Exit and Growth Strategies for Middle Market Businesses

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The Value of Middle Market Investment Bankers

By Robert St. Germain | Sep 03, 2020

During these challenging COVID-19 times, most long-tenured business owners are likely shouting, if not out loud then in their minds, “Oh no, not again!!!” as they are reminded of the Great Recession of 2008 and the many years it took for them to recover from that downturn. Today’s uncertainties may have them thinking that it is finally time to consider an exit.

The decision to exit from a business is very personal and generally results from answering questions like: “Do I have the energy/interest/health to continue running my business?”; “Do I have tolerance for the continued financial risk of supporting my business?”; and “Do I have a well-defined post-close life plan that I know I would enjoy as a ‘former business owner’?”.

When answering those questions leads to the decision to sell the business, the typical next question is “Should I sell my business on my own or hire an investment banker to help me do what I (likely) have never done before?”

The answer to the question of using an investment banker (IB) or not can be informed by revisiting a study titled The Value of Middle Market Investment Bankers published by Fairfield University in October 2016. The study’s purpose was to answer two basic questions of its own: a.) Do IBs add value to the business sale process?; and b.) Which IB service do business sellers value most?

The study surveyed 85 business owners who utilized IBs to sell their privately held companies or majority stakes therein for between $10M and $250M during the period 2011 to 2016. The results were quite illuminating.

To the study’s first question of whether or not IBs added value to their respective sale processes, 100% of the surveyed owners indicated their IBs did add either moderate (31%) or significant (69%) value to their processes and the achievement of successful transactions.

To the study’s second question, the owners were asked to rank by value to them eight specific services provided by their IBs. The owners ranked first and foremost the management of the complex M&A process and its associated strategy setting as the most important service of their IBs in support of their companies’ sales.

For the uninitiated, that M&A process and strategy setting typically include: a.) establishing pricing/valuation expectations; b.) crafting compelling marketing documents; c.) identifying all suitable strategic and financial potential buyers; d.) conducting the outreach campaign to those potential buyers; e.) establishing a virtual data room to house due diligence information appropriate for each stage of the process; f.) creating and maintaining competition between potential buyers to maximize shareholder value in the outcome; g.) calling for and negotiating indications of interest (IOI) to down-select to the sub-set of most viable buyers; h.) managing the post-IOI seller/buyer interface to include conference calls, management presentations and on-site visits; i.) calling for and negotiating letters of intent (LOI) to down-select to an exclusive potential buyer; j.) facilitating final due diligence during the post-LOI period; k.) assisting in the negotiation of the sale/purchase agreement and its associated documents; and l.) maintaining confidentiality throughout the entire process.

If participating in a professionally run sale process to maximize the return on your life’s work is of interest, contact your local CFA office, which is staffed with senior, securities licensed investment bankers operating in the context of a worldwide organization with over six decades experience assisting business owners sell their companies.

Are You Running Your Business as a Lifestyle or as an Investment?

By Robert St. Germain | Nov 26, 2019

As M&A advisors to privately held businesses in the lower middle market, we see companies generally divided into two camps i.e. those being operated as “lifestyles” and those being operated as “investments”.

Wikipedia describes a lifestyle business as “[one] set up and run…..primarily with the aim of sustaining a particular level of income and no more; or to provide a foundation from which [the owner can] enjoy a particular lifestyle.” Key indicators of such a business are sequential P&L statements showing little or no growth in revenues over an extended period of time. Businesses operated as investments, on the other hand, tend to have P&Ls showing a consistent upward trajectory in revenues over time.

How owners choose to operate their businesses is entirely their choice and for which there is no right or wrong answer. However, that choice should be informed and made with a full understanding of its potential implications in light of the fact that all business owners will eventually exit their businesses… is only a question of how and when.

Given that an exit is inevitable, an important consideration in how one chooses to run a business is how much value one wants to extract from or build up in the business over the owner’s tenure in preparation for that exit. Lifestyle businesses often have value depressing characteristics e.g. little/no revenue growth as cited above; focus on organic growth only; owners operating in the business and not on the business; underinvestment to increase cash flow to the owner; reliance on a concentrated set of customers/clients; contentment with being a “me too” enterprise; etc.

Businesses operated as investments typically have value enhancing characteristics e.g. consistent growth over time as noted above; focus on growth via both organic and non-organic means; strong second tier management teams; debt and/or equity infusions as required to maintain growth; broad customer/client diversity; niche leadership; etc.

Just as these two types of businesses are differentiated by their operating characteristics, so are their outcomes at the time of exit. The lifestyle business may have been very lucrative for the seller; but its very nature represents a risk to the follow-on buyer who will have to scale from a sub-optimized platform to generate an acceptable ROI. All other things being equal, that risk will be reflected in a lower valuation than that for the business run like an investment where the latter’s attributes make it more readily scalable and more likely to generate an acceptable ROI for the buyer.

Again, there is no right or wrong answer to the question of how, between the lifestyle or investment paths, owners should run their businesses. However, they should fully understand the implications of their choice. An investment banker can provide an objective view of the business by examining it as through the eyes of a buyer to help in that choice and advise on mid-course corrections to meet the owner’s objectives for the inevitable exit.

Middle Market M&A

By Robert St. Germain | Nov 30, 2018

Business PlanningThe National Center for the Middle Market (NCMM), which is a collaboration between The Ohio State University’s Fisher College of Business, SunTrust Banks Inc., Grant Thornton LLP, and Cisco Systems, conducted a study in late 2017 that reported on the state of M&A within the middle market.
For the reader’s frame of reference, the NCMM defines the middle market as both privately and publicly held companies that generate between $10 million and $1 billion in annual revenues, of which, there are approximately 200,000 such companies in the U.S. In aggregate, they generate $10 trillion in annual revenues and account for one-third of private sector GDP and employment.
The stated purpose of this report was “…to inform both middle market executives and their external advisors and consultants in order to facilitate more successful deals in the future.” Its findings were quite illuminating:

  1. 60% of study participants said that inorganic growth plays an important role in their company’s growth strategy.
  2. Every year, roughly 20% of middle market companies complete an acquisition and about 5% of those companies sell to or merge into another business.
  3. Among companies that had completed a purchase in the previous three years, for 29%, it was their first deal while another 41% had limited previous experience.
  4. Among sellers in the previous three years, for 46%, it was their first deal and only one in 10 companies had significant previous experience with sale transactions.
  5. Middle market leaders said that finding the right target or buyer was one of the most confusing aspects of M&A.
  6. On the front end of an acquisition or sale, 41% of buyers and 43% of sellers found it difficult to assess the value of the business they were buying or selling.

In spite of the above findings, however, the study also found:

  1. Both buying and selling companies tend to rely mostly on their internal executives and top managers when searching for companies to buy or to whom to sell.
  2. Only about a third of buyers consulted an external law firm, and even fewer talked to consultants or investment bankers.
  3. Sellers were even less likely to bring in external advisors as part of their search for the right buyer.

The study did not provide any deal specific details (e.g. transaction prices as a function of a financial metric); but juxtaposing the first set of findings with the second set would lead one to infer that the deals generally referenced in the study were likely sub-optimal in outcome.

That inference comes from the companies’ cited paucity of deal making experience, as well as their general avoidance of using outside M&A experts to complement their relatively inexperienced internal resources.

So, one major take-away from this NCMM study is for buyers and sellers to first build a high quality deal team that certainly includes their appropriate insiders, but, importantly, also includes outside experts with deep and current M&A experience. Among those outside M&A experts should be an attorney, a CPA and an investment banker.

The investment banker on the team will add significant value by running a sophisticated buy-side or sell-side process in accordance with expected market protocols. That process will naturally include finding the right target or buyer, as well as assessing the value of the business being bought or sold, which were two of the weaknesses cited in the study when companies used internal resources only.
Investment bankers also add significant value by allowing management to keep their focus on the business while the buy/sell process is run in parallel; and, most importantly, by negotiating on behalf of management the best price and deal terms to optimize deal outcome.

Still Not Licensed to Deal

By Robert St. Germain | Aug 09, 2018

Several years ago this author penned an article titled “Licensed to Deal”, which discussed the federal and state requirements for intermediaries (i.e. business brokers, M&A advisors, investment bankers) to legally facilitate business sale/purchase transactions having a security (i.e. stock, promissory note, earn-out agreement) in their deal structures.

That article described in detail what licenses and registrations were required by intermediaries party to such transactions; why many intermediaries refuse to become licensed and registered (i.e. to avoid the costs to set up and maintain a registered broker-dealer in full compliance with the various applicable federal and state regulations); and the potential onerous consequences of utilizing the services of an unlicensed and unregistered intermediary (i.e. under the Sarbanes-Oxley Act, an aggrieved party to an illegal securities transaction exercising their right of rescission up to five years post-close and also initiating legal proceedings against the parties to the transaction).

Since the publication of the original article, many intermediaries continue to practice without the required licenses and registrations while putting their clients at risk as described above. However, they do so more boldly today claiming they are now protected by the M&A Brokers No Action Letter published by the SEC staff on Jan. 31, 2014.

At first glance, it might appear that those unlicensed and unregistered intermediaries are now finally operating within the law and, in so doing, finally protecting the interests of their clients. Closer examination, however, tells a very different story.

First, no action letters represent the opinion of the staff of the SEC and are not rules promulgated by the SEC Commission itself. Therefore, these letters have absolutely no force of law.
Second, because SEC no action letters have no force of law, they can be and have been ignored by the courts.

The D.C. Circuit first broke ground by differentiating between SEC no action letters and actual SEC rulemaking in its Roosevelt v. E.I. du Pont de Nemours & Co. decision wherein it stated that the principle of judicial deference as described in Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc. did not apply to SEC no action letters.

That ground was further plowed by the Second Circuit, which found in both Amalgamated Clothing & Textile Workers Union v. SEC and NYCERS v. SEC that judicial deference for SEC no action letters was not warranted.

Examples of where SEC no action letters were actually ignored by the courts include Amalgamated Clothing & Textile Workers Union v. Wal-Mart Stores Inc. and NYCERS v. American Brands, Inc. both by the Federal District Court for the Southern District of New York, and Trinity Wall Street v. Wal-Mart Stores, Inc. by the Federal District Court for the District of Delaware.

Given the above, the requirement under both federal and state securities laws that anyone who “effects the transaction of securities” be a Registered Representative working in the context of a Registered Broker-Dealer and be regulated by an organization such as the Financial Industry Regulatory Authority (FINRA) continues to apply. Intermediaries not meeting those requirements are still not licensed to deal.

Business buyers and sellers would be wise to only engage the services of an intermediary who is also a Registered Representative (i.e. is sponsored by a Registered Broker-Dealer); has their required securities licenses (i.e. Series 79 plus the Series 63 that is separately required for interstate transactions); and, further, is registered in the state where their practice is located, the state where the seller is located, if different, and the state where the buyer is located, if different again. Proof of licensures and registrations is available at and at your state’s division of securities. Seek legal counsel first to ensure that you are selecting a legally qualified intermediary.

When Will The Buyer Stop Asking All These Annoying Questions?

By Robert St. Germain | Mar 19, 2018

Business sellers often reach the point in the sale process where, in complete exasperation, they start asking the above question of their investment bankers.

The short answer is that questions will be put to the business seller by the impending buyer right up to closing.

Yes, the due diligence phase of the business buy/sell process can be very demanding and very frustrating, especially for the seller. For the first time, they are being asked to share what previously had been closely guarded information with whom are, likely, complete strangers. And that goes against every natural instinct of sellers for whom, theretofore, absolute secrecy was the order of the day to keep any and all info that could possibly be used to their disadvantage from employees, suppliers, customers, and competitors.

On the other hand, the seller must understand that it is the buyer who will be taking on the responsibility for a lot of capital in some combination of debt and equity to make the acquisition. So, the primary reason for all those “annoying” questions is to help the buyer assess the likelihood of replicating or improving historic cash flows to support the debt component of the capital package while generating the necessary return on the equity component.

Those capital components typically will be provided, in part, by the buyer and, in part, by third parties in the form of at least one lender and, perhaps, at least another equity investor. Each supplier of capital to the transaction will have their own set of questions coming from their own unique perspectives. Additionally, each supplier of capital will be assisted by their own set of advisors who will each have their own set of questions to protect the interests of their respective clients.

In aggregate, there will be many questions, some of which the seller very likely will never have asked themselves during their ownership tenure, and some of which will require an extra work effort to answer.

Sellers that engage the services of investment bankers (IB) to lead them through the sale process will be advised in advance of what to expect during DD and how to prepare.  Further and very importantly, the IB will advise the seller both on how to legally protect themselves from compromise in the information exchange and how to stage the release of various types of information only to when it is absolutely necessary to the process.

Where Have All the Baby Boomer Business Owners Gone?

By Robert St. Germain | Nov 17, 2015

Baby BoomerIt has long been predicted that the “baby boomers” (i.e. the population cohort born between the years 1946-1964), who own businesses in the U.S., would begin to exit their businesses en masse as they began reaching the age of 65, starting back in 2011. The related prediction was that this mass exit would represent the greatest private transfer of wealth in the history of the U.S. To put those predictions into perspective, it is estimated that some 8+ million businesses in the U.S. with a total valuation of $10+ trillion are owned by boomers; and, for most of them, the vast majority of their personal net worths are tied up in their businesses.

Have those predictions come true? The answer, like so many other predictions in life, is a resounding no. While some boomers have certainly elected to exit and pursue their personal “bucket lists”, the majority, so far, seem to be hanging on to their companies. So, what is going on, especially in this period of plentiful and low cost capital, an abundance of buyers, and, as a result of the previous two factors, high purchase multiples?

In an effort to answer that question, The Wall Street Journal looked into this phenomenon; and on Oct. 14, 2015 published the related article titled “The Missing Boom in Small-Business Sales” with the sub-title “An expected rush in sales of small firms by the baby boomer generation has yet to materialize”. Their findings, in my words, were very interesting.

First, this is not their fathers’ generation that looked upon age 65 as the automatic start of the last stage of their lives i.e. wearing the stereotypical gold watch while golfing/fishing throughout their golden years. The boomers are a healthier and longer living generation with the energy and interest to continue running their companies. Read more »

Congratulations! You Sold Your Company. So, How Much Money Did You Leave on the Table?

By Robert St. Germain | Nov 05, 2013

Money BlocksIt was certainly flattering when you received that unsolicited call from the CEO of one of the major players in your industry. Maybe he remembered you granting him that one foot “gimme” putt at the trade association golf tournament two years ago. In any case, during the call, he said some very nice things about your company and how teaming up with his would be a “win-win” situation for both of you.

During the discussion, he offered a price that seemed fair; and, in short order, you signed an LOI that took you off the market for 90 days while all the final details got worked out. Sure enough, he kept his word; paid his price on the designated close date; and you are now golfing near full time while regularly granting one foot “gimme” putts in anticipation of more good karma in the future.

So, looking back, have you ever wondered how much money you left on the table by accepting that seemingly “fair” price from that single offer? Actually, you will never know because you fell into the all too common trap of voluntarily binding yourself into a non-competitive process that, by design, was to the clear advantage of the buyer and to the distinct disadvantage of you, the seller. Read more »

Should You Consider a Recap? Part 5

By Robert St. Germain | Apr 03, 2012

Money BlocksIn the last four blog posts I have discussed the different types of middle market business buyers in the market today, how they differ and what they look for when they invest.  Now that we know about the buyers…is there anything the seller can do to make sure the transaction runs smoothly?     

If all the prerequisites have been properly put in place, the seller has at least one more tool to extract the highest price and best terms from the PEG marketplace. That is a well constructed, competitive sale process consistent with the protocols and expectations of the PEGs. As with selling to any third party, competition among potential buyers can help maximize the outcome for the seller. Read more »

Should You Consider a Recap? Part 4

By Robert St. Germain | Mar 29, 2012

Money GraphThis series of posts has examined the different types of buyers of middle market companies, focusing on selling to a third party.  Learning more about how the financial buyer makes investment decisions is important to anyone considering a business sale.

Although, as previously discussed, each Private Equity Group (PEG) has its own specific investment criteria, most of them are attracted to acquisition targets with certain general characteristics that independently and, in aggregate, help reduce the risk of their investment. Therefore, sellers interested in exploring recap opportunities should be aware of these and put as many as possible into place before marketing themselves to the PEG community. Read more »

Should You Consider a Recap? Part 3

By Robert St. Germain | Mar 27, 2012

This series of blog posts examines the exit options of middle market business owners as they contemplate the sale or recapitalization of their companies.  My first two posts in the series described the seven primary ways owners leave their businesses – sales of assets, sale to partners, sale to children, management, employees, to the public and a third party… and the ramifications when the third party is a strategic buyer.  The third party financial buyer is another option that may be worth consideration.

A financial buyer, for this discussion, is a private equity group (PEG). This is a type of investment manager that raises funds specifically to be invested in the private equity of operating companies in accordance with a limited partnership agreement between it and its sources of those funds (e.g. pension plans, universities, insurance companies, foundations, endowments, and high net worth individuals). The funds typically have a ten year life, during the first half of which, capital is invested into companies and, during the second half of which, that capital and any appreciation thereon is harvested back out through the resale or IPO of those companies. Read more »