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Planning on Selling Your Business? Think Again…

Selling Your Business

Everyone’s heard about how Baby Boomer business owners will be retiring and the wave of business successions/exits that will occur as a result of those retirements. But there’s a problem that almost no one is discussing. Our research clearly shows that there aren’t enough buyers for all those businesses. Here’s why and what you can do about it.

The SBA reports that there are roughly 6,000,000 small employers in the U.S. Of those 6 million businesses, approximately 3,600,000 are owned by Baby Boomers and about 2,400,000 are owned by GenX’ers. Based on the US Census population statistics, this means about 4.5% of Boomers own a business and about 3.0% of GenX’ers own a business. Human nature being what it is, we expect the percentage of GenX’ers who want to own a business to also rise to 4.5% as they get older. None of that is especially surprising – until you think about it a bit more. And then it becomes alarming. It becomes alarming because that rise in GenX owners from 3.0% to 4.5% represents only 1/3 of the Boomer businesses that will be for sale.

The result is that 2/3 of all Boomer businesses won’t find an individual buyer!

But what about strategic acquisition and private equity money? There’s lots of money looking for a home, right?

There are always companies looking to acquire or merge with businesses that complement or expand their core business. After all, the acquisition is considered “strategic” because it expands their market share, affords economies of scale, or adds products and services that dovetail with or complete their current offerings. But only the most profitable, highest regarded, or fastest growing businesses will be strong candidates for a strategic acquisition at full market value. The reality is (and always has been) that most companies will not be good candidates for strategic acquisition.

When it comes to private equity, pretty much all private equity investors are looking for opportunities with high profit growth potential. And as we know, most businesses are more about steady growth and consistent profits. They just don’t pencil out for that big, private equity payday.

Historically, between M&A deals and Private Equity deals, only about 15-25% actually close. Even if we’re optimistic and assume 25% of the available businesses can attract private equity money or a strategic buyer, it leaves a full 50% of Boomer businesses without a buyer or acquirer! (75% of the 2/3 noted above)

If owners REALLY want to sell their company to an outsider, they should work with an experienced M&A Advisor, Investment Banker, or Business Broker. It will maximize their chances of getting sold. In addition, they should get preliminary Quality of Earnings and Quality of Leadership reports done. These reports will highlight any weaknesses that need to be addressed before going to market, thereby increasing their chances of attracting a buyer and closing a deal. 

So, where does that leave owners who can’t find a buyer or attract money?
Here are the five options open to them:

“FIRE SALE” ACQUISITION
Businesses whose profitability and growth are weak or who aren’t quite a perfect fit for an acquiring company may still be candidates for acquisition. The problem, however, is that they won’t be able to command their full market value. Because they’re not as attractive to a strategic buyer and because there will be so many businesses on the market, the only incentive to complete a deal will be to lower their asking price – sometime significantly.

FIND A SUCCESSOR
One of the better options for many businesses will be to recruit and develop a successor, and then sell the company to them at full price. Some banks may be willing to fund a portion of the buyout, but the majority of internal sales will be paid (in part or in full) out of future cash flow. Consequently, it is critical to find a successor as soon as possible and ensure they are well-prepared to be an effective leader and a successful owner. It generally requires one to two years of development to hone someone’s leadership capabilities, their strategic thinking, and their judgment. Without that development, you run the risk of the business not being able to make those buyout payments.

KEEP THE BUSINESS
A variation of selling to a successor is to bring on a successor to run the company but not sell the stock. This option allows the owner to draw out the business’ value from the company while still owning it, but without needing to run it on a day-to-day basis. It requires finding and developing a strong successor, and then rewarding him or her for good performance.

CREATE AN ESOP
In the absence of a strong successor, an option that will also yield full market value is to set up an Employee Stock Ownership Plan (ESOP). This approach can increase employee loyalty and productivity, ensure business continuity, and gain some tax advantages. An ESOP can be effective, but it requires one or two years of planning, along with the training and development of the people who will be directing the organization. But it can be expensive to establish an ESOP and is therefore not a practical option for most companies.

CLOSE THE BUSINESS
If a business can’t find an individual buyer, is not a candidate for acquisition, has no successor and isn’t able to structure an ESOP, the only course of action will be to close the business and sell off the assets. Obviously, this is the least desirable outcome. The owner will receive pennies on the dollar and the livelihood of all the employees and their families will come to an end.

We believe all too many businesses will be facing this stark reality if they don’t put plans in place at least two to three years in advance of retirement.

THE BOTTOM LINE
The bottom line is that if your businesses isn’t in high demand and you’d like to sell it for a reasonably strong price, the best course of action is generally going to be to recruit and develop a strong successor.

If you’d like help recruiting, assessing, and/or developing a successor for your business, please contact us. It’s what we specialize in. www.ElicitingExcellence.com

Contributed by Michael Beck

Growing by Acquisition or Merger

Mergers and Acquisitions

Acquisitions and mergers are not just for big companies. Emerging companies can grow faster and gain more control of their destiny by acquiring synergistic competitors and suppliers. Acquiring or merging with another company sounds complicated, but it can be easier than you think with the proper guidance and leadership.

Start with an objective to find one complementary company that will strengthen your position in your market. Then develop and execute a strategy to make it happen.

When you have one under your belt, look for others. Like anything else, the first one is the most difficult, but you will be glad you took that first step.

Benefits of an Acquisition/Merger Strategy

This article provides some pointers on how you can make this happen, but first, let’s look at a few of the most important potential benefits from an acquisition and merger strategy:

  • Removing your competitors from the game avoids costly price wars over customers.
  • Reduced cost of sales and recruitment: In a single transaction, you can add a significant number of new customers and usually gain some very good employees; be careful to pick the ones who add value to your operation.
  • You may gain new technologies and process ideas that can boost your own operations.
  • Acquiring companies in your supply chain gives you more control over your own destiny; you set pricing on the products and services you need because you own the channel and you are no longer at the mercy of others.

Finding Likely Targets

  • Your top two or three competitors are the best place to start because they usually have similar customers and employees, so there are natural synergies. Consider both mutually beneficial mergers and outright acquisitions.
  • Also consider smaller competitors that are weaker and more vulnerable.
  • Look up and down your supply chain for points of weakness that you can strengthen with a strategic merger or acquisition.

How to Approach Targets

  • Do your homework, gathering as much information about your targets as you can — their customers, suppliers, key employees, strengths and weaknesses. Do a SWOT* analysis on them just like you would on yourself.
  • Keep your cards close to your vest until you are ready to move; keep your interest in the targets within a very tightly controlled circle.
  • Look for third-party verification on all information you collect; strengthen your knowledge with multiple cross-verified data points.
  • Depending on the situation, you can approach them directly to show your interest, send an intermediary on your behalf, or authorize a third party to make an anonymous inquiry.

Avoiding Trouble

  • Pay careful attention to technologies, software and process issues, because they can cause many problems if not managed properly.
  • Watch out for problem employees and customers who may want to undermine the transaction; seek legal advice when necessary.
  • If you want to keep key employees, make sure they are on board with the transaction and have incentives to make it all work smoothly.

Also, consider leveraged buyouts using the cash flow from your target to bankroll the buyout.

Depending on the size of the transaction, you may want to have an independent accountant (CPA) audit the financial statements you are relying on. At the very least you should have the financial statements reviewed by an independent accountant.

Engage an experienced advisor to lead and guide you through the process.

*SWOT: strengths, weaknesses, opportunities and threats (http://www.quickmba.com/strategy/swot/)

Contributed by Frank Dane

Strategies for M&A Deal Making in a COVID-19 World

Deal Making

Successful mergers & acquisitions intermediaries possess three professional attributes: knowledge, experience, and ability. Knowledge can be gained academically or through mentorship. Experience can only be gained from repetition of the deal making process in transactions with a spectrum of different variables ranging from industry to geography to economic environmental issues including interest rate fluctuation, labor market demand, tax rate variance, and national & local economic cycles. Knowledge and experience can be vested individually or institutionally. Ideally, a retained M&A broker will possess these attributes individually and be affiliated with an established firm that has them institutionally. Knowledge & experience are the foundation of success for a business broker. It is critical that a M&A professional knows how to effectively value a business, create a marketplace for the company, and the process necessary to complete a transaction employing “best practices”.

These elements often allow for a business broker to sell a quality business in a stable economic environment. Unfortunately, economic stability has not been in the forecast for 2020. In economic times like we are experiencing this year the professional skill of the intermediary will often play a more significant role in getting the deal successfully to closing than knowledge and experience. The professional skill sets of the top M&A intermediaries include strong listening skills; superior communication acumen both verbally and written with a comprehensive understanding of relevant legal, accounting, investment, business, and/or real estate concepts; and the ability to problem solve through dynamic, sophisticated issues in real time.

Relevant knowledge & experience play a significant role in a business broker’s ability to problem solve, as they are the source for the menu of options to address a given situation in a negotiation.

An anticipated issue in deals in the second half of 2020 will be the appropriate allocation of risk between the parties. Deals will occur in 2020 where buyers purchase businesses for 100% cash. The values in these deals will be based on the perception of risk on both sides of the table.

Perception of risk by business buyers will also result in negotiations where the seller is asked to modify expectations to reflect present economic and market conditions. The following are a few of the problem-solving strategies likely to be employed to get buyers & sellers to “yes” by professional intermediaries in 2020.

  1. Deferred Closing Date – How municipal, state, regional, and the national economies respond when they are progressively allowed to return to normal is unknown at this time. It is anticipated that the velocity of the bounce back will vary based on the local economy; municipal, state, & federal government strategies, support, and restrictions; the industry of a business; the specific attributes of a company; and the ability of executive management. It is reasonable for a buyer to delay closing until a time when these elements can be more accurately accessed. A business that mirrors or exceeds August 2019 performance in August 2020 will at initial assessment appear to have weathered the COVID-19 storm successfully. Depending on the industry and seasonality of the business model it may take more than a few months to properly assess the impact of the Coronavirus on a specific company. It is a reasonable ask for a buyer trying to properly price a company to defer the closing date until appropriate data can be collected.
  2. Earn-Out – One methodology for allocating risk between a buyer & seller negotiating in “good faith” in a time of uncertainty is to create a variable, performance based financial component in the deal. It is my recommendation, if this deal element is incorporated into a deal that the parties first agree on a baseline value that both sides feel is justified based on anticipated conservative projections for performance of the company in the next 12 months. The variable element would be added to that value after an agreed time period based on the performance of the business. The advantage of this element is that the seller is paid a fair value relevant to the performance of the company and the buyer only pays for what is delivered. Two disadvantages associated with employing this element are that future performance can be impacted by the management ability of the new owner and banks will traditionally reject the inclusion of a variable performance element as a deal component because it prevents the ability to calculate future debt service coverage with a high degree of certainty.
  3. Seller Financing – A variation on an earn-out that will be accepted by some banks is a principal credit against a seller promissory note, if company performance is below an established threshold. The reason this element is acceptable to some financial institutions is the maximum amount of debt service can be calculated. A reduction in debt service or the sale price with a principal credit to a promissory note will not impact this high-water mark of future payments calculated by underwriting.
  4. Retained Equity – A risk allocation strategy that encourages seller engagement in facilitating a smooth transfer of ownership and the future performance of the company is to have selling ownership retain an equity stake in the company. This strategy has the potential to result in a higher price being paid for the business, if the company increases financial performance and market share post transaction. Many buyers view this negatively as they wish to pay for what they purchased, not what they bring to the company as an acquirer. If equity is retained it is recommended that the legal documentation have a clear mechanism for valuing the equity and an established timetable for a seller to have the option of being cashed out.
  5. Retained Employment – One strategy to mitigate transition risk is to retain existing ownership in an executive management capacity post sale. The term and compensation for retention can be anything agreed to between the parties. One strategy employed by buyers is to overpay a retiring president of a company for their continued employment post sale. The advantages of this strategy include the ability to write off the value over a shorter period of time versus 15 years if the value was allocated to goodwill in an asset purchase and keeping the a seller emotionally & mentally engaged through knowing that a portion of their sale price value is tied to management performance during the transition of ownership.

The goal for all mergers and acquisitions intermediaries is to get the parties to “yes” and complete the transaction. Knowledge, experience, and ability are the three ingredients needed to achieve that goal. Significant M&A activity will occur in the second half of 2020. I am projecting IBA’s team of seasoned, highly skilled business brokers will be busy deal making in the Pacific Northwest. We successfully facilitated four transactions in June with counties in phase 2 of reopening. We have successfully completed over 4200 transaction and navigated through turbulence in the economy numerous times in our 45-year history as the premier main street & middle market intermediary firm in the region. If you are looking to sell or buy a privately held company or family business in 2020, we would welcome the opportunity to provide an overview of our services. 100% of IBA’s fees are payable upon completion of a transaction by satisfied clients.

Gregory Kovsky, the President & CEO of IBA since 2000, has personally facilitated over 300 transactions involving privately held companies. He is recognized nationally for his knowledge & experience as a “sell side” broker in the manufacturing, international import, industrial, marine, construction, technology, and horticulture industries and a commonly published author and seminar speaker. Mr. Kovsky has held a real estate brokers license in one or more states since 1994 and has the ability to comprehensively represent entrepreneurs in the sale of their privately held companies and commercial real estate. He is honored to represent IBA as a member of the Seattle chapter of The Professional 50 along with Bill Southwell, and to have Stephen Cohen represent the firm in The Professional 50 chapter in Portland.

Contributed by Gregory Kovsky

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