Will appear on Buy-Side pages – RECENT BUYER ARTICLES

The Best Financial Decision I Ever Made

In 2007 I found myself at a crossroads. After almost twenty years on a steady career path, I felt it was time for a change. The problem was that I didn’t know what I wanted to do next. I considered going into consulting, did the mandatory networking with old contacts, and even gave serious thought about doing a start-up. But I didn’t have that one great “do what you love” or “change the world” idea.

It was at that point that I started seriously considering buying an established business in California. I spent a couple of hours each day scanning various business for sale websites, and made quite a few inquiries. I learned quickly that there are many great businesses out there, and that people sell for all kinds of reasons. There was such a variety of businesses to explore that it was much easier for me to eliminate business categories that I didn’t want to look at (for me it was restaurants) than to focus my search on any one particular type of business.

I ultimately came across an interesting company that had established an ecommerce presence selling identification and security products – ID cards and readers, printers, convention badges, lanyards, etc. Despite having no prior experience in the industry, it was an easy enough business to understand and to envision how I could make it work. I had done my homework and knew how much cash flow I needed from a business and how large a transaction I could pull off, and this one fit within my parameters. I made an offer, and after a short negotiation we reached agreement on price and deal structure. As of January 2008, I was the proud owner of my own business.

My wife and I ran the business for seven years until we were ultimately bought out by another firm in our industry. After all of the transaction related taxes and other costs, our initial investment in the business had grown by more than 6x during our seven-year ownership. That works out to an annual rate of return of over 30%. In addition, we were able to pay ourselves a decent salary throughout the time we owned the business. There are not many other investments that can pay your salary and grow your net worth at the same time.

In case you missed it, we bought the business in January 2008 – just a few months before the biggest financial crisis in a generation hit. Our timing could not have been worse. Because of the financial crisis, we didn’t come anywhere close to hitting the sales and profit targets that I had projected. In fact, it wasn’t until 2011 that we achieved total sales greater than 2007 – the year before we became the owners. But despite the bad timing, purchasing a business was the best financial decision I ever made.

Mark Soeth is an M&A Advisor with Exit Strategies Group’s Sacramento California office. 

Recent Trends in the M&A Market

Pepperdine University, of Malibu, California, in conjunction with the International Business Brokers Association and M&A Source, publishes a quarterly Market Pulse Survey of business brokers that provides useful information concerning the market for Main Street ($0-$2M sales price) and lower middle market ($2-$50M sales price) businesses.

Highlights from their most recent report for Q1 2016, include:

  • 50% of all business sell
  • Retirement is still the prime motivating factor for sellers followed by burnout.
  • The strongest growth for new sellers is in the $2M-$5M segment
  • Although the magnitude had declined somewhat, the lower middle market it is still a Sellers’ market.
  • Main Street multiples of SDE have remained relatively stable between 2 and 3x over the past 7 quarters
  • Multiples of EBITDA in the lower middle market have also remained fairly stable at 4x for $2M-$5M sales, but have risen for the $5M-$50 sales to 5.5x in the current quarter.
  • The average Main Street business sold for about 92% of asking price, while lower middle market companies sold for around 94% of the advisors’ and sellers’ expected price.
  • First-time buyers accounted for 43% of <$500K transactions while Private Equity Groups comprise 43% of buyers of $5M-50M businesses
  • It takes an average of 9 months to close a lower middle market deal.

To view the latest Market Pulse report or to discuss a current need in the area of business sales and acquisitions, please contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com. 

Benefits of Buying an Established Small Business

So you want to be your own boss ― no superiors, no shareholders, and no board of directors. Consider the options ― you can work as an independent contractor, start your own company, or buy an existing business. Each option has benefits. If you analyze the risks-versus-rewards carefully, you’ll learn what many seasoned entrepreneurs have discovered … the scale tips in favor of purchasing an existing business.

Admittedly, as an independent contractor (including sole practitioner professional practices and consultants) your risk is minimal and the initial investment and overhead costs are relatively low. You can make a comfortable living; however, without the ability to leverage the work of others, your personal production will probably limit financial returns and equity growth.

Starting a business may pay great dividends over time, but it’s important to understand that most start-up businesses falter and eventually fail. According to Michael Gerber, renowned author of The E-Myth Revisited, 40 percent of new businesses fail in the first year and 80 percent fail within 5 years. Poor planning (choice of location, market, product or service) and being undercapitalized are common causes of failure.

On the other hand, purchasing an existing business, when done correctly, reduces an entrepreneur’s risk and provides the opportunity for a return on equity. There are a number of reasons to consider purchasing an existing business rather that starting one:

  • Cash Flow on Day One. Acquisitions are often structured so that you can take a reasonable salary, cover the debt service on acquisition financing, and have some money left over. Owners of start-up businesses, on the other hand, often starve for months or years.
  • Proven Business Model. Buying an established business is less risky ― as a buyer you already know the process or concept works, and the products, services, location and markets are proven. Lots of expensive mistakes have already been made in order to get it right.
  • Acquisition Financing. Existing businesses have a track record of viability. Securing financing for a business acquisition is far easier than funding a start-up for that very reason. A bank can rely on actual historical results for that specific business, not just plans and wishful projections.
  • Recognized Brand. Chances are the seller spent years building a brand. That brand recognition and any marketing the seller has done should transfer to you. When you have an established name and presence in the business community, it’s easier to make cold calls and attract new business than with an unknown, unproven start up.
  • People & Relationships. In a small business acquisition, one of the most valuable and important assets you’re buying is established relationships with people and allied businesses. It took the seller time to find employees, develop them and assimilate them into the company culture. With the right team in place, you will have an easier time implementing growth strategies, and more opportunities to spend time with family, take vacation, or work on other business ventures. In start-up mode, when you go on vacation, the business goes with you. When you purchase an existing business, you also usually buy an existing customer base, vendor base, and other strategic relationships that took years to develop. It’s common for the seller to stay on with the business for some time to ensure that these relationships are properly transferred.
  • Focus on Growth. You may be wondering if buying an existing business leaves enough room for innovation and creativity. Experienced entrepreneurs know that starting a new business means spending a lot of time and money on basic necessities like computers, telephones, furniture and equipment, policies, insurances, permits, recruiting, and numerous other infrastructure and tasks that don’t directly generate cash flow. When you purchase an existing well-run business, because the seller has already laid the foundation, made and corrected the mistakes, incurred the usual string of start-up losses and dispensed with the time-consuming and tedious start-up work, you should be in a position to focus on business improvements, innovation and growth soon after you take the reigns.

10Benefits

Becoming your own boss involves risk, but by successfully purchasing an established business, you can reduce the risk of failure associated with a start up and enjoy the opportunity to build enterprise value over time.

Al Statz can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.

The Federal Reserve and Interest Rates

The Federal Reserve controls the three tools of monetary policy — open market operations, the discount rate, and reserve requirements. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate.

Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services [1].

As shown in the graph below, the federal funds rate has been at .25% from 2009 through the end of 2015, primarily as a result of the 2008 financial crisis and the lingering effects on employment and the economy. At the end of 2015, the federal funds rate target was increased to .50%.

Historical United States Federal Funds Rate

usfedfundsrate
Now is a good time for a Company owner looking for an exit strategy, as federal funds interest rates at historically low levels contribute weight to a seller’s market.

[1] More information on the Federal Reserve can be found at their website, http://www.federalreserve.gov/default.htm

What is a Confidential Information Memorandum and why should I care?

There is a critical document used in the business sale process known as the Confidential Information Memorandum or “CIM.” Other names for this document are pitch book, deal book, offering memorandum and confidential business review. A CIM tells a company’s story and lays out important facts and figures for prospective buyers. This article answers common questions about deal books and explains how they benefit sellers of businesses.

Who receives the CIM and when?

Buyers receive a CIM after signing a non-disclosure agreement (“NDA”) and after passing our screening process. One of the CIM’s main purposes is to help buyers make informed, confident and swift go/no-go decisions. Not having a CIM is a big time waster for sellers and buyers.

Who prepares the CIM?

The CIM is prepared by an M&A broker from interviews with and documents from the seller client. We also rely on our industry knowledge and research. Finalizing a CIM can take a few weeks after all the facts are gathered, but it makes the rest of the sale process goes faster, with fewer headaches and missteps. Remember, the goal is not to be for sale; but to sell and maximize value in a sale. In parallel with putting a CIM together, we complete our list of potential strategic buyers and build-out a data room for due diligence. We also coach our client on final business preparation during this time.

What information goes into a CIM?

A CIM discusses a company’s products and services; history; customer base; end markets; operations; technologies, systems, processes and capabilities; management and personnel; facilities and fixed assets; key contracts and certifications; IP and intangible assets; strategic relationships; growth plans; and more. It presents and analyzes several years of financial statements with normalization adjustments, and may include financial projections. It often discusses the competitive landscape and industry trends.

Every CIM is a custom document that tells our client’s unique story to potential buyers. Stories should have numbers attached to them, and every number should have a story. CIMs can be 10 to 60 pages in length, plus exhibits, depending on the complexity of the business.

When writing the CIM, we exclude highly sensitive information. For example, a CIM typically presents a detailed analysis of the customer base without naming customers. Some things should wait for due diligence or even closing.

How does a deal book benefit sellers?

A professional CIM improves business sale outcomes in several ways:

  1. Sets expectations.  Sets a professional tone for future discussions, builds credibility, and let’s buyers know you’re serious about maximizing value.
  2. More interest.  More buyers will explore a deal if they receive quality information.
  3. Perceived value.  A consistent story with supporting information leads to better offers. Conversely, uncertainty produces low offers.
  4. Speed.  Having reviewed a quality CIM, buyers can move quickly to the next stage in the deal process, or move on, which is in everyone’s best interest.
  5. Persuade stakeholders.  Buyers use the CIM to educate their investors, partners, lenders, CFO, attorney, CPA, and other advisors and stakeholders.
  6. Save your time.  A CIM helps you avoid spending time with the wrong buyers. And meetings with buyer candidates will be more productive.
  7. Less renegotiation.  Fewer surprises during due diligence means less renegotiating and fewer blown deals
  8. Secure your proceeds.  A CIM makes important disclosures, early on. Important facts are less likely to be missed.
  9. Confidence in your team.  Because you help shape the story and approve the CIM. You will understand exactly how your company will be represented by your M&A advisor.

It’s hard to believe, but some business brokers think that CIMs are too much work. Those who rush to market and skip or skimp on the CIM disappoint most of their clients.

If you are considering selling your company, I urge you to hire an M&A firm that will invest the time to analyze and present your company in the professional manner it deserves. The Confidential Information Memorandum or CIM is an essential part of a successful business sale process.


For further information on the benefits of a Confidential Information Memorandum or to discuss a current business sale, acquisition or valuation need, contact Al Statz in our Petaluma, California office, 707-781-8580 or alstatz@exitstrategiesgroup.com.

The Significance of Disclosure in a Business Transaction

Full disclosure by buyer and seller is a vital component in any successful business sale/purchase transaction.  In a small business transaction, buyer and seller disclosure statements are customarily exchanged and reviewed before or during the due diligence process. Hopefully there are no significant surprises at that point and the transaction proceeds smoothly.
When the buyer is an individual, the buyer’s disclosure statement generally focuses on the buyer’s personal, professional, and financial background and reorganization plans.  However, the seller’s disclosure statement is broader and is often organized into these categories:
  1. Business Conditions
  2. Regulations
  3. Other Considerations
  4. General
Business Conditions encompass internal aspects of the business.  Any financially adverse conditions such as prior bankruptcy, undeclared income or expense, client or vendor concentration, future promises to current employees or independent contractors, current or anticipated conflicts with landlord(s), deferred maintenance issues, unpermitted work performed on premises, equipment in need of repair, anticipated increases in worker’s compensation insurance due to recent claims, and existence of hazardous materials must be disclosed and addressed should they exist.
Regulations focuses on required licenses and permits, zoning, tax compliance, and local, county, state or federal law violations or investigations of any kind.
Other Considerations may include union or employment agreements, employee stock ownership plans, underfunded pension liabilities, accrued back wages, vacation pay or sick leave, equipment leases, pending or threatened litigation, unresolved insurance claims, unpaid local, state or federal tax, etc.
The General category raises one all-encompassing question: is the seller aware of any other facts or conditions not disclosed in the three prior categories that may adversely affect the operation of the business, a buyer’s decision to purchase it, or the price that a buyer might pay for it?
Should any of the aforementioned conditions exist, it is critical that they be acknowledged and explained to the buyer before they buy. A significant business weakness or risk revealed early in the discovery phase is usually a manageable hurdle or a point to negotiate around. That same information revealed during due diligence becomes a catalyst for buyers to reexamine other data, lower their price, or walk away. In our experience, appropriately exposing warts early in the M&A process builds trust and credibility with buyers, which is an advantage in negotiations, and helps ensure that sellers avoid disputes and keep all of their proceeds after the sale.
Ultimately, the best advice is: Disclose, Disclose, Disclose.
For further information on disclosures in the business sale process contact Don Ross.

SBA Loans: Capital for Small Business Acquisitions

So you’re thinking of selling your business and prefer to be cashed out rather than be paid in installments over time. Uncle Sam wants to see your business continue as a job creator, and hence, works with lenders to make attractive loan terms available to business buyers, on loans up to $5 million.
US Small Business Administration (SBA) loans come in two types: business loans – type 7(a), and real estate loans – type 504. According to Bob Porter of Plumas Bank in Auburn, CA, who has been in the SBA lending business for a very long time, the “lending formula is complicated,” but here are typical loan terms:
7(a) Loans [Business]
  • Loan-to-value ratio is typically 70-85% of the business purchase price.
  • Term is typically 10 years.
  • Interest rates are typically Prime rate plus 2.0-2.75%. Prime as of this writing is 3.25%, so interest rates are currently 5.25% to 6%. Interest typically adjusts quarterly.
  • Banks may loan up to $5 million under the 7(a) program.
  • Terms are competitive among banks and vary with perceived business risk and the creditworthiness, outside collateral and business experience of the borrower.
  • Loans over $250,000 (and smaller loans when the business is being transferred between related parties) require a fair market value appraisal by a certified business valuation expert.
  • To help offset risk, banks typically like to see a 4 times debt-equity ratio (80% debt; 20%cash [equity]) to the appraised value of the business, because if the business is priced at fair market value it should have the ability to service the SBA debt payments. If the buyer is paying more than appraised value, the loan amount will be reduced accordingly.
504 Loans [Real Estate]
  • Loan-to-value ratios are typically 90% for general purpose properties like office and warehouse buildings, and 85% for specialized/dedicated properties such as restaurants, bowling alleys and gas stations.
  • Two loans are actually made: a 50% First Trust Deed held by the bank with a term of 20 to 25-years and a fixed or variable interest rate (currently around 5%), and a Second Trust Deed from the SBA with a 20-year term and a fixed rate (currently 4.9%).
  • Although rare, SBA 504 loans can also be used to purchase equipment such as printing presses, tractors, or machining equipment.
In cases where a business is being purchased with real estate, banks may offer the borrower a blended term 7a loan, or break the transaction into both a 7(a) loan for the business purchase and 504 loan for the real estate purchase.
 

Bob Altieri, Certified Business Appraiser (CBA), regularly conducts business valuations for SBA business acquisition loans and serves lenders throughout California. For further information on this topic call or Email Bob Altieri in our Roseville, California office.

Marketing a Business: The Need for Confidentiality

Maintaining confidentiality during the M&A sale process is a critical factor in successful business transactions. 
At the onset, during the marketing phase of a business sale, you are walking a tightrope between those you want to inform and those you don’t.  Confidential information is shared only with qualified buyers who have evidenced professional and financial capacity.   Information is withheld from those, who by virtue of their relationship with the seller’s business, could prove detrimental to the ongoing operations or constituents of the business.  Constituents can include employees, competitors, vendors and lenders.
Buyers want to buy a stable businesses. If employees learn that their employer is for sale, they may seek other employment to protect their income. Customers may begin to favor other sources for the company’s products or services. Key suppliers may begin seeking alternate channels to the market. Any of these events can erode business performance and stability, which translates to reduced value and increased risk for the current and future owner.
Marketing pieces include “blind executive summaries” where company name and location are not disclosed.  Non disclosure agreements help to maintain confidentiality with buyers.
Information of a highly sensitive or competitive nature, such as customer lists and proprietary processes, should not be divulged prematurely.  As the transaction progresses and the parties agree to terms, such information is safeguarded and discretely released to the buyer late in the due diligence process or when the transaction closing is imminent.
Finally, after the transaction closing, details of the transaction remain private.  In 13 years of selling businesses, Exit Strategies has managed to keep the details of every private to private company transaction confidential.
It is the maintenance of confidentiality throughout the transaction that sustains the integrity and comfort of the business for both buyer and seller during the process and going forward.
For further information on maintaining confidentiality in a business sale process contact Don Ross.

Baseball and Business Acqusition Financing: Five Tools Scoring Matrix

The “Hot Stove League” is an expression that describes the six month hiatus from baseball, beginning the day after the final World Series game and extending through the cold winter months until Spring Training opens in March.  There is plenty of time and opportunity for baseball fans to roll up their general manager sleeves and discuss the relative merits of potential roster moves on and off their fantasy teams.

And that is where the five tools come into play.
Five tools is a commonly used benchmark used by Pro Scouts, General Managers, George Will, and self-proclaimed fantasy baseball nerds. It measures past and present position players (pitchers excluded) according to five essential criteria:
  • Speed
  • Power
  • Average
  • Fielding
  • Arm Strength
Of the thousands of professional athletes who have graced the diamond, fewer than 100 are widely considered to be 5 tool players.  According to Bleacher Report, the King of Swat, Babe Ruth, ranks #9  among all players, past and present.  Number 1?  More about that later.
Similarly, many banks employ a 5 tool scoring matrix when reviewing an application for a business acquisition loan.  The five tools of loan worthiness are:
  • Cash Flow: Can the projected debt service coverage be adequately covered by projected net income.
  • Collateral: Does the collateral pledged against the loan represent a significant percentage of liquidation value to loan.
  • Management: Does the borrower have significant experience owning and managing a business in the same or related industry.
  • Credit: Does the borrower have excellent credit history.
  • Down Payment: What percentage loan to value using unborrowed cash is the borrower prepared to inject in the deal.
Each of the five tools is scored on a scale of 5 to 1.  For example, in the case of cash flow, a debt service ratio (net cash after tax income divided by total annual debt service) of 1.75 scores a 5, while a ratio of 1.0 scores a 1.  A total score of 20 or more is considered excellent.  A 25 may get you inducted into the Hall of Fame (and a favorable loan).
More information regarding the five tools and the measurements that distinguish the scoring system is available by calling Don Ross at 707-778-0210.
Incidentally, William Howard Mays (‘Willie’) is regarded as the all time #1 Five Tooler, according to Bleacher Report.

Small Business Transactions Up 18%, Sellers Earn Higher Sale Prices – According to Industry Report

It’s a very good time to be a seller.
According to a report released on October 16, 2014, U.S. small business sale transaction levels are on pace for a record-breaking year. And while the post-recession market has generally favored buyers, a shift appears underway, with sellers now receiving higher selling prices, higher percentage of asking prices and improved cash flow multiples.  The full results are included in BizBuySell’s Q3 2014 Insight Report, which aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide.
Report Highlights
  • The number of closed transactions in Q3 represented both a 17.9 percent increase from last year and the highest number of small business sales recorded in a third quarter since BizBuySell began tracking data in 2007.
  • The median sale price for businesses sold in Q3 rose 5 percent compared to last year.
  • The average cash flow multiple jumped nearly 9 percent.
  • Service-related businesses led the way with a 17 percent increase in closed transactions, while manufacturing was up 16.2 percent and restaurants were up 13.3 percent compared to last year
  • In addition to an increased number of closed sales in Q3, there was also a growing number of businesses offered for sale.
  • 2014 remains on pace to record the highest number of closed transactions reported since the BizBuySell Insight Report’s inception in 2007.
Our View
Without a doubt, as business financial results and the economy continue to grow, and as buyer liquidity and acquisition financing options continue to improve, Exit Strategies is seeing more buyers and sellers entering the market here in California, at both the main street and middle-market levels.  Set amidst the backdrop of an aging baby boomer business owner population, low interest rates, plenty of private equity dry powder, and the potential for future tax rate hikes, we expect this trend to continue into 2015.
Business owners without a successor who have an eye toward retirement should look closely at entering the market. The sale process takes 9 months on average. Add time on the front end to evaluate and prepare the business, and on the back end for management transition, and a full year or more is not uncommon.
For more information about current market conditions or to understand how your business is likely to be received by prospective buyers, investors and lenders, feel free to contact us, in total confidence.