Private Equity is Open for Business

/in , , /by Al Statz

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

/in , , /by Joe Orlando

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

/in , /by Joe Orlando

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.

Business Values May Not Decline

/in , , /by Al Statz

A recent survey of M&A advisors and business brokers showed that of all small and medium businesses on the market at the end of Q1, about 35% had closed (temporarily at least), 40% were operating at partial capacity, 4% had benefited, and 21% remained unaffected by COVID-19. Not surprisingly, advisors indicated that 46% of lower middle market deals were delayed at the end of Q1 and 11% had been cancelled altogether. For deal cancellations, 25% were attributed to sellers pulling out, 46% due to buyers backing out, and 12% due to changes in bank financing.

For business owners, the COVID-19 pandemic was like getting punched between the eyes. It knocked people down. And even when they could stand up again, their head was still spinning. But now, we’re starting to see the cobwebs clear.

Advisors like us saw an instant drop in buy-side activity in March. We had some new buyer conversations in April, but nothing solid. By early June, though, we started to see a resurgence.

Affect on Valuations

The question now, as buyers move forward with acquisition plans, is what will happen with business valuations?

For those businesses that remained fully active, their valuations will likely stay solid. Even businesses that partially closed or were negatively affected may find that valuations remain consistent. Businesses that were essential or able to pivot to an online or contactless model will be attractive to buyers.

And while declining cash flows typically do impact business values, we may see special considerations granted for the pandemic. Most businesses trade on a multiple of “normalized” historical cash flow or EBITDA. Normalizing financials includes making adjustments for one-time and unusual events. As buyers and lenders evaluate your business, they may accept normalization adjustments due to COVID-19, after your business recovers.

Affect on Deal Structures

In terms of deal structures, though, sellers who want to receive full value for their businesses should be prepared to carry more risk. Buyers will be seeking more of the purchase consideration in the form of seller financing, earn outs, or equity rollover.  Here’s what that might look like for sellers:

Seller financing. 

Seller financing can bridge a buyer’s resources with the value they see in your business. Essentially, it’s a loan from you, typically structured with monthly payments over a number of years.

In the past year, seller financing has hovered between 10-15% for Main Street deals, and 6% or less for deals over $5 million, per the Market Pulse Survey. The more perceived risk (e.g., COVID-19 closures and declines), the more seller financing buyers tend to request. So, we expect we’ll see these numbers climb in the year ahead.

Earnouts.

An earnout is a commitment by the buyer to pay you a certain amount of money tied to future business performance after a sale. If the business meets certain benchmarks, you receive additional value.  An earnout is a way of sharing risk.

Equity rollovers.

In an equity rollover, the seller maintains an ownership stake in the business. They roll a portion of their equity into the new capital structure in lieu of cash proceeds.

Rollovers are common with financial buyers, such as private equity groups. These buyers generally acquire businesses with the intention of holding them for five to seven years before reselling at a profit. Financial buyers often want sellers to receive a portion of their consideration as equity. It’s part of their financing model and it demonstrates the seller’s faith in the business.

Rolling over some of your equity gives you get a second bite at the apple when the business sells again. If the new owner successfully grows the business, that minority stake could be worth as much or more than your original sale.

Deal structures will also be driven by lending activity in the months ahead. If lenders pull back, both buyers and sellers will be motivated to reach alternative financing arrangements.

For further information on M&A market conditions or to discuss a current need, contact Al Statz, 707-781-8580.

M&A Advisor Tip: SBA debt relief incentivizes buyers

/in , , /by Exit Strategies

SBA debt relief is is a big incentive for buyers to move ahead with small business acquisitions right now.

The SBA will pay six months of principal, interest, and any associated fees that borrowers owe for all current … as well as new 7(a), 504, and microloans disbursed prior to September 27, 2020.

As an added incentive, SBA lenders have the authority to defer loan payments for six months. That means some buyers could acquire a new business and have almost a full year free of loan payments.

For further information on this topic, or selling a business, or financing a transaction, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

Hard Times: Great Opportunities

/in , /by Don Ross

Don Ross, CBBThe effects of the Covid -19 Pandemic have been real and apparent.  GDP in the first quarter declined by 4.8% according to the Bureau of Economic Analysis and economists are predicting the American economy to contract by as much as 30% in fiscal year 2020.  Brutal.

So what is there to get excited about?

Opportunities are laying in the weeds – that’s what.

Entrepreneurs of newly acquired businesses are aggressively moving forward in their business pursuits, predicated upon two newly emerging dynamics:

  • Greater availability of resources
  • Evolving customer needs

In the case of resources:

  1. Capital is more plentiful and interest rates are at historical lows.
  2. Commercial landlords are becoming more negotiable as vacancies and available inventory increase. The service industry – finance, human resources and internet – related – for example, are encouraging more office at home and shrinking their office building footprint. Leases of restaurants and other retailer brick and mortar retail facilities are being renegotiated on the basis of net useable, “socially distanced” square footage rather than the conventional gross square footage.
  3. The labor pool, with unemployment projected to be as high as 25%, is a growing resource for unskilled and skilled workers.
  4. Liquidated furniture, fixtures and equipment are available at discounted costs.
  5. Existing supply chains anxious to get back to business are offering better terms. Newly emerging domestic supply chains are developing and eliminating over-reliance on unreliable overseas suppliers.

As for customer needs:

Given the change in the social landscape as a result of the Pandemic, entrepreneurs are forecasting the future needs of a society that arguably may have more time and less space.  Restricted travel and working from home, for example, may translate to a healthier environment and greater family life at the expense of travel overseas and large sports and music venues. I am reminded of my great grandfather who after World War I and the Spanish Influenza (and the Model T Ford) transitioned from the largest carriage making operation north of the Golden Gate Bridge to a successful tire and farm equipment dealership.

“If it works, don’t fix it” will be a hackneyed expression that will go the way of the buggy whip.  Entrepreneurs will re-invest and re-tool physical plant, operations and labor resources to meet the newly evolving needs of their customers.

Opportunities await those who are inspired by optimism, gifted with vision, and empowered by hard work.

For further information contact Don Ross, 707-778-0210 or donross@exitstrategiesgroup.com.

M&A in Pandemic, Not Panic

/in , /by Exit Strategies

Business advisors are digging in right now, trying to figure out how COVID-19 will affect their clients. We’ve been talking with business owners, active buyers, and other advisors around the country.

Right now, we know that some M&A deals are getting delayed over routine process points. Certain bank approvals that used to happen in regular in-person review meetings are being held up as discussions take place via email chain instead.

Some businesses with real estate transitions are no longer able to get appraisers or environmental assessors out to their property. That’s a standard part of the process, and if it can’t happen the rest of the transaction must hold.

Of course, some deals are getting pushed out over more than procedural issues. Certain businesses, particularly anyone in travel or hospitality or key vendors to those industries, are getting beat up right now and will want to wait until conditions normalize.

But other business owners are unaffected, as of yet, and moving forward with plans to sell in 2020. We are still having conversations with potential sellers and prepping businesses for market. The key will be to mutually agree on when it makes sense to take actually “go to market” with each specific client.

Money to Invest

What we know is that many companies and private equity firms have been doing well for years. The private equity industry alone had $1.5 trillion of “dry powder,” that is capital to invest, at the start of the year. They still need to honor their commitments to investors and put that money to work.

What we’re hearing is that some buyers are putting all equity into deals right now. They’ll refinance later when things calm down, rather than wait on bank approvals to get things done.

That’s a sign of the times. The market has been very active up until now, and many buyers aren’t going to let up. In fact, some are getting more aggressive because they think they might find a better deal in the months ahead.

Considering Valuations

Herein lies the real question. Are sellers going to take a reduction in business value?

Imagine your company manufactured sanitizing wipes and was already in active negotiations with a buyer when the pandemic started. Your EBITDA is going through the roof with numbers your business has never seen before. But will the buyer adjust the price up for that extra cash flow, based on a one-time anomaly? My guess is no.

So, will buyers get away with asking sellers to take a haircut over a one-time dip? Perhaps a bit. Most likely we’ll see a shift in deal structures. Buyers will put in less cash at close, with slightly more hinging on earn outs or other contingencies based on future performance.

Still, given the competition in the market just a month or two ago, buyers will need to be cautious about pressing sellers for a bargain. The underlying, long-term value of most companies will remain the same, despite a temporary dip in cash flow. Savvy buyers understand that and will be judicious in their valuations.

What about right now?

If your business has been affected, and you still have slow times ahead, look at this as an opportunity to catch up on all the things you didn’t have time for before. Spring clean, if you’re allowed to be on site.

Document business processes. A business is more saleable, and will typically sell for more money, when there’s less risk involved. And there’s less risk when all systems and procedures are documented on paper instead of secreted away in the owner’s mind.

Think about how you can be training and growing your employees during this time. This might be a good time for online training, or even expanded team conference calls to discuss things like process improvements or strategic planning.

Focus on ways you can grow from the situation. Complete this sentence: The challenges we face today will help our business be __________. (If you can weather the storm and use this time for development, the answer could be: more valuable.)

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.

Market Pulse Survey: Deal Cancellations due to COVID-19

/in , , /by Exit Strategies

M&A advisors saw many of their business sale/acquisition deals delayed, put on hold or cancelled in March 2020 as a result of the COVID-19 Pandemic.  Who was cancelling these deals?  The following chart shows the results of this survey question from the latest Market Pulse Survey.

Presented by IBBA, M&A Source & in partnership with Pepperdine University

“Deal activity is always expected to constrict during times of uncertainty. Both sellers and buyers are being conservative right now, taking a wait-and-see approach,” said Scott Bushkie, managing partner, Cornerstone Business Services. “Once we have some clarity on when businesses will be allowed to reopen and in what capacity, some deals will continue to move forward.”

“For many business owners who had already put their businesses on the market, this is a temporary pause,” Bushkie continued. “Owners who were burned out or near retirement will still be looking to exit their business. The nature of that exit will look different now, but once you get so close to the finish line, it can be difficult to envision holding out for much longer.”

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.

Exit Strategies Group Advises Health Concerns on Sale to Life Seasons

/in , /by Louis Cionci

Transaction advisory firm Exit Strategies Group served as exclusive M&A advisor to ADG Concerns, Inc. DBA  Health Concerns on its successful sale to Life Seasons, Inc.

Health Concerns is at the leading edge of research in herbal medicine and is known for bringing the centuries of knowledge amassed in the Chinese herbal tradition to the West. Health Concerns was the first company to manufacture Chinese herbal products in the United States for practitioners. Today Health Concerns continues to research, test, and adapt traditional formulas by applying the science of modern biochemistry. As a result, Health Concerns can offer a variety of formulas for a full range of TCM treatment protocols as well as many products that address the specific conditions of Western patients.

Health Concerns President Andrew Gaeddert said, “We’re pleased to be part of the Life Seasons family. Selling to the right buyer was important to us. Their relationships, systems and financial resources will allow us to expand our technical sales force and systems manufacturing capabilities.”

“Exit Strategies did a tremendous job guiding us through the sale process. Their M&A process and deal-making knowledge really helped us navigate through the ups and downs of the sale process and were essential in achieving a successful outcome”, Mr. Gaeddert observed.

About Life Seasons

Life Seasons Inc., headquartered in Delaware, with operations in Texas, Utah, and Pennsylvania, is premier provider of natural health supplements. Life Seasons is an organization that was formed for the sole purpose of formulating medication for the health issues that arise throughout the different phases of life.

Life Seasons CEO Darren Peterson said “we are very pleased to add Health Concerns products to our product list. This acquisition extends our ability to provide wellness solutions to healthcare providers. We are excited to also have Andrew Gaeddert join our team with his extensive knowledge base and teaching skills.”

Mr. Peterson noted “I was very pleased to work with Louis Cionci at Exit Strategies Group. He helped guide the process with honesty and integrity, and his expertise in the M&A process helped the deal come to fruition.”

About Exit Strategies

Exit Strategies Group is a California-based merger and acquisition advisory and business valuation firm serving lower middle market companies in a variety of industries.  For further information about investment banking and M&A advisory services contact Louis Cionci , 707-781-8582.  Terms of the Health Concerns – Life Seasons deal will not be disclosed.

Begin with the Knowns and Unknowns

/in , /by Exit Strategies

The world feels like it’s turned on its head right now. People are anxious, with good right to be. There’s so much we can’t predict about the weeks and months ahead. When planning your response, begin with what you know and what you don’t know.

What we know:

We’re in a pandemic, and social distancing can flatten the curve, meaning slow the rate by which the illness spreads. And, at this point, we can probably say this pandemic will be linked to an economic recession.

Start by responding to what we know. If you’re a business owner or in another position of influence, this begins with supporting social distancing efforts and following guidance from the CDC. For many, this means finding creative ways to keep your employees engaged and working so you can keep paying them for as long as possible.

Whether you’re shoring up remote work operations, or innovating your business model, remember your employees are anxious. Many of them are trying to balance work and childcare. Others are alone and will be feeling the isolation more keenly.

Now is the time to practice compassionate leadership. You can’t really know how much this situation is affecting each employee – who has vulnerable family members, who is most economically at-risk, and who has underlying mental health issues that will make this situation more difficult to bear.

Prioritize social connection as part of your workday. Plan virtual coffee meetings or happy hours via conference call. Managers, make it a point to check in on employees. Find out how people are doing, and not just in terms of work and technology. Ask how they’re feeling. Find out how the separation from the office is affecting them and what else is raising their anxiety.

Communicate. Rumors fly in uncertain times. Give your employees clear, reliable information. If you don’t know what your plan is yet, it’s okay to say that. Employees need to hear from you, and even those “we’re still considering our options” messages can head off misinformation.

What we don’t know:

The unknowns are many. We don’t know how long this situation will last. We don’t know the depth of the economic impact. So how do we respond in uncertain times?

Madison, Wisconsin based futurist Rebecca Ryan recommends scenario planning. Map out your worst fears, your highest aspirations, and your reasonable expectations (what feels most plausible over the next 18 months).

Do this together with your leadership team. Part of the value, as Ryan explains it, is stating your assumptions to the group. Which possibilities are you putting in the plausible zone, rather than the best- and worst-case scenario boxes?

Any scenario is possible, so spend time on each. Try to imagine how your business will respond to each possible future. A few weeks or months from now, you will have more information and can revisit your scenarios again.

If you tend toward pessimism, this kind of scenario planning may help lift you up out of fear by forcing you to imagine positive outcomes. That slight lift, that shift in perspective, can be extremely beneficial in times of stress.

But more than that, scenario planning helps you make thoughtful decisions in uncertain times – times when informed decisions aren’t always possible.