Q3 2014 M&A Market Update

As we reflect on the third quarter of 2014, we have seen several trends develop that are impacting valuations as well as the number of sale/recapitalization transactions of closely held businesses. Some of this industry data was also developed from the recent M&A Source conference held in Austin November 17- 21. 56 private equity firms were in Austin for the Expo, plus 180 M&A intermediaries from across the U.S.

Two trends were noted at the conference: 

First, contract terms that previously were reserved for the upper middle market are now appearing in lower middle market transactions. Items such as representation and warranty insurance policies, previously only used in the upper middle market, were now being employed in lower middle market transactions. We recently were involved in a $15,000,000 EV transaction in which the private equity buyer, based in New York, was purchasing a "representation and warranty insurance" policy from AIG. These policies had normally only been used in larger transactions. Items such as "clawback" provisions may now appear in the purchase agreements of lower middle market transactions. In addition, many acquirers are engaging accounting firms to perform a "quality of earnings" review as part of due diligence.

Second, minority recapitalization transactions are becoming much more popular in current transactions. Business owners who are not ready to retire or give up control of the business, are able to cash out some of their equity, diversify their net worth, but continue to run the company, as well as maintain control. As the company grows, the eventual sale in 7-10 years may yield a substantial premium over current valuations, due to increase in EBITDA, as well as multiple expansion based upon the increased revenue and earnings. EBITDA multiples for well-run operations, with deep management teams and EBITDA in excess of $3,000,000 are seeing multiples between 5 and 6 times adjusted EBITDA in some cases.

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Q1 2014 M&A Market Update

As we complete the first quarter of 2014, we have seen several trends develop in M&A that are impacting valuations, as well as the number of sale/recapitalization transactions of closely held businesses. In 2013 and Q1 2014, we closed numerous transactions across the state, in varied industry sectors, including an Austin-based client company that was acquired by a public company based in Europe. Our opinion is that the M&A market is extremely favorable to sellers today. This was reinforced by a recent article by Andy Greenberg, CEO of GF Data, who stated:

"The primary drivers of middle-market deal flow - company and industry performance, capital availability, macro-economic conditions, and public equity values - are more favorable to the private business seller than at any time since the mid-2000s, but the volume of change-of-control deal activity is just not on par with these favorable market conditions."

In addition, an article in the New York Times on February 11, 2014, contained the following:

"The market is further constrained by a lack of companies willing to sell, as they wait for the economy to improve further", said Milton J. Marcotte, head of the national transaction advisory services practice at McGladrey, an accounting, tax and consulting firm for private equity. "That intensifies competition among buyers. We've been doing this awhile, and I don't remember a time when it was really quite this competitive," said Mr. Marcotte.

We also know from our industry sources that private equity firms are collectively sitting on about $1 trillion in capital that they must invest. So, with well-capitalized buyers in the market, what is holding back sellers of closely held businesses? We believe that many sellers are skeptical when we discuss what is clearly a "sellers' market". They have heard this before. However, we can verify that multiple offers for good businesses, especially in Central Texas, is the norm rather than the exception.

So, is now the time for business owners to ask themselves if it is a good idea to have a significant amount of their net worth tied up in their privately-held business? We have noticed businesses have recovered from the 2008-2009 recession, and now the business is doing quite well, and thus, the owners ask "why sell now?" Unfortunately, history shows that recessions happen in 7-10 year cycles, and most of us cannot predict the future very well. Selling at the top may have appeal as the smart move. But we know that it is difficult to accurately predict the ideal time. Our message to business owners is don't wait for uncontrollable factors, such as health issues or other personal factors, to force you into an exit strategy. The better course of action is to take control and plan your exit in a way that maximizes value. We believe that the only way to maximize value upon the sale of a privately held business is to run a well-managed process that leads to multiple offers.

So if it's a "sellers' market", what impact is that having on valuations? It varies, of course, by industry and size of company, but some broad parameters do apply. The following appeared in the GF Data article:

"The non-institutionally-owned businesses offering neither above-average financial characteristics nor a management solution post-close that continued the march towards closing in the first months of 2013 traded at an average of 4.4 TTM Adjusted EBITDA."   GF Data, March 2014.

Two salient points in that statement: These businesses were neither above average, nor did they have a strong management team after acquisition, yet were still getting a multiple of 4.4 times TTM Adjusted EBITDA. So if a business has better than average financial performance and a solid management team, it should command an even higher multiple. This is supported by a recent New York Times article, in which David Humphrey, a managing director at Bain Capital, noted:

"Valuations for clean, easily extractable businesses are quite high."

So going forward in 2014, we expect continued high demand for Central Texas businesses with upward pressure on pricing for well-managed, profitable businesses. There were over 150 Private Equity Groups at the recent ACG conference in Houston, intensely focused on finding solid acquisitions of both platform and add-on businesses.

Please do not hesitate to contact us for specific information about market trends.

http://www.corpinvest.com

Webinar: Business Valuation

Webinar time/date:
Wednesday, January 29, 2014
12:00 PM-12:45 PM CST.

Join us to learn about business valuation, a crucial step in selling your business.

Webinar participants are completely anonymous. You can call in or listen on headphones for maximum confidentiality.

What will we cover in this webinar?

• Value vs. Price
• Acceptable valuation methods
• Recasting process
• Value drivers
• Valuation Example

Why should you attend this webinar?

Even if you aren't ready to sell your business today, finding out more about the sales process is advantageous.

• How do you add value to your business?
• What are the methods for valuing a privately held company?
• What is the difference between value and price?
• If you need to recast your finanicals, what is the process?
• What drives the value in your business?

Register now.

http://www.corpinvest.com

Webinar: How to Sell a Privately Owned Business (for Maximum Value)

Webinar time/date:
Wednesday, January 15, 2014
12:00 PM-12:45 PM CST.

Join us to learn how and when to sell your business for maximum value.

Register now.

Webinar participants are completely anonymous. You can call in or listen on headphones for maximum confidentiality.

What will we cover in this webinar?

• Planning for the sale
• Marketing the business
• Deal making
• Closing

Why should you attend this webinar?

Even if you aren't ready to sell your business today, finding out more about the sales process is advantageous.

• How do you add value to your business?
• Who are the possible buyers for your company?
• What increases or decreases value?
• How is the deal structured?
• How do you deal with employees and customers?
  

http://www.corpinvest.com 

What factors determine the "Multiple" of earnings?

A "multiple" of earnings is a valuation method whereby the value of a company is expressed through the use of a multiple applied to the Company's earnings.  For instance, a company that has Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) of $2,000,000, that has a "value" of $10,000,000, was valued at  5 x EBITDA. The appropriate earnings multiple that should be used to value any particular company depends upon a number of factors, or attributes.  One way to drive a higher value for your company is for it to possess some of those attributes that warrant a higher earnings multiple.  Predictability of revenue, sometimes referred to as "stickiness" of revenue, is one of those attributes that impacts the earnings multiple.

Companies with highly predictable or recurring revenue streams sell for much higher multiples than companies whose revenue is not recurring, or is dependent upon constantly generating transactions with new customers for its revenue stream.

Some of the factors that demonstrate a higher level of predictability of revenue include:

• Contractual agreements with customers for repetitive sales of goods or services, such as manufacturing companies with long term purchase orders, or service companies that have annual recurring service contracts.
• Operating in an industry where the barriers to entry are high. 
• A solid and growing customer base with very little turnover.
• Serving a market, either industrial or geographic, that is growing. 
• In the case of distribution companies, protected territories or exclusive rights to product lines.
• A revenue model that resembles a razor/ razor blade concept - where customers are "locked in" to a company's product or services. 

Factors that indicate revenue is not highly predictable include:

• The majority of the customer relationships are managed by the owner of the business, or a small group of sales executives (the risk being that if the owner is no longer involved, or if the sales executives leave, the customer base may no longer have loyalty to the company). 
• The barriers to entry are low - new competitors can easily enter the market, thus increasing the competitive landscape. 
• Revenue is project dependent. 
• There are pricing risks, either from changing technology or governmental regulation.

There are many other factors that come into play, way too many to outline in this article. As a business owner, we recommend that you review the sources of revenue for your company and, if possible, take steps to improve the "stickiness" of your company's revenue stream.

In future articles, we will discuss other factors that impact a company's earnings multiple, such as strength and depth of the management team, the company's operating systems, reliability of the financial reporting system, opportunities for growth, the make-up of the customer base, intangible assets, strength of cash flow, scaleability, the amount of capital investment required to sustain or grow a business and preparedness for the due diligence process.

If you have any questions or would like to discuss your particular company and how you can improve your valuation multiple, contact us, we would be happy to share our knowledge with you.

http://www.corpinvest.com

Five Key Issues to Address in a Business Sale Transaction

These five issues are key to consider when you are contemplating selling your business.

1. Non-Disclosure Agreement

This agreement contains a few key elements that may easily be overlooked by an uninformed Seller. The first of these is the “non-solicitation” of employees, which should be coupled with a time frame of a minimum of two years, we suggest three years. A second important provision will state that “all obligations under this agreement shall survive for a period of ___ years (we suggest three), except that sections _ , _, _, and _ shall continue at all times. One of these specifically enumerated provisions states that the entire discussion must remain confidential. When a business owner goes to market, if they do not sell, they surely want that fact to remain confidential, even after two years, so this provision is extremely important. Buyers sometimes strike this provision, and a Seller must understand its importance.

2. Excluding Certain Types of Buyers from the Marketing Process

The goal of the business owner is to receive maximum value in the sale of their business. Strategic buyers typically pay a premium of 10% – 20% ( or more ) than pure financial buyers. A Seller should let their M&A professional contact the universe of qualified acquirers, including strategics, to insure that they receive the maximum value. If strategics are not included in the marketing effort, the Seller will never know if they received the highest price that was possible.

3. Letter of Intent – Timeline

One of the pitfalls that a Seller may experience when dealing with only one buyer, is the buyer’s total control of the timeline of the transaction. “Time is the enemy of a transaction.” That is not to say that the parties should rush to closing, but stretching out the timeline of due diligence and closing typically benefits the buyer, not the seller. The letter of intent should include a timeline of critical dates for important milestones, such as confirmation from the bank that a loan is approved, date for buyer to deliver initial contract draft, and closing date. The letter should contain language that the binding provisions of the LOI are contingent upon the buyer’s adherence to the timeline.

4. Letter of Intent – No Shop Provisions

Most Buyers insist upon a “No-shop” provision in the letter of intent. The Buyer is committing time, energy, paying CPA’s and attorneys, and as a reasonable request, typically asks the Seller for exclusivity (as long as the timeline is met !). However, many Buyers will include an additional sentence in the no-shop provision that the Seller must inform the Buyer if they are contacted by another party during the due diligence period, including the name of the potential buyer. We do not recommend our clients accept this specific provision.

5. Contacting Employees Early in the Due Diligence Process

Many Buyers will ask to speak to key employees early in the process – this should not happen. Discussions with key employees should only occur after financial due diligence is complete, a draft of the contract is received, evidence that financing is in place is received, and we are at the 11th hour. The Seller should always attend these meetings, which can be an issue for the Buyer. This is an extremely sensitive issue and must be handled carefully.

Considering selling your business? Corporate Investment can advise you in how to start the process.

http://www.corpinvest.com

Ten Ways to Maximize the Value of Your Business

Achieving the maximum value for the business when it sells is the goal of every business owner. These ten ideas can help you see if you are on the right track.

1. Develop a strong, stable management team

A business with a strong management team, allowing for key activities to operate independent of the owner, will command a higher price. The depth and stability of the management team are extremely important factors in the valuation analysis by a buyer. In many businesses, sales and marketing may be very dependent upon the owner, and this can be a significant value detractor. If most of the key account relationships reside with the owner, buyers will factor this risk into the valuation or the deal structure. Part of the price may become contingent upon the owner remaining with the business to maintain continuing customer relationships.

2. Demonstrate sustainability of earnings

Revenue and earnings that have been steadily growing over several years, versus earnings that fluctuate dramatically, will drive a higher valuation. Year over year growth demonstrates a solid operation that is gaining new customers and/or market share. Dramatic fluctuations in revenue typically indicate that either product demand may be subject to outside factors, or the business has experienced problems, indicating management is not stable. Recession proof businesses have been commanding very strong multiples in the market over the past three years.

3. Develop systems and procedures

A business must exist separate and apart from the daily actions of its owner to have a valuation, including goodwill, over and above the asset valuation. An owner who takes a week off at least one or two times per year, is exhibiting confidence in the systems and procedures of the business to function while they are away. If the owner is seldom or never away from the business for any length of time, buyers will question the strength of the operating systems, and the management team. The amount of goodwill that a buyer is willing to include in the purchase price will be dependent upon systems and procedures.

4. Maintain excellent financial records

Sloppy financials are a worry for both buyers and lenders. Valuation will be based primarily upon the numbers, and the more reliable the financial statements, the more chance they will hold up in due diligence. If your business has revenue in excess of $10,000,000, audited financials will be worth the investment. In the absence of audited financials, reviewed financials are preferable over internal financials, as the presentation, account classifications, footnotes, and organization of the statements, in general, will be much more professional than internally prepared financials. Most purchase agreements will contain a representation that  “Seller’s financials are presented in accordance with GAAP”. We routinely ask for this representation to be reviewed very carefully, as the majority of private company financial statements do not contain all the disclosures required by GAAP.

5. Minimize personal expenses paid by the business

When the financials are “clean,” with very few “add backs” related to owner’s personal expenses paid through the business, buyers and lenders believe the numbers are more credible. Asking a buyer to believe that various expenses that have been paid by the company are in fact “not necessary” for the business creates uncertainty. Uncertainty is the enemy of a successful sale transaction. When the EBITDA computation is partially based on excessive “add backs” to earnings, the seller will be hard pressed to obtain a favorable valuation.

6. Transition Planning

When a seller has a definite plan to “phase out” of the operation, whether that is over one year, or three to five years, the buyer recognizes that sound planning has occurred. The process of developing this transition plan will often generate excellent suggestions for improvement in management’s role in the everyday operations of the business. Many sellers begin to outline their “job description” as part of this process, which highlights areas where there is a need to delegate more to the management team. Quite often this activity will result in improvements to the organization structure of the business and produce tangible benefits.

7. Diversified Customer Base

Customer concentration is a significant value detractor. When the revenue from any one customer accounts for over 20-25% of the total revenue of the business, the business will be valued at a discount.  Losing 20-25% of revenue in most businesses will typically wipe out most or all of the profit of the operation, so this risk may not be ignored.  When the buyer’s valuation is prepared, and this risk is factored into the valuation analysis, the goodwill included in the valuation of the business will be dramatically altered. Working to diversify the customer base will result in significant increases in the value of the business.

8. Solid Reputation in the Marketplace

Business acquirers are constantly searching for the leading business in the industry, and many sellers refer to their business as an “industry leader”. Savvy buyers can mine the internet for information about what customers actually think about most businesses. Multiple websites exist that give “feedback” from customers about businesses, and buyers may gather this data easily.  Buyers will attend trade shows, industry conferences, and multiple other events, quietly asking competitors and suppliers about a company, using multiple techniques to determine what customers think about a business.

9. Diversified Base of Suppliers

A very narrow base of suppliers, or extreme dependence upon one supplier, may cause a decrease in valuation. Many business owners routinely buy from multiple sources, just to manage the risk that one supplier may experience shortages or interruptions in supply. This extends to the labor pool as well, if the business needs specialized skills, such as in healthcare. “What happens if…” is a typical question a buyer may ask – and many sellers do not have a ready answer for that question.

10. Stable Facility of Operations

A business may or may not be dependent upon its location, but a buyer will not want to take the risk of moving the business right after the purchase. The business should have the right to remain in their current facility for at least 3 – 5 years through an existing lease, or ownership of the building.  The location may be critical to a retail operation or restaurant, but also important to a wholesale or manufacturing operation. Many times key employees live close by, and the buyer having to relocate the business may place loyal employees in peril. If the lease is about to expire, and the buyer will have to renegotiate the lease right after closing, this situation creates uncertainty, which reduces the valuation. Lease options are an excellent method to remove this uncertainty, whereby the business has the right, but not the obligation to extend their lease beyond the current term.

For more information on maximizing the value of your business, contact Corporate Investment.

http://www.corpinvest.com