?
  3. Does the buyer have the necessary licenses or credentials to operate the business?
  4. Have they successfully completed an acquisition previously?
  5. What is their plan to operate the business?  What personnel or other changes are planned?
  6. Will the buyer’s character facilitate successfully managing the business?  Ask for personal and business references.

In summary, a small business seller should conduct a reasonably thorough due diligence process on a prospective buyer to reduce risk in the transaction and ensure that the buyer can successfully run the business.

For further information or to discuss selling your business, contact Adam Wiskind at awiskind@exitstrategiesgroup.com or (707) 781-8744 for a no-obligation assessment of your situation.

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.