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Better to sell early in consolidation. Here’s why.

Consolidation is inevitable in maturing industries.  As an M&A advisor working with owners of private wholesale distribution and manufacturing companies, I often get asked whether selling early or late in a consolidation phase is better from a valuation perspective.  My answer is always case-specific, but generally earlier is better.

Before I explain why, I want to point out that industry consolidation is not always at the top of a seller’s list of sale timing considerations. More important factors may be:

What is your exit time frame?

Next year or so?  Three to five years?  Five or more years?  The answer is often driven by how much money you (or a majority of the shareholders) will need to retire or fund your next venture. Obviously, as with any investment, the shorter the time frame, the more conservative one should be with respect to anticipated returns.  Maybe the value today isn’t quite what you think it can be in the not too distant future – but eliminating risk may be worth a lower price tag.

For a seller who either wants to stay and manage the acquired/merged business or help the consolidator in a strategic (e.g. corporate development) role, that tail of income is above and beyond the sale consideration. Sellers who prefer to buy a boat and sail to the Bahamas had better have a strong management team to lock that future strategic value down. If not, they will likely be passed on by the buyer for another acquisition with a stronger management team and lose out on that strategic value.

Is your company performing well?

Last I checked, fundamental financial performance was still king when it comes to acquisition values. If your business is performing well (relative to industry peers and alternative investments) and further improvement is likely, now may be your best opportunity to maximize value in an M&A sale process.  If not, you’ll have to decide if and how you and your management team are going to change that performance and by when. And what is your track record of achieving past projections?

Is the macro-environment favorable? 

Does the economic outlook portend for several more years of strong economic growth, or is there increasing uncertainty or even signs of an imminent slow down?

If the former is the case, perhaps you have time to continue to grow revenues and profit margins to increase value and better position your business for future sale.  If the latter is likely, are you prepared financially and mentally to wait it out indefinitely and hope to again consider achieving liquidity several years from now?  If that’s not an option, maybe now’s the time to take some or all of your chips off the table.

Conditions can change quickly for all sorts of reasons and you can be stuck, not just with a reduction in valuation, but closed private capital markets altogether.  M&A came to an abrupt halt in Q2 of this year and has only recently started showing signs of life in certain industries. And look at what happened in the wake of The Great Recession.

Why earlier is usually better.

Industries consolidate at different times and in different ways.  So, to make my answer more informative, let’s use the example of industrial distributors, where regional and national players have acquisition-based growth strategies. Driving consolidation are mergers and product line expansion by upstream manufacturers (suppliers) and both vendor reduction programs by and consolidation among downstream customers.

  1. If I’m an aspiring consolidator/acquirer, I’m probably willing to pay a nice premium for the first acquisition in a particular region – to attract the best of the options available and to secure that first foothold ahead of my competitors.  I may want to make a statement in the geography and elsewhere with regard to the quality of organization I intend to build.  Hence, there is more of a strategic component in the valuation of earlier platform acquisitions, whereas later add-ons may be more simply about purchasing market coverage and earnings.
  2. Further, the first couple of acquisition targets are likely to have more to say (and be credited for) relative to the manufacturers they are aligned with.  Later acquisitions may be forced to discard certain lines and replace them with others to conform to the acquiring organization.  You can count on the acquirer considering the risks and costs of making those transitions when determining the value of an acquisition.
  3. Early on, there are likely to be more strategic acquirers in the market. As the market  consolidates further, the number of viable strategic match ups will decline, which favors the remaining buyers and reduces the likelihood of a strategic premium for sellers. Eventually, the only option for the last few independents standing may be to sell to pure financial buyers – such as private equity groups (if the independent has become large enough and profitable enough), their management teams, families or private individuals.  For some owners these are perfectly acceptable options, for others they are not.
  4. Then there is the likelihood that consolidators will eventually have competitive advantages over independent operators – in terms of buying power/terms with suppliers, proprietary products, lower administrative costs, ability to attract and retain talented employees, better access to growth capital, financial stability, etc.  To the extent true (which sometimes it’s not and/or there are other associated disadvantages) the market share and value of the smaller independents will gradually deteriorate.

Conclusion

Going to market early in a consolidation phase is likely to produce a stronger valuation than waiting around, all else being equal. However, when making exit plans, company owners should carefully consider shareholder needs, business performance and market conditions, in addition to what stage of maturity their industry is in.

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Al Statz is the founder and president of Exit Strategies Group, a leading lower middle market M&A advisory and business valuation firm. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, Al can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.

 

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.

ESGI COVID-19 Normalization Checklist

Available for a limited time, download the COVID-Era Normalization Adjustments Checklist now.  And check back for updates. The 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

M&A Advisor Tip: Finish Strong

Begin the sale process while your business is on an upward trend. Buyers pay a premium for businesses with well-defined opportunities and a strong growth story.

Too many business owners get tired or complacent and psychologically retire early, before the sale. In fact, after retirement, burnout is the number two reason business owners sell. Unfortunately, burnout usually leads to declining revenues and reduced leverage in the sale process. Stay focused until the end and sell while you still have energy and enthusiasm for your business.

The fact is, many buyers base their valuations on the financial performance of your company over the last 12 months. So after decades of hard work, waiting just 12 months too long can leave significant money on the table.

For further information on finishing strong or to discuss a business acquisition or valuation need, contact Al Statz in our Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.  Exit Strategies Group is a partner in the Cornerstone International Alliance.

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.

 

Selling Your Business in the Covid-19 Era

Business owners contemplating a sale may be asking the question: Is this a good time to sell my business or do I need to wait until the Covid-19 economic disruption is over?

Let’s explore three interrelated factors to help an owner answer that question for their situation.

Market Conditions

  • Are their buyers for my business during this pandemic?  Yes, there is no shortage of buyers for well-run companies.

That statement was true before Covid-19 and it is true during the era of Covid-19. As a M&A professional, I get inquiries almost daily from buyers who are interested in acquiring a well-run business that fits within their industry and financial parameters. In addition, buyers have access to capital at historically low interest rates, and deals are getting done.

Business Value

  • Will I be able to get the price I want in this market?  Yes, is the short answer.

The longer answer: Yes, if the seller has reasonable expectations based on past, present and future earnings, growth and risk. Yes, because buyers are competing. Yes, price is one component of value when selling, terms are the other component. The best offer is really a combination of the best price and terms available in the market.

Personal Needs

  • What is the best timing for me personally? The answers stem from asking yourself these questions: Are you ready? What will you do if you exit? How long do you WANT to work? Is your family taken care of? Are you slowing down?

Some people think – My business is always for sale, if the price is right. Right? No. Telling people you’re not for sale is no way to sell, at least not on your terms and preferred timeframe. Selling should be proactive, planned and deliberate. Selling a business is a process that takes time, on average, from start to finish 9 months.

Summary

The three factors discussed above don’t align perfectly in most business sales. The best outcome for a seller is a proactive and planned exit strategy. If you are thinking of selling within the next 2 years, now is the time to start the process.  Obtaining a professional assessment of value and sale readiness is normally one of the best first steps an owner can take in the sale process.

For more information on exit planning or the business sale process, Email Louis Cionci at LCionci@exitstrategiesgroup.com or call him at 707-781-8582.

 

Get to know your buyer: Conducting Seller Due Diligence

Adam Wiskind, CBIAs a business owner selling your company, prospective buyers will perform due diligence on you and your company.  But you should also conduct thorough due diligence on the prospective buyer.

When a buyer conducts due diligence on a company, they want to know that the company’s operations, finances, HR, environmental and legal matters (etc., etc.) are in order.

When a seller of a small business conducts due diligence on a buyer, they want to know that the buyer, whether a corporation or an individual, has:

  • the financial wherewithal to acquire the company
  • the legal standing to own it, and
  • the character and business acumen to successfully operate it.

Banks or other financial institutions lending money to a buyer for an acquisition will conduct their own due diligence on a buyer.  However, sellers shouldn’t rely on the bank’s due diligence process because they have their own timing, protocols, and criteria that may not align with the seller’s interests.

Some sellers focus their process principally on financial due diligence, believing that once the company is sold that they needn’t be concerned that the buyer can effectively manage it.  This approach is shortsighted even for business owners that are not concerned with their legacy.  Many transactions tie the post-sale business performance to the seller’s proceeds through an earn-out or a seller’s note.  If business performance suffers under the buyer’s direction, the seller loses too.  Even with a 100% pay out at the close of the transaction, when the seller has no post-sale financial interest, they may face legal risks if the buyer whose company is not performing contends that the seller misrepresented the business opportunity.

Minimally the objective of financial due diligence is to determine that a buyer prospect can qualify for acquisition financing and has sufficient capital for a down payment.  Regardless of whether the seller is financing part of the purchase or not – a credit check is a standard tool for evaluating a buyer’s credit worthiness and financial capacity.  A buyer should comfortably have access to at least 10% of the transaction amount in liquid funds (preferably more than 20%) plus sufficient working capital for day to day operations and a reserve.  Lastly, a seller that extends a loan to the buyer should ensure that the buyer has sufficient personal collateral available, in case of default.  It should be noted if a bank or other lending institution is involved that they will likely take a superior position on the available collateral.

The seller’s due diligence process should also explore whether the buyer has the character, capacity and legal standing to operate the business successfully.  The specific matters to be investigated depend on the type of business being sold and its management needs.  A seller should at least understand the buyer’s general business management experience and their experience within the specific business industry.

Below is a list of other areas to explore.  Rather than simply providing a due diligence list for the buyer to respond to, a savvy seller may want to interview a buyer to get in-depth answers:

  1. Does the buyer have the authority to acquire the company?
  2. Does the buyer face or have they faced any legal issues?
  3. Does the buyer have the necessary licenses or credentials to operate the business?
  4. Have they successfully completed an acquisition previously?
  5. What is their plan to operate the business?  What personnel or other changes are planned?
  6. Will the buyer’s character facilitate successfully managing the business?  Ask for personal and business references.

In summary, a small business seller should conduct a reasonably thorough due diligence process on a prospective buyer to reduce risk in the transaction and ensure that the buyer can successfully run the business.

For further information or to discuss selling your business, contact Adam Wiskind at awiskind@exitstrategiesgroup.com or (707) 781-8744 for a no-obligation assessment of your situation.

Pros & Cons of Selling Your Company to a Strategic Buyer

When it’s time to sell your business, you will likely have multiple buyer types to choose from. You could receive offers from strategic, financial, and individual buyers.

As you start thinking about selling your business, think about what’s most important to you in a sale. Different buyer groups tend to operate by different playbooks. Understanding what each group typically has to offer can help us target the buyers who are the best fit for your business.

A strategic buyer is an existing business that operates in the same industry, or a synergistic industry. Strategic buyers may be a competitor, a client or a vendor to your business. It’s almost just as likely, however, that you will have had no prior business relationship with the strategic companies interested in acquiring your business. Sometimes, you won’t even have heard of them before. A strategic buyer is generally looking at your business as a path to growth with a long-term hold. Your business may represent an opportunity to move into new territory, new product lines or services, new customers or a new distribution channel.

Pros of selling to a strategic buyer

  • Higher value:  Strategic buyers are often willing to pay more than financial buyers. That’s because strategic buyers may be able to realize immediate synergistic financial benefits. Usually though, they won’t pay more unless they have competition at the negotiating table, which is where we come in.
  • Faster exit:  If you are feeling burned out or you’re just anxious to get started on the next chapter of your life, strategic buyers typically enable you to walk away in the shortest time frame. This assumes they already have experienced leaders who know your business and don’t need a long period of transition support.
  • Smoother due diligence:  A strategic buyer already understands your industry and probably has a good grasp on how you do business. That means the due diligence process may go faster. They will still take a close look at your financials and business practices, but they can use their industry knowledge to streamline their analysis and decision making.
  • Easier financing:  A strategic buyer is usually a larger established company with ready access to capital. Financing is less likely to be a hurdle than when selling to an individual or investment group that isn’t already funded or will rely heavily on new debt financing.
  • Better opportunities for employees:  A strategic buyer may be able to offer your employees a richer benefits package and greater opportunities to grow. Large companies can offer new career challenges and advancement opportunities.
  • Advantages for your clients:  Strategic buyers tend to be larger and more developed than the companies they acquire. That means your clients may gain access to a stronger service team, more advanced technology, or a wider breadth of services.

Cons of selling to a strategic buyer

  • Employee reductions:  Buying a business typically affords the acquirer some economies of scale. Unfortunately, that can lead to redundancies in management and administration. Worst case, certain businesses (e.g., small manufacturers) could be acquired by a company that just wants their customer list and has capacity to absorb all their existing work – leading to a total shut down.
  • Legacy:  When selling to a strategic, your name may not stay on the sign out front very long. It’s often just a year or two until your business is fully integrated into the acquiring company.
  • No equity options:  A strategic buyer is typically going to purchase 100% of your business. If you were looking to maintain a minor equity stake and stay on to help the business grow, a strategic buyer is probably not the right one for you. Also, equity opportunities for your key people are usually limited or don’t exist.
  • Culture:  Ideally, you’ll be able to find a buyer with the same work style, values and cultural norms as yours, but don’t expect your company to look and feel the same for very long. Strategic buyers usually look to shift your business practices to their way of doing things.

I should also point out that there are exceptions to every rule. I recently worked on a deal where my seller client selected a strategic buyer over a financial buyer, even though the value was not higher (though we got them to nearly double their initial offer) and the due diligence was not expected to be smoother.

At the end of the day, every business seller has different goals and priorities. There is no best type of buyer – it’s a matter of what’s best for you. The better your advisor understands your personal goals, the better opportunity they have to find a buyer that meets your ideals.

Al Statz is President and founder of Exit Strategies Group, a leading California-based M&A advisory, valuation and exit planning firm with decades of experience. For further information on types of business buyers or to discuss your exit plans, confidentially, contact Al Statz at 707-781-8580.

 

M&A Advisor Tip: Put on Your Poker Face

Ready to sell?  Talk to your spouse and trusted tax, financial and legal advisors. Beyond that, keep it a secret.

Confidentiality is extremely important in almost any business sale, merger or acquisition. When stakeholders think your business is for sale, it creates dangerous uncertainty. Valuable employees start looking for other jobs, vendors tighten credit terms, and competitors use it as an entry point to poach your customers.

The average business takes 9 to 12 months to sell. If confidentiality is breached early in the process, it can put the company in a downward spiral. Suddenly you’re not only running a business, but you’re busy putting out fires and patching holes in the dam. That will discourage potential buyers. Buyers want to buy a stable and successful operation with the only changes occurring when they are ready to make them.

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

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.

Assignment for the Benefit of Creditors: Alternative to a Bankruptcy Sale

When the goal of a financially distressed business owner is to sell with minimum publicity, free of unsecured debt and potential liability for directors and management, the most advantageous exit path may be an Assignment for the Benefit of Creditors (ABC). Most buyers won’t acquire the assets of an insolvent entity unless the assets are “cleansed” through an ABC or bankruptcy process. Typically, the board of the troubled entity has decided that a rapid sale is in the best interests of the company and its creditors, and it is aware of a handful of likely strategic buyers. This article briefly explains how an ABC works and its advantages and disadvantages.

How does an Assignment for the Benefit of Creditors work?

In an ABC, the shareholders of a troubled company (the “Assignor”) voluntarily assign the title, custody and control of its assets to an independent third party (“Assignee”) of their choosing who acts as a fiduciary to the creditors of the business.  The Assignee’s role is to similar to that of a bankruptcy trustee. They are responsible for selling the assets of the business and distributing proceeds to creditors. The business may continue to operate and can be sold as a going concern if the Assignee believes that will maximize value to creditors. If creditors are paid in full, any surplus proceeds will go to the shareholders.

Advantages of an Assignment for the Benefit of Creditors

  1. Faster than a bankruptcy process, which preserves business value.
  2. More flexible, efficient and cost-effective than bankruptcy.
  3. Company management can select an Assignee with appropriate experience and expertise.
  4. A sale is less likely to be challenged since the Assignee acts on behalf of creditors.
  5. The business can continue to operate to maximize value.
  6. Not secret, but much quieter than a bankruptcy case.

An ABC often involves an auction sale process, which maximizes sale proceeds and protects buyers. They can even be prepackaged, which means there is a 3-way negotiation between a seller, a proposed assignee, and a buyer or buyers. The ABC happens and is immediately followed by the sale closing.

ABC’s do have some disadvantages. Because, in California at least, the ABC process is nonjudicial, there is no court supervision and no court order, so there is less certainty for buyers. Also, relative to bankruptcy, an ABC requires the cooperation of secured creditors and counterparties to leases and contracts.

This is the fifth in a recent series of articles from Exit Strategies’ senior team with insights on valuing and selling distressed businesses. See Insights.


Al Statz is President and founder of Exit Strategies Group, a leading California-based M&A advisory firm with decades of experience selling companies in all conditions. For further information, or if you are interested in exploring the potential sale or acquisition of a financially troubled business, contact Al Statz at 707-781-8580 to discuss your needs, circumstances and options, confidentially.