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What is a Recapitalization Exit Strategy?

/in , /by Al Statz

One of the exit strategies available to company owners is called a recapitalization, or “recap”.

In a recapitalization, an investor (usually a private equity firm) purchases an equity interest in your company using a combination of cash and debt financing. They expect to grow the company and earn an attractive return on their cash investment when they sell the company at a higher price in 3-7 years. Their value creation strategy usually involves initiatives to accelerate growth, increase profit margins, mitigate business risks, and professionalize the business to make it more attractive to future buyers.

Why Recapitalize?

A recapitalization gives an owner significant liquidity now AND gives them a second larger bite of the apple when the PE firm is ready to exit and sells the company to another PE firm or strategic acquirer. A recapitalization can also facilitate:
  1. a buyout of only specific shareholders,
  2. the transfer of partial ownership to the next generation, and
  3. equity participation for remaining management.

When they recapitalize a business, PE firms usually acquire a majority (controlling) interest and don’t play a role in day-to-day management. They bring financial acumen, systems and growth capital, sit on the board, and participate as a strategic advisor.  They prefer to retain the existing management team, which often includes the owner. Owners who recapitalize and stay on can achieve material liquidity and maintain control over day-to-day operations. Alignment with the investor is of course very important.

Exit Strategies Group maintains relationships with Private Equity groups and other types of financial buyers across the country and is experienced in both sourcing potential equity partners and negotiating recapitalization transactions that fit our clients’ goals.

Al Statz is the founder and president of Exit Strategies Group. He is based in Sonoma County California. For more information on selling or recapitalizing your company, or to discuss your strategic exit options, contact Al at 707-781-8580 or alstatz@exitstrategiesgroup.com.

How Well Do You Know Your Exit Options?

/in , /by Exit Strategies

You have built a business that provides a strong income and comfortable lifestyle. However, if you are like most business owners you haven’t made the time to know the range of options you have to successfully exit the business and transfer your wealth. The tax, legal, valuation, deal structure, and insurance considerations are many. Even if you had the time, where do you begin?

Before you can evaluate any of these options, you must first decide what your goals are. Are there other owners to consider? If so, are their goals similar or different than yours? What personal and family issues do you want to consider? Are you strictly looking for the best price? Are you tax sensitive? Have charitable intent? Are you financially prepared? Mentally? The earlier you begin planning, the more options you will have at your disposal.

Once you have determined your goals, you can begin to narrow the list of exit options available to you. Do you intend on doing an internal transfer to a key employee or employees? Family member? Is an ESOP a viable alternative? Is your estate plan designed around your desired exit? Are contingencies planned for and protections in place?

Whether you plan to transfer your interest internally or to a third party, knowing how much your business is worth is a great starting point. Internal and external transfers can imply different valuation standards that can render very different values. You want to know these differences before you make a decision. A business valuation will also give you a good idea if the transfer can be financed.

What is your time horizon? More time is better, especially for external sales. Is the business saleable as is? Aspects of your operations may need improvement before you go to market. How do you select an M&A advisor?

The earlier you begin planning your exit, the more options you will have at your disposal.

Achieving a successful business transfer requires a process. An M&A broker/advisor can lead this process and guide and coordinate the professionals required to help you reach your goals. An owner can attempt to lead this process on their own, but it’s not easy. Your time is probably best spent running your business at peak performance. Still, it’s up to you to appoint a competent adviser to guide the process and ensure that your other professional advisors are on board and up to the task.

For a confidential conversation regarding your exit options, contact one of our senior advisors.  

Asset Appraisals May be Needed to Support a Business Valuation

/in , /by Jim Leonhard

I recently valued a number businesses that required the appraisal of certain tangible assets, such as real estate and equipment – in one case its was an extensive library of manuals and maintenance specifications for a service business.  At what point do we look for a appraisal specialist with particular expertise to value such assets?  

The simple answer is, it depends on materiality.  If it is clear that the business enterprise value is well above the net tangible asset value, as evidenced by the market and/or income valuation methods, we may be able to rely upon the owner’s estimates or rough calculations of the market value of tangible assets. The answer can also depend on the intended use and intended users of the business valuation.
When the asset(s) in question have very significant value  that will impact the market and/or income approaches to value, or if one of the asset approach methodologies, such as net book value or liquidation value will be relied upon, we will request that a client obtain a third party appraisal of the asset(s) in question that we can incorporate into our business valuation.
Typical  Situations Where Asset Appraisals are Recommended
  • Real Estate Appraisals
    • the business owns real estate, e.g. for agricultural enterprises or a real estate partnerships
    • the business leases real estate from a related party and we need to ensure the business is paying market rent
  • Equipment appraisals
    • the business is capital intensive
    • it has a large amount of used equipment – making rough value calculations unreliable
  • Unique assets
    • the business has a significant amount of unusual assets that are not common to most organizations
  • Non-operating assets
    • non-operating assets are items that can be removed from the business without affecting business operations, e.g. an airplane owned by a construction business, or a vacation home
For more information about how asset appraisals are used in business valuations, please contact Jim Leonhard, CVA, at 916-800-2716 or jhleonhard@exitstrategiesgroup.com. 

A Pyrrhic Victory

/in /by Don Ross
A Pyrrhic Victory is defined as a victory that is offset by staggering losses, to the extent that the victor incurs losses that are equal to or greater than those of the adversary.  Its origin dates back to Pyrrhus, the king of Epirus (now part of present day Greece) who defeated Roman armies at Asculum in 280 B.C. and suffered such heavy losses of troops and commanders that he was unable to amass new officers and troops to sustain the war effort.
Similarly, Pyrrhic Victories can disrupt and derail negotiations in a business transaction.   Buyers and sellers occasionally lose sight on the ultimate objective – consummation of the deal – and immerse themselves in any number of details. “Sweating the small stuff” can entail financing terms, exclusion of certain assets, retention of employees, seller training or consulting, inventory valuation, lease assignments, condition of leasehold improvements, prorating expenses, covenants not to compete, allocation of asset values: small negotiation battles that are waged and won (and lost), occasionally at the expense of losing the war.
Just as Pyrrhus lost sight of his ultimate objective, the defeat of Rome, so the parties of a business transaction need to vigilantly focus on their motivations and ultimate objectives for buying and selling and the prioritized values of what they expect to receive.  Sellers, for example, may be selling due to burnout, lack of capital, lack of successors, health or retirement. Buyers may be buying to gain greater independence, improve income, synergies, additional revenue streams, or tax avoidance.
Squeezing an extra dollar out of the transaction at every step, may be negotiation points conceded and small battles won, but ultimately may echo Pyrrhus’ famous lament, “one more such victory and we are lost”.

Avoid Seller Let Down

/in /by Don Ross
The “Let Down” is commonly a reflexive response to imminent success of a stated objective.
Recently, in an NBA playoff series between the Los Angeles Clippers and the Houston Rockets , Houston defied the odds by winning the last three games to take the series 4 games to 3.  The pivotal game was game 6 when Houston, down by 19 points with 14:30 remaining, outscored Los Angeles 49 – 18.
The final and deciding game 7 was anticlimactic.  Houston won on Los Angeles’ home court.
Game. Set. Match.  Penthouse for the Rockets; Outhouse for the Clippers.
And therein is a “Let Down”.
Business sellers are susceptible to the same dynamic.  Having resolved to sell and exit the business, and in some cases having progressed to negotiations and due diligence, many business owners prematurely visualize success.  They figuratively break out the champagne while the game still rages on.
They let down.
Sales efforts or service levels decline, the physical appearances of the facility and equipment atrophy, employee morale wanes, etc. The balance sheet and income statement predictably reflect the let down and the buyer’s optimistic view of future earnings becomes clouded.
The solution to this potential pitfall can be attributed to “It aint over til it’s over”, a common expression that owes its origins to:  (1) Kate Smith singing “God Bless America” at a 1969 Philadelphia Flyers Hockey Game, or more likely,  (2) the 10 minute solo sung by Brunnhilde in the closing act of Wagner’s fourteen hour Ring Cycle Opera.  It is a helpful mantra worth repeating throughout the stages of a business sale transaction. It will sustain the spirit and propel the daily work ethic. “Aint over” means eliminating non-performing assets that take up space, maintaining inventories that will sustain or grow sales, adding to the customer base, collecting on aged receivables, and keeping one’s head in the game.
Enterprise value, business marketability and buyer enthusiasm will be maintained and often elevated when the seller continues to operate at a high level. Play it out to the very end, avoid “let down”, and when it’s over and done, there is plenty of time to celebrate . . . off the court.
 
Using an experienced M&A broker to manage the sale process allows owners to focus on running the business at peak performance until the final buzzer. For more information contact Don Ross in our Petaluma, California office at 707-778-2040 or donross@exitstrategiesgroup.com.

Business Acquisition Financing: What Lenders Want

/in /by Al Statz
In 13 years of selling private businesses, financial leverage has been a consistent success factor for us in expanding the pool of buyers and closing deals. Fortunately for business owners, the Small Business Administration’s (SBA’s) loan guaranty program is an excellent funding source for deals up to about $5 million. Today’s interest rates are low, and lenders are lending now.
Here are ten things lenders look for when evaluating a loan request for a small business sale/acquisition:
From the Borrower (Buyer):
  1. Down Payment.  Lenders want a buyer to inject 15%-25% of the total project in cash, at minimum, depending on several factors including whether real estate is included in the sale. Common down payment sources are retained earnings, savings, retirement plan funds and gifts from family members. The buyer’s cash injection cannot be borrowed.
  2. Creditworthiness.  Lenders investigate a buyer’s credit at the outset of the approval process. A bankruptcy, foreclosure or judgment usually nullifies their chances, no matter how good other criteria look. Buyers should remove blemishes from their credit history before they apply.
  3. Track Record.  Individual buyers must have experience in the type of business and/or industry they are buying into. Lenders look for management experience, and they prefer to see prior business ownership. Buyers should tailor their resume to highlight  applicable management and industry experience.
  4. Collateral.  Buyers with real property to pledge as collateral may compensate for weaknesses in debt service coverage, business assets, experience, credit, or liquidity. Generally, if they have equity in real property, the SBA requires that it be used to secure the business acquisition loan as a secondary source of repayment.
  5. Business Plan.  Buyers have to submit a business plan for the business they are acquiring. Lenders want to see an intimate understanding of the business and industry. In most cases a plan calling for modest growth and incremental change is the safest bet for the buyer.
From the Company / Seller:
  1. Cash Flow.  Business cash flows must service the loan and provide adequate income for the owners. Lenders analyze the historical tax returns of the business—allowing reasonable adjustments for owner perquisites and non-recurring costs. The quality of financial records comes into play here. Your business plan also comes into play. Synergistic benefits, increases in working capital and capital expenditure needs are considered in the cash flow calculation.
  2. Positive Trend.  Nothing scares lenders more than negative sales and earnings trends in a business or its industry. Conversely, a pronounced positive trend is a thing of beauty to a lender. They often look back several years to see how the business performed through past economic cycles.
  3. Continuity.  Commitments by existing managers, key personnel, suppliers and customers to continue with the new owner represent reduced risk to a lender.
  4. Training.  Lenders want to see a well thought-out management transition plan. The training/transition period can be anywhere from 1-12 months, depending on circumstances. Be sure you negotiate this point up front and clearly spell it out in the purchase agreement or letter of intent.
  5. Seller Financing.  When a seller finances even 10-15% of a deal, subordinated to the bank note, it shows the lender that the seller is confident in the business under the buyer’s leadership. This deal point is commonly imposed by lenders.
For loans over $350,000 or whenever a buyer and seller have a close (non-arm’s length) relationship, the SBA requires a fair market value appraisal by an accredited business appraiser to validate the purchase price. The deal can’t exceed the appraised value.
Sellers are advised to prepare months or years in advance, to increase their odds of cashing out when they are ready to exit. Owners should be asking themselves, “does my business qualify for acquisition financing?”
•   •   •
Financing is a critical element of almost every small M&A transaction. For help finding business acquisition financing, call Exit Strategies at 707-778-2040 or Email us.
 
This is an update of my October 2011 blog. This also appeared as an article in the North Bay Business Journal in January 2012. Not much has changed with respect to financing small business sales!

Business Valuation: Step one in the sale process.

/in , , /by Louis Cionci

If you are considering selling your business, I would like to let you in on an M&A (merger and acquisition) professional’s insight. I have been involved in initiating and managing M&A transactions for over 15 years and have handled deals representing over $250 million in transaction value. Those transactions ranged from $2.6 mm to $90 mm. In addition, I was on a team that helped an international client acquire a $2.6 billion industry rival back in 2000.

Whether $2.6 million or $2.6 billion, these successful transactions started with a business valuation.  The sale or acquisition of a business is a multi-step process, and the first step in a successful transaction between a buyer and seller almost always begins with a professional business valuation. Steps that follow the valuation include, marketing the company, buyer due diligence, negotiating the deal, and the closing.
A business valuation is a critical step on both sides of the deal table. Normally, the seller will do the first valuation, to get an idea of their company’s market value and then decide upon a price range that would motivate them to sell. The seller will generally share their historical and projected financial information with a vetted buyer. The buyer can then apply their own specific investment requirements to the shared information. Both sides utilize their valuations to negotiate the deal.
In my experience, no matter the size of the deal, the first step in a successful M&A transaction is a business valuation.
 
For more information on business valuation for M&A transactions, Email Louis Cionci or call him at 707-778-2040.

How to Sell Your Business for More Than Fair Market Value

/in , /by Louis Cionci

If you are selling your business and you want the highest possible price, here is one way to get a premium over its Fair Market Value.

First, consider that the value or price an owner can expect to receive for their business is generally a function of: 1) free cash flow generated, 2) growth expectations, and 3) the risk involved in receiving the cash flows. These factors combine to determine the value for the business entity. Expressed another way, the value of a business is the present value of the risk adjusted future cash flows specific to the selling company.

Each company has a unique set of these factors. A Financial buyer is interested in how these factors measure up for the company on a stand-alone basis, and will determine a price that they are willing to pay for the business, or Fair Market Value, relative to their other business investment opportunities, including other businesses for sale. Most buyers are financial buyers.

But there may be another type of buyer looking to buy your business — a Strategic buyer.  This type of buyer has a complementary business, generally in the same industry or a related field, and expects to be able to combine the two companies to achieve synergistic economic benefits. Synergistic economic benefits can take many forms: reduction of expenses through economies of scale, new or complimentary products or services, industry risk diversification, increased market share, customer acquisition, defense of a market position, upstream or downstream vertical integration, increased sales of core products, less expensive than building from scratch, and others.

By combining the two companies, the buyer expects to produce an economic benefit that is greater than that available to the selling company on a stand-alone business. Therein lies your premium to fair market value. The seller is now more valuable by the amount of the expected synergy, to that particular strategic acquirer. The seller’s premium is some portion of the synergistic value. The strategic acquirer can pay a higher price than FMV because they see more value in the selling company. In addition, the strategic buyer is generally motivated to achieve the strategic benefit. This provides the seller with some leverage, and helps the process to achieve a successful completion, particularly when the seller’s M&A advisor brings multiple strategic buyers to the table.
 
Identifying, educating and motivating strategic buyers is one of the many facets of successful M&A brokerage work. For more information on strategic buyers or the M&A selling process, Email Louis Cionci or call 707-778-2040.

Exit Planning: A New Year’s Resolution

/in , , /by Al Statz
“Expect the best, plan for the worst, and prepare to be surprised.” – Dennis Waitley
This is the time of year when many of us decide that we need to change things or accomplish new things, and we set goals at the beginning of the New Year. Quit smoking; lose weight; make more money? How about taking a look at your business this year and begin to prepare it for your exit, which will ultimately arrive whether you’re ready or not.  Surveys have shown 75% of business owners have done little or no exit planning. Owners that do plan ahead are more likely to attract buyers and obtain a higher selling price. Here are some key steps to take this year:
1. Clean up financial records.
  • End commingling of expenses, assets & liabilities. This may result in increased tax liability, but will more than pay for itself by returning a higher sale price. Example: suppose you wanted to sell your businesses in 3 years. If the market multiple of EBITDA (Earnings Before Interest, Taxes Depreciation & Amortization) is 4, for every extra $1 of EBITDA you show on the bottom line, you receive an extra $4 in the selling price.
  • Declare all sales revenue.
  • Sensible, consistent, GAAP financial statements (from the buyer’s CPA prospective).
  • Normalize each of your financial statements. Make notes below each of your year-end statements regarding expenses that are non-recurring in nature, or one-time expenses that are not normal in your business operation.
  • Control expenses: if you have a corporation, take a look at your salary, perquisites and benefits. Decide what it would cost if you had to replace your services with someone else. A business broker/appraiser would make this adjustment to arrive at a modified level of earnings that is commensurate with market rates of compensation. If you have more than one owner working in the business, adjust the salary, perquisites and benefits for each of the owners.
  • If you personally own the building that houses your operation and the corporation or LLC pays rent to you, check to see that the rent is at a market rate. Differences between market rent and actual rent being paid will adjust EBITDA.
  • Pay all of your taxes on time; sales, personal property, payroll, etc.
  • Maintain sensible, accurate management reports.
2. Systems, policies and practices.
  • A well-documented operation pays off by adding intangible value from a buyer perspective.
  • Develop or update systems – and have detailed documentation for all processes your business performs.
  • Measure, report and act on key performance indicators
  • Develop or update employee manuals, policies and job descriptions  for each employee.
3. Personal Goodwill.
Depending upon the type of business and your role in it, take a hard look at your involvement with customers. If most of them do business with the organization because of personal relationships with you, begin to transfer these relationships to someone else or a new hire in your organization. From a value perspective, goodwill that is attached to you is more difficult to transfer to a buyer than goodwill attached to the enterprise.
4. Customer Concentration.
Take a look at your top 10 customers and the percentage of revenues and gross profits that each customer generates. A high concentration of business with a small number of customers will have a negative effect on value. One way to correct high concentration levels is to increase the size of the customer base.
For advice on exiting your company feel free to contact Bob Altieri at 916-905-5706 or boba@exitstrategiesgroup.com. 

February Seminars: Maximize the Value of Your Business

/in , , /by Al Statz
Now in its 9th year, Exit Strategies’ Maximizing the Value of Your Business seminar delivers essential and practical information to business owners who would like to sell for top dollar in the next 1-5 years.  It is not too early to plan the successful exit you deserve!
In this fast-paced workshop, business owners learn …
  • The elements of an effective exit strategy
  • Types of buyers and what they value
  • Business valuation nuts and bolts
  • How to increase valuable and marketability
  • M&A selling process steps and timeframes
  • Current market conditions
  • Deal structures and tax implications
  • The secret to cashing out
  • What a professional M&A broker brings to the table
  • Answers to your questions and concerns
This seminar is complimentary to owners of $1-30 million revenue businesses
 
Dates: Petaluma – Tuesday, February 10, 2015
Roseville – Tuesday, February 24, 2015
Time: 4:00 to 6:30 pm
Presented by: Exit Strategies senior-level advisors and a guest speaker
Register:
Petaluma:  707-778-2040, info@exitstrategiesgroup.com
Roseville:  916-800-2716, info@exitstrategiesgroup.com
Space is limited. For privacy, we allow just one owner (or set of partners) per business type. When we confirm your registration we will provide the location address. Schedule conflict? Contact us to be notified of future dates.
“Amazing amount of information that I can use immediately. You made a complex topic clear and easy to grasp.”  -KM
“Everything that you said would happen when we sold our business happened, and we were prepared. Thank you.” –TB
Because you only sell your business once!

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