The IBBA and M&A Source Market Pulse Survey Report for the fourth quarter of 2018 has a range of interesting insights. The survey’s purpose is to provide an “accurate understanding of market conditions for businesses being sold in Main Street (values $0-$2MM) and the Lower Middle Market (values $2MM-$50MM). This national survey was designed as a tool for business owners and their advisors and has the support of both the Pepperdine Private Capital Markets Projects and the Pepperdine Graziadio Business School.
One of the most striking facts to leap out of the report is the fact that a full one-third of advisors fully expect the strong market to end this year. Overall, advisors are not optimistic that the current climate will continue through 2020. In fact, advisors are encouraging sellers to consider placing their businesses on the market now, while the market is still strong. This is according to Craig Everett, PhD and Assistant Professor of Finance and Director of the Pepperdine Private Capital Markets Project.
One fact from the report that could be overlooked is that only a mere 8% of advisors expect the current climate to last for 48 months or more. Additionally, only 9% believe that the current climate will last between 24 to 48 months. Perhaps most striking of all is the fact that 60% of advisors feel that the current climate will end within the next two years.
Business owners who are considering selling should be advised that almost two-thirds of advisors now feel that there will be a significant shift in the next two years. Considering that it can take a year or more to sell a business, business owners would be wise to consider this important fact.
The report sites Neal Isaacs, Owner of VR Business Brokers of the Triangle who states, “Deals are taking longer in due diligence as buyers work hard to validate their investment and make sure that what they’re buying is worth the premium price today’s sellers are commanding.”
So, is now the time to sell? Many experts feel that it is possible to lose a sizable amount of value if one waits too long to sell. Even just a few months can make a huge difference in terms of perceived value and the ultimate sales price. Working with a proven business broker is a key way to ensure that you are selling at the right time and secure the best possible price.
Where your money is concerned, myths can do damage. A recent Divestopedia article from Tammie Miller entitled, Crazy M&A Myths You Need to Stop Believing Now, Miller explores 5 big M&A myths that can get you in trouble. Miller points out that many of these myths are believed by CEOs, but that they have zero basis in reality.
The first major myth Miller explores is the idea that the “negotiating is over once you sign the LOI.” The letter of intention is, of course, important. However, this is by no means the end of the negotiations and it is potentially dangerous to think otherwise. The negotiations are not concluded until there is a purchasing agreement in place. As Miller points out, there is a great deal that can go wrong during the due diligence process. For this reason, it is important to not see the LOI as the “end of the road.”
Another myth that Miller wants you to be aware of is that you don’t have to take a company’s debt as part of the purchase price. Many business brokers, such as Miller, recommend that buyers don’t take seller paper.
A third myth that Miller explorers is a particularly dangerous one. The idea that everyone who makes an offer has the money to follow through is, unfortunately, simply not true. Oftentimes, people will make offers without securing the money to actually buy the business. No doubt, this wastes everyone’s time. As the business owner, it can derail your progress. If you are not careful, it could actually prevent you from finding a qualified buyer.
Another myth is built around the notion that sellers don’t need a deal team in order to sell their business. Again, this is another myth that has no real foundation in reality. While it may be possible to sell your business without the assistance of an experienced M&A attorney or business broker, the odds are excellent that doing so will come at a price. According to Miller, those working with an investment banker or business broker can expect, on average, 20% more transaction value!
Additionally, there are other dangers in not having a deal team in place. A business broker can handle many of the time-consuming aspects of selling a business, so that you can keep running your business. It is not uncommon for business owners to get stretched too thin while trying to both run and sell a business and this can ultimately harm its value.
Miller’s final myth to consider is that you must sell your entire business. It is true that most buyers will want to buy 100% of a business, but a minority ownership position is still an option. There are many reasons to consider selling a minority stake, so don’t assume that selling your business is an “all or nothing” affair.
Ultimately, Miller lays out an exceptional case for the importance of working with business brokers when selling or buying a business. Business brokers can help you avoid myths. In the end, they know the lay of the land.
Before buying any business, a seller must ask questions, lots of questions. If there is ever a time where one should not be shy, it is when buying a business. In a recent article from Entrepreneur magazine entitled, “10 Questions You Must Ask Before Buying a Business”, author Jan Porter explores 10 of the single most important questions prospective buyers should be asking before signing on the dotted line. She points out to remember that “there are no stupid questions.”
The first question highlighted in this article is “What are your biggest challenges right now?” The fact is this is one of the single most prudent questions one could ask. If you want to reduce potential surprises, then ask this question.
“What would you have done differently?” is another question that can lead to great insights. Every business owner should be an expert regarding his or her own business. It only makes sense to tap into that expertise when one has the opportunity. The answers to this question may also illuminate areas of potential growth.
How a seller arrives at his or her asking price can reveal a great deal. Having to defend and outline why a business is worth a given price is a great way to determine whether or not the asking price is fair. In other words, a seller should be able to clearly defend the financials.
Porter’s fourth question is, “If you can’t sell, what will you do instead?” The answer to this question can give you insight into just how much bargaining power you may have.
A business’ financials couldn’t be any more important and will play a key role during due diligence. The question, “How will you document the financials of the business?” is key and should be asked and answered very early in the process. A clear paper trail is essential.
Buying a business isn’t all about the business or its owner. At first glance, this may sound like a strange statement, but the simple fact is that a business has to be a good fit for its buyer. That is why, Porter’s recommended question, “What skills or qualities do I need to run this business effectively?” couldn’t be any more important. A prospective buyer must be a good fit for a business or otherwise failure could result.
Now, here is a big question: “Do you have any past, pending or potential lawsuits?” Knowing whether or not you could be buying future headaches is clearly of enormous importance.
Porter believes that other key questions include: “How well documented are the procedures of the business?” and “How much does your business depend on a key customer or vendor?” as well as “What will employees do after the sale?”
When it comes to buying a business, questions are your friend. The more questions you ask, the more information you’ll have. The author quotes an experienced business owner who noted, “The more questions you ask, the less risk there will be.”
Business brokers are experts at knowing what kinds of questions to ask and when to ask them. This will help you obtain the right information so that you can ultimately make the best possible decision.
A recent article on Businessbroker.net entitled, First Time Buyer Processes by business broker Pat Jones explores the process of buying a business in a precise step-by-step fashion. Jones notes that there are many reasons that people buy businesses including the desire to be one’s own boss. However, he is also quick to point out that buyers should refrain from buying a business that they simply don’t like. In the quest for profits, many prospective owners may opt to do this, but it could ultimately lead to failure.
Step One – Information Gathering
For Jones, there are seven steps in the business buying process. At the top of the list is to gather information on businesses so that one has an idea of what kind of businesses are appealing.
Step Two – Your Broker
The second key step is to begin working with a business broker. This point makes tremendous sense; after all, those new to the business buying process will benefit greatly from working with a guide with so much experience. Business brokers can gain access to information that prospective business owners simply cannot.
Step Three – Confidentiality and Questions
The third step in the process is to sign a confidentiality agreement so that you can learn more about a business that you find interesting. Once you have the businesses marketing package, you’ll want to have your broker schedule an appointment with the seller. It is vitally important that you prepare a list of questions on a range of topics. There is much more to buying a business than the final price tag. By asking the right questions, you’ll be able to learn more about the business and its long-term potential.
Step Four – Evaluation
In the fourth step of the business buying process, you’ll want to evaluate all the information that you have received from the seller. Once again, a business broker can be simply invaluable, thanks to years of hands-on experience, he or she will know how to evaluate a seller’s information.
Step Five – The Decision
In the fifth step, you’ll need to decide whether or not you are making an offer. If you are making an offer, you will, of course, want it to be written and include contingencies.
If your offer is accepted, then the process of due diligence begins. During due diligence, you and your business broker will look at everything from financial statements to tax returns. You will evaluate the company’s assets. Again business brokers are experts at the due diligence process.
Buying a business is an enormous commitment. Making certain that you’ve selected the right business for you is one of the most critical decisions of your life. Having as much competent and experienced help as possible is of paramount importance.
“Exit strategies may allow you to get out before the bottom falls out of your industry. Well-planned exits allow you to get a better price for your business.”
From: Selling Your Business by Russ Robb, published by Adams Media Corporation
Whether you plan to sell out in one year, five years, or never, you need an exit strategy. As the term suggests, an exit strategy is a plan for leaving your business, and every business should have one, if not two. The first is useful as a guide to a smooth exit from your business. The second is for emergencies that could come about due to poor health or partnership problems. You may never plan to sell, but you never know!
The first step in creating an exit plan is to develop what is basically an exit policy and procedure manual. It may end up being only on a few sheets of paper, but it should outline your thoughts on how to exit the business when the time comes. There are some important questions to wrestle with in creating a basic plan and procedures.
The plan should start with outlining the circumstances under which a sale or merger might occur, other than the obvious financial difficulties or other economic pressures. The reason for selling or merging might then be the obvious one – retirement – or another non-emergency situation. Competition issues might be a reason – or perhaps there is a merger under consideration to grow the company. No matter what the circumstance, an exit plan or procedure is something that should be developed even if a reason is not immediately on the horizon.
Next, any existing agreements with other partners or shareholders that could influence any exit plans should be reviewed. If there are partners or shareholders, there should be buy-sell agreements in place. If not, these should be prepared. Any subsequent acquisition of the company will most likely be for the entire business. Everyone involved in the decision to sell, legally or otherwise, should be involved in the exit procedures. This group can then determine under what circumstances the company might be offered for sale.
The next step to consider is which, if any, of the partners, shareholders or key managers will play an actual part in any exit strategy and who will handle what. A legal advisor can be called upon to answer any of the legal issues, and the company’s financial officer or outside accounting firm can develop and resolve any financial issues. Obviously, no one can predict the future, but basic legal and accounting “what-ifs” can be anticipated and answered in advance.
A similar issue to consider is who will be responsible for representing the company in negotiations. It is generally best if one key manager or owner represents the company in the sale process and is accountable for the execution of the procedures in place in the exit plan. This might also be a good time to talk to an M&A intermediary firm for advice about the process itself. Your M&A advisor can provide samples of the documents that will most likely be executed as part of the sale process; e.g., confidentiality agreements, term sheets, letters of intent, and typical closing documents. The M&A advisor can also answer questions relating to fees and charges.
One of the most important tasks is determining how to value the company. Certainly, an appraisal done today will not reflect the value of the company in the future. However, a plan of how the company will be valued for sale purposes should be outlined. For example, tax implications can be considered: Who should do the valuation? Are any synergistic benefits outlined that might impact the value? How would a potential buyer look at the value of the company?
An integral part of the plan is to address the due diligence issues that will be a critical part of any sale. The time to address the due diligence process and possible contentious issues is before a sale plan is formalized. The best way to address the potential “skeletons in the closet” is to shake them at this point and resolve the problems. What are the key problems or issues that could cause concern to a potential acquirer? Are agreements with large customers and suppliers in writing? Are there contracts with key employees? Are the leases, if any, on equipment and real estate current and long enough to meet an acquirer’s requirements?
The time to address selling the company is now. Creating the basic procedures that will be followed makes good business sense and, although they may not be put into action for a long time, they should be in place and updated periodically.
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When the sale of a business falls apart, everyone involved in the transaction is disappointed – usually. Sometimes the reasons are insurmountable, and other times they are minuscule – even personal. Some intermediaries report a closure rate of 80 percent; others say it is even lower. Still other intermediaries claim to close 80 percent or higher. When asked how, this last group responded that they require a three-year exclusive engagement period to sell the company. The theory is that the longer an intermediary has to work on selling the company, the better the chance they will sell it. No one can argue with this theory. However, most sellers would find this unacceptable.
In many cases, prior to placing anything in a written document, the parties have to agree on price and some basic terms. However, once these important issues are agreed upon, the devil may be in the details. For example, the Reps and Warranties may kill the deal. Other areas such as employment contracts, non-compete agreements and the ensuing penalties for breach of any of these can quash the deal. Personality conflicts between the outside advisers, especially during the
due diligence process, can also prevent the deal from closing.
One expert in the deal-making (and closing) process has suggested that some of the following items can kill the deal even before it gets to the Letter of Intent stage:
- Buyers who lose patience and give up the acquisition search prematurely, maybe under a year’s time period.
- Buyers who are not highly focused on their target companies and who have not thought through the real reasons for doing a deal.
- Buyers who are not willing to “pay up” for a near perfect fit, failing to realize that such circumstances justify a premium price.
- Buyers who are not well financed or capable of accessing the necessary equity and debt to do the deal.
- Inexperienced buyers who are unwilling to lean heavily on their experienced advisers for proper advice.
- Sellers who have unrealistic expectations for the sale price.
- Sellers who have second thoughts about selling, commonly known as seller’s remorse and most frequently found in family businesses.
- Sellers who insist on all cash at closing and/or who are inflexible with other terms of the deal including stringent reps and warranties.
- Sellers who fail to give their professional intermediaries their undivided attention and cooperation.
- Sellers who allow their company’s performance in sales and earnings to deteriorate during the selling process.
Deals obviously fall apart for many other reasons. The reasons above cover just a few of the concerns that can often be prevented or dealt with prior to any documents being signed.
If the deal doesn’t look like it is going to work – it probably isn’t. It may be time to move on.
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A recent study revealed that only about 28 percent of family businesses have developed a succession plan. Here are a few tips for family-owned businesses to ponder when considering
selling the business:
- You may have to consider a lower price if maintaining jobs for family members is important.
- Make sure that your legal and accounting representatives have “deal” experience. Too many times, the outside advisers have been with the business since the beginning and just are not “deal” savvy.
- Keep in mind that family members who stay with the buyer(s) will most likely have to answer to new management, an outside board of directors and/or outside investors.
- All family members involved either as employees and/or investors in the business must be in agreement regarding the sale of the company. They must also be in agreement about price and terms of the sale.
- Confidentiality in the sale of a family business is a must.
- Meetings should be held off-site and selling documentation kept off-site, if possible.
- Family owners should appoint one member who can speak for everyone. If family members have to be involved in all decision-making, delays are often created, causing many deals to fall apart.
Many experts in family-owned businesses suggest that a professional intermediary be engaged by the family to handle the sale. Intermediaries are aware of the critical time element and can help sellers locate experienced outside advisers. They can also move the sales process along as quickly as possible and assist in negotiations.
Keeping it in the Family
It’s hard to transfer a family business to a younger kin. Below are some statistics regarding family businesses.
- 30% of family businesses pass to a second generation.
- 10% of family businesses reach a third generation.
- 40% to 60% of owners want to keep firms in their family.
- 28% of family businesses have developed a succession plan.
- 80% to 95% of all businesses are family owned.
Source: Ted Clark, Northeastern University Center for Family Business
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Consider two different companies in virtually the same industry. Both companies have an EBITDA of $6 million – but, they have very different valuations. One is valued at five times EBITDA, pricing it at $30 million. The other is valued at seven times EBITDA, making it $42 million. What’s the difference?
One can look at the usual checklist for the answer, such as:
- The Market
- Revenue Size
- Regional/Global Distribution
- Capital Equipment Requirements
- Intangibles (brand/patents/etc.)
- Growth Rate
There is the key, at the very end of the checklist – the growth rate. This value driver is a major consideration when buyers are considering value. For example, the seven times EBITDA company has a growth rate of 50 percent, while the five times EBITDA company has a growth rate of only 12 percent. In order to arrive at the real growth story, some important questions need to be answered. For example:
- Are the company’s projections believable?
- Where is the growth coming from?
- What services/products are creating the growth?
- Where are the customers coming from to support the projected growth – and why?
- Are there long-term contracts in place?
- How reliable are the contracts/orders?
The difference in value usually lies somewhere in the company’s growth rate!
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It has often been said that valuing companies is an art, not a science. When a buyer considers the purchase of a company, three main things are almost always considered when arriving at an offering price.
Quality of the Earnings
Some accountants and intermediaries are very aggressive when adding back, for example, what might be considered one-time or non-recurring expenses. A non-recurring expense could be:
- meeting some new governmental guidelines,
- paying for a major lawsuit, or
- adding a new roof on the factory.
The argument is made that a non-recurring expense is a one-time drain on the “real” earnings of the company. Unfortunately, a non-recurring expense is almost an oxymoron. Almost every business has a non-recurring expense every year. By adding back these one-time expenses, the accountant or business appraiser is not allowing for the extraordinary expense (or expenses) that come up almost every year. These add-backs can inflate the earnings, resulting in a failure to reflect the real earning power of the business.
Sustainability of Earnings
The new owner is concerned that the business will sustain the earnings after the acquisition. In other words, the acquirer doesn’t want to buy the business if it is at the height of its earning power; or if the last few years of earnings have reflected a one-time contract, etc. Will the business continue to grow at the same rate it has in the past?
Verification of Information
Is the information provided by the selling company accurate, timely, and is all of it being made available? A buyer wants to make sure that there are no skeletons in the closet. How about potential litigation, environmental issues, product returns or uncollectible receivables? The above areas, if handled professionally and communicated accurately, can greatly assist in creating a favorable impression. In addition, they may also lead to a higher price and a quicker closing.
© Copyright 2015 Business Brokerage Press, Inc.
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Putting a price on privately-held companies is more complicated than placing a value or price on a publicly-held one. For one thing, many privately-held businesses do not have audited financial statements; these statements are very expensive and not required. Public companies also have to reveal a lot more about their financial issues and other information than the privately-held ones. This makes digging out information for a privately-held company difficult for a prospective purchaser. So, a seller should gather as much information as possible, and have their accountant put the numbers in a usable format if they are not already.
Another expert has said that when the seller of a privately-held company decides to sell, there are four estimates of price or value:
- A value placed on the company by an outside appraiser or expert. This can be either formal or informal.
- The seller’s “wish price.” This is the price the seller would really like to receive – best case scenario.
- The “go-to-market price” or the actual asking price.
- And, last but not least, the “won’t accept less than this price” set by the seller.
The selling price is usually somewhere between the asking price and the bottom-dollar price set by the seller. However, sometimes it is less than all four estimates mentioned above. The ultimate selling price is set by the marketplace, which is usually governed by how badly the seller wants to sell and how badly the buyer wants to buy.
What can a buyer review in assessing the price he or she is willing to pay? The seller should have answers available for all of the pertinent items on the following checklist. The more favorable each item is, the higher the price.
- Stability of Market
- Stability of Historical Earnings
- Cost Savings Post-Purchase
- Minimal Capital Expenditures Required
- Minimal Competitive Threats
- Minimal Alternative Technologies
- Reasonable Market
- Large Market Potential
- Reasonable Existing Market Position
- Solid Distribution Network
- Buyer/Seller Synergy
- Owner or Top Management Willing to Remain
- Product Diversity
- Broad Customer Base
- Non-dependency on Few Suppliers
There may be some additional factors to consider, but this is the type of analysis a buyer should perform. The better the answers to the above benchmarks, the more likely it is that a seller will receive a price between the market value and the “wish” price.
© Copyright 2015 Business Brokerage Press, Inc.
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