M&A Financing During the Pandemic

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

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

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.

Exit Strategies Group Advises on the Sale of Poly Seal Industries

Exit Strategies Group recently advised the owner of Poly Seal Industries on a sale to Goodyear Rubber Company.

Founded in 1974, Poly Seal Industries is a Berkeley, California based manufacturer of molded rubber products for customers in the biopharmaceutical, water & wastewater treatment, chemical, healthcare, food & beverage, and consumer electronics industries. In addition to producing quality custom products, Poly Seal helps customers succeed by providing manufacturing engineering and material science expertise.

Goodyear Rubber Company is a world class custom rubber company with molding, extrusion, mixing and sheeting operations in Southern California and Mexico. They specialize in manufacturing custom elastomer components that facilitate motion. They offer turn-key elastomer solutions, including material formulation and part design as well as both small and large-scale production. This acquisition diversifies end markets for Goodyear and takes advantage of available capacity in its molding operations.

Exit Strategies’ client, Dan Baker, was the owner and full-time president of Poly Seal.  His main objectives were to obtain a good price, retire from the business to spend more time with family, provide an uninterrupted supply of quality products to customers, and retain the real property for future redevelopment.

Detailed planning and execution went into achieving Dan’s objectives. Dozens of carefully selected buyer prospects were identified, contacted and screened, leading to multiple bids. Only buyers that could meet Poly Seal customers’ exacting requirements were considered. A substantial effort was required by the deal team to develop a workable transition plan.

Dan Baker said, “I could not have managed this transaction without Exit Strategies and Roy Martinez. They quarterbacked the deal process from start to finish including deal book preparation, buyer outreach, obtaining bids, negotiations, due diligence, contract, and close.”

Exit Strategies was pleased and honored to deliver a positive outcome for its client and other stakeholders. Roy Martinez and Al Statz led this project for Exit Strategies Group.

Exit Strategies Group is a leading California-based M&A advisory firm with almost two decades of experience selling small-to-medium-sized and lower middle market businesses. Al Statz is the President and Founder of Exit Strategies. He can be reached at 707-781-8580. Roy Martinez has been a business intermediary an certified valuation analyst (CVA) at Exit Strategies for over eight years. Prior to Exit Strategies Roy was VP of Finance at WineDirect where he completed two acquisitions. Roy can be reached at 707-781-8583

Exit Strategies Group Represents Shareholders in the Sale of Gibson Engineering

Exit Strategies Group is pleased to announce that Applied Industrial Technologies has acquired Gibson Engineering Company, a value-added distributor and system integrator of industrial automation technologies. Exit Strategies Group served as the exclusive M&A advisor to Gibson shareholders.

Gibson Engineering, based in Norwood, MA,  distributes advanced robotics, vision systems, sensors, motion and machine controls, material handling and other industrial automation products, and integrates mixed technology systems. For over 40 years, Gibson has been a trusted supplier partner to major OEM and end user manufacturers throughout the Northeast and Mid Atlantic region. Under the principled leadership of CEO Dan O’Brien, Gibson Engineering has developed into one of the most capable and respected automation solution providers in North America.

Al Statz, who led the engagement for Exit Strategies said, “Our sale process generated keen interest from several top firms. Applied ultimately presented the right balance of strategic opportunities and cultural alignment for our client. I am confident that Gibson’s suppliers will benefit from this partnership and I look forward to seeing what the Gibson team can accomplish as part of the Applied family.”

Financial terms of the transaction were not disclosed.

About Applied Industrial Technologies: Publicly traded AIT is a leading multi-national distributor and technical solutions provider of industrial motion, fluid power, flow control, automation technologies, and related maintenance supplies. Read the Applied news release.

About Exit Strategies Group, Inc.:  Founded in 2002, Exit Strategies Group is a boutique M&A advisory firm providing full-service sell-side representation, business valuations and exit planning assistance to owners of private lower middle market businesses in automation, material handling and other industries.

Discover Exit Strategies’ New Checklist of COVID-Era Normalization Adjustments

For most of us, 2020 has been one of the most challenging years of our lives. The pandemic has affected business performance both negatively and positively, temporarily and structurally.  It will permanently reshape the global economy in several ways, most of which we are just beginning to understand.

Change and uncertainty makes the job of valuing and appraising businesses and business assets more challenging. At the core of every business valuation analysis is the process of normalizing or recasting the financial statements of the subject company from an historical accounting basis to a proforma economic basis.  If you get this wrong, the value conclusion will be wrong.

Exit Strategies recently developed a checklist of nonoperating and nonrecurring revenue, COGS, expense, assets and liabilities that should be considered for valuations performed during the COVID-19 era. Developed by our team of seasoned valuation analysts and M&A advisors, this checklist provides a framework for private investors, business owners, financial executives and other business valuation professionals to use.

COVID-19 Normalization Checklist

Download the COVID-Era Normalization Adjustments Checklist now.  And check back for updates. This checklist is a work in process as the effects of the pandemic on the economics and financial statements of businesses continue to unfold and evolve.

Best regards,

The Exit Strategies Team

Lopsided Market Drives M&A Values in Pandemic

With all the upheaval in the world right now, you’d expect M&A deal values to take a dip. But recent market analysis shows that’s anything but the case.

According to GF Data [1], companies with an enterprise value of $10 million to $25 million sold at an average multiple of 5.9 times EBITDA in the first two quarters, versus a 5.7 average from 2003 to present.

Similarly, business sales with a transaction value of $25 million to $50 million transacted with an average 6.8 multiple, which is again higher than the 6.4 average over the last 17 years.

Deal volume is down, but values are not. The market has seen a significant pullback from sellers who are waiting out this period of uncertainty – assuming that now was not a good time to go to market.

We know that some buyers too, have hit the pause button on acquisitions. But not all. Private equity, which is still sitting on an estimated $1.5 trillion of dry powder, has continued to push ahead in the current market. In conversations with firms across the country, they’re telling us they are “absolutely open for business.”

Meanwhile, strategic buyers (i.e., existing companies) are still at the table, though in fewer numbers. Corporations were in generally strong shape before the pandemic and still have the balance sheets to move ahead with strategic acquisition and consolidation strategies.

So what’s driving such strong multiples, despite the downturn we’d expect to see in times of uncertainty?

It’s coming down to supply and demand. There are still active buyers in the marketplace, but it’s sellers who are holding off.

We’ve had an imbalance in the marketplace for years, with more buyers than sellers with good, solid companies looking to exit. But now the imbalance is even more pronounced, and the number of buyers competing against each other has allowed values to stay strong through the first half of this year.

Based on conversations with industry peers, we do believe there will be a spike in the number of companies going to market in the fourth quarter. It seems sellers and advisors alike were waiting for summer to be over and the new normal to settle in.

It will be interesting to see if an uptick in sellers will have any effect on value multiples. What I can say is that it would take a significant increase in sellers to get even close to rebalancing the supply and demand equation. The market is lopsided right now, and sellers in the lower middle market still have leverage.

[1]  GF Data collects and publishes proprietary valuation, volume, leverage and key deal term data contributed by over 200 lower-middle market private equity funds and other deal sponsors.


For further information or to discuss a current M&A need, 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.

 

Private Equity is Open for Business

We stay in regular contact with  private equity groups from around the country to monitor M&A market activity. Currently, the message we are hearing is that these firms are “open for business.”

Private equity firms are in the business of buying, building and selling businesses. It’s how they deliver investor returns. They don’t have time to sit back and wait things out. The clock is ticking as they work to meet investor expectations within fund deadlines.

These firms are pretty good about tracking and studying their deal flow. They have data, going back years, on the volume and quality of potential deals that they see.

What we’re hearing, from multiple private equity firms, is that the number of good, quality companies coming to market is down anywhere from 50 to 80% over a year ago. That means the law of supply and demand is working in sellers’ favor.

We know that some buyers have pulled out of the market. Based on what we and our peers are seeing, I’m estimating that 25% of buyers have left the market. But compared to the number of new sellers who are not going to market, we still have a demand/supply imbalance.

That competition has kept valuations and deal structures strong. Previously, we predicted sellers would be sharing much more of the risk through increased earn outs and other alternative deal arrangements. And we are seeing a bit of that, but not to the degree that we expected 3 to 6 months ago. In fact, according to the latest Market Pulse Report sponsored by IBBA and M&A Source, Q2 median selling prices in the Main Street market came in anywhere from 89 to 92% of benchmark. Meanwhile, lower middle market companies in the $5 million to $50 million range achieved the highest values at 100% of benchmark.

What we’re seeing in M&A is somewhat mirroring a phenomenon in the home buying market right now. Fewer sellers are listing their homes, but buyer demand is still high. According to data from Zillow, new for-sale listings are down about 25% over a year ago but house values are up 4.3% year-over-year.

To clarify, sellers that are faring well in the M&A market are those who have been relatively unaffected by COVID-19 and those who were able to recover quickly. Essential businesses and those who have otherwise remained resilient are still having success in the M&A market.

As one example of the competitive dynamics at play, we recently took a technology distribution business to market and within 45 days had 8 written indications of interest on the table on similar terms to what we would have expected 12 months ago. And deals are getting done. A peer organization of ours in Pennsylvania just sold a company with $4-5 million EBITDA at an eight-multiple (above the 2019 market average) with 80% of cash at close.

So if you’re thinking you have to wait out the market to sell, talk to an M&A advisor before you count yourself out. If you have a quality business, it’s easier to get attention right now. Private equity and corporate buyers have fewer businesses to consider and more time on their hands to evaluate acquisition opportunities.

The right businesses are still selling with strong values and favorable deal structures. The window has not closed for high quality companies; in fact, you may be able to benefit from the current market dynamics.


For further information or to discuss a potential sale, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Petaluma, California office.

Gifting Window for 2020 May Be Closing

With a Global pandemic and prospects of a sustained recession with double digit unemployment coupled with West Coast wildfires and East Coast hurricanes, I would say that everyone in these United States is looking forward to ringing in the New Year on January 1st. But before the ball drops on a socially distanced crowd in Time Square, you should think about other changes that may occur as we put 2020 in our rear-view mirrors. Specifically the possibility of tax legislation if the party in power shifts in the Executive and Legislative branches of our government.

Proposed Changes

With no political bias intended, it makes sense for everyone to consider what changes to individual and corporate tax policy a Democratic president and a possible Democratic majority in the both chambers of Congress may enact. Bay Area business and real estate attorney Hubert Lenczowski, reminds us that “under a 1984 court case, Congress can enact retroactive tax legislation in an emergency”, thus limiting a individual or corporation the ability to act prior to the effective date.[1] In a Tax Planning Alert letter penned in late August, 2020, he notes that the following proposals have been identified by Vice President Joe Biden as his legislative agenda for tax policy:

  1. Extend the 12.4% social security tax on earnings over $400,000;
  2. Restore the 39.6% tax rate on ordinary income over $400,000;
  3. Cap the tax benefit of itemized deductions to 28% or less;
  4. Tax capital gains as ordinary income for those with income over $1,000,000;
  5. Eliminate the deferral of gain on like-kind exchanges of real estate;
  6. Apply estate taxes to estates exceeding $3,500,000;
  7. Apply gift taxes to transfers exceeding $1,000,000;
  8. Repeal the step-up on basis at death; and
  9. Increase the corporate tax rate to 28%.

Governor Newsom has already fired the first shot for California introducing AB1253 “which, if enacted, would increase the California income tax rate retroactive to January 1, 2020 by another 1% on income over $1,180,000; 3% on income over $2,363,000, and 3.5% on income over $5,900,000.”[2]

A “Use it or Lose it” Opportunity

Before any change to Federal and State tax legislation takes place, we believe that it is time to reconsider the following advantages currently available to those looking to gift ownership in businesses and assets before the clock strikes midnight on January 1st;

  • Lifetime Transfers – The current $11,580,000 exemption on lifetime transfers and bequests that allows married couples to make tax- free lifetime gifts up to double that amount, or $23,160,000. Even without a change in the current Republican government, current law stipulates that this exemption is temporary and will reduced to approximately $6,500,000 per person in 2026.[3]
  • Depressed Values – While the stock indices are at record levels, most operating businesses have been feeling incredible pain from COVID-19 shutdowns leading to record unemployment and negative GDP growth. The sunshine hiding behind these storm clouds is the opportunity to gift business ownership and other illiquid at significant haircuts to values seen only six months ago.
  • IRS Announcements – The “IRS has announced that transfers that take place during our current favorable transfer tax structure will not cause more estate or gift tax in future years as a result of the limits being reduced by tax legislation. In effect, right now we have a ‘use it or lose it’ opportunity to transfer a significant amount of assets under very favorable conditions.”

Tax strategies take time to develop and execute. It makes sense now to talk to your estate planning specialists to determine if these opportunities will work for you and your family. Putting in place a coordinated gifting plan now has the potential to save you and your estate millions of dollars in taxes and transfer more ownership to the next generation under the current temporary exemptions without any gift tax. While you are at it, it’s probably a good time to lock down your health care directive and power of attorney so that it mirrors your current wishes. Regardless of the above tax considerations that you can control, this pandemic has reminded us of risks beyond our control. It’s a tough conversation to have with family but it is one that they will see as a blessing when tough health and financial decisions need to be made.

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA at 503-925-5510 or jorlando@exitstrategiesgroup.com.

[1] www.lenczowskilaw.com

[2] Ibid.

[3] Ibid.

Exit Strategies Adds Machinery & Equipment Appraisal Services

Exit Strategies Group, Inc. (ESGI) is pleased to announce that we are expanding our valuation services offering to include Machinery and Equipment Appraisals, also referred to as asset appraisals.

Asset appraisals can be an adjunct to a business valuation, or provided as a stand-alone service. Adam Wiskind, CBI, CMEA will be leading this practice out of our San Francisco Bay Area (Sonoma County) office.

Our appraisers are Certified Machinery & Equipment Appraisers (CMEA) through the NEBB Institute.  NEBB is a leading equipment and machinery appraisal association in the U.S., with a network of over 400 members, representing a vast pool of machinery and equipment data, appraisal experience, and collaboration.

Exit Strategies is considered a “qualified source” of business valuations and asset appraisals, as defined by the Small Business Administration and Internal Revenue Service. Our valuations and appraisals are USPAP-compliant and they hold up to review by financial institutions, courts, government agencies, buyers, sellers and financial auditors.

To learn more about our Machinery and Equipment Appraisal services or receive a complimentary consultation about a potential need, please contact Adam Wiskind at awiskind@exitstrategiesgroup.com or 707-781-8744.