InSight

Exit and Growth Strategies for Middle Market Businesses

M&A Quarterly News In The Industrials Sector

By Steve Hauser | Nov 21, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Industrials Sector. M&A activity for North American based target companies in the Industrials sector for Q3 2019 included 141 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector was announced in September when Alamo Group, Inc. (NYSE: “ALG”), with yearly revenues exceeding $1.0 billion, and a history of 25+ acquisitions of mobile equipment businesses, acquired Morbark LLC, a portfolio company of Stellex Capital Management LP, for US$352 million in cash, subject to certain post-closing adjustments. Founded in 1957, Morbark is located in Winn, Michigan and manufactures equipment for the forestry, recycling, sawmill and biomass industries. It has approximately 720 employees and has generated total sales of US$225 million in during 2018.

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M&A Quarterly News In The Business Services Industry Sector

By Brad Purifoy | Nov 21, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Business Services Industry Sector. M&A activity for North American based target companies in the Business Services sector for Q3 2019 included 849 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector was announced in August when Perspecta, Inc. acquired Knight Point Systems LLC for US$250 million, subject to price adjustments. The acquisition further enhances Perspecta’s offerings in cloud, cyber, digital transformation and enterprise IT. Knight Point Systems is located in Reston, Virginia and provides information technology consulting services.

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M&A Quarterly News In The Energy Industry Sector

By Roy Graham | Nov 18, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Energy Industry Sector. M&A activity for North American based target companies in the Energy sector for Q3 2019 included 53 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector closed in August when Qatar Investment Authority, a subsidiary of Government of Qatar, acquired an undisclosed minority stake in Oryx Midstream Services LLC, a portfolio company of Stonepeak Partners LP for US$550 million. The transaction enhances Qatar Investment Authority’s United States Portfolio and its investment in major infrastructure projects. Founded in 2013, Oryx Midstream Services is located in Midland, Texas and acquires and develops oil and natural gas reserves.

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The Good, The Bad, and The Ugly in Mergers & Acquisitions

By John Holland | Nov 14, 2019

In the classic Western film The Good, The Bad, and The Ugly, the “good” character portrayed by Clint Eastwood rode off in the sunset with bags of gold after arduous escapades. After working for years to build their businesses, many business owners dream to sell the businesses and then head off in the sunset with the well-deserved wealth. Some business owners achieve that dream with financial security, but many business owners are unable to ever attract a buyer for their businesses. The private equity groups and strategic buyers (large corporations) that acquire businesses are sophisticated, discerning, fastidious, and fickle. Let’s explore the criteria that buyers consider when they distinguish “good” businesses from “bad” or “ugly” businesses. Business owners who understand buyers’ acquisition criteria are in a better position to build up the “good” aspects of their businesses while purging the “bad” or “ugly” aspects of their businesses over time and thereby making their businesses more attractive and more valuable.

The Good
As an international investment banking firm, CFA receives hundreds of email messages each month from private equity groups and strategic buyers searching to acquire businesses with the following features: consistently growing revenues and earnings, recurring revenues, high switching costs for customers, earnings (EBITDA) above a certain level such as $5 million, low capital expenditures, low customer concentration, and solid management. Some of these buyers focus upon “hot” industries like cyber security or software-as-a-service, but there are private equity groups and strategic buyers searching for acquisitions in every industry.

In general, businesses with higher earnings attract a larger audience of buyers. Hence, businesses with higher earnings tend to sell for higher multiples on earnings. For example, according to the Q2 2019 Market Pulse Report from Pepperdine’s Graziadio Business School, businesses with EBITDA of $2 million to $5 million sold for an average multiple on EBITDA of 4.0 in Q2 2019, while businesses with EBITDA of $5 million to $50 million sold for an average multiple on EBITDA of 5.9. In the information technology (IT) industry, we can observe this phenomenon on a larger scale by comparing the largest IT solutions player in the industry, CDW (CDW) with $17.5 billion in annual revenues and a multiple on EBITDA above 16, to an IT solutions company named Dyntek (DYNE) with roughly $200 million in annual revenues and a multiple on EBITDA of merely 4.

The Bad and the Ugly
Strategic buyers and private equity groups are repulsed by businesses that are plagued with litigation, unreliable accounting records, labor unrest, extraordinarily high insurance or workers compensation claims, or investigations by governmental authorities for matters such as infractions of labor or environmental regulations. Buyers discount or reject businesses with high customer concentration, unstable or declining revenues or earnings, elevated customer turnover or churn, weak management teams, and high sensitivity to economic cycles. A business valuation report might show a theoretical value for a particular business with a multiple on EBITDA consistent with previous sales of similar businesses in that industry, but the reality is that companies with “ugly” problems rarely find a buyer.

Conclusion:
Just as the character “Blondie” portrayed by Clint Eastwood persevered through dehydration in the desert and incarceration in a Union Army prison and achieved his goal of riding off in the sunset with his bags of gold, business owners can overcome their businesses’ deficiencies by inviting objective investment bankers, management consultants, and CPAs to identify the deficiencies of the business while charting a path of corrective action. For example, a business with one customer representing 50% of revenues could develop and execute an aggressive business development and marketing strategy to attract new customers. Likewise, a business with irregular accounting practices could find a reputable CPA firm and recruit a Chief Financial Officer to review and refine accounting processes and improve the quality of the financial statements. With a concerted effort over a few years, a business owner can overcome such “ugly” business deficiencies to make a business very attractive for buyers and thereby very valuable.


Why George Didn’t Accept The Highest Offer

By Dean Durbin | Nov 12, 2019

How Sometimes Less Is More When Selling A Business

Well, there we were…..after months of hard work marketing his company, reaching out to over 1,000 potential buyers, obtaining over 100 signed Confidentiality Agreements (CA’s), several dozen Indications of Interest (IOI’s) and a handful of management meetings, we, along with the owner, scoured with a fine-toothed comb through seven printed Letters of Intent (LOI’s) laying on our conference room table.

The only thing left for our client to do was to pick the LOI with the highest price and let us push this deal across the finish line so he can cash his check and retire, right? After all, who in their right mind would take less than the highest offer? But as the old football coach Lee Corso says every Saturday morning on ESPN GameDay, “Not so fast my friend!”

It’s true that some owners care only about the maximum monetary payout. However, it’s been my experience that more often than not it’s a combination of price and terms that determination which buyer to choose. Every client has different objectives and perspectives on what they want their exit, or in some cases partial exit, to look like.

The owner, let’s call him George, was approximately 65 years old accurately be described as a humble, gentle and wise human being. Fortunately for George, there were numerous quality offers ranging from $34M to a high offer of $47M.

The CFA Team constructed a decision matrix, which is just a fancy word for a table containing the pertinent data, pros, cons, and comments on a large one page chart. It was at that point, we let George lead the conversation and we primarily listened to him as he went through the offers. Within, five minutes, four of the offers were pushed to the side and that was the easy part, it was the “Final 3” that took a little more time and discussion.

Among the 3 remaining offers, there were many differences in price, terms, future objectives management teams and numerous other categories. In the end, George elected to sign an LOI with Company Y for about $6M less than the $47M offer from Company X. But why?

George is not unlike a lot of other sellers.  While I can tell you that the ultimate sales price was a factor, it absolutely was NOT the primary factor. The reason George chose Company Y’s offer was because it most closely resembled his “mental image” of his post-sell world. Although not the highest offer monetarily, I personally believe that Company Y was overall best fit after getting to know George throughout the process and it didn’t surprise me in the least.

The key decisions that drove George’s decision, in what I perceive to be order of importance were as follows:

  1. Employees were treated well – moving the factory out of state or large-scale layoffs would’ve been a deal-breaker regardless of price, yes regardless of the price. The buyer gave written assurance of the employees’ job security and actually improved some of their pay and insurance packages.
  2. Price and Terms of the payment – during negotiations, the $41M price remained constant. However, due to the competitive nature of the engagements we were able to negotiate several improvements: –
    • George’s rolled forward equity went from 15% to 19%, thus allowing George or his heirs a potentially larger “second bite of the apple”
    • The payout was all cash at closing, while the other offers were paid out over several years and structured as an “earn-out” and even some as seller notes
    • Distribution formula for George’s future equity payouts was greatly improve
  3. Management team – during the management meetings George had a wonderful connection personally with Company Y. It was obvious that they “clicked” better than the other buyers. Additionally, Company Y came to the management meetings with creative ideas, especially in the product marketing area to increase the company’s market share. It was clearly stated by George that “he felt like he could breathe easy for a change and was confident that Company Y’s team would put the company in good hands”. Confidence in the management team’s ability to continue the growth of the business was a significant factor in his decision.
  4. Opportunity to stay connected to the business – George now sits on the Board of Directors, helping to consult with operational and marketing issues from time to time. Today, he spends most of his time with his wife and family and is semi-retired, because he hates the word “retired”.

In the end, there were several items that George gave up that he didn’t even care about and very few that he did care about. He did sign a non-compete, however he’d never considered competing against his old company especially at 65 years of age. George was not interested in an earn-out. It probably cost him some money, but he was content to remove some risk in exchange for a slightly decreased payout.

The lesson we can learn from this case history (which was modified to protect client confidentiality) is that every owner is different and it’s typically a combination of factors that drive a decision, not just the final sale price.

As a final commentary, one of the things that make our job as CFA investment bankers so satisfying is to see people like George, that have taken risks, sacrificed time and worked incredibly hard to build a terrific business, get rewarded for their efforts when they end their journey as business owners.


M&A Quarterly News In The Healthcare Industry Sector

By Daniel Sirvent | Nov 08, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Healthcare Industry Sector. M&A activity for North American based target companies in the Healthcare sector for Q3 2019 included 168 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector closed in August when AtriCure, Inc. acquired SentreHEART, Inc., a portfolio company of Pinnacle Ventures LLC, Presidio Management Group Inc, Prospect Venture Partners, Vivo Capital LLC, Deerfield Management Co LP and Decheng Capital LLC, for US$281.4 million in stock and contingent payout with an undisclosed amount in cash. Founded in 2005, SentreHEART is located in Redwood City, California and develops catheter-based solutions.

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M&A Quarterly News In The Print and Packaging Industry Sector

By Jeff Wright | Oct 30, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Print and Packaging Industry Sector. M&A activity for North American based target companies in the Print and Packaging sector for Q3 2019 included 23 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector was announced in August when PLZ Aeroscience Corp, a portfolio company of PPC Partners Ltd., acquired Precise Packaging, Inc., a portfolio company of Trive Capital LLC, for an undisclosed amount. The transaction allows PLZ Aeroscience to enhance its position on the North American specialty aerosol and liquid manufacturing market. Precise Packaging is located in Fall River, Massachusetts and provides filling, compounding, packaging development and pharmaceutical development services.

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M&A Quarterly News In The Wholesale Distribution Industry Sector

By Jeremiah Hughes | Oct 28, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Wholesale Distribution Industry Sector. M&A activity for North American based target companies in the Wholesale Distribution sector for Q3 2019 included 46 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector closed in August when Brady Industries, Inc. acquired Datek, Inc. for an undisclosed amount. Established in 1976, Datek is located in North Little Rock, Arkansas. The company distributes janitorial chemicals, laundry products, cleaning equipment and other miscellaneous cleaning supplies.

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M&A Quarterly News In The Hospitality and Leisure Industry Sector

By David Hulett | Oct 28, 2019

The report below gives a good overview of the fourth quarter M&A activity in the Hospitality and Leisure Industry Sector. M&A activity for North American based target companies in the Wholesale and Distribution sector for Q3 2019 included 75 closed deals, according to data published by industry data tracker FactSet.

One of the notable middle market transactions in the sector was announced in July when Vail Resorts, Inc. acquired Peak Resorts, Inc. for US$167.5 million in cash. Vail Resorts is a holding company that engages in the operation of mountain resorts. Peak Resorts engages in resort operations. It offers activities, services and amenities including skiing, snowboarding, terrain parks, tubing, dining, lodging, equipment rentals and sales, ski and snowboard instruction and mountain biking. The company was founded in 1997 and is headquartered in Wildwood, MO.

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Welcome to the Land of OZ

By David DuWaldt | Oct 22, 2019

Now that I got your attention, no, this is not a mystical journey down the yellow brick road to Emerald City. This is about investments into Opportunity Zones (“OZs”). The Tax Cuts and Jobs Act of 2017 added Subchapter Z to the Internal Revenue Code, which provides certain tax benefits for making such investments. OZs are defined as economically distressed communities where new investments may be eligible for preferential tax treatment. The tax related incentive for making investments into OZs come in the form of a deferral of tax on recognized capital gains, including a partial reduction in such gains based on the holding period of the investment.

To illustrate the tax benefits, let’s assume the following fact pattern: On August 31, 2019, shares of stock of a C corporation were sold for $10 million by a stockholder and the tax basis which the stockholder had in the stock was $5 million. Within 180 days from the date of the stock sale, the stockholder can invest the gain portion ($5 million) into a Qualified Opportunity Fund (“QOF”), which is an entity that invests into OZs, and defer the payment of tax on the capital gains. In addition, if the investment in the QOF is held more than 5 years, the tax basis in the investment increases by 10% of the deferred gain ($500 thousand in this example) and, if the investment is held for more than 7 years, the tax basis in the investment increases by an additional 5% of the deferred gain ($250 thousand in this example). In 2026, the tax on the remaining deferred capital gain is reported on the tax return (i.e., tax on capital gain of $4.25 million in this example) even if the investment in the QOF is not sold. If the stockholder continues to stay in the investment, for at least 10 years in total, gain from a sale of the investment in the QOF is not taxable.

For any significant tax strategy, it is important to pay close attention to the details in order to avoid some disqualifying event or issue with the fact pattern. Here are some of the requirements connected with OZs:

  • The qualifying gain that is intended to be deferred must be capital gain, not ordinary income. The capital gain requirement does include Section 1231 gain.
  • The qualifying gain that is intended to be deferred cannot be the result of a sale to a related party.
  • The type of taxpayers that qualify for this tax treatment is quite broad to include not only individuals but also corporations, partnerships, trusts, estates, real estate investment trusts, and regulated investment companies.
  • As alluded to in the example above, starting from the date of sale that gives rise to the gain to be deferred, an investment into a QOF must be completed within 180 days.
  • The QOF must hold at least 90% of its assets in qualified opportunity zone business property. The type of property that meets this requirement includes both tangible personal property and real property.
  • As for business structure, the QOF can be a C corporation, an S corporation or a partnership.
  • If the QOF invests in a business operation, at least 50% of the gross receipts must be derived from the active conduct of a trade or business in OZs.
  • Such active businesses cannot include a golf course, a country club, a racetrack or similar facility used for gambling, a liquor store, a hot tub facility, a massage parlor, or a suntan facility.
  • The investment in the QOF must be sold before January 1, 2048 to receive the gain exclusion tax treatment.

Before making an investment into a QOF, it is wise to seek the advice of a competent tax professional.