InSight

Exit and Growth Strategies for Middle Market Businesses

Archive for the ‘Corporate Finance’ Category

M&A Deal Structure

By Kim Levin | Aug 23, 2016

deal structureDeal structure in an acquisition usually involves much more than deciding on selling stock vs. selling assets.  The devil is in the details and can involve significant dollars to the seller of a middle market business. GF Data, a company which collects data on middle market M&A transactions, recently reported on issues in deal structure.  One of the areas they considered is how seller financing or earnouts (SFE) effect a transaction in terms of purchase price.

When buyer and seller agree on the terms of the deal, one of the most important issues negotiated is the purchase price.  Generally, the buyer seeks assurance that he isn’t buying a business that will nosedive after the closing and the seller wants to be certain that the buyer will continue his business legacy.  As part of the deal structure, the buyer may ask the seller to assume some of the ongoing business risk by structuring part of the purchase price of the transaction in the form of an earnout.  And in some cases, in order for the transaction to move forward, the buyer may need the seller to finance part of the transaction in the form of a seller note that is paid in monthly instalments over a fixed period of time.  In either case, earnout or seller financing, both parties must be confident that the other will honor the terms of the purchase agreement.  This is why finding the right buyer-seller pairing is paramount.

GF Data recently reported the impact SFE clauses have had on deal values. Nearly half of all transactions in the $10-$25 million enterprise value range use seller financing or earnouts when structuring the deal.   The valuations on SFE deals in that size range was slightly lower, a half a turn.  However, with transactions over $50 million, use of SFEs was not as prevalent and the resulting valuations on those deals was at or above those that did not.  GF Data suggest that seller financing/earnouts is a way to bridge the gap against the seller’s sense of “market” on smaller deals and provide an added premium on larger ones.

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Canada M&A | Record Breaking 2015

By Kim Levin | Jun 14, 2016

Canada M&AIn 2015, Canada dominated the field of US cross border transactions, so we’re keeping a watchful eye on our neighbor to the north. One measure of Canada M&A health is private equity (PE) deal volume and value, which were at record breaking levels in 2015.  Buyers spent nearly $49 billion last year across 283 completed deals, according to Pitchbook, a private equity and venture capital database.

2016 is off to a slow start, as we have seen volume drop by 33% and value down nearly 16%.  This decline is not a signal of any fundamental shift in Canadian PE dynamic, but is, rather, a typical progression as fund managers swing from racing to complete deals by year’s end to deal sourcing anew, with the cycle coming full circle.

Like the United States, Canada is experiencing a trend toward smaller deals.  As we’ve mentioned before, financial buyers first look to large, well-managed companies with unique product offerings or niche markets to add to their portfolios as long as the price is right.  Over the past few years, competition for those prized companies has pushed prices to the stratosphere. As a result, many private equity investors have begun to focus on companies that have many prized company attributes but are smaller in size and fit their price objectives. In 2015, 61% of all transactions were smaller, add-on deals and as of the first quarter of 2016 that number is up to 68%.  Looking back, before the M&A bubble burst in 2008, 68% of investments were in larger, platform-size transactions so we’ve seen a huge shift in investment focus.

From a lending standpoint, Canadian banks are well capitalized and are aggressively lending to sponsors.  In addition, when compared with transactions in the US, the size of most Canadian deals are smaller, and thus less risky for lenders.

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Middle Market M&A Business Insights – Declines in 2015

By Kim Levin | Mar 22, 2016

According to data published by international financial data tracker Bureau Van Dijk, middle market (deal value of $50 million to $500 million) deal volume and value in North America declined in 2015. There were 10,517 middle market deals worth an aggregate $254.93 billion announced in 2015 compared to 11,296 deals worth $313.73 billion in 2014. The year-over-year volume decrease was 10%, while value declined 19%.

Private Equity

Private equity and venture capital volume and value mirrored the rest of the market in 2015. There were 3,224 deals valued at 81.5 billion in 2015, down from 3,420 deals worth 84. 7 Billion in 2014.

Sector Activity

Healthcare and technology were the most active sectors driven by multiple mega deals in each segment. The biggest deal announced in 2015 was drug giants Pfizer and Allergan’s pending $160 billion merger. On the technology side, the largest transaction was the $78 billion Charter Communications Time Warner Cable merger. Another mammoth deal took place in the food and beverage sector when Anheuser-Busch InBev reached an agreement to buy U.K. rival SABMiller in mid-November for $120 billion.

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Status Quo in M&A?

By Kim Levin | Jan 27, 2016

status quo in M&AGF Data recently published its Q3 M&A report and the take away from their collected data is a slight variation on the status quo in M&A…or more accurately “Less of the Same.”

Trends in transaction activity remained fairly constant, but the number of completed deals dropped over 27% from the second quarter to the third, 51 deals to 37.  This drop off may be slightly exaggerated due to late reporting, but the volume in the September quarter was light.

Size premiums remained at near record levels and valuation rewards for better than average performing companies continued.  Companies in the $50-250 million total enterprise value range traded at an average of 8.0x for the first nine months of the year, while smaller size companies ($10-50 million) traded at an average of 6.3x. Buyers continued paying premiums for companies with not only better than average financial performance, but also prior institutional ownership and management retention post sale.  Buyouts featuring these elements have been valued at an average 8.9x year to date.

Prior to 2012, buyers paid anywhere from .2x to 3x more for platform vs. add-on acquisitions.  During the past three years, the valuation differences between platform acquisitions and add-on acquisitions have narrowed significantly and in the most recent quarter – 3Q 2015 – add-ons had the upper hand. Valuations for the year are now about even for the two groups – 6.9x for platforms vs. 6.8x for add-ons.

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U.S. Corporation Income Tax – Studies and Proposals

By David DuWaldt | Nov 10, 2015

Tax CalculatorIn my blog post of October 27, 2014, The Art of Corporate Inversions, I alluded to the fact that, relative to other countries, the United States has the highest income tax rate imposed on C corporations. And since the late 1990s, several multinational corporations have changed their domicile to another foreign territory or country. Federal lawmakers have passed stricter rules in an attempt to prevent corporate inversion transactions and income shifting strategies.

With the concerns about the shifting of income from the United States to lower tax rate countries and the effect upon the U.S. economy, several studies were conducted. An interesting recent article at the Tax Foundation website touches on some of the studies and suggests that a lower tax rate structure for corporations, which are subject to U.S. income tax, could reduce income shifting by multinational corporations and increase the tax base. In some ways, this concept is similar to the famous “Laffer Curve” that was introduced by Dr. Arthur Laffer in the late 1970s and supported the macroeconomic theory of supply-side economics.

Last February, as part of the 2016 budget proposal, President Obama recommended a reduction in the corporation income tax rate from 35% down to 28%, with a special rate of 25% for manufacturers. The proposal provided for unspecified cuts in tax preferences and a one-time tax on unrepatriated foreign earnings of U.S. based multinational corporations. At this moment, we are patiently waiting for Congress to pass a budget for the 2016 fiscal year.

Last July, Representatives Charles Boustany (Republican – Louisiana) and Richard Neal (Democrat – Massachusetts) released a discussion draft of their Innovation Promotion Act of 2015, which is an “innovation box” bill to provide for a 10.15% effective tax rate on income derived from certain intellectual property. This tax based incentive is not new to some of the countries that belong to the Organisation for Economic Co-operation and Development (OECD) and have their own “innovation box” low tax rate incentives. Unfortunately, with any specific tax incentive, legislation of this type adds to the complexity of the tax code and the cost of tax administration.

We do have some corporation tax reform proposals by some of the presidential candidates that rank high in the recent polls. Democratic candidate, Hillary Clinton, has not proposed a specific corporation tax rate but has commented that she likes the pre-Bush tax rates of the 1990s. Democratic candidate, Bernie Sanders, did not specify a proposed corporation income tax rate but did comment that it should be higher than the current rate. Republican candidate, Donald Trump, proposes a reduction in the corporation income tax rate from 35% to 15%. Dr. Ben Carson proposes a corporation income tax rate of between 15% and 20%. Marco Rubio proposes a reduction in the corporation tax rate to 25%. Jeb Bush proposes a reduction in the corporation income tax rate to 20%.

It is challenging to guess what the corporation income tax rate will be in a few years from now but it will be interesting to observe what happens when Congress addresses the issue.

Posted by David DuWaldt.

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Private Equity Deal Flow

By Catherine Patience | Oct 09, 2015

Private Equity Deal FlowAccording to AARP, 8,000 people a day are turning 65. That’s over 40 million baby boomers hitting retirement age between now and 2029. Recent U.S. Bureau of Labor statistics confirms that approximately 13% of the U.S. work-force own businesses. Even a conservative estimate of the number of businesses that will change hands as the boomer population retires over the next fourteen years puts the number in excess of 4 million. The looming question is, as the “for sale” signs go up on those businesses, will there be sufficient capital resources and private equity deal flow for everyone to “cash out?”

For that reason, we keep a keen eye on capital resources. Private Equity investors are a huge source of investment capital. So, how is private equity faring this year? As we finish the first half of 2015, investment is down 7.1% from Q1 to Q2, and down 20% from Q4 2014. In this highly competitive market the number of quality investment targets has shrunk. The higher the quality, the higher the multiple, so many Private Equity Groups (PEGs) are finding it harder to find quality companies in their price range. To compensate, PEGs are looking to middle-market sized companies with slightly lower multiples. But even those “add-ons” are at the lowest levels we’ve seen since 2013.

With only a few large transactions to bump up average deal size, the upper and core middle market size companies comprise the majority of deals done year to date. Private equity investors have been shedding holdings at a fast clip, with corporate buyers having already spent about $160 billion, just $7 billion short of last year’s total.

53% of the $75.6 billion capital raised year-to-date has gone into the $1 billion – $5 billion size funds. This is likely due to PE portfolio consolidation and a trend toward larger fund managers. Confidence in larger firms is also expressed by a drop in average fund closing time.

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2015 1st Half M&A Activity | Part 2

By Kim Levin | Sep 15, 2015

Middle Market Business Insights – M&A Activity

Two North American industry segments that continue to be impacted by M&A activity are healthcare and manufacturing.

Healthcare M&A in 2015

M&A activity in the Healthcare space continues to be strong in 2015.
  • According to data published by Factset, there were 458 healthcare transactions in the U.S. in the first half of 2015 with an announced aggregate deal value of USD $190.54 billion.
  •  For the same period in the same geography in H1 2014 there were 487 transactions but announced deal value was lower at USD $118.73 billion.
  • This feverish M&A activity has been led in part by drugmakers seeking new treatments that can replace the billions of dollars in sales they will lose when their existing patents expire.
  • According to data from Thomson Reuters, M&A transactions targeting biotech and pharma companies thus far in 2015 have reached $59.30 billion, a 94 percent increase over the same period a year ago and the highest volume for this stage in any year since 2009.
  • According to data from international consulting firm PWC, the sectors lagging behind the overall volume trends from 2014 include Home Health (-16%), Hospitals (-8%), and Labs, MRI & Dialysis (-67%).
  • Private equity has remained active in the space with particular focus on Healthcare Information Technology (HIT), Revenue Cycle Management and other insurance related businesses according to data from Bain Consulting.

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2015 1st Half M&A Activity | Part 1

By Kim Levin | Sep 09, 2015

Middle Market Business Insights

After a multiple quarters of strong growth in North American M&A activity, things slowed down a bit in the first half of 2015. Still, a slight dip in activity does not signal an impending downturn, rather a leveling off of what has been a feverish pace. Below is a by the numbers look at H1 2015 according to data published by global research firm Bureau Van Dijk:

  • In the U.S. in H1 2015, there were 6,237 total transactions worth a combined USD $848.58 billion over the six months, compared to 7,664 deals worth a total USD $953.07 billion in H2 2014.
  • In Canada, deal value grew 8 per cent from USD $96.27 billion in H2 2014 to USD $103.53 billion, marking the fourth consecutive increase, despite a decline in volume to 1,890 transactions (H2 2014: 2,125).

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SBA – Great Source of Business Capital

By David Sinyard | Aug 10, 2015

Business CapitalEntrepreneurship in America remains vital to the U.S. economic growth.    The number of new business establishments tends to rise and fall with the business cycle of the overall economy.  The U.S. Bureau of Labor Statistics collects data on new businesses and job creation. The number of business starts is roughly 550,000 per year, yet survival rates are tough.   A major reason is often lack of business capital.

A major source of entrepreneurial funding is through the Small Business Administration (SBA) loan programs.  The primary SBA lending program is the SBA 7(a) guaranty loan program which is extended to business owners to use for start-ups, expansion, business acquisition working capital, equipment and inventory.  The maximum loan amount is $5,000,000 and the terms vary and range between 7 years for working capital and 25 years for real estate.   As an example, the bank of which I am a director recently approved a $3 million loan to a restaurant owner to take out the construction loan on his building in which he has two different food service establishments.

Another popular SBA loan program is the SBA 504.  This program is focused on commercial real estate, either new construction or acquisition and some major equipment financing.  Maximum loan size is $13,500,000.  Loan terms can be up to 30 years.  A recent example that I have seen is a $12,000,000 loan to construct a new assisted living complex.

Community banks are very interested in pursuing these loans.  The SBA guarantees a major portion of the indebtedness.  The loans are often sold in the secondary market, freeing capital for the bank.  In addition to origination fees, the banks also earn a servicing fee.

The key for a business owner is to find an experienced SBA lending group that has an extensive record of underwriting and closing these loans for business capital.

Posted by David Sinyard.

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Is the Hot Seller’s Market Cooling Off?

By John Hammett | Feb 19, 2015

Seller's MarketFor the last 18 months, I have been telling private company owners that we are in a hot “seller’s market” that is pushing up values for companies in the $5 million to $25 million range.  The lack of active company sellers juxtaposed with the high demand from private equity investors working hard to invest $400 billion in new acquisitions drove up valuations last year by about 1.0 times EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization.

Now it looks like that price premium is starting to go away.

GF Data, is a data analysis firm that reports on deal prices paid by private equity investors.  GF data reported today that Price/EBITDA multiples for transactions valued between $10-$250mm dropped ½ of a “turn” from 6.6X EBITDA to a 6.1x average multiple.  The GF Data report explained further that:

“Our data suggest that for the first time since 2007 more business owners are beginning to feel that the current mix of economic, industry and capital market conditions will not last forever, and that these conditions themselves are becoming an impetus to sell.”

This may be the beginning of a return to historically lower values for private company sellers.  My sense is that owners who planned to sell their companies in 2015-2016 need to move now if they are going to pick up part of the 20% premium from the seller’s market conditions during 2014.

Posted by John Hammett.