Merger and acquisitions are expected to be the top business headline in 2017 as large corporations and Private Equity (PE) firms start to deploy their record amounts of cash. Rollups of related companies will accelerate in 2017as companies seek critical mass and Initial Public Offerings (IPO) are expected to grow exponentially in 2017.
The accounting firm of KPMG recently commissioned a survey with respect to the prospects for consolidations in 2017. Study findings included:
- 60% of respondents said that large cash reserves would accelerate deal flow in 2017 and 40% indicated that favorable credit terms would drive activity.
- Primary drivers of activity increase: companies expanding their geographical reach (20%), PE buyers seeking more profitable operations (19%) and companies pursuing line of business expansion (17%).
- There are financial buyers and strategic buyers. Financial buyers are all about the numbers and how they can drive the business to achieve its greatest value to sell again. Strategic buyers see the acquisition of your Company as a way to grow their business and blend best practices, expand relationships and potential customers and leverage the market position and reputation the seller has put in place over the years of having run a successful business with a positive reputation. The strategic buyer is not a bottom fisher and recognizes value.
NOTE: In the process of selling your business, you will be approached by competitors and even by competitors you may not like for one reason or another. Do not let these opportunities pass you by and remain open to discussions. It is very often these competitors who would make the best acquire for your employees, to preserve legacy and for your customers. When selling, it isn't about liking the buyer. It's about good business that achieves the seller's goals.
Private companies should prepare for enticing calls from PE firms and corporate buyers. Be prepared with a strategy to explore and seriously consider the “deal that may be too good to pass up.”
Analyzing the Option to Exit
Private companies considering an exit should be prepared to analyze the full range of options from all relevant perspectives including financial expectations, time horizons, risk appetite and tax issues for the Board, investors, managers and other stakeholders.
A key issue to expect: stakeholders may not have the same time frame for a transaction. Some stockholders might have tax issues if a sale is structured as a taxable transaction.
Steps to improve a company’s business enterprise value preparatory to a sale include:
- Engage an advisor and consultant to provide a third party review and assessment of how to position the company to maximize value. Few owners know how to do this as few owners have sold a company and know what a buyer is seeking.
- Have a number in mind and then build a case around that number. Recognize that any good transaction has to have something left on the table for the buyer and also that neither party should come out getting 100% of what they want.
- Consider the basic parameters of a potential exit including the desire of the current owners to retain a stake in or the desire to have certain key employees retained.
- If there are family members involved in the business, consider their desires and assess their true abilities to continue the legacy of the Company after the owner's "retirement" or significantly reduced day to day role. If family members do not share the same passion as the father founder, the legacy will not be continued and in many instances there is a degradation of the value of the business.
- Anticipate issues that are likely to be raised in due diligence and fix as many problems as you can. The advisor/ consultant can be of tremendous help in this regard.
Assess Transaction Readiness
If there is initial interest in pursuing an exit, companies must determine if they are prepared to execute a transaction. Consider having an outside advisor provide a preliminary valuation of the company to manage the owner/investors’ expectations.
Be ready to define the current state of the company’s readiness to execute a transaction and:
- Address availability of basic collateral to support a sale, such as material for a “book.”
- Consider the readiness to respond to the key criteria that will drive buyers’ interest in a transaction and the price they will pay including: predictability and consistency of the company’s revenue, profit and cash flow, customer base and its loyalty, pricing power, concentration issues and incentives to keep key employees and executives.
- If you have experienced flat revenue growth or declines be prepared to provide factual data for the declines and why you believe the revenues will be different this year verses last.
- No buyer will pay you for future earnings. Those below to the buyer who takes on the risk to achieve those projections. Value is based on a point in time and does take into account good will and intrinsic and intangibles.
- The seller has to accept and recognize that they do not benefit in the pricing from the economies of scale that would occur because or redundancies. Those benefits accrue to the benefit of the buyer making the investment and assuming the risk going forward.
- Consider how you have been compensated as an owner and what you have taken out of the Company. The cash and retained earnings always goes to the seller. Make modifications to your compensation to maximize multiple value. Example: A buyer is going to ultimately come up with a multiple of EBITDA that will incorporate all factors. If the only is paying himself above market compensation, the deduction from the NOI/ EBITDA will reduce the purchase price. If the president/principal owner is taking a market competitive salary and compensation the deduction is market reasonable and therefore the seller will not lose value.
- Consider differentiation and market positioning relative to competitors.
Consider Buyer’s View of the Company
Successful companies do not face their customers unprepared. All the more so when it comes to facing a buyer.
Be ready to address the concerns of prospective buyers of the company. Expect them to ask about:
- Capital investment and operating improvements they would need to do after the acquisition to realize the value they are targeting.
- How quickly and well a strategic acquirer would be able to integrate your operations, customers and culture.
- Drivers of sale value such as: intellectual property, R&D, technology and updates to products and human talent. Some of these can be improved before negotiating a transaction.
Create An Exit Plan
Key steps to an exit are often tax driven. Mergers can be fully, partially or tax free of taxable and can generate capital gains or ordinary income, depending upon how the transaction is structured. Most sellers will want a stock deal while most buyers will want an asset deal to avoid any contingent or undisclosed liabilities. The only way a buyer would agree to a stock deal, because of the liabilities issue would be if a sales price hold back sufficient to underwrite potential unknown liabilities was agreed to. Most small company transactions are asset sales.
- Most small business transactions have a cash/ earn-out component. How much cash is paid up front verses paid in an earn-out impacts the EBITDA multiple and purchase price. Buyers and sellers are risk adverse. The seller wants as much cash up front as possible and the seller the least amount. It is a matter or risk balance for both seller and buyer.
- The second consideration for a seller is the option to provide a certain level of seller financing. This can be both a tax benefit and a cash flow factor. There may be a seller subordination requirement for a partial buyer bank loan for the purchase. All financial structures are ultimately a matter of negotiation but a seller like a buyer should be prepared to be flexible to ensure that an optimal transaction for both parties can be consummated.
- Understand the ramifications of each transaction scenario. A private equity deal will close off other funding options and involve an aggressive exit strategy.
- Develop the preliminary “story” about the business to give an acquirer a compelling vision about prospects to grow the business and earn a return on their investment.
- Integrate into the operating metrics and analytics that you use to run the company the model that you think potential buyers will use to put a valuation on the company.
- Prepare information memoranda and related presentation material.
- Create a presentation to investors and be ready to respond to their concerns.
You have worked long and hard to build a company. Take the time and devote the focus required to exit it successfully.