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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. 

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 4

M&A buyers are still active in the midst of this uncertain business environment. However, they are mindful of added risks caused by COVID-19.

These are some financial questions that are likely to come up in future due diligence in light of COVID-19:

  1. Did the business utilize any government relief, debt deferrals, or rent reductions?
  2. In terms of government relief, was the business accurately entitled to that relief and did they meet requirements for debt forgiveness?
  3. Did the business take on new debt that would impact the viability of an acquisition?
  4. Are revised financial projections reasonable?
  5. What is the financial condition of the business’s key customers?
  6. Are there risks to collecting on accounts receivable?
  7. What is the seller doing, if anything, to reduce or renegotiate operating expenses?

Business owners looking to sell soon should review their current practices now, so they’re prepared to address buyer concerns.

Read our previous posts on coronavirus era M&A due diligence:

For further information or to discuss a current M&A need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Petaluma, California office.

Recapitalization Pros and Cons

When we talk about recapitalization, we’re talking about a partial sale of a company that allows the owner to liquidate some of the value they have in their business. Typically, this involves selling a part of your equity (usually 70-80%) to a third-party, however some business owners do sell just a minority stake.

Recapitalizations are a standard investment tool for private equity firms. They have investor dollars they need to put to work and a timeline in which they’re expected to deliver returns. So they buy businesses with the intent of growing them and/or repackaging them with synergistic businesses for resale approximately 5 to 7 years down the road.

Using this playbook, they generally prefer to buy businesses with an active owner or strong management team in place. You or your existing leadership team will continue to run the business day-to-day while the private equity investor provides resources and assistance to fuel new growth.

Advantages of a Recapitalization

Liquidity: As a business owner, you may have all your financial resources tied up in the business. A partial sale allows you to take some chips off the table, securing your financial future.

Professionalize the business: Recapitalizations can have the effect of increasing management rigor. Your investment partner may help you implement new reporting practices, processes or management software. While these tools help you remain accountable to your new partners, they can also help the business make more informed, data-driven decisions.

And because private equity excels in developing businesses for resale, they understand how to make a business more attractive to buyers and position it for even greater value in a future sale.

A partner for growth: If you see a clear growth opportunity in front of you, but are not prepared to take on new debt or risk at this stage in your life, an investment partner can provide the resources to fuel growth plans.

For example, one business owner in the physical therapy space grew his business from one clinic to 50 over the course of 20 years. After partnering with private equity, the business doubled to 100 locations in just two and a half years.

He got to do what he loved, integrating new clinics, while the investment team focused on acquisitions. When he sells his remaining equity in the business, his minority stake will likely sell for a much larger value than what he received in the initial sale.

Potential disadvantages:

No fast exit: If you are burned out, this is generally not the right approach for you. In a recap model, the investors are typically looking for a business leader who will stay for roughly five years. That doesn’t work if you don’t have any gas left in the tank.

This approach could work, however, if you have a strong management team. Equity can be transitioned to management, creating a new group of minority owners motivated to drive success.

Loss of control: While you will still run the day-to-day business, you will no longer be the primary owner and decision maker. Your investment partner will be involved in all significant financial and strategic decisions.

So before you partner with an investment firm, make sure you feel like your goals align with their intentions. And talk to other business owners they’ve partnered with in the past, to find out how well the relationship worked out.

Pressure to grow: If you’re being recapped late in the life of an investment fund, your investors may need to show returns in just a few years. That could lead to a situation in which you’re pressured to grow quickly.

You could find your investors are more interested in short-term returns than long-term strategic growth. Then again, if your investor is looking to sell quickly, one concentrated push with a faster exit might appeal to you.

At the end of the day, recapitalizations can be a great tool to grow your business and increase your overall value. Finding the right partner takes careful consideration and due diligence. But with the right fit, you can often accomplish more and reap greater rewards than with a traditional full sale.

For further information on recapitalization contact Al Statz at 707-781-8580.

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 3

M&A buyers are still active in the midst of this uncertain business environment. However, they are mindful of added risks caused by COVID-19.

These are some contract-related questions that are likely to come up in future due diligence in light of COVID-19:

  1. Did the business default on any third-party agreements?
  2. What are the termination rights on key contracts?
  3. Are counterparties adhering to their contract obligationss?
  4. Were terms modified or waived in a way that would impact future enforcement, force majeure, or other provisions that would enable termination or suspension of an agreement?
  5. What ongoing challenges and risks will the business face due to non-performance?

Business owners should review their current practices now, so they’re prepared to address buyer concerns.

Read Part 1 and Part 2 of this series on coronavirus era M&A due diligence.

For further information or to discuss a current M&A need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com in our Petaluma, California office.

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 2

M&A buyers are still active in the midst of our uncertain environment. However, they are mindful of added risks caused by COVID-19.

These are some technology-related questions that are likely to come up in future due diligence due to COVID-19:

  1. Do employees have the ability to work remotely – without frustrating workarounds?
  2. Does the IT system have sufficient capacity to support remote operations?
  3. Are further developments necessary to sustain a long-term virtual environment?
  4. Are security measures sufficient in a time of increased scams and attacks?

Business owners looking to sell should review their current practices now, so they’re prepared to address buyer concerns.

For further information or to discuss a current need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

M&A Advisor Tip: COVID-19 Era Due Diligence, Part 1

M&A buyers are still active in the midst of uncertainty. However, as you would expect, they are mindful of added risks caused by COVID-19.

Talent-related questions that may come up in future due diligence due to COVID-19:

  1. Did layoffs or other cuts impact the business’s ability to retain key employees?
  2. Did the business comply with state and federal laws related to layoffs and furloughs?
  3. How is employee health and well-being managed?
  4. Are policies and practices sufficient to protect employee safety?
  5. Do employees have the ability to work remotely – without frustrating workarounds?
  6. How well does company culture support engagement and accountability in a remote environment?

For further information on business sales, mergers and acquisitions in the midst of coronavirus or to discuss a current need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

Methods of Selling Distressed Businesses

As most companies transition from survival to rebuild mode in the second half of this year, some will become financially distressed and the owners will want to move on. Fortunately, for the shareholders and creditors of these companies, there is an active market for distressed business assets. Distressed businesses can be attractive acquisition targets for strategic buyers, and sellers can optimize financial outcomes through a proactive M&A sale process.

Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. (Source: Wikipedia)

Distressed business sales range from simple out-of-court transfers of a company’s tangible and intangible assets, to highly structured and expensive bankruptcy proceedings.

Four Routes to Selling the Assets of a Financially Distressed Business

  1. Sale of assets (Asset Purchase Agreement), where lenders and certain creditors may be asked to forgive or discount outstanding debts
  2. Secured party short sale under Article 9 of the Uniform Commercial Code
  3. Asset sale in an Assignment for the Benefit of Creditors
  4. Section 363 asset sale in a Chapter 11 or Chapter 7 bankruptcy

Selecting the appropriate method is case-specific and involves a number of considerations, including:  (i) the particular assets involved; (ii) the seller’s runway and the speed of consummating a transaction; (iii) the cost of the process; (iv) privacy concerns; (v) the cooperation of secured creditors and ability or need to sell assets free and clear of liens; (vi) buyer protections afforded; (vii) exposure to subsequent challenges and liability (i.e., fraudulent conveyance or successor liability claims); and (viii) which process will most likely maximize value to shareholders. Choosing the most effective method requires careful analysis of facts and circumstances and understanding of alternatives.

If your company is facing financial distress, the sooner you get help and take action the better. When financial distress is severe and on a path to insolvency, an attorney with specialized expertise in complex workouts, restructurings and bankruptcy must be consulted early on.


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 market conditions. For further information, or if you are interested in exploring the potential sale or acquisition of a distressed business, contact Al Statz at 707-781-8580 to discuss your needs, circumstances and options, confidentially. 

M&A Advisor Tip: M&A in a Virtual Environment

Due to ongoing concerns over coronavirus, virtual meetings will continue to replace most of the in-person meetings typically held between a buyer and a seller at some stage in the business sale/acquisition process.

When selecting an M&A advisor, be sure that they can help you best present your business in a virtual environment and run effective remote team meetings. And ask about their investment in virtual deal room technology. Virtual deal rooms store sensitive information, track user access, and streamline the due diligence process. It’s good protection for you, and it’s valued by experienced buyers who expect to work with efficient, organized, tech-savvy teams.

For further information on technology used in business sales and acquisitions, or to discuss a current need, contact Al Statz, 707-781-8580 or alstatz@exitstrategiesgroup.com.

 

Business Values May Not Decline

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.