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Why Lower Middle-Market Companies are Attractive to Buyers

The lower middle market encompasses some of the most diverse selection of companies available to buyers, from “Mom & Pop” service shops to highly innovative technology firms paving the way for disruptive change at the highest levels. For this reason, lower middle-market companies have been the backbone of the U.S. economy from the very beginning—and remain so to this day. The value that these companies bring does not go unnoticed by the broader market, making this segment a high-activity space for engaged buyers and sellers. And motivated buyers are adept at spotting value, providing opportunities for well-informed sellers to maximize value on their exit.

Many companies at this end of the market operate in highly fragmented industries. From HVAC equipment providers and servicers to pool maintenance and other small businesses, you can see this fragmentation simply by driving around any local geography. When an industry is highly fragmented—and also highly profitable—it creates a “sweet spot” for both strategic and financial buyers. Private equity strategies, for example, will often follow a formula of buying a larger “platform company” then searching the lower middle market for smaller “bolt-on” acquisitions to grow the company from there. The strategy is often referred to as a “roll-up.” If done correctly, it can bring large returns for both the acquired company and the buyer. Strategic buyers (firms already operating in the same industry as the acquisition target) often regard M&A in this end of the market as a better way to grow market share versus slow and costly organic expansion.

 

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Business owners and managers in the lower middle market are often looking to exit for retirement purposes. This reality can be advantageous for both buyers and sellers. Oftentimes, there is no succession plan in place heading into the retirement/exit decision and process. Many small businesses do not have a large chain of top executives that make a transition easy, and handing the business over to their children is often not a realistic option either. In other circumstances, the notion of selling the business comes up suddenly as a response to situations like health problems or other personal “black swan” events. In all circumstances, the right buyer—be they financial (private equity) or strategic—presents lucrative solutions that provide for the off-ramp and transition that ownership is seeking.

As such, there has been a large increase in demand for companies at this end of the market, as well as a corresponding awakening of ownership to recognize and test the benefits of a sale process. Investors are sitting on an ever-growing pool of capital that they are looking to deploy, seeking returns they cannot get elsewhere. The lower middle market allows investors of all stripes to purchase assets with relatively low debt (and, therefore, risk) compared to much larger companies. Additionally, the COVID-19 pandemic impact cannot be ignored when selling your business. COVID has hurt and even crippled a lot of businesses at the smaller end of the market. It also put an elongated pause in the mergers and acquisitions process. These two factors have led to pumped-up demand and lower supply, driving to significant increases in activity and deal volumes as the economy begins to pick up again.

When the time comes, business owners need to be ready to act quickly on sale opportunities. There are a lot of factors that go into selling your business. There will be different types of individuals and entities that come through to inquire about the potential acquisition of your company. While it might be tempting to jump at the first offer that comes, it is better to get a sound understanding of the wider market, and where the highest synergies/motivations (and therefore, the best valuations) can be found. There are always more opportunities to transact than one might think, and there are potential buyers out there for any type of company. The process of finding the right buyer always takes some “travel time”—with some speed bumps along the way—but a sound process that is run correctly can bring windfalls that will certainly justify the effort.

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Should I Sell to an SBIC: Making Sense of an Often-Misunderstood Buyer Type

Many business owners are already aware of the myriad loan programs offered by the Small Business Administration (SBA). The lower market is saturated with buyers who frequently and successfully turn to the SBA for financing a transaction. For all its benefits, however, the SBA’s maximum check size can prove restrictive in how much a company can sell for. Additionally, the SBA requires that sellers exit their business within one-year post-close, which can shut out sellers who want to be part of the company for a longer period and watch it grow.

To bridge the gap between buyers and the broader market of sellers, the SBA created a robust, multi-billion dollar lending program designed to motivate the acquisition of lower-middle market companies. To meet their objective, the SBA began licensing a new class of buyers: the Small Business Investment Company (SBIC).

SBICs are committed-capital funds that start by raising money from limited partners before deploying it via a series of investments in lower-middle market companies with less than $6 million in net income and at least 51% of their employees in the United States. These investments can come in the form of either debt financing or straight equity purchases, with the latter being commonly used to help SBICs build a portfolio of companies that they own and help operate on a day-to-day basis.

 

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The traditional SBA loan instrument is famous for providing buyers with up to $4.5 million in debt financing on the condition that buyers lose access to other important transaction instruments, such as seller notes, earnouts, and equity rollovers. Commercially speaking, these instruments typically play a major role in facilitating transactions by providing a more equitable outcome for all parties involved. Losing access to these instruments can, at times, interfere with deal completion. Unlike SBA loan-based buyers, SBICs have access to debt up to $175 million for the purposes of acquiring companies and have comparatively few limitations on other tools that help get a deal done. As a result, SBICs experience superior flexibility in pushing a deal over the final ten-yard line. Sellers are likely to be better compensated for their companies and on more mutually acceptable terms. The low cost of debt associated with SBICs translates to more cash on their balance sheet post-close—leaving more cash available for growth, fostering a stronger buyer-seller relationship, and helping to secure the seller’s legacy.

The success of SBICs goes beyond financial capacity, however. To become a licensed SBIC, its founders must undergo SBA scrutiny that will question their experience, background, industry knowledge, and fortitude to run an investment firm—which is a much higher barrier to entry than is faced by many buyers. Furthermore, the incentive to help their acquisitions succeed is heightened for an SBIC because, if they make poor choices, they will not only have to deal with angry shareholders but also will face ramifications from the SBA. As a result, starting an SBIC can be as difficult as opening a federally chartered bank. A final, critical requirement for becoming a licensed SBIC is that the founders must have significant experience either investing in or running small business investments; meaning, as buyers, an SBIC manager is more likely to relate to the daily highs and lows associated with running a company and can provide valuable insight based on lived experience.

When it comes to selling your business, choosing the right buyer is crucial. If you’re looking for someone to take your company to the next level, to help it grow, to set you up for a better exit, then the capabilities of an SBIC are hard to match.

According to the SBA, top brands such as Under Armour, Chipotle, Staples, and Apple benefited in their youth from SBIC funding. If your small business meets the eligibility requirements for an SBIC investment, this buyer class could substantially improve your company’s growth and help build a strong, recognizable brand.

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The “New Normal” for the Restaurant Industry

Restaurants all over the world express their own environments and tastes that help people identify the culture. People travel all to all ends of the earth to savor a certain style of food or experience a certain society or tradition. Restaurants are places that we go to enjoy everything from a quick lunch to a celebration of any sort. We engage restaurants as a platform for many activities, especially in the United States. The COVID-19 pandemic inflicted issues on all social gatherings, and the world had to change the way we do many normal, day-to-day activities, impacting the restaurant industry significantly. My focus today is to enlighten you on some aspects that may help your business adapt, and make your restaurant a more attractive target to be acquired.

The restaurant industry is a monstrosity. It has various moving parts and year-over-year new aspects and competition. From ingredients to efficiency to ambiance, the restaurant sector has always been competitive and continually pushing forward with the times. 2020 brought all of that to a screeching halt. Though demand for certain items such as beans, rice, and bread was higher than ever, and grocery stores were being raided, restaurants were forced into full panic mode. There was no way to prepare, and no one knew what to do. Unlike several other diseases in the past, COVID-19 thankfully does not spread directly through livestock and agricultural products. Though that is not where the issue lies. Getting the products delivered to the location and having employees inside without spreading the disease was nearly impossible. The restaurants still surviving have obviously adapted to the times by focusing on enhanced delivery options and marketing schemes that helped them to stay afloat. With the world beginning to open back up, what is going to be the best tactic to getting the financials back to pre-COVID numbers?

More than 110,000 establishments have closed permanently over the past year, with others filing for bankruptcy. Everyone has changed their dining habits over the past year, particularly shifting to takeout and delivery. Moving forward, the industry is going to need to maintain a focus on responsiveness, and prioritization of health and safety. No one wants a cold pizza or cold veal parmesan in a plastic container. Presentation has come further into play. Restaurants need to get a foot ahead of the competition in any way possible. More restaurant concepts will have a drive-thru or pickup window in construction designs. Marketing schemes have been redirected to be community-based on a larger sense. For example, homeowner associations, next-door-neighbor sites, and city blog pages are going to need to be targeted. Along with that, customer loyalty programs, organic menu options, social media options, and mobile paying all may be beneficial. With the vaccines being distributed more widely, people are tired of being cooped up for over a year and are starting to travel and go to the newest, trendiest, most happening areas. How do you make your business compete and intrigue the crowd? There has to be a niche to your business—one that makes it stands apart from the chains and competition. There are restaurants on every corner, so you must create a particular dish or unique ambiance that people will remember. It is a difficult median that must be found where you are focusing on your health, yet also creating a memorable experience. Technology has also made its presence known, as nearly all communication over the past year has been through phone, text, video chat, or online ordering.

 

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When it comes to mergers and acquisitions, what can you do to make your restaurant more sellable? There are a lot of factors that come into play, but a large portion has to do with profit & loss statements, balance sheets, and showing consistency. Of course, 2020 will not be taken out of consideration, but at the same time, buyers cannot consider last year to have been normal. Some buyers will try to take this into consideration as they want the better deal, and this may work out in certain situations, but overall growth or consistency makes your company enticing. Outside of financials, strategic buyers seem to focus on how it lines up with the current business they are operating. Room for development is a trait that I’ve learned many potential buyers seek. With wanting to bring your business into a current facility, or operating under the same name, buyers want to be able to see the room for growth. Along with that, the capability to adapt is a key aspect because any time new management is put in place, there may be at least a few altercations. Looking forward, what is going to be the challenge is getting your financials back to where they were pre-COVID. This is easier said than done, but a few good places to start are re-accumulating an employee base, providing a safe environment, following all government regulations, and providing the same pre-COVID quality of service and food.

With mergers and acquisitions, if you were one of the larger firms such as OPES Acquisition Corp. or Inspire Brands, this would be an opportunity to make significant acquisitions. When smaller brands struggle, they can swoop in and save the day by acquiring them. The stage has been set in a sense for the next several years with different outlooks. Well-performing chains with drive thrus and delivery options yield high multiples, while frustrated owners are selling struggling chains. Activity will be fueled by cheap debt thanks to low interest rates, private equity groups, other investors that remain ready to spend, and strategic investors eager to get bigger. There is a lot of money that private equity firms have held onto for 2021, along with SPACs making their presence known. Getting your restaurant’s financials back up to normal and showing that your business has withheld and adapted with the times will make it more attractive.

Along with the direct work in the restaurant industry, the delivery options such as Grubhub, DoorDash, Postmates and Uber Eats have exploded, and their presence has been known in the mergers and acquisitions industry. DoorDash is the industry leader with 50% market share, Uber acquired Postmates, with GrubHub in a close second. Before COVID, many companies said they intentionally avoided these apps because the cost to the business seemed too high. Once COVID hit, these apps were essential to keeping many businesses open. There was a survey taken with 2,500 consumers in July that stated that 52% of them would avoid restaurants and bars even after they open back up. Showing your capability to work with these companies as efficiently and effectively as possible will be a contributing factor to the success in your business for the next several years.

The restaurant industry will overcome this pandemic and to adjust to what the new normal will look like. With the vaccines being distributed, the light at the end of the tunnel seems visible. Although it will not be an overnight process, the economy will recover and there will be new adaptations to get used to. Restaurants are opening back up and doing all they can, and the competition is eager to do the most they can with the government regulations. It may be far from over with limited capacities and dine-in options still somewhat limited, but local companies are doing everything they can to accrue the income to keep the doors open. Local restaurants need this, and there is a difficult balance that needs to be found. The hope is there, and the future is bright for both buy-side but sell-side M&A in the restaurant industry.

SOURCES

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The Importance of Timing When Bringing a Company to Market

Any company sale process features numerous factors outside of the seller's control. These include the overall state of the economy, finance market behavior, and advancements within specific industries. Most sellers do not fully appreciate that taking the time to thoughtfully prepare a company for its own sale is one of the biggest opportunities to exert control in the process. This opportunity should not be missed.

In business, thinking long-term is crucial – if the overall goal revolves around an exit, business owners need to take advantage of their ability to shape and polish their companies in a way that will ultimately increase their chances of a successful exit. Preparation is key and when a sale is being contemplated, timing is essential. The earlier sellers start preparing, the higher their chances of finding the right buyer and successfully exiting. Ultimately, owners that plan and take enough time to address small issues/details make their businesses more attractive to both financial and strategic acquirers.

 

Ready to explore your exit and growth options?

 

Typically, it is not feasible to make radical changes to the nature of a business, product line, or management structure just before a sale, so conducting an internal review is generally the most time- and cost-effective approach – and one that gives sellers the best chance to maximize value. Below is a summary of key items for review prior to your sale process.

 

  • Financials – Getting your company's financials in good shape is essential and will ultimately facilitate getting a deal through each stage of the process smoothly. Choosing adequate accounting principles and standardizing monthly, quarterly, and annual statements (P&L, Cash Flow, and Balance Sheet) typically ensures businesses are valued fairly. Being able to show strong performance credibly – and present long-term sustainability – is essential. 
  • Litigation – If possible, sellers should settle all litigation before coming to market. Litigation is simply part of doing business, and buyers understand that. However, any more serious or particularly risky legal disputes will present an element of perceived risk and should be dispatched prior to the sale process.
  • Online Presence – Investing in sharpening the company's website and overall online presence is often a worthwhile use of time and resources when contemplating a sale. Consider developing and regularly updating the company's website. Be sure to announce company "wins," partnerships, contracts, and milestones on social media platforms. Prospective buyers will most likely access every available platform when engaging in purchasing activities; the more quality information they find, the better.
  • Management – In most cases, the Owner/CEO's leadership, relationships, and practices were key contributors to the business's overall success. When looking for the best deal, sellers must convince buyers that the stream of sales/earnings will remain unchanged (or, even better, grow) after they are no longer behind the wheel. This can be done by elaborating a succession plan (hiring/grooming a number two to take the Owner's position) and delegating critical tasks/functions of the business to members of the team that will remain with the company post-acquisition. 

Although the preparation period requires time and resources, by putting the effort in early, sellers can best leverage their companies’ overall position when entering the market. The chance of a successful transaction increases proportionately as time and effort are invested into preparation. When the business is fully prepared for a sale, all parties win, and the process usually runs most smoothly.

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Owning a Lifestyle Business

A lifestyle business is a business that sustains or supports the income and personal needs of the owner. The business is profit-oriented, but the owner's goal is not to grow the company but maximize profits. The goal of a lifestyle business is for the owner to enjoy a work/life balance while generating enough profit to support the owner's current lifestyle without negatively affecting the owner's personal life.

Often, lifestyle businesses are small businesses and center around the owner's passion. Some examples of lifestyle businesses include e-commerce clothing boutiques, breweries, and art galleries.

Lifestyle businesses are different than being self-employed. Typically, when you are self-employed, you work defied hours. Like any business, a lifestyle business has additional time requirements. You open it up daily and work long hours and weekends, but it intertwines with your personal life. The business may be online or have a physical presence. It may or may not sell goods, or it may provide services to others.

 

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Why would someone want to own a lifestyle business? The owner does not have to sacrifice their personal life. You are not required to work certain hours, answer to superiors, or deliver specific amounts of work on strict deadlines. There are no obligations to investors because the owner provides the funding for the business, so they also receive all the profits. You have freedom of time and location, so you can come and go as you please. The owner controls all aspects of the business. There is no board or third party to report to on the state of the business. The business provides financial freedom because the owner is earning an income that supports their chosen lifestyle. Typically, since there are few employees or other overheads, the lifestyle business tends to be positive cash flow early on.

Like all businesses, there will be challenges. The owner may struggle to fund the business at times or have limited funding. Finding the right employees could be challenging because a lifestyle business tends to have fewer employee benefits than other employers within the market.

When considering starting or buying a lifestyle business you should take the following steps:

  • Define your goals: Make a list of what you hope to achieve with a lifestyle business. What do you want to accomplish with the business? What are your personal goals? Consider the amount of freedom you are seeking. Set an income target for your personal needs.
  • Identify a passion or interest: Businesses can fail because the owner losses interest. A lifestyle has a higher chance of succeeding because the owner is passionate about the business or purpose. People tend to excel at their passion because they tend to spend more time on the topic because they enjoy it.
  • Find a problem that needs to be solved: The business is likely to have more customers for your business if you offer them an option to solve a problem. People should be willing to pay for the problem’s solution.
  • Decide on the business: After assessing the items above, you should have a good idea of what type of business to buy or start. Put together a business plan to help execute the strategy.
  • Execute on the plan: Now is the time to execute your business plan. If you are going to purchase a lifestyle business and need help, there are many resources available to help with the purchase process. If you are going to start the business, begin by establishing the business. You may need to purchase inventory and begin to target clients.

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Tips for Making Sellers Comfortable with You as a Potential Buyer

The acquisition process can understandably be a very daunting task for sellers, let alone an uncomfortable experience that pulls back the curtains on their business and its most intimate information. Many sellers realize this is not their area of expertise and will make the informed decision to contract with a sell-side M&A advisory firm before officially entering the marketplace. The M&A advisory represents the seller, but can function as your ally as a buyer if you let them because they have incentive to get a deal done. Although M&A advisors can guide a seller through the sales process and educate them on market norms, they’re not capable of self-fabricating the comfort level between buyer and seller. Over time, a seller’s relationship with a potential buyer will prove to be most advantageous in getting to the finish line of a transaction, as there will be numerous items both sides will have to work through together. Unfortunately, agreements can fall apart due to a lack of mutual comfort between the buyer and seller, and this is typically a result of a combination of multiple factors set in motion long before official due diligence even began. The following are steps you should consider when working side by side with a seller during the transaction life cycle.

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Mid-Management: Dreams of Owning a Business

Have you always dreamt of owning your own business? What about having your boss’ job? If you are in management and in a privately owned company, it might be possible for you to be the boss and the owner one day. However, many mid-level managers do not know how to accomplish their dream of owning a company that currently employs them. The good news is that your dream can become a reality.

One of the challenges of transitioning from an employee to a business owner is thinking like a business owner. As an employee, your manager/owner provides guidance, and often you may not question the guidance. As a business owner, you make all the decisions, set goals, and create a plan that will drive the future of the company. Then, you will be the one that has to drive and financially fund the vision. Yes, you will develop mentors around you, but as a business owner, you are the one that benefits and suffers from the positive and negative outcomes of your decisions.  

While you may work long hours currently, be prepared for a more immense workload and additional hours. Employees have a work schedule, and business owners that operate the company do not have work schedules. You are on call 24/7, and it is hard to get away from the business as you always carry that burden with you. Vacations are interrupted and weekends are often spent at the business. However, if you are in a place in your life where you can dedicate the required time, mentally and physically, to the business, the long term pay-off, whether it be financial or time freedom, can be significant.

Interview your owner and shadow him/her if possible. Ask the company owner for insight into their day. Understand the stresses that the business owner deals with daily. Some of the stresses will be confidential, such as employee issues or financial issues, so anticipate that your receiving limited insight.

 

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Then commit to making your dream a reality. Ask the business owner their exit strategy. Some owners may be open to a slow exit where you can purchase the company over a few years, or they may want a clean exit where you have the option to purchase the company immediately and the current owner walks away after a short handover period. Having an introductory conversation about your interest in purchasing the company is going to be important. Once you understand the business owner's personal goals regarding their exit, it will allow you to structure a deal to achieve both parties' goals.

It is important to prepare your financing so you know how much you can afford. This knowledge is key to structuring an offer. The business owner will need to share the information around the business' performance for a bank to underwrite an acquisition. The company's current banker might be a good starting point. After your conversation with the business owner, ask if they would be open to making an introduction to the company’s banker. The banker understands the business and risk as they have underwritten the business previously. Their goal would be to underwrite the business to incorporate the new ownership. 

Be patient and ask for help when needed. Purchasing any business can be an emotional process. If you have never been through the process previously, you may need to seek help from your advisers or hire an experienced buyer side M&A advisor. There are many resources available to you to help with the purchase.

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Why the Best Buyer May Not Be the Highest Bidder

Taking your business to market is a very challenging yet rewarding process. Receiving feedback from potential buyers enables you to learn both what specifically attracts buyers to your company and what your business is generally worth. Throughout the process, a valuable lesson learned will be the importance of weighing all potential offers, rather than strictly accepting the highest offer.

Consider the likelihood that the buyer can finance the proposed offer

Having multiple Letters of Intent (LOIs) to compare against each other is a great problem for a seller to have. Each offer is unique and presents different solutions to finance the proposed transaction. However, an LOI is not binding and simply moves you into an exclusive relationship with a buyer for a set period (typically 60-90 days). Deciding to enter an exclusive relationship with this one buyer can affect your perceived value with other serious buyers, should you have to reopen dialogue if the agreed upon LOI does not ultimately close the deal.

A major component in valuing an LOI is the legitimacy of the offer. One buyer may come in and submit an offer that is a percentage higher than that of other buyers. If you agree, spend time working with the buyer, and ultimately learn that the buyer does not have the funds necessary to pay the intended price, you have lost valuable time on market and there is no guarantee the landscape will be the same upon return to market. For example, other buyers that extended an LOI may have moved on, eliminating them as a potential buyer for your company. Effectively, each seller must determine the authenticity of an offer in respect to the time it will need, the resources that must be committed, and the effect it will have on relationships with other buyers.

Deal structures can be valued in many ways

A second characteristic to consider is the structure of the deal. Four broad levers that buyers have in structuring an offer are cash, equity, debt and earnouts. The percentage makeup of each component is a huge aspect of the offer. For example, a seller who values cash upfront may value a $10 million all-cash offer more than a $12 million offer that is split between 50% cash and 50% earnouts based off estimated financial performance post transaction. An earnout structure would be less appealing to that seller due to the uncertainty of achieving the targeted earnout performance and/or the potential for litigation in the period between transaction-close and the earnout’s expiration.

 

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Compatibility with your potential partner

Unless you fully exit your company and receive a full-cash offer, another topic to consider is determining how well the buyer aligns with you and your company. While not always the case, some buyers may state that proposed deals are contingent upon the owner remaining on full time after the sale because they value the owner’s role for a successful transition of ownership. For any deal in which this is the case, you would also need to reflect on whether you are willing to transition from being the manager to being managed.

A buyer’s compatibility with your company also matters when your payout is contingent upon earnouts or a retained equity position. As mentioned in the previous section, funding for the sale can include earnouts. An earnout is a post-closing purchase price payment that is contingent upon the acquired company meeting negotiated performance goals post closing. If your company’s performance post acquisition does not pan out as expected, the earnout expectations may not be met and you would not receive the compensation which was expected at the close of the deal.

Alternatively, if the seller retains an equity position in the company post sale, then there may be a benefit to accepting an offer from a buyer that is not the highest bidder: if that buyer brings a strategic relationship that grows the value of the retained equity position. Oftentimes this strategic relationship manifests itself in operating synergies allowing for expense reductions, new revenue growth opportunities, or additional management expertise.

Financing strength, deal structure, and compatibility are three of many attributes in addition to the final price that must be considered when selling your company. Ultimately, in a process that is so complex and intense, choosing which offer to accept is not quite as simple as accepting the highest offer.

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Leading Positive Change After an Acquisition

Though every business will go through changes as it evolves, being acquired by a business is perhaps the one that can be the most stressful for its employees. There can be much uncertainty for a company that is acquired. If not handled properly, the buyer can lose some of their people (along with their customer relationships, institutional knowledge, etc.) that made the company successful. Managing the change positively during this tumultuous time can reduce a mass exodus after a sale is completed.

Key employees may be worried about whether their jobs will be intact after an acquisition. Perhaps they feel their role won't be needed, or the buyer will want to use their people to perform their functions. At the same time, the buyer may be worried that these key employees will leave. Leaders and other influencers within organizations set the tone for a company's culture, innovation, and strategic initiatives. Losing them reduces the value of the company they are acquiring.

One key to reducing uncertainty for the acquired company’s employees is first to create readiness for change. People will resist change unless they are ready for it. On the other hand, when they are open to change, employees are more likely to accept everything that comes with it. These employees will be an essential part of the transitional period after the acquisition. Getting their buy-in will pave the way for creating a stronger company in the future.

 

Ready to explore your exit and growth options?

 

In their book Developing Management Skills, Whetten and Cameron suggest four ways to create readiness when leading positive change:

Benchmark best practice and compare current performance to the highest performance

Within the context of an acquisition, it's possible (likely even) that each of the involved organizations can perform certain functions better than the other. This may be one of the catalysts behind the acquisition. In that respect, synergies can be experienced when buyers and sellers learn each other’s best practices and implement improvements. Improvements can mean doing things better, faster and/or cheaper.

Institute symbolic events to signal the positive change

Symbolism can have a significant impact. The authors indicate that to be "successful in leading positive change, you must signal the end of the old way of doing things and the beginning of a new way of doing things." This can be accomplished in a variety of ways and can be elaborate or more reserved.

Create a new language that illustrates the positive change

Changing the way people talk about the change that is occurring is vital. If negativity abounds, positivity must replace that language. Taking the time to reframe things with a positive outlook can impact how employees view change.

Overcome resistance

People are typically against change because of the unknown. Finding common ground and having people participate in the change helps. Converting resistors is especially important because they have a way of influencing the rest of the team. Proactively identify the employees most likely to undermine the change and help them get on board first. They will, in turn, help persuade other employees.

Helping people understand the importance/urgency of the change that is happening through the acquisition will increase the likelihood they will stay and help ensure a smoother transition of ownership. The key is conveying that the company's employees are an essential part of the company's success going forward and preparing them for the change they will experience.

 Benchmark International Buyer Profiles

Want to be the first to know when new opportunities come to market that fit your acquisition criteria? Create a buyer profile today. While you're there, be sure to check out all the resources we've created specifically for buyers, including opportunities, on-demand webinars, buyer events, and our latest edition of The Mark magazine.

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Buyer Comfort

Buyers tend to assuage their discomfort with deal structure.  When negotiating with buyers, it is prudent for the seller, guided by a seasoned M&A Advisor, to consider what the underlying issue is, discomfort, instead of addressing the result of that discomfort, a specific deal structure. Huh, you say? Let me dive a bit deeper.

Buyers of businesses use deal structural devices to cure many issues or concerns. Let's take a second to illustrate the most typical elements of a structured deal. While the following encompasses the most common deal structures, it is, by no means comprehensive.

Cash at the closing table is obvious and needs no further illustration. A seller note or seller financing is also fairly simple. The seller essentially serves as a lender to the buyer. The attorneys draft a promissory note, perhaps a stock pledge agreement and incorporate them and potentially other documents in the definitive agreements. The buyer pays off the principal of the note and interest over the course of a few years.  Seller notes don't tend to be contingent upon anything other than the solvency of the entity backing the note. They are deferred. Rollover equity, often known as Seller Rollover, Rollover or simply Roll, occurs when the seller maintains a position in either the existing business or Newco. In some circumstances, a seller may sell 80% of the shares in his or her company while in another, that seller may sell 100% of the shares in her business and simultaneously reinvest what amounts to 20% of the proceeds in Newco. This is generally a cashless exercise. It is critical for the seller to engage seasoned advisors to assist in structuring the rollover in the most tax-efficient manner. The final typical structural element of a deal is an Earnout. Where the seller note isn't contingent upon performance, an earnout is. Earnouts pay out a prescribed dollar amount over time as certain agreed upon and defined metrics are achieved. While these tend to be quantitative metrics like EBITDA and Revenue, they can also be tied to qualitative measures like maintaining key customers or employees or integrating technology. In addition, earnouts can be tied to maintenance or growth.   

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As I hinted at earlier, buyers use these structures to cure their apprehension. What is behind that discomfort or apprehension? Many things but at the heart of most of those is the oft-cited, yet misunderstood concept, risk. Risk, in a business context, is the chance for an unanticipated outcome. Risk can be specific to a business, to an industry, to geography or more global. Risk isn't inherently bad, thus the risk/reward model, but it needs to be accounted for in decision making. Buyers, in their initial diligence, aim to understand the underlying risks and determine their tolerance for said risks. When structuring an offer, they seek to allocate and incorporate those risks.   

Some buyers seek out businesses that are very easy for them to understand, have very predictable financial performance and robust operational teams.  Those types of businesses, if proper controls are also present, will garner simple offers with a high percentage of the deal in the form of cash. This is a low-risk deal. A business with more volatile performance introduces incremental risk. A buyer may still be interested in the business but may shift cash at close to an earnout. If the business is growing rapidly, but that growth hasn't been consolidated in the buyer's eyes, that earnout may be linked to the growth of earnings or revenue. Perhaps the buyer will apply a three-year average to EBITDA to incorporate the volatility into the valuation.  If the seller wants to be paid on the recent growth, a buyer may use an earnout to bridge the valuation gap. A buyer willing to pay 5x EBITDA in an all-cash deal may pay 8x or more if allowed to incorporate structure, thereby mitigating their risk.

If the seller is adamant that he or she won't accept an earnout, it behooves an M&A advisor to dig deeper into where the actual buyer's discomfort lies.  Rather than fighting the earnout, might it be a better strategy to uncover the underlying issue and solving that? The earnout is the solution, not the problem. Why might a buyer incorporate an earnout? There are several possible reasons; 1. Earns reduce the cash required to close the deal.  2. They create alignment between buyer and seller post-close, thereby ensuring the seller continues to act like an owner even when he longer is an owner. 3. They confirm their diligence. Can these concerns be addressed in other ways? Of course, they can. If the earnout is moved to a seller note, no additional cash at close is required of the buyer to fund the deal. Both two and three can be addressed through a seller roll. If the buyer wants to ensure the seller acts like an owner, make him an owner. Rollover allocates some of the risks to the seller in both an earnout and rollover equity. Perhaps an employment contract signed by key employees would provide the buyer some comfort? Many deals incorporate an options pool, Management Incentive Program (MIP) or Profits Interest as additional ways to create alignment post-close. 

The central idea is this. Rather than focusing all of your attention on the proposed structure of a deal, attempt to think through the concerns the buyer is trying to sooth with that deal structure. Solving for the actual underlying problem rather than the buyer's proposed solution may lead to better outcomes for both parties.

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What is included in the M&A due diligence?

The due diligence process is one of the final steps in an M&A transaction where the potential buyer does its obligation to best confirm and verify the seller's company data and relevant information. This information typically includes but not limited to: financials, IT, operations, legal & compliance, insurance, corporate bylaws, contracts, customers, among other important information. Typically, the due diligence process follows the execution of a letter of intent (LOI), a non-binding document outlining the intent of both parties to commit to the transaction.

Once the LOI has been executed, the buyer will request a list of items to be shared by the seller with the intention of disclosing the selling company’s key details that could uncover risk buyer. As mentioned before, items can range all the way from financials to operations to insurance to contracts, among others. In cases where the seller owns the real estate, additional documents pertaining to the real estate, such as: deeds, mortgages, tax documents, owners’ insurance, etc. will need to be provided. Given today’s advancements in technology, once the due diligence request list has been sent to the seller, the team leading the deal will proceed to open what we call in the M&A world a “virtual data room” or a “data room.” These two terms are referred to as online portals that hold and store the information requested by the buyer with high levels of security only available for certain parties, including: buyer, seller, M&A attorneys, CPAs, advisors, among others. The data room allows activity within the room to be tracked and archived so there is a file of the information exchange after closing should any issues arise.

Once the due diligence starts, it is highly recommended for the buyer to hold, at the very least, weekly meetings or calls with the seller to discuss outstanding items or any questions that may have arisen from the process. As the due diligence process progresses, the buyer will become more familiar with the seller’s company. For an instance, should the buyer find any items that may play against the seller in the due diligence process, the buyer may use this to lower the valuation of the business which may ultimately result in a lower offer price.

In addition, this process can result as a discovery of potential opportunity to better structure the deal, find real synergies among parties, review any benefits and challenges for potential system integrations, and any associated risks that may arise from the result of this potential acquisition. 

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Buyside Perspective

As stated on Benchmark International’s website, our perspective makes us different. We strive to help clients reach their maximum value for the sale of their business. To accomplish that goal, it’s important to also have good buyside perspective.

Buyers look at companies differently than sellers and some advisors. Certainly, a company’s financials are a common barometer for both sides to gage a company’s performance and success. And cultural fit is a must. Beyond those metrics; however, buyers prioritize characteristics to mitigate investment risk. These characteristics include, scalability, stability, resiliency, and the ability to grow.

Scalability is about a company’s ability to accommodate growth – to behave as a larger entity. Some acquisitions result in smaller companies becoming part of much larger organizations. The new structure sometimes brings new processes, systems, and reporting requirements. These changes in scale can introduce risk if personnel lack the bandwidth, appetite, skills, or resources to ramp up. Buyers seek assurance that the team is adaptable and capable of scaling.

Many investors also seek stability. The project-based business with wild swings in revenues or heavy seasonality, for example, presents significant challenges in performance, planning, and execution. For most investors, consistency is vital and this is often tied to a company’s revenue model. This is a key reason why buyers prefer recurring revenue models. For industrial services businesses, long-term or preventive maintenance contracts provide recurring revenue. Many equipment manufacturers have transitioned to providing a service rather than hardware. For example, some compressor manufacturers retain the physical asset and provide an “air as a service” guarantee for a monthly fee. And software companies achieve this by transitioning to a subscription, or software as a service (SaaS) model. Together with a “sticky” customer base – high switching costs or risk – these all provide a level of revenue stability that might otherwise be absent.

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