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M&A’s dirty playbook

/in , /by Al Statz

If you work in M&A, you can take a class on how to take advantage of people. It’s true! Buyers can go through mergers and acquisitions training, at some of the most prestigious universities, learning how to pay as little as possible for a family-owned business or privately held company.

M&A transactions are complex, and it’s natural that buyers and sellers will have some competing interests. When both parties come to the table in good faith, with a commitment to finding a workable agreement, these negotiations don’t have to be overly contentious.

But when buyers are out to do their worst, negotiations can devolve into a hostile power play. Worse yet, some sellers don’t know enough to push back. They get steamrolled and taken advantage of by specialists who wake up every morning intent on getting the best possible deal for their investors, at all costs.

These buyers know what they’re doing and they’re willing to play dirty to get what they want. Here are some of the tactics they might use:

Tie you up in exclusivity

Many M&A negotiations include a no-shop clause. This is a period of exclusivity when the seller cannot solicit offers from other parties. The due diligence process is expensive for buyers, so sellers sign these agreements as an act of good faith, giving buyers some security that their investment will be worthwhile.

Typically, a no-shop clause has a near-term expiration date and are only in effect for a couple of months (45—90 days). Buyers with a lot of leverage, and those working with inexperienced sellers trying to represent themselves, will work hard to tie you up in exclusivity for as long as possible.

If they can get away with it, the no-shop clause won’t have any expiration date at all, allowing the buyer to drag their feet indefinitely. Which brings us to the next strategy…

Drag it out

The goal here is to wear the seller down. They’ll request more and more documents. They’ll find “surprise concerns” they need to discuss with their team.

They’ll tell you, “We like your company, but we’re finding some issues we need to look into more. We need you to get us X, Y, Z.” They want to amplify tension, use up your mental energy, and distract you from the real work of running your business.

Re-trading the deal

At the end of the day, the whole play is about getting you to accept a lower value. You will have entered into exclusive negotiations based on certain expectations, but they’ll “uncover” issues to rationalize a price adjustment – an adjustment they were planning on from day one.

Play on your emotions

In the book of dirty plays, this one is a doozy. Buyers will find out key occasions in your life: your spouse’s birthday, your kid’s graduation date, your anniversary. And right before the big day, they’ll find something in due diligence and call an emergency meeting.

They’ll make you think the whole deal is going to blow up if you can’t make that meeting. Again, they’re looking to get you to wave the white flag of surrender.

In every industry, there are good and bad actors. Unfortunately, the bad ones are perfectly willing to engage in psychological warfare.

The less interaction the buyer and seller will have after a sale – i.e., the less future success hinges on the seller’s continued cooperation – the less incentive a buyer has to treat the seller fairly. Unsuspecting sellers can find themselves at the losing end of a winner-take-all kind of game.

It’s like a boxing match. You’re going into the ring at 0-0 and they’re at 40-2. They’ve been playing the game for two decades. I don’t care how strong you are, you’re not going to win that fight. That’s why it’s important to have professional, specialized advisors by your side before you enter the game.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Deal Terms: Fall 2021

/in , /by Al Statz

You may have heard – it’s a bifurcated market.

Declining caps on general indemnification against breaches of representations & warranties [1] had been a feature of the seller’s market for lower middle market businesses, going back well before the pandemic. Average caps have remained in the range of 15-16% of Total Enterprise Value (TEV) since the fall of 2020, according to GF Data’s semi-annual report on key deal terms, covering transactions by 243 active private equity data contributors completed through June 30, 2021.

However, a drilldown shows the same kind of market delineation we have seen in valuation.   Selling businesses featuring neither above-average financial characteristics (EBITDA margin and revenue growth) nor rep and warranty insurance (RWI) completed deals with an average cap of 23 % of TEV. For businesses offering above-average financials, RWI or both, cap averages were in the low to mid-teens.

The indemnity survival period [2] in the first six months of this year across all industries was 20.3 months, up slightly from the 2016-to-present average of 19.2 months.

The chart below makes clear that businesses with above-average financials and the ability to use RWI are rewarded in valuation. Businesses lacking both are subject to higher caps, in addition to dampened pricing.

In the first half of 2021, utilization of rep & warranty insurance bounced back to 59.1% of all deals. RWI usage anomalously declined in 2020, averaging 53.0% for the year. This reflected a temporary icing of the insurance market following the onset of the pandemic.

GF Data collects and publishes proprietary business valuation, volume, leverage and key deal term data on private equity sponsored merger and acquisition transactions with enterprise values of $10 to 250 million. GF Data gives M&A deal participants and advisors more reliable external information to use in valuing companies and negotiating transactions.

[1]  Indemnification cap refers to the general indemnification provided by the seller to the buyer against breaches of reps and warranties. This does not include carveouts for specific issues or items. For example, parties often agree that the general cap will not apply in the event of fraud.

[2]  Survival period refers to the period after closing during which a buyer may assert a breach of the reps and warranties against seller. Again, this does not include carveouts. For example, exposure on tax, environmental, and ERISA issues often exceeds the general survival period.

For assistance with selling a lower middle market business, contact Al Statz in Exit Strategies Group’s Sonoma County California office at 707-781-8580 or alstatz@exitstrategiesgroup.com.

M&A Advisor Tip: Stay Bonuses Add Value

/in , /by Al Statz

Confidentiality is important in a sale. But what do you do when critical employees must be informed? We recommend stay bonuses. A stay bonus provides an incentive for key employees to cooperate and assist with a sale.

We see stay bonuses ranging from 20% to 100% or more of an employee’s salary. It’s common to allocate around 50% percent at closing and 50% six months or a year later. Buyers want assurances the management team will stick around. A stay bonus significantly increases that chance. It’s a nice carrot for the employee, and it makes your company more saleable because it lowers a buyer’s risk.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

 

Can I retire if I sell my business?

/in , , /by Al Statz

Not every business owner wants to retire, but most do, someday. And in my experience as an M&A advisor, when an owner is ready, they want to move quickly. However, for business owners who have most of their net worth tied up in an enterprise that they personally manage, retirement planning is more complicated.

If you are a business owner, obtaining answers to these two simple but powerful questions will bring clarity to your retirement plans.

Question 1: What is the asset value I need to retire?

This question isn’t unique to business owners, but since your business is your most valuable asset, understanding your total net worth is more complicated.

Find out how much your business is worth by having a business valuation expert or M&A advisor do a reasonable amount of analysis on the company to determine the most probable selling price range. It helps to select a valuator who also sells businesses and is not just a theoretician.

You’ll need a CPA or tax attorney to help you understand the taxes on a sale of the business and develop strategies to minimize or defer taxes. Experienced M&A and financial advisors can often introduce tax minimization strategies, but you need a licensed professional to dial this in.

Then you should sit down with a financial advisor to run the numbers on your retirement assets and your desired lifestyle, and estate and philanthropy goals. Investment returns depend on the type of assets you hold and expect to hold in retirement. Income sources may include installment payments, Social Security, deferred compensation payouts, pensions, dividends, annuities, and rental income. Is the income sufficient or will you need to liquidate holdings in retirement? There’s a lot to consider and having the right financial advisor(s) is extremely helpful.

When there is a gap between the current value of your retirement assets and the value you need, owners often look to the business to fill that gap by increasing sales and net margins, and driving out business risk. A seasoned valuator can point to opportunities to improve the value and marketability of the business, and make it more attractive to target acquirors. They can help you understand market conditions, and when the time is right, they can represent you in the sale process and help you obtain the best deal available in the marketplace.

Do this sooner than you think. Best is 5 years before your target retirement date. The sooner you start to plan, the more knowledgeable you become about your situation, your exit options, and the financial and operating metrics that you must achieve to launch the sale process. If you find you have a valuation gap, it can take time to close. Also, you never know what market conditions are going to be, or what investment returns will be in retirement, so best to have a comfortable asset value safety margin.

Question 2: How well will the business perform without me?

Business valuation, whether performed by an independent expert or a potential acquirer, is a function of expected future cash flows and risk. The lower the risk the higher the value. Changing management introduces risk for the next owner. Whenever an owner’s efforts drive business performance, the future of that business without that owner is riskier.

For some business owners the question of how the business will perform without them is an easy to answer. They’ve worked themselves out of a management or key contributor role and the business can reasonably be expected to perform just fine without them. However, most small and medium sized businesses are significantly dependent on the talents, experience and/or relationships of the owner(s).

The way to overcome this is to grow the business, build a strong management team, groom your successor, and have an org chart that makes good sense to prospective buyers. Absent that, it helps to be willing to stay on for a period after the sale (typically 1 to 3 years), at a normalized salary, until you replace yourself. The first option is usually far better from a valuation perspective.

When choosing a valuator, find one with general management experience and years of M&A dealmaking experience to receive an objective assessment of your management organization and get actionable advice in this area. Remember, the goal is to sell and retire, not just sell and keep working!

You may have to revisit these two questions multiple times before initiating a sale process. And your business valuator, if you find the right one, should become a trusted advisor for you as you go forward.

These are just two of many questions to answer when assessing the value, marketability and sale readiness of a business and deciding if market conditions are right for a successful sale. See Exit Strategies Group’s blog for hundreds of articles on exit planning for business owners.

Al Statz is CEO and founder of Exit Strategies Group, Inc., a lower middle market business valuation and M&A advisory firm with offices in California and Portland OR. For further information or to discuss your retirement goals and circumstances with an M&A advisor and valuation expert, privately and confidentially, contact Al at 707-781-8580 or alstatz@exitstrategiesgroup.com.

M&A Advisor Tip: Fix Gas Guzzler Before a Sale

/in , /by Al Statz

Working capital is like gas in a car—it makes your business go. So when buyers acquire a company, they expect some “fuel” to be included in the tank.

But when business owners get successful and comfortable, they get lax about working capital. They establish a habit of fast payment, slow collections, and excess inventory, and they turn their well-oiled machine into a gas guzzler. Go into a sale in this condition and you’re basically giving away money.

Working capital can be a sticking point in negotiations, so the sooner you minimize working capital the better. Plan to make adjustments at least a year prior to sale.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Burnout drives business owners to sell their companies

/in /by Al Statz

Business owners are burned out, worn out, and getting out. More than 1 in 4 business owners who put their business on the market this spring did so because of burnout. That’s according to a first quarter survey of business brokers and M&A advisors conducted by IBBA and M&A Source.

Retirement still leads as the number one reason sellers go to market. That hasn’t changed in the Market Pulse survey’s nine year history. But this time we saw a real jump in burnout as the reason business owners are selling.

Even more concerning, 15% of sellers had some kind of health issue driving them to market. That’s also higher than previous surveys and suggests the pandemic has taken a heavy toll on business owners.

Business owners already deal with a lot of stress and pressure. Getting qualified employees has been a constant challenge – and we’ve been hearing about that for a couple of years already.

For many, the pandemic was the straw that broke the camel’s back. And we’re not just talking about businesses that had financial struggles. Even those businesses that stayed operational through the pandemic still had worries over employee safety, PPP versus unemployment, and retaining their talent.

It’s not that big of a surprise that business owners are saying, “Enough is enough.”

In addition, to burnout and health reasons, 7% of sellers went to market to get ahead of potential increases in capital gains tax. The Biden administration has indicated it will ask for significant increases in the capital gains tax rate in the near future.

If Biden’s tax plans come to fruition, the capital gains tax rate could effectively double, from 20% to 39.6% for income exceeding $1 million. Right now, that means business owners need to shift their focus from maximizing total transaction price to maximizing after-tax proceeds.

Even if a business owner is projecting 5% annual growth, they’d have to run their business another five years just to net out the same amount they could today after increased capital gains.

Business brokers and M&A advisors say they’re already seeing an uptick in activity with 41% reporting stronger deal flow over a year ago. They predict M&A will continue to pick up through the rest of the year.

Without some big resurgence in COVID, the market is going to finish out hot by year end. Right now we have double the deal flow we typically do, and our peers across the country are reporting the same thing. Everyone is busy.

Sellers are coming back to market, but the buyers never left. Sellers with COVID-proof, or at least COVID-resistant, businesses are seeing competitive bids and getting strong values.

Al Statz is President and founder of Exit Strategies Group, a leading California-based M&A advisory firm with decades of experience selling manufacturing, distribution and service companies in the lower middle market. For further information, or to discuss a potential sale or acquisition, confidentially, contact Al Statz at 707-781-8580.

M&A Advisor Tip: Be ready when you are ready

/in , /by Al Statz

When a business owner says it’s time to sell, I ask, “How fast do you want to be out?” The answer I hear most is, “Yesterday.” But sellers underestimate how long the process takes. Once we sign our engagement agreement with the business owner, it takes about 9 to 12 months to sell. After that, expect a six-month to one-year transition.

In an ideal world, you’d be working with an advisor 2-3 years before you put your business on the market. Plan ahead and there are several things you can do to maximize value or better position your company for sale. The more you plan, the more options you will have at the time of your exit.

Figure out what you want and then work the numbers backwards. Start talking with your advisors now, so when you’re ready, you’re ready.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Know the 3 types of business buyers and what motivates them

/in /by Al Statz

When selling your business, you may receive offers from three kinds of buyers: Individual, financial, and strategic. Here’s a look at the most common buyers and where their motivations lie.

Individual buyer:

A first time buyer looks at the business to get out of corporate America and control their own destiny. Some of these buyers are passive searchers and others have very specific targets and timelines in mind.

The more motivated an individual buyer is, the more they’ll pay. But because they haven’t purchased a business before, they also tend to be more cautious. They will likely have personal guarantees on their loan, which means if the acquisition does not go right, they could lose everything.

Individual buyers will look at the business’s existing cash flow, determine what kind of salary they want to make, and then look to see how much cash flow is left over to pay the lender.

Another individual buyer is a serial entrepreneur—someone who started or bought a company, had a successful exit, and now wants to do it again. They have much the same risks and motivations, but they have more confidence because they have been successful before. That confidence means they may pay slightly more than the first-time buyer.

Financial buyer:

The largest group of buyers in the financial category is private equity (PE) firms. Twenty years ago, this was a very small segment of the buyer category. Now there are an estimated 4,000 PE firms throughout North America.

These PE firms have over $1.5 trillion of “dry powder,” in other words financial assets they need to put to work. And with interest rates as low as they are, investors will continue to pour money into PE firms as they have out-performed most other investment options.

A quick overview of how PE firms work: A PE firm will go out and raise a fund. They may get money from high-net-worth families, from individuals, or they may go to institutions, pension funds, large banks, insurance companies, etc.

Once the fund is raised, the PE firm typically has 10 years to find companies, purchase them, grow them, and sell them again. Therefore, most hold times are around five years +/-. PE firms may be motivated to pay more for a business to hit their investment timeframe.

The family office is much like the PE firms, but they can be a little more flexible. Generally, a family office is investing the funds from one high net worth family, usually $200+ million net worth.

They typically have “patient capital” which means they do not have to sell the company within a certain predetermined window of time.  Also, they don’t have a set mandate to put capital to work by a certain deadline. Therefore, if they like a deal but see that several buyers are bidding it up, they may back out as they don’t have as strong a motivation to get their funds invested quickly.

In terms of deal structure, PE firms and family offices are most likely to offer the seller an ongoing equity stake in the business. This allows sellers to take advantage of future growth and get a second bite at the apple when the business is resold.

Another kind of financial buyer is the search fund. A search fund is often an investor-backed individual looking for a company to buy. These individuals will manage the company with the goal of providing a financial return for themselves and their investors.

One of the downsides here, is that if you get to the Letter of Intent (LOI) stage with a search fund, you often have to “resell” the deal to their investor team. When narrowing your buyer pool, you need to be careful that a search fund buyer really does have their investors on board.

Strategic buyer:

The strategic buyer is a company that is looking to grow by acquiring another business that has synergies with its own. For a synergistic buyer, 1+1=3.

Strategic buyers may be looking to grow market share in the same industry, find new products or services to sell to their existing customer base, get more control over their supply chain, acquire distribution channels, etc.

The strategic buyer can typically offer a higher value, but sometimes that value comes at a price. There may be redundancies or facility closures after a sale, for example. Likewise, strategic companies are least likely to offer the seller equity in the business going forward.

The takeaway here is that different buyers will see different value in the same company. They will also have different preferred deal structures. Which buyer you choose will often depend on what you value most in a deal.

Al Statz is the CEO of Exit Strategies Group. For more information on exit planning or to discuss a potential M&A or business valuation need, contact Al at alstatz@exitstrategiesgroup.com

Seller’s Market Sentiment Back to Pre-Covid Levels

/in , /by Al Statz

What a difference a year makes! Sellers of $1M+ enterprise value businesses have an advantage, with roughly 2/3 of M&A advisors and business brokers calling it a seller’s market for these larger businesses. Confidence is rising across all sectors.

Market Pulse Survey – Quarter 1, 2021 Presented by IBBA & M&A Source

Al Statz is the CEO of Exit Strategies Group. For more information on exit planning or to discuss a potential M&A or business valuation need, contact Al at alstatz@exitstrategiesgroup.com

Put Time into Planning Sale of Business

/in , /by Al Statz

Over my 19 year M&A advisory career, I have met many business owners who spent more time planning their children’s wedding, their 50th wedding anniversary, or even their fantasy football draft, than they spent planning for the sale of their business.

According to the quarterly Market Pulse Report, we know that when it comes time to sell their business, less than half of all business owners plan ahead. That means that most owners wait for some type of trigger event before they go to market. Those triggers are unplanned and unpleasant in nature, stemming from a family health issue, conflict, or burnout.

According to Christopher Snider, CEO of the Exit Planning Institute, 50% of business owners exit because of one of the “Dismals Ds”: death, divorce, disability, distress, disagreement.

Unfortunately, that often means business performance is on the decline. Or, at the very least, it means the business owner hasn’t made specific changes that will better position their company for a sale or transition.

Selling a well-prepared business is a completely different experience than selling due to a Dismal D trigger event. You have more leverage, and the process is less stressful as you are proactively executing a strategy versus reacting to an event in your life. With planning, you’ll be able to walk away from the closing table feeling satisfied and confident that you made the right choices.

It’s true that you may still be able to sell your business without planning. But the more you plan, the more options you have when you want to exit. When a business owner is well-prepared with an attractive business, they typically receive more offers. That gives you more leverage in the sale negotiations.

The holy grail is when you have prepared the business, you are emotionally ready, and the M&A market is robust. If you can pull that off, it’s typically a win in terms of valuation and deal structure. Plus, the sale process will go faster and smoother, reducing the inevitable emotional turmoil for you.

Not everyone achieves such perfect timing, but your chances are significantly better if the sale is part of a planned exit strategy. Whether you’re 10 months or 10 years away from exiting your business, take time now to truly think about how and when you will leave.

Have a conversation with an M&A advisor. It doesn’t mean you have to sell right away. But you become better educated about your exit options, the importance of timing, and how the process works.

Al Statz is the CEO of Exit Strategies Group. For more information on exit planning or to discuss a potential M&A or business valuation need, contact Al at alstatz@exitstrategiesgroup.com