Electing to sell a private business is one, if not the most important, decision an owner(s) will make during their lifetime. It usually presents a once-in-a-lifetime opportunity, that, if timed correctly and managed professionally, can be a financially rewarding and painless experience.
In recent years, the economy has rebounded from the “Great Recession” and generally, businesses in most industries have prospered. During this recovery, values of lower middle market companies (revenues of $5M-$100M) have also reached record highs.
Some factors driving recent record M&A levels:
• An abundance of lenders and financing options for buyers
• Continued low interest rates relative to historic norms
• Limited organic growth opportunities for buyers
• The need for buyers to gain access to new markets, intellectual property, or business models
Due to renewed confidence by buyers and an increase in their numbers (particularly private equity firms), sellers have never had more options to consider. These can include a sale of 100% of their business, a sale of a majority interest, or even a sale of a minority interest. There are advantages and disadvantages to each.
As a result of the U.S. enjoying an unprecedented ten-year period of favorable conditions, most economists believe the economy will soon cool, as the FED raises interest rates, and external factors (geopolitical instability, regulatory, trade tariffs, etc.) impact deal value. As a result, many owners today are developing an “exit strategy”.
THE NEED FOR HELP
Few business owners are experienced in the selling process. Most are ill suited to negotiate on their own behalf and they often do not give serious thought to a transaction until they are approached by a suitor. Many are intimidated and threatened by the complexities of making a deal or talk too much without regarding the importance of confidentiality. Some elect to take the first deal that comes along, which in just about every case, can be a mistake. They underestimate the time and resources required to close a successful transaction and fail to appreciate the complexities of making a deal.
The best Buyers today are experienced, highly focused, and served by advisors. A Fortune 500 or public company would never consider a sale transaction without the assistance and participation of experienced advisors. They’ve seen studies that confirm that an experienced, professional intermediary can add as much as 40-50% to the selling price of a business and more importantly, greatly increase the odds of the deal closing.
An experienced M&A Advisor should provide the following:
• An opinion of fair Market Value based upon current MARKET conditions and not just financial history and other theoretical considerations used in most “valuations”
• Financial Benchmarks that compare the Company with its peers and competitors
• An independent business assessment that includes a close look at the Company’s management and employees, market, customers, assets, etc. and identifies its intrinsic value, strengths, weaknesses, threats, and opportunities
WHO TO HIRE?
Many firms and individuals represent themselves to be qualified at selling a business. Lawyer and accountants play a role in M&A but seldom possess the relationships with buyers or the knowledge and experience of all aspects of a successful transaction.
Large Wall St, Investment and Commercial Banks have highly educated and credentialed bankers with industry expertise that work mostly in teams, for public companies, Due to high overhead they don’t normally represent companies with values less than $100Million. Their minimum fee is usually $1 Million which they expect to collect within 6 months.
“Business brokers” who sell small businesses do not normally have the academic/professional credentials or expertise to handle larger or complex transactions. Many “brokers” have acquired a “franchise” where little, if any, experience is required to open an office. Their closing percentage can be low with fees, if successful, of 8-10%.
National, regional, and local “Boutique” M&A firms often serve companies in the lower “middle market” (revenues of $5M-$100M). Many of these have seasoned partners who serve as "rainmakers", while less experienced “associates” handle the details and “heavy lifting”. Fees at these firms can vary but in a $20M transaction are typically in the 3-5% range.
Some M&A advisors specialize in specific industries. This can be beneficial in some instances but it can also be problematic if the advisor brings preconceived biases and/or conflicts of interest to the engagement. Industry agnostic advisors, with broad experience, can offer an unbiased and wider perspective and relationships, and a more creative approach to maximize value.
QUALITIES TO LOOK FOR IN A M&A ADVISOR
In selecting a M&A advisor(s) it is important that the individuals involved in the deal have the proper licenses and credentials. Recent regulatory changes have eliminated the need for securities broker-dealer for most middle market transactions, however many states still require intermediaries be licensed real estate brokers (Fl and GA included)
The advisor(s) should be experienced professionals with expertise in all aspects of a transaction, financial, legal, tax and operational. The best advisors are former business owners or C-level executives.
Other important qualities:
• A knowledge of and experience with the corporate governance of private companies/family businesses and the unique issues they present
• Advice that is independent, without emotion or bias, based upon good business practices, and without conflicts of interest
• The ability to provide consulting services as well as M&A advice and make suggestions that will enhance value
• Guidance and suggestions as to various deal alternatives and structure to minimize taxes
• Access to the detailed research (much of which is expensive, and subscription based) required to be informed about the Seller's industry
• The relationships and resources required to patiently identify the best buyers (strategic and financials)
• The ability and commitment to professionally package the business and present it in its best light
• Demonstrated negotiation skills
• The ability to assist the buyer in arranging financing for the acquisition, if necessary
• A long track record of managing the lawyers and the due diligence process, reviewing the sale documents, and getting deals closed
• Solid advice that is independent and fact based, without conflicts of interest, and in the client's best interest
• A process that is highly disciplined with timelines and deliverables, under no pressure to close quickly above all else, preserves confidentiality
GET TO KNOW THE PEOPLE DOING THE WORK
When selecting an advisor, it’s important that the seller not focus exclusively on the M&A firm, but also the individual(s) who will personally handle the work. Being comfortable with the advisor on a personal basis is very important. Look for these qualities:
• An experienced, mature individual with the wisdom and appreciation of and an understanding of the non-financial issues of a sale, including a sale’s impact on customers, family and employees
• Personal financial stability and a long track record of managing multiple M&A transactions over many years
• A personal commitment of time and energy to the project, the patience to take the time required to make the best deal, and 24/7 availability
• A professional appearance and the confidence that reflects positively on the seller and the business with the communication skills, intelligence and maturity required to handle stressful, complex and difficult situations
THE SALE PROCESS
Time management is critical in a sale process. Without deadlines, buyers (and sellers) take their time in due diligence and find reasons to re-negotiate. Taking too long to close also increases the risk that key managers, employees, customers, suppliers, and competitors learn of the sale.
A professional advisor should have a proven sale process that includes the following:
• The ability to run an efficient and timely process and maintain confidentiality at all cost
• Preparation of a Confidential Information Memorandum or Executive Summary which includes most of the information buyers require without having to visit the business or interview the owner and employees. Almost all interested buyers will want to know (i) revenue and gross profit by customer and product, and (ii) details of the Company’s market and related market share.
• Prior to going to market, conduct a business assessment thereby reducing the likelihood that interested parties discover aspects of the business late in the process that can kill a deal or when the seller’s leverage is reduced.
• Prepare industry benchmarks comparing the Company’s financial performance with its peer group and others of similar size in the same industry
• Present various transaction alternatives
• A time-proven process to identify and pre-qualify potential buyers
• Personally, contact potential buyers, build relationships with each, and establish the seller as credible and serious and not simply interested in testing the market
• Negotiate the terms of the transaction
• Participate in and supervise the due diligence process
• Review the legal documentation, assist and manage the lawyers, and close the transaction.
In some cases, the advisor is asked to perform additional services:
• Restructuring and/or renegotiating the seller’s debt
• Arranging financing for the buyer
• Provide strategic consulting well in advance of a transaction to prepare the Company for sale
• Assist in resolving shareholder/family issues that can destroy value
• Develop incentive compensation (golden handcuffs) plans for key employees
HOW TO INSURE A SUCCESSUL OUTCOME
For many reasons, most proposed M&A transactions fail to close. In the process, sellers become frustrated and the business can be damaged.
Above all else, the owner must remain focused on managing the business, not handling the sale. Visits by buyers should be restricted to after-hours, and guarantee the protection of the Company’s confidential information.
CONSIDER ALL ALTERNATIVES
There are many alternatives in a sale of a business. A sale to employees or management is an option in some cases. A sale to an Employee Stock Ownership Plan (ESOP) can offer substantial tax advantages to the seller. Strategic partnerships and joint ventures are not uncommon, are relatively simple to negotiate and structure, and can be attractive alternatives to a sale transaction. A good advisor has experience in developing these agreements.
To maximize value, it is often important that the sale process includes strategic and financial buyers. These buyers have fundamentally different objectives, which usually affect the deal terms as well as the post-transaction integration.
The engagement of a M&A firm should always include a written agreement. Fees in the deal business are standard based upon industry norms, but can vary in important components and certain provisions can be negotiable. Unlike CPAs and lawyers who charge on an hourly basis regardless of the closing of a transaction, a M&A advisor’s fees should ALWAYS be PRIMARILY incentive-based and paid upon the closing of a transaction. This insures that the advisor’s financial interests are in total alignment with the seller’s.
Upon the closing, the advisor receives a “success” fee which can be an agreed upon flat fee or a percentage of the transaction value. The percentage is larger in smaller deals (8-10%) and decline to less than 1% in $100M transactions. Fees for consulting services are based upon time devoted and are in addition to normal transaction fees.
To close a sale of a business requires a great deal of information. The preparation of the “pitchbook” is designed to answer most buyer’s questions and to present the business in a professional, positive light. Professional advisors should prepare the book and charge a fee to cover their costs. Depending upon the size and complexity of the Company, the cost can range from $15-$50k or more. This fee also serves to demonstrate a commitment that the seller is serious about making a deal, and the advisor is not spending time and money working on a project where the seller is simply seeking free information.
Normally, advisors also charge for travel expenses. In all cases, the seller is responsible for income taxes and other professional fees including, accounting, legal, tax, and environmental.
The sale of a business can be a very time-consuming process. Owners attempting to manage a sale themselves report that it can require 70-80% of their time for many months or years. This is time away from the business. Although deals can have been closed in as little as 90 days, a professionally managed sale process can take 12 months or longer.
70% of all proposed M&A deals never close. Buyer and/or sellers often don’t appreciate the complex issues involved in a transaction until late in the process. Negotiations can be intense and difficult. Due diligence can be extensive, time consuming and expensive. Emotional or personal factors sometimes interfere with good business judgement.
An experienced and knowledgeable M&A advisor should have a unique combination of deal experience, knowledge, communication and transaction skills, and integrity. They can shift the experience factor in favor of the seller. Most importantly, they should have the commitment required to make every transaction a win-win for everyone.
According to recent surveys, buyers (strategic and financial) see a continuation of merger and acquisition (M&A) activity this Fall, both in the number and size of deals.
2018 is forecast to be the most active for M&A since 2015, just shy of the record year of 2007. The dollar value of deals for the first half of 2018 was up 1/3 over 2017 with the number of deals up 60% in the 1st QTR 2018 vs 2017. Over the past three years, capital invested in private U.S. companies has exceeded capital raised via IPOs by almost 150%!
Factors contributing to a continued “bullish” outlook into 2019:
• Investor Confidence- GDP growth is projected to slow but still increase 2.8%. Inflation is expected to grow 2.5% and corporate profits are expected to jump 8%. For the first time in a decade, 100% of developed nations worldwide are experiencing economic growth. This increases buyer confidence, encourages cross-border transactions and encourages buyers to take a longer-term view of the benefits of acquisitions.
• Access to new Markets and Technology – This is the single most significant factor driving current M&A activity. With slow economic growth, strategic buyers need acquisitions to grow market share, gain access to new products/services or acquire the latest technology.
• Favorable Interest Rates – Though the cost of borrowing has edged up recently and is projected to increase further in 2019, the historic cost of debt remains relatively low - high yield debt relative to investment grade debt is lower today than more than 85% of the time in the last fifteen years.
• Cash rich buyers. Since the recession, strategic buyers have paid down debt and conserved cash resulting in plenty of “dry powder” for deals. The number of cash-rich Private Equity Firms has exploded during the same period.
• Limited opportunities for organic growth. Buyers are increasingly frustrated over an inability to organically grow value. They see acquisitions as their best option to enhance value.
• Better deal tools – New technology provides buyers with non-spreadsheet tools that improve the acquisition process, deal integration, etc. and increases confidence in predicting deal success.
In the lower middle market (transactions with values of less than $100M) deal activity is also projected to remain strong in the near term:
• Numerous Sellers – The backbone of the U.S. economy, there are about 350,000 “small businesses” in the U.S. with annual revenues between $5 million and $100 million. For most owners, their business is their largest asset. Due to age, lifestyle changes, and family issues, owners are considering a sale as an exit strategy. An abundance of buyers results in high valuations and a “seller’s market”.
• Pace of change increasing – Consolidation is accelerating in many industries leaving smaller businesses vulnerable with fewer customers and vendors. Many owners fear losing control. A need to constantly re-invest in their business, a shortage of skilled managers and workers, and rising operating costs results in many owners electing to cash out soon.
Despite favorable conditions forcast through 2019, there are concerns regarding 2020 and beyond:
• The current ten-year favorable economic cycle can’t last forever. Based upon history, many economists project a significant slowdown in 2-3 years. Though not expected to result in another recession, there likely will be fewer buyers and lower values.
• Interest rates are expected to continue to rise with Prime projected at 6.25% by the end of 2019. Any unexpected or rapid increase in rates and/or restriction in the money supply could quickly and negatively influence valuations of private companies.
• Anticipated macro-economic changes (trade wars, geo-political unrest, regional conflicts, etc) will adversely impact financial markets and the deal business.
• Increased government oversight of deals will discourage consolidation in some industries (energy, telecom, media, etc) thus lowering values.
As companies grow, they often fail to consider strategic alliances as a source for intellectual and financial capital. By definition, a strategic alliance is a formal agreement between two businesses as an alternative to forming a legal partnership, agency, or corporate affiliate relationship (merger or acquisition).
Strategic alliances gained increased popularity in the 1990s. From 1987 to 1992 more than 20,000 new alliances were formed in the U.S, up from 5100 between 1980 and 1987. By 1999, U.S. corporations were involved in over 2,000 alliances with companies in Europe alone.
The primary benefits of a strategic alliance is the opportunity it creates to combine resources or share expertise in order to quickly build or expand market opportunities or gain some other competitive advantage. Some of these include:
• Shared manufacturing and marketing expenses and R&D costs to gain economies of scale
• Expanding a customer base through a partner's relationships or geographical footprint
• Gaining access to intellectual talent and/or protected technology
• Co-branding or capitalizing on another company's brand or market position
• Access to capital
Strategic alliances force companies to share revenues and profits, but they also share the risk of loss and failure. As a result, their popularity increases as projected risk increases, thus companies enter into alliances when other options are too risky or too costly.
One common misconception is that large companies only partner with large companies. This has never been the case and is less so these days when change can come quickly, business needs to respond, and where new niches are created every day.
Some recent examples of successful alliances:
Starbucks - Starbucks partnered with Barnes and Nobles bookstores in 1993 to provide in-house coffee shops, benefiting both retailers. In 1996, Starbucks partnered with Pepsico to bottle, distribute and sell the popular coffee-based drink, Frappacino. A Starbucks-United Airlines alliance has resulted in their coffee being offered on flights with the Starbucks logo on the cups and a partnership with Kraft foods has resulted in Starbucks coffee being marketed in grocery stores.
Apple- Apple has a long history of strategic alliances having partnered in the past with Sony, Motorola, Phillips, and AT&T. Recently it partnered with Clearwell in order to jointly develop Clearwell's E-Discovery platform for the Apple iPad. E-Discovery is used by enterprises and legal entities to obtain documents and information in a "legally defensible" manner.
Hewlett Packard/Disney - HP and Disney have a long-standing alliance dating to 1938, when Disney purchased eight oscillators to use in the sound design of Fantasia. When Disney wanted to develop a virtual attraction called Mission: SPACE, Disney Imagineers and HP engineers relied on HP's IT architecture, servers and workstations to create Disney's most technologically advanced attraction.
Eli Lilly – This pharmaceutical giant has been forming alliances for nearly a century, and was the first in big pharma to establish an office devoted entirely to alliance management. It currently has over one hundred partnerships around the world devoted to discovery, development, and marketing.
Some alliances are geography centric. Others focus on specific customers, products, or technology. Vendors, suppliers and even potential competitors can be potential partners. Often the strategic partner eventually becomes a buyer or a seller.
Keep in mind that there must always be "consideration"— value gained by both parties. Often the alliance fails due to one party or the other gaining too much from the relationship. The best alliances are often completely voluntary, where either party can walk on short notice.
The Inman Company and its consultants have years of experience in designing, managing, and monitoring strategic alliances