Will appear on Buy-Side pages – RECENT BUYER ARTICLES

M&A Financing During the Pandemic

/in , , /by Al Statz

The pandemic has put lower middle market business sales and acquisitions on somewhat of a roller coaster ride. Deal volume declined sharply in Q2-Q3 and came back strong in Q4. Valuations have remained strong throughout the pandemic, at least for COVID-resistant businesses. Though there was a slight Covid-effect in Q2-3.

In terms of M&A financing, capital structures shifted to slightly more less debt during 2020, before edging back up to pre-pandemic levels in Q4. To compensate, the capital stack was being filled in with more buyer equity and more rollover equity.

Interest rates are still low and banks keep lending, but they have pulled back slightly. Lower middle market deals have typically had senior debt of around 3x EBITDA. According to GF Data, that ratio dipped to 2.7-2.8 in Q2-3 (the lowest level in 5 years) and returned to 3.2 in Q4 2020.

GF Data reported an uptick in buyer equity from 2019 to 2020, from 46.1% to 49.1%. We are still seeing buyers bring more equity to the table than pre-pandemic, and showing more interest in seller rollover equity.

Rollover equity is when a business owner retains a minority stake in the enterprise. For businesses valued between $10 million and $25 million, rollover equity accounted for 13.9% of deal funding in 2020.

At the start of the pandemic most of us were expecting to see more earnouts (contingent consideration) in transactions, but that hasn’t materialize. Because demand for acquisitions remained high during the pandemic, most sellers have been able to avoid earnouts.

If risk and uncertainty subside and interest rates remain low, we should see a return to more typical M&A funding levels in 2021.

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

 

Market Pulse Survey: Still a Seller’s Market

/in , , /by Al Statz

Despite the effects of the pandemic, we continued to experience a seller’s market in the fourth quarter of 2020, for businesses with enterprise values over $2 million.

Presented by IBBA & M&A Source

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.

M&A ADVISOR TIP: Cybersecurity is a Buyer Priority

/in , , /by Al Statz

New research from Datasite reveals that cybersecurity is the #1 cause of buyers withdrawing from a merger or acquisition during due diligence.

Deal makers said about 1 in 10 deals fell through during due diligence. Cybersecurity issues was the cause in 36% of these failed deals, followed by financial weakness, excessive valuation, financial irregularities, and leadership issues.

To ensure that your data security practices will not be a concern for prospective buyers of your company, Exit Strategies Group recommends that you talk to your technology team about potential issues, and consider obtaining a cybersecurity audit from an independent third-party firm. Ask your M&A advisor or CPA for a referral.

Exit Strategies Group is a partner of Cornerstone International Alliance.

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

/in , , /by Al Statz

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

/in /by Exit Strategies

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, contact Al at alstatz@exitstrategiesgroup.com.

Key Deal Terms – Fall 2020

/in , /by Al Statz

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 months, up slightly from the 2015-to-present average of 18.8 months.

  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

/in , /by Al Statz

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

/in , /by Adam Wiskind

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

/in , , /by Al Statz

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

/in , /by Al Statz

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.