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

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

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

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

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

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

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

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

 

M&A Advisor Tip: Earnouts Break Valuation Deadlocks

Earnouts are often used to bridge a valuation gap between a buyer and a seller. It’s a compromise, of sorts, to break a purchase-price deadlock when the seller wants more than the buyer is willing (or able) to pay.

In an earnout, a portion of the purchase price is paid out later, based on the company’s financial performance over time. Earnouts typically last from 1 to 3 years, subject to negotiation.

Some earnouts include acceleration provisions, stipulating that payments are due immediately if certain events occur e.g.,:

  • Buyer breach of post-closing covenants
  • Termination of key employees
  • Sale of the company or a substantial reduction in assets

These provisions are designed to protect the seller from changes that would harm the company/buyer’s ability to meet their earnout targets.

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

‘No Shop’ Protects Buyer Investment in M&A

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

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

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

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

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

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

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

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

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

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

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

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

Secrets to Business Valuation – a Lesson from Curly

Remember that scene from the 1991 movie City Slickers where Curly (Jack Palance) shares the secret to life with Mitch (Billy Crystal) shortly before he dies? Curly holds up his index finger and says to Mitch that the secret to life is to figure out his one thing and then stay with it. Channeling Curly today, I will share with you the three things that determine the value of any operating company, with rare exception.

As M&A advisors and valuation experts, we frequently see similar companies of the same size sell for vastly different sums. Let’s look at a simple illustration. Say Company A and Company B both distribute industrial products in similar markets, both do $30 million in revenue and both go to market at the same time. At the end of a rigorous sale process, Company A sells for $25 million and Company B sells for $15 million.

What caused the difference in the price buyers were willing to pay? It usually boils down to three factors: cash flow, growth and risk.

Cash Flow

At the end of the day what matters most to investors is future cash flow. Net cash flow is influenced by net profits, as well as working capital levels and capital investment needs. Owners can use free cash flow to either pay themselves, pay debt providers or reinvest in the business. Looking at our example, even though Companies A and B have the same revenue, Company A operates more efficiently and generates significantly more cash flow for its investors.

Growth

The second factor is growth — top line and bottom line growth. The more cash flows are expected to grow over time, the more cash flow investors will have at their disposal, and the higher they will value a company. Company A has likely proven – based on its historical financial results and investment record – that they are capable of growing at a faster pace than Company B.

Risk

The third thing affecting valuation is the level and types of risk associated with receiving those expected cash flows. Investors decide how certain they are that a company will continue to perform the way it has or achieve its growth projections. The more certain they are, the more they’ll pay, and vice versa. In our example, Company A may have less cash flow volatility, a stronger leadership team, or more market or product diversification, which would reduce perceived risk and increase certainty of performance.

Valuation theory and actual prices paid support the view that similar companies can have very different values. Acquirers and investors, when deciding how much to pay for a company, quickly look past gross revenue and EBITDA to net cash flows, growth and risk. The sooner a company owner understands and embraces this, the happier they’ll be when they decide to sell.

Exit Strategies values private companies for business owners before they make important decisions about sales, mergers acquisitions, recapitalizations, buy-sell agreements, equity incentive plans, and more. If you are business owner and would like to learn more or discuss a potential M&A transaction or valuation need, confidentially, give Al Statz a call at 707-781-8580.

 

Exit Strategies Group Joins Cornerstone International Alliance

Exit Strategies is pleased to announce that we have combined resources with some of the best independent M&A firms to deliver more value to lower middle market business owner clients.

Cornerstone International Alliance (CIA) is a global alliance of independent M&A firms. Formed in early 2019, it is the world’s only such alliance focused exclusively on the lower middle market. Member firms are selected for their extremely high integrity, extraordinary ethics and extensive mergers and acquisitions experience.

Alliance members share industry expertise, regional knowledge, transaction experience, contacts, resources and best practices. This exclusive partnership will allow Exit Strategies to provide company owners, strategic buyers, private equity firms and trusted advisors with more resources and more expertise in a wider range of industries. It will help us assemble the best possible team for every client engagement.

To learn more about CIA, visit www.cornerstoneia.com or give Al Statz a call at 707-781-8580.

Nine Warning Signs Your Buyer Can’t Close the Deal

The proof is in the pudding. It ain’t over ’til it’s over. Don’t count your chickens before they’ve hatched. Pick your cliché. Just because someone makes an offer to buy your business doesn’t mean they will close the deal.

As a seller, you need to look at more than dollar signs on a purchase offer. Make sure your advisors are researching and asking questions to figure out which buyers are for real, and which ones are just talking a big game.

Sometimes buyers want to rope you in to an exclusive negotiation. They throw out a high price, fully intending to negotiate down as they conduct due diligence and “discover” weaknesses in your business.

Some buyers have big egos and want to be the big dog at the table. But their balance sheets or lending relationships can’t really support the promises they’ve made.

Still others make what they believe to be legitimate offers with good intent. But if they’re not the final decision maker — the person controlling the checkbook— their efforts might be scuttled by a higher up, or a lender, who simply doesn’t see the same advantages in the deal.

These things happen more often than you probably think.

Nine warning signs your buyer won’t follow through:

  1. Too good to be true. They offer a super high price and a 45-day closing “guarantee no risk” if you’ll sign their exclusivity agreement. Your buyer may have ulterior motives. They’ll get access to your sensitive information and get you off the market (weakening your position). Later, they’ll try to renegotiate a sizeable haircut or walk away when you don’t accept their lowball offer. Either way, they gained meaningful competitive intelligence which could significantly hurt your business or its value going forward.
  2. Too vague. They won’t estimate cash at closing. They say, “We’re going to try to get as much as we can.” Or, “We’re not quite sure yet.” A good buyer should have an idea of how much of the purchase price will be paid in cash at the closing.
  3. Unclear funding plan. They won’t disclose their lending sources. A buyer isn’t qualified if they can’t demonstrate financial ability to fund the deal.
  4. Lack of transparency. They won’t connect you to their prior business partners. If they’ve done acquisitions in the past, they should provide seller references. We want to know what the buyer is like to work with and if they do what they say they’re going to do.
  5. “Hidden” history. They won’t disclose anything about their acquisition history. A buyer who keeps their past business under wraps may not have as much experience as they say they do.
  6. No digital footprint. We’re looking for a website, press releases and announcements of past companies the buyer has acquired. Ideally, we’d like to see a few published news items, too. Active acquisition firms want to get their name out there.
  7. Fuzzy deal terms. Once you get to the letter of intent (LOI) stage, you need to strike a fine balance between strict detail and vague conditions. While this is generally not the time to demand all the deal specifics, unclear deal terms could put you in a position of weakness later on. Alternately, a vague LOI could be a sign your buyer is kicking tires and not really committed to a deal.
  8. Slow to respond. Perhaps your buyer was engaged and enthusiastic at the start of the process, but now they’re taking a long time to get back to you. If there’s a noticeable change in communication, that’s a signal you’re no longer a priority acquisition target.
  9. No control over the purse strings. Buyers reps and corporate development teams aren’t the final decision makers. Business owners without enough capital to fund their own deals aren’t the final decision makers. These buyers have to sell your deal to their lenders or other equity partners, and that introduces risk into the transaction.

As you evaluate offers for your company, you have to consider whether one buyer is more likely than another to get a deal over the finish line. Some buyers are just bad actors, looking to take advantage. In other cases it’s a lack of time, money, information, experience or authority that can derail a deal.

M&A advisors are skilled at recognizing these warning signs and helping you avoid these types of problems. Contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com for further information or to discuss a potential sale, merger or business acquisition need. Exit Strategies Group is a partner of Cornerstone International Alliance.

M&A Advisor Tip:  What Buy-and-Build Means for You

Private equity firms have increased their use of buy-and-build investment strategies.

A buy-and-build strategy involves bolting together several smaller companies into a larger business enterprise that will likely sell at a higher multiple. See our post on the size effect. This trend is affecting many industries, from healthcare clinics to niche business service companies.

The uptick in buy-and-build acquisitions could mean more buyers and more competition for your business than you expect. Contact Al Statz at 707-781-8580 or alstatz@exitstrategiesgroup.com to learn more about consolidation trends in your market.

Why business transactions don’t close: Signs of a flaky Buyer/Seller

Selling or buying a business is time consuming, emotional and stressful, and having a deal fall through can be demoralizing. But the reality is that only a fraction of potential business acquisitions actually close. Many deals never really get off the ground. Even deals that make it to the letter of intent (LOI) phase often don’t close. When it comes to selling or buying, you really need to find out if the other party is serious and likely to perform. But, how do you know? It’s not as if it’s written on their foreheads.

Fortunately, there are tell-tale signs that you may be dealing with a person who is impractical, flighty, unreliable, inconsistent, indecisive, deceitful or will flake out before closing day. If you’re worried that you might be dealing with a flaky buyer or seller, look for these signs.

1. The buyer or seller is untrustworthy.

Before buying or selling, learn to do research on the buyer or the seller. It is still your asset before they buy it, and it will be your asset when you buy it from them, so it is best that you do some checking on the character of the individual, company or private equity group you are dealing with. Look up past deals they have done and check references.

2. The buyer seems to have financial problems.

When a buyer is financially weak, there’s a strong chance that buyer won’t make it to closing. Buyers should show proof of funds for a down payment in order to make an offer on a potential purchase, and in some cases get prequalified for a loan. Try to avoid entering into an exclusive LOI without proof of funds. If a buyer won’t agree to provide proof of funds early on, or stalls for any reason, simply walk away.

3. The buyer or seller is slow to act.

When a seller or buyer drags his feet in providing disclosures or other diligence it could mean lack of interest or something to hide. If they are serious about buying or selling, rest assured they’ll be quick to act and respond with clear and accurate information or a thoughtful reply. If you’re hearing a lot of “I don’t know,” “maybe,” or “I’ll let you know,” they are not ready for a transaction. Or if you message them “can you meet me at XYZ at 5:30 pm?” And they reply with “I gotta see”, or “I work today”, and they don’t reply with a follow up time and place they can meet you, chalk this one up to the birds. They’re not serious about doing the deal.

4. Lack of transparency.

If a buyer or seller seems to be less forthcoming, it doesn’t mean the deal will fall through, but it isn’t a good sign. If there’s anything less than full transparency, there’s generally a reason. A lack of transparency has a lot of gray areas, it could mean that they can’t really provide all the information that you have asked for and are just trying to buy time till they can get it. Nonetheless, a lack of transparency is a sure sign of a flake buyer or seller.

5. The seller, buyer or agent becomes less responsive.

One of the biggest signs a sale is going to fall through is if there’s a noticeable change in the communication from a once cooperative party. We all live busy lives and are can’t always check our texts and phones every hour, BUT, when it comes to doing business deals, time is often a deal killer. So, when a buyer or seller takes days to reply to simple requests, you are probably wasting your time. Still, don’t assume that the seller or buyer is no longer interested. A text or email message can be missed or misinterpreted, and calling or meeting with the other party is imperative. Nonetheless, avoid anyone that is taking longer than necessary to reply.

6. Low enthusiasm for the deal.

Enthusiasm is a sign that they want the transaction to close. If you sense that the other party is just going through the motions and isn’t all that excited to be selling his or her business or jazzed about buying, it’s a warning sign. There’s a fair chance that your deal will fall apart. Perhaps the prospective buyer has found a different business that they are excited about. Whatever the reason, you’ll definitely want to address it right away

Another sign that a purchase is going to fall apart is when one partner on the buy side loves the business, but their partner is more hesitant. When it’s a joint venture, all partners should be equally excited to sell or buy, it shouldn’t be one-sided.

In Summary

Flakes often flash clear warning signs through their lack of transparency, indecision, inaction and lack of preparation. But it is easy to miss or look past these warning signs if you haven’t been through this process numerous times. The surest way to avoid flaky buyers or sellers and increase your chances of a successful deal is to hire a business broker, M&A advisor, investment banker or transaction intermediary. These professionals spend a lot of time watching for these signs, and make appropriate recommendations and take appropriate actions when they occur.

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Bob Bates, CPA, CVA is a senior valuation analyst in Exit Strategies Group’s San Jose California office. For more information on the use of earnings and cash flow measures used in business valuation, or to discuss a current business valuation need, Email Bob at bbates@exitstrategiesgroup.com or call him at 408-769-4404.

The Sale of a Business May Actually Excite Employees

Many sellers worry that employees might “hit the panic button” when they learn that a business is up for sale. Yet, in a recent article from mergers and acquisitions specialist Barbara Taylor entitled, “Selling Your Business? 3 Reasons Why Your Employees Will Be Thrilled,” Taylor brings up some thought-provoking points on why employees might actually be glad to hear this news. Let’s take a closer look at the three reasons that Taylor believes employees might actually be pretty excited by the prospect of a sale.

Taylor is 100% correct in her assertion that employees may indeed get nervous when they hear that a business is up for sale. She recounts her own experience selling a business in which she was concerned that her employees might “pack up their bags and leave once we (the owners) had permanently left the building.” As it turns out, this wasn’t the case, as the employees did in fact stay on after the sale.

Interestingly, Taylor points to something of a paradox. While employees may sometimes worry that a new owner will “come in and fire everyone” the opposite is usually the case. Usually, the new owner is worried that everyone will quit and tries to ensure the opposite outcome.

Here Taylor brings up an excellent point for business owners to relay to their employees. A new owner will likely mean enhanced job security, as the new owner is truly dependent on the expertise, know-how and experience that the current employees bring to the table.

A second reason that employees may be excited with the prospect of a new owner is their potential career advancement. The size of your business will, to an extent, dictate the opportunities for advancement. However, if a larger entity buys your business then it is suddenly possible for your employees to have a range of new career advancement opportunities. As Taylor points out, if your business goes from a “mom and pop operation” to a mid-sized company overnight, then your employees will suddenly have new opportunities before them.

Finally, selling a business could mean “new growth, energy and ideas.” Taylor discusses how she had worked with a 72-year-old business owner that was exhausted and simply didn’t have the energy to run the business. This business owner felt that a new owner would bring new ideas and new energy and, as a result, the option for new growth.

There is no way around it, Taylor’s article definitely provides ample food for thought. It underscores the fact that how information is presented is critical. It is not prudent to assume that your employees may panic if you sell your business. The simple fact is that if you provide them with the right information, your employees may see a wealth of opportunity in the sale of your business.

Copyright: Business Brokerage Press, Inc.

Understanding Seller’s Discretionary Earnings

If you have acquired or sold a small company, or had one appraised, you’ve probably heard the term “Seller’s Discretionary Earnings”. Or you may be thinking “Earnings are discretionary? My earnings aren’t discretionary at all!” Let’s examine this often-misunderstood term, and how it compares to EBITDA, another common earnings measure.

What is Seller’s Discretionary Earnings?

Seller’s Discretionary Earnings (“SDE”) is a calculation of the total financial benefit that a single full time owner-operator would derive from a business on an annual basis. It is also referred to as Adjusted Cash Flow, Total Owner’s Benefit, Seller’s Discretionary Cash Flow, or Recast Earnings. Here at Exit Strategies, we prefer the term Discretionary Earnings or DE. For this article I’ll use the more common SDE.

SDE is most often used in the valuation and sale of “Main Street” businesses. While there is no precise definition of what a Main Street business is, it often refers to owner-operated companies with less than $5 million of revenue. Larger businesses primarily use EBITDA.

SDE vs EBITDA

SDE = Adjusted EBITDA + Owner Compensation (one full-time owner)
Where EBITDA = net Earnings + Interest + Taxes + Depreciation + Amortization.

So SDE is always a larger number than EBITDA. This is a bit counter-intuitive for people used to working in the middle market. They usually think of EBITDA as the large number that things are subtracted from to calculate net cash flow. And wouldn’t SDE be similar to or smaller than EBITDA? A look back at the formula clears this up.

When applying price multiples for sale or valuation purposes it’s important to accurately differentiate between SDE and EBITDA. A mismatch between the earnings measure used and the multiple applied can result in significantly overvaluing or undervaluing a business.

Normalization Adjustments

Once we calculate EBITDA (or SDE) from a company’s profit and loss statement, we need to work through normalizing adjustments. We often break normalizing adjustments into two categories: discretionary items and non-recurring items.

Discretionary Items

Discretionary expenses are those that the business paid for but are really a personal benefit to the owner. Discretionary expenses exist because owners want the “tax benefit” of expensing these items. But they also want the benefit of adding them back into earnings when it comes time to value and sell the business.

Typical discretionary expenses are owner medical or life insurance, personal travel, personal automobiles, personal meals/entertainment, and social club memberships. To qualify as discretionary, each expense must meet all three of these criteria:

  1. Benefit the owner(s)
  2. Not benefit the business or its employees
  3. Are paid for by the business and expensed on tax returns and P&Ls

Whether an expense is discretionary or not isn’t always obvious:

Definitely AdjustDon’t AdjustGray Areas
Retirement plan contributionsNetworking group membershipsTravel (business and pleasure)
Home landscapingMarketing expensesContributions

Discretionary expenses are often the subject of debate between a buyer and seller. Buyers, of course, are risk averse and dubious about all these co-mingled expenses the seller claims are “not really expenses.” Items that fall in the gray area will require extra documentation by the seller and due diligence by the buyer. Certain items that a buyer might accept won’t be accepted by a bank. Generally speaking, sellers will benefit from stopping all commingling of business and personal expenses at least three years before they sell a business.

Non-Recurring Items

The other major category is extraordinary/one time income or expenses. Adjusting for extraordinary one time income and expense makes sense because they are not expenses that are indicative of the core business operations. Common examples are restructuring costs, costs related to acts of nature, asset sales, litigation expense and emergency repair costs.  One-time expenses are also scrutinized and debated. Did that bad debt really only happen once? Or is it likely to occur again in the future?

Why is this important?

In M&A transactions buyers are concerned about risks: What aren’t you telling them? How could this investment go bad? We often say that getting to a closing is about removing roadblocks in the deal – and often the biggest among them is reducing the buyer’s level of perceived risk. With that in mind it’s important to think about the line items that go into SDE well before you go to market and do your best to reduce any areas that might fall into the “questionable” zone. The cleaner your financials are the more likely you are to sell on the best price and terms.

Bob Bates, CPA, CVA is a senior valuation analyst in Exit Strategies Group’s San Jose California office. For more information on the use of earnings and cash flow measures used in business valuation, or to discuss a current business valuation need, Email Bob at bbates@exitstrategiesgroup.com or call him at 408-769-4404.