Why boomer business owners should watch M&A cycles

/in , , /by Al Statz

Approximately 20% of private business owners are over the age of 65. Another 30% are between the ages of 55 and 64, according to estimates from the Census Bureau Annual Business Survey.

If we’re going by age trends alone, that suggests roughly half of America’s businesses will transition ownership in the next five to 10 years. This will be the largest transfer of wealth the nation has ever seen in such a short period of time.

Right now we’re in a strong seller’s market. Despite the economic uncertainty, rising interest rates and world turmoil, mergers and acquisitions has not cooled down much. It’s economics 101, supply and demand, and there are just more buyers than sellers on the market.

Between private equity and corporate balance sheets, there is more than $8.5 trillion in “dry powder” waiting to be invested in corporate growth and acquisitions. That’s at least $6.84 trillion in cash and short-term investments on corporate balance sheets, and $1.8 trillion in uncommitted capital in private equity funds, according to reports from S&P Global.

Corporations have added 20% to their balance sheets since 2019, and private equity continues to up the ante with record fundraising year over year. All that cash drives up demand and increases value for business sellers.

At some point, though, supply and demand could flip. Right now, experts estimate 10,000 baby boomers are retiring daily. By some estimates, roughly 15% of them own businesses. That’s 1500 additional businesses looking for new ownership every day – and only a small fraction of those will get passed along to a second generation.

By the tail end of this cycle, we could end up in a buyers’ market with more boomers selling their businesses than buying.  Business owners who get ahead of the trend will be in the best position to take advantage of positive market conditions.

Take these steps to increase your chances of a successful sale:

Plan:

It’s tough to maximize value when you’re burned out, so aim to sell while you’re still energized by the business. The average sale takes nine months to a year, not including post-sale transition time.

Instead of planning your retirement around a certain age, you can often reap greater rewards by timing a sale around your business value. Get a regular valuation so you know what your business is worth in the current market.

If age is still your primary deciding factor, begin planning several years in advance. With enough time, your advisors can provide leadership, cash flow and tax positioning strategies that will help you net the most out of a sale.

Prepare emotionally:

Don’t underestimate the emotional impact of selling your business. Leaving an ownership role is hard, especially if you’ve built your business from the ground up.

Many baby boomers struggle to step away when the time comes. Decide how you will define the next chapter in your life. It’s important to have something you’re “retiring to” instead of just something you are “retiring from.”

Seek advice from mentors and peers who have made a similar transition. Talk through what it means to give up your identity as a business owner. For many, it’s easier to make that transition if they already have other strong plans and commitments.

Make selling part of your succession plan:

Don’t have next generation leaders ready to take over the business? Leadership team not prepared to buy you out? Consider how selling your business can play a role in your succession plan.

When selling to private equity, for example, you can often arrange for family members or other key managers to receive an ownership stake in the business. This can be a great way to set your next generation leadership up for success, with strong connections and financial backing behind them.

These arrangements can protect you both financially and emotionally – without the specter of money and debt hanging between you and your family.

Consider staying on after a sale:

Sellers can often negotiate a full-time or part-time advisory role and phase into retirement. Employment contracts can make your business more attractive (and more valuable) to private equity buyers who need experienced leaders in place to maintain operations while they fuel new growth.

The long-predicted seller tsunami is coming. Business was strong before the pandemic, but the crisis put everyone in a short-term holding pattern. With recession fears ahead, people are taking this opportunity to go out on a high note – while they still can.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip: F-reorganization

/in , /by Al Statz

Deal structure can have a big impact on your after-tax proceeds. The right structure can help you retain more of the sale price. For example, an F-reorg is a tax efficient method that allows you (the seller) to rollover equity into the buyer’s new entity without paying taxes on the rollover amount.

Without using an F-reorg, you might sell 100% of the company and get taxed on that full amount (ouch!) before reinvesting some of your proceeds in the buyer’s new business.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Market Pulse – Q4 2021

/in , /by Al Statz

Financing Deals in 2021

Presented by IBBA & M&A Source

Deal financing has not changed significantly since before the pandemic. On average, sellers continue to receive 80% or more of total consideration as cash at close. (Cash at close includes senior debt and buyer equity.) Seller financing accounts for 15% or less of most deals.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Is it the right time to sell your business?

/in , /by Adam Wiskind

Business owners often ask, “When is the right time to sell my business?” The answer is some version of “A good time to sell is when there is a seller’s market, and the owner and the business are prepared”. Simple enough, but there is a lot to unpack in this response.

Don’t Try to Time the Market

A seller’s market exists when, because of economic conditions, demand for viable businesses is higher than the supply of businesses on the market. There are some universal economic metrics that drive demand for businesses like low interest, tax rates and high corporate cash reserves and earnings rates. When investors are confident about the business environment, they are more likely to pay premiums for their investment targets.

However, local and industry specific factors are often more important to the creation of a seller’s market. A mature industry that begins to consolidate may create an industry-specific seller’s market that doesn’t exist in other industries. The rise of private equity has driven consolidation in many industries. Also, when a regional competitor embarks on an acquisition growth strategy it may create a localized opportunity for owners in the same industry to sell.

It is wise for a business owner to pay close attention to these market signals. However, owners can’t control supply and demand in the marketplace and are generally better off not trying to time the market. In the second quarter of 2020, the market for small businesses came to an abrupt halt, dashing the hopes of many owners that were ready to retire. But by the fourth quarter of the same year the market returned stronger than before. No amount of prognosticating could have anticipated those market changes.

Business Preparation is Key

The preparation of the business is more important to the success of the business sale than the state of the marketplace, and it’s something that the business owner can control. A well-prepared business is more likely to sell in a soft market, than a poorly prepared business in a strong market.

It’s been estimated that 80% of US small business owners don’t have a written transition plan and 50% have no plan at all. A key component of the transition plan is preparing the business for succession. Many books have been written and teams of professionals deployed to help business owners prepare their businesses for sale. Conceptually, the buyer of a business is investing with the confidence that the future earnings and growth potential enjoyed by the seller can be transferred to the buyer. To make the business attractive, the owner must then mitigate the risks in the business and to fortify its opportunities for growth.  The specific measures necessary to prepare the business vary widely.  Some critical areas for consideration are:

-What are the growth prospects of the business? Is there a viable pathway to achieve growth?
-What constitutes the goodwill of the business? Is the goodwill persistent and can it be transferred to a buyer?
-Is the business’ intellectual property sufficiently protected?
-What is the owner’s role in the business? How easily can the owner be replaced?
-Does the remaining management team have the experience and resources necessary to operate the business efficiently?
-Is the business properly staffed for its size and to recognize its growth potential?
-What supplier and customer risks exist? How can they be addressed?
-Do the business assets have deferred maintenance or unfunded capital expenditures?

There are times when a business is clearly not ready to be placed on the market. The business may not be performing because of loss of an important client, vendor, or key employee or because of an acute business issue that the business is facing like a lawsuit or a loss of facility lease. These red flag issues should be resolved by the owner, before trying to sell their business.

The process to identify and address the specific issues faced by a company may take 3-5 years, so it’s important to plan ahead. But the owner of a company that has been properly prepared for sale, may be rewarded with a price premium, while an unprepared business may sell for a discount, or not at all.

The Owner is Motivated, but not Compelled to Sell

Lastly and most importantly, the owner needs to be psychologically ready and financially prepared to exit their business. Most owner’s only own one business in their life and selling it is momentous. For some, the business is tightly intertwined with their personal life and identity. However, there inevitably comes a day when the owner no longer wants to or no longer can be involved in the business.

Owner’s end up selling for a variety of reasons, for some it’s poor health, for some its divorce from their life or business partner. These personal challenges can make the process of selling the business more difficult and may put the owner at a disadvantage during negotiations with a buyer. The best reasons are because the owner realizes that there is something that they would rather be doing with their time or assets like retirement or another venture. Ideally, they are personally motivated, but not compelled to exit.

Even if the owner is determined to sell, they may hesitate to do so if they haven’t determined that the proceeds from the sale are sufficient to support their retirement or pursue other ventures. Professionals can help with this analysis. Business appraisers can help to anticipate the proceeds from selling the business. While a financial planner can help an owner estimate the amount needed to support their retirement.

Ultimately, determining the right time to sell their business requires the owner to plan ahead and prepare the business for the time when market conditions are adequate, and the owner is personally motivated. Exit Strategies Group helps owners to plan for and execute their business exits. If you’d like help in this regard or have any related questions, you can reach Adam Wiskind, Certified Business Intermediary at (707) 781-8744 or awiskind@exitstrategiesgroup.com.

Market Pulse – Quarter 4, 2021

/in , , /by Al Statz

Seller’s Market

Presented by IBBA & M&A Source

A seller’s market occurs when demand exceeds supply. There are more interested, active buyers than there are quality deals on the market. In a seller’s market, buyer’s compete in order to win deals. This typically translates to increased values and more favorable deal terms for the seller.

In Q4 2021, seller market sentiment rebounded, setting a new peak in all but the $5M-$50M sector.

“Business confidence, and competition, is high. It’s amazing how fast we rebounded to record levels,” said Anthony Citrolo, managing partner of The NYBB Group. “This is the strongest upwarad swing we’ve seen in any 12-month period.”

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip: And the economist says…”Sell!”

/in , /by Al Statz

Economist Steven Chiavarone presented at CIA partner’s annual State of M&A conference in February. As he pointed out, there have been 11 rate hike cycles since 1970 of three hikes or more. Of those, nine were followed by a recession. (The other two were followed by a stock market crash and the Mexican peso crisis.)

He had about 50 minutes more of economic analysis for us, but his takeaway advice was this: “If you are a seller, sell.”

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip: Avoid key-man risk

/in , /by Al Statz

Business owners should ask themselves, if I became incapacitated, could my business run without me? If the answer is no, buyers will be concerned about the business’s ability to operate when you’re gone.

If you can’t get away for at least a week of vacation at a time… if you hold key customer relationships… if you’re solely responsible for an essential business function… buyers will see risk, and rightly so.

To get the most value in a sale, you need to build a business that can operate without you. Better yet, try to eliminate key-man risk throughout the organization so that business operations can continue no matter who gets sick or quits unexpectedly.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

$1.1 Billion Sets New Record for C.I.A. Members

/in , /by Al Statz

Cornerstone International Alliance (C.I.A.) members completed 146 business transactions in 2021, representing more than $1.1 billion in combined transaction value.

Cornerstone International Alliance is comprised of 25 industry-leading M&A and investment banking firms in the U.S. and across the globe, focused exclusively on serving businesses in the lower middle market. Exit Strategies Group is a founding member of the Alliance and our CEO Al Statz serves on its board.

“This is an incredible accomplishment and a testament to our member’s expertise, the strength of the organization and the global network it creates,” said Nick Olsen, Managing Director of Cornerstone International Alliance. “The members’ combined experience, resources and collaborative efforts are generating a new level of value for their clients in the lower middle market, and we’re excited about what’s ahead in 2022.”

The Alliance members typically work with business owners whose companies have $500,000 to $10 million in EBITDA or $5 million to $150 million in revenue; the primary services provided include business sales, acquisitions, and valuations.

“We’re always striving to find ways to help one another through networking and the sharing of best practices, which is the goal of the organization,” explains Al Statz, CEO of Exit Strategies Group. “All CIA member firms have a track record of success and high integrity. And together we are actively working to set the standard for M&A excellence in the lower middle market.”

Founded in 2018, C.I.A. members have completed over 3,600 business transactions.

M&A Advisor Tip: Perks & business value

/in , , /by Al Statz

Business owners take a number of perks from their business, from the standards like auto expenses, memberships, and insurance plans to extras like entertainment, vacations, or an additional family member on the books.

Perks are a way for owners to be further compensated for their hard work. However, they can complicate valuing a business. When preparing your business for sale, your advisors will “normalize” your financials to account for these extras.

Be aware of providing products or services for cash – or perks that can’t be adequately tracked and proven in your books – can diminish the value of your business. When planning to sell, talk to your advisor about the tax benefits / value tradeoff of certain perks and consider where it would be better to drive cash to the bottom line.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Creative deal structures and deal terms move to lower middle market

/in , /by Al Statz

When selling your business, price is not the only important factor you’ll negotiate with a buyer. The deal structure includes a wide range of considerations from transaction type, ownership and payment structures, working capital, assurances, timelines, and more.

What we’re seeing in the market right now is a rise in creative deal structures. These are non-typical solutions that help dealmakers bridge some sort of gap between the buyer and seller. If properly negotiated, these structures can make a lot of sense for both sides, but it’s critical for a seller to have an experienced M&A advisor and transaction attorney on their side to ensure they understand these more complex provisions.

An earnout is, perhaps, the classic example of a creative deal structure. Under these agreements, the seller receives additional payments provided the business hits certain targets down the road. Earnouts can be a great way to bridge valuation gaps, such as when the business is expecting a big performance boost in the near future – and the seller wants to be paid for those as-yet-unrealized gains.

Some creative deal structures are more common in the middle market M&A (transactions with values over $50 million). But as private equity buyers continue to shift into the lower middle market (business values of $2 million to $50 million), they’re bringing deal structures like these with them:

Reps and warranties insurance. When selling your business, typically you’re going to “represent and warrant” certain things about the business (e.g., you’ve provided accurate info, no known legal or customer issues pending). If something turns out to be not wholly accurate, the buyer can come back to you for a certain percentage of the purchase price.

In smaller deals, the seller will simply agree to a guarantee. But as transactions get larger, buyers may ask sellers to put that money in escrow. That money is then tied up for a certain period of time, not earning any returns.

As an alternative to escrow, the deal can include reps and warranties insurance. In this case, the insurance company does their own due diligence and agrees to take on that risk. The advantage for sellers is that they don’t have to hold that money in escrow anymore and shed the risk of covering a reps and warranty claim during the warranty period.

Premiums for reps and warranties insurance often start at around $250,000. Because of the cost and additional diligence required by the insurer, it was only common in larger transactions over $50 million. Now we’re seeing that move down into deals as small as $10 million in enterprise value.

In some cases, buyers are using reps and warranties insurance as a tool to win the deal. If competition is strong (and these days it often is), buyers may offer to pay for reps and warranties insurance. As sellers evaluate multiple offers, they might consider the opportunity to bypass escrow as a factor that tips them in a buyer’s favor.

338(h)(10). In these transactions, the deal is treated as a stock sale from a legal standpoint but as an asset sale from a tax standpoint. From a legal standpoint, this structure can eliminate the need to comply with time consuming and sometimes challenging customer contract “change in control provisions.” For the buyer, that means they can get a step-up in basis and re-depreciate the assets they just acquired.

F reorganization. An F-reorg is a tax efficient method to allow the seller to rollover equity into the new business (i.e. retain a small portion of the business ownership) without paying taxes on the rollover amount.

Without using an F-reorg, for example, the seller might sell 100% of the company and get taxed on that full amount before reinvesting some of their proceeds in the buyer’s new entity.

Deal makers predict an increase in these and other creative deal structures in the year ahead. The pandemic is one factor behind that. Businesses saw their operations disrupted, and that has created some business opportunities and some risks. Alternative deal structures are one way for buyers to mitigate valuation gaps, reduce seller’s taxes, and create win-win agreements between buyers and sellers.

Deal competition and private equity activity are also driving creative structures. According to a Mergermarket survey, private equity respondents indicated they were more likely to consider creative deal structures than corporate dealmakers (75% to 37%).

That may be because private equity firms simply have more experience with these structures. Or it could be that they have a stronger imperative to win deals, and creative structures provide more flexibility to do that. Regardless of the reason, by utilizing an experienced M&A advisor sellers have an opportunity to embrace these more complex deal terms leading to increased enhanced upside.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.