InSight

Exit and Growth Strategies for Middle Market Businesses

Archive for the ‘Exit Strategies’ Category

Buying Out A Controlling Partner

By George Walden | May 14, 2018

As an advisor for companies, I regularly encounter the situation of a minority owner wanting to buy out a controlling partner. This scenario, if handled poorly, can end in significant value destruction to the company. Owners should have a buy-sell agreement in place defining the actions that need to occur for one partner to buy out the other. Depending on the buy-sell agreement, there are a number of things a minority owner can do to make a smooth transition. Remember, this is not a situation where you’re trying to discount the value of the company. Fairness to your partner should be your first thought.

Number one, agree in advance how you both are going to measure the value of the company. What is the fair market value, should be assessed constantly? Number two, how will you and the company be able to pay for the buyout? This is an interesting dilemma for the business. This is not a situation where you’re borrowing funds to improve the company by adding equipment or funding a growth initiative. This is capital to be exchanged for equity. Banks don’t like situations that aren’t accretive. Is the company buying out the stock of the controlling shareholder or is the individual buying the stock?

A common solution to handle this situation is to have the company buy back the shares from the controlling partner in some form of structured payout, usually cash, a long term note, and occasionally, a performance upside. Another solution is to look at private equity to fund the buyout. Done with the right people, this can be a very attractive alternative because PE groups often have access to additional capital, providing financial stability, and they usually initiate growth strategies to accelerate company value.

Finally, the third, keep the conversation civil and positive. Strive to make the situation a win-win. Change is difficult for all parties in a negotiation. A poor attitude and arrogance can be very destructive to the company and to the current relationship. In closing, this is a situation where I advise using a third party negotiator such as your investment banker to facilitate the process especially if both principals trust the intermediary.


Collaborative Transactions

By George Walden | May 09, 2018

Recently, I was asked the question, “Can a transaction be a WIN/WIN?”

In sport’s we see winners and losers and assume business is that way. If someone wins then someone must lose. Too many sellers go into a transaction with the mindset, it is my company so it is my way or the highway. Strangely enough that mindset introduces risk into the equation. Risk is usually associated with a lower valuation. Unfortunately, for sellers with that mindset buyers have other options and tend to take their moneys somewhere else.

So, what can you as a seller do to make a transaction Win/Win.

1. Know your objective:
Before you decide to sell, get the expertise and advice needed to understand what you are trying to accomplish. The sale of a privately held company is a complicated process requiring knowledge, expertise and strong negotiation skills. Few business owners possess these traits at a level sufficient to complete a transaction. Have your company evaluated and prepared for the process of going to market. Understand,” what is” a fair market value for your company. Understand in advance what is important to a buyer. How they look at your business. Surround yourself with your team of professionals, accountants, attorneys, wealth advisors and M&A advisors before you go to market. Use them to assist you in filling in the gaps in your company. Allow them to do their job.
Remember: Negotiations commenced from a position of knowledge have a greater probability of achieving the desired outcome.

2. Full Disclosure:
Be an open book. If you have prepared your company properly you should be able to provide detailed information that is both accurate and verifiable. Be candid about the strengths and reveal early in the process any weaknesses.

3. Collaborate:
Be collaborative. The best deals are those where buyers and sellers are working together for the greater good. Negotiations about price are certainly a part of all transactions. But once price is established there are many things that can usually be done to facilitate the ease of transition and ensure additional value creation.

In closing, know your objective, be candid about both the strengths and weaknesses of your company and then work collaboratively to facilitate a better outcome.


Management Led Buyout

By George Walden | Oct 23, 2017

Today we will continue our discussion on the different types of buyers for your business. If you have a management team capable of making business decisions and running your company, you might want to consider some form of management buyout. This was first popularized in the 1980’s. Since the existing managers are buying the company, they know the corporate culture and processes. They have the inside scoop on the business and in a transaction there should be, in theory, no learning curve.

Management teams rarely have the ability to fund the buyout through traditional bank financing alone without some outside capital infusion or owner financing. Said another way, the company can only support a fixed amount of debt. That difference between the debt limits of the company and the valuation of the company must be made up with an equity capital infusion. Enter the financial buyer, such as private equity groups and hedge funds. The MBO, like was done in the 1980’s, with a management team receiving a controlling interest in the company, has transitioned.

Today’s most common structures, more of a hybrid, with minority equity interests going to the management team in exchange for continuing to run the company or a buy in at a percentage of the capital structure. Private equity groups and hedge funds often support this type of structure in exchange for the financing and capital needed to underwrite the transaction. The financial group gets a strong operational management team with solid industry knowledge. The management team gets ownership, committed capital and usually, thoughtful oversight with a strategy for future growth.

There can be drawbacks to management led buyout. Not every executive can make the transition from employee to owner, from the managerial mindset to the entrepreneurial. Not every team can handle the risk profile. It is one thing to receive a salary. It is another to take on the debt responsibilities and obligations of ownership. Another conceivable problem is the management team could become a competitor in the deal. This potential conflict of interest could work against the seller and lower the value of the company, even sabotage the deal.

There should always be an M&A adviser investment banker in this type of transaction to litigate the pitfalls. As a rule, having a management team capable of running a company makes a business more valuable to most prospective buyers. This best business practice is a goal owners should strive for.


Generational Family Succession – Mergers & Acquisitions Minute

By George Walden | Oct 17, 2017

Today we’re going to talk about generational family succession. Companies are sometimes passed on to the next generation. They can be the perfect vehicle for continued legacy transition. I grew up in a family business in the plastic extrusion and machining industry. I started working in the business when I was 14 I ran my own shift by the time I was 17. It was how I put myself through college, working four to midnight, and going to school during the day.
I love the business and grow up thinking I would be the owner one day. I went off to finish my master’s degree and when I came back, I found the company had been sold. Not the transition I expected nor wanted. Part of it was because it hadn’t really been discussed, but most of it was because, like most business owners, there was no thought or plan for a transition in place that addressed succession.

According to Forbes only about a third of family business survive the transition to a second generation. Fewer still make it to the third generation. Family business failures can essentially be traced to one factor. According to The Family Business Institute, that is a lack of succession planning.

Here are a couple of points I believe should be considered in evaluating family succession planning. Number one, the transition should be structured in advance and be thought of as a long term process. Just because you were born into a business does not make you the best qualified to run it. Family members should be honestly evaluated just like you would any other employee. Before being considered the recipient of the company, the family members must show a competence worthy of taking over the reins. That not only requires a succession plan but it requires a way to measure family member development and educational needs. This requires time, thoughtful milestones, and key performance indicators.

While it is important to be technically and tactically proficient on how the company operates. Family members also need to demonstrate leadership and managerial skills. If family members aren’t ready to take on all the roles necessary for success, consider outsourcing the gaps and work towards filling the voids through further training, education, or hiring practices.
Number two the company should be purchased by the next generation. The most common mistake I see in this form of transition is not treating the next generation as a true buyer for the company. If you were to ask most next generation family members that question they would unanimously agree the company should be gifted to them. That however does not create wealth for the parents. Family members should be required to buy into the company. They should have skin in the game. There is a place for gifting and the best structure actually has a component of both capital requirements and gifting.

Number three, have a system in place to handle conflicts and additional capital needs. Address in the beginning with a unilateral agreement or pact, how family members are to be treated. Establish for all members the terms and restrictions for a family member to be able to buy in, leverage, or transfer their shares of stock. Rules should be established in the beginning on how conflicts will be resolved.

Finally, establish the compensation and promotion policies of the company for all family members and how distributions will be handled in advance. In closing, transitioning your company to the next generation should be a thoughtful process designed to remove as many risks up front to avoid family conflict. There is nothing wrong with wanting to pass on your legacy to your descendants.


In-between

By Dan Halvorson | Oct 17, 2017
Selling My Business

While a company owner, and before joining CFA, I thought that with regards to an exit strategy it was simply ‘all-or-none’.  That I either retained ownership of my company, and perhaps position it for the next generation, or sell it and walk away.  Unless they’ve taken the time to research this (and surprisingly few have), most owners of lower-middle market companies feel the same way.  This leads to a natural hesitation and, at times, delay in planning their exit until.. Read more »


What is a Strategic Buyer?

By George Walden | Jul 05, 2017

A strategic buyer is typically an operating company that usually has some relationship in the product line or service sector you are in. You would often consider them a competitor, supplier and perhaps even a customer of your company. Bottom line is they usually have strong industry knowledge.

Strategic buyers are looking for synergies or additions. These synergistic benefits are often the motivation behind the acquisition. As a result, valuations can be higher for a strategic buyer, because the synergies created can bring greater returns. There is an expression in my industry, solve a problem for a strategic buyer and the solution can create very different valuation math.

    • 1. Expansion can be vertical, such as acquiring a supplier or customer or
    • 2. Horizontal, expanding in news markets or products.

Strategic acquisitions tend to be accretive. Economies of scale and scope usually come into play in strategic acquisitions.

As I implied during the last M&A minute. The Strategic buyer doesn’t always need your management team, personnel, facilities, or back room services. They often bring their own capabilities to the table. Where there is duplication, those positions, services and processes are often consolidated or eliminated. Their goal is usually one of integration to their existing systems. As a general rule, they tend to be all or nothing in the acquisition meaning they will typically buy only a 100% of the company.

Strategic acquirers are just one of the two primary types of buyers. Next month we will dig deeper into the other primary group and that is Financial buyers.


4 Reasons the Timing is Right to Sell Your Business Now

By Brian Ballo | Jun 30, 2017

Time to sell your businessBusiness owners inquiring whether the timing is right to sell their business, often start by asking: “What are business valuations in the market today?” EBITDA multiples can provide a quick thumbnail answer to this question. However, just focusing on today’s industry numbers, does not wisely evaluate the risk of whether the business will be worth more or less in the future, as compared to selling the business now.

 

Savvy business owners, who are attuned to macro factors impacting business valuations, such as the aging population, financing terms and tax reasons, understand that several conditions exist today, that point to selling your business in 2017. In addition to these macro factors, the question of when to sell your business also depends on the life-stage of the company, as well as compelling personal reasons and family situations.

1. Due to Aging Boomers, the Supply of Businesses for Sale will be Increasing

In 2017, the massive generational shift in wealth is underway, as hordes of boomer business owners are motivated to retire. In the next 5 years, 40% of family-owned businesses in the United States will be sold, due to baby boomer retirements. By 2019, the boomer’s sale of their closely held businesses will create nearly $6 trillion in liquidity.
Most M&A professions view the tidal wave of baby boomer retirements as resulting in a potential glut of businesses coming on the market. This mounting supply of businesses for sale, means downward pressure on valuations for years to come. When that tipping point may occur is not known. What is known, is that every day for the next 12 years, another 10,000 baby boomers will turn 65.

2. Slowly Rising Debt Costs Would Decrease Purchase Prices

How fast interest rates rise will affect the M&A sector. Typically, the London Interbank Offered Rate (LIBOR), which is connected to the Federal Reserve’s short-term rate, determines the debt financing rate. Although the Federal Reserve did not raise rates recently, the consensus is that the Federal Reserve will increase rates sometime in 2017.

A rise in LIBOR would make using debt more expensive when funding an acquisition, resulting in buyers offering to paying less for companies. If rates rise too quickly, business owners may have trouble getting the prices they want.

3. Your Company’s Life-Cycle Timing indicates a Strategic Reason to Sell

Each company has life-cycles, and the challenges of passing to the next developmental stage, can often be strategically improved through a sale or merger. Companies in the initial development and emerging growth stages, require debt and minority equity capital, but, generally, are not good acquisition candidates. On the other hand, companies in later stage growth, that have reach a stable, mature level, or that are declining, are attractive to both strategic corporate acquirers and Private Equity Groups (PEG).

Companies that are earning profits, and that have promising projections for increasing revenues, need financial resources to sustain growth. The right Buyer can provide needed working capital, management expertise, competitive strength, and expansion into new markets. For mature companies, the right Buyer can provide more effective distribution channels, improved operating margins, as well as fresh management, to return the company to growth.

Companies in the declining stage of their life-cycle, typically resulting from owner burn-out, can also be attractive acquisition targets. Corporate and PEG Buyers have the money and other resources needed in order to achieve a turnaround. In addition, the right Buyer provides a renewed sense of direction, while working to solve the reasons for decline, defend the company’s market share, and improve competitive performance.

Unlike the macro factors discussed above, where your company is in its’ life-cycle is specific to your company. Usually the best time to obtain the highest price occurs when sales and earnings are good and trending upward, with a history of good performance. This gives buyer’s confidence in projected future earnings.

4. As an Owner, You have Compelling Personal Reasons to Sell

The emotional bonds of an owner to his business can be strong. In American culture, being an owner is an important part of how we define ourselves, part of our self-image. Ownership provides a general sense of self-esteem, pride, and a feeling of control. As result, for many owners, their business and social lives are interwoven, making letting go of the business, all the more difficult.

However, smart business owners appreciate that businesses are in business to make money, and they view at their companies primarily as assets. With the right investment and tax planning, the proceeds from the sale of the business, can be utilized to achieve retirement goals, and be distributed to heirs pursuant to properly structured trusts. Talk about these issues with your investment banker, wealth manager, attorney, and accountant.

Yet, selling impacts the owner’s lifestyle, as well as the lifestyles of other family members. With work-outs common, the owner will often have to adjust to the more restrictive responsibilities of being an employee of the new owner.
With certain macro conditions pointing towards selling now, do compelling personal reasons also exist for a transition to “life after sale”? Talk about these issues with your spouse, and your family, and then you will be better prepared to decide if the timing is now right to sell your business.


4 Ways to Maximize the Proceeds from the Sale of Your Business

By Brian Ballo | Jun 27, 2017

Naturally, business owners believe that their business can be sold at the higher end of the pricing range. However, an attractive Letter of Intent to purchase a business typically does not come unsolicited. Therefore, to increase the odds of maximizing the price and proceeds from the sale of your business, the following tactical steps can be taken:

1. Focus on Increasing EBITDA

If corporate and private equity group buyers are focused on EBITDA, then you should be also. Cash flow is king. That means, improving your income statement is the best way of maximizing the price at which the business sells.

Owners who have structured business operations to benefit themselves and their families, through above-market salaries or tax treatments, should prepare recasted financial statements to exclude certain perks in order to present the company as a profit-generating engine to potential new owners. Items such as personal expenses, charitable contributions, and significant non-recurring expenses can also be added-back to earnings.

Real EBITDA can be bolstered by focusing on the business’ core competency, or the most profitable income streams, which is also more appealing to a buyer than a company going in many different directions at once. Obtain profit and loss statements by division, or by customer-type, then address weaknesses, before such risks are identified by potential buyers.

Buyers seek a return on investment, and pay a premium for a company with a healthy growth trend. A strong brand, loyal customers, and competitive market positioning, are all attractive. Mitigating risks such as customer concentration and product diversity will also enhance value.

2. Assemble Accurate Financial and Operational information

Buyers pay more when they are comfortable that historical and pro-forma financial statements are accurate. Three years audited financial statements is a best practice, although some buyers may accept reviewed financials instead.
Having updated and accurate financial and operational information will also enable you, as a business owner, to understand and make pre-sale improvements. In addition, good documentation will also permit your advisory team to identify relationships or transactions which could have purchase price implications, such as assets on the balance sheet that have been valued on a historical basis that need to be adjusted to reflect market prices.
The buyer’s due diligence requests are coming. To give the buyer confidence, and to assist your advisors in responding to the buyer’s requests, having accurate financial data assembled, will make the buyer feel he knows what he is getting, and likely result in an increased purchase price. Your investment banker will summarize the company’s numbers and story in an initial Confidential Descriptive Memorandum, then, organize the data in a Virtual Deal Room password protected access.

3. Strengthen the Management Team and Operational Systems

Buyers pay more when they are comfortable that the company’s earnings trend will continue post-transaction. The challenge is that if the seller CEO – who has been making all the key decisions, and has the primary relationships with key customers – will be transitioning out of the business, with part of the purchase price paid an earn-out.

The CEO owner can mitigate the risks to the company, and himself, by strengthening the management team, including, identifying a replacement CEO, who will remain with the company post sale. This way, the existing CEO can move to a less demanding new position, while the probability remains good that projected earnings estimates will be to hit.

Part of improving housekeeping should also focus on systems and procedures, particularly, the information technology network. Outdated technology and processes, will negatively impact value. A good IT system will create the favorable impression that the company is poised to move into the future. The procedures manuals should also be updated, so the buyer is able to operate the business without you.

4. Achieve Teamwork Throughout the Sale Process

Corporate Finance Associates, a major investment banking services firm, works to implement NextStep, a systematic, team-driven, sale of business program, which guides business owners through the process of extracting both themselves and their wealth from the business. CFA approaches exit planning in a systematic way, working as part of a team of advisors to ensure that the process addresses all options, and is focused on pursuing the goals and objectives established by the business owner.

As the investment banker, CFA focuses on creating a competitive bidding environment amongst multiple buyer candidates. The other team member, including a Wealth Advisor, Tax Attorney, and an Accountant, provide expert counsel in their respective disciplines to help ensure the business owner is fully informed as to the merits and demerits of proposed strategies.

An effective team will support the ongoing performance of your company during the sales process. If the owner selects a capable team of advisors, then he can focus on maintaining the financial performance of the company, while the advisory team handles all the details of closing the sale transaction.


“Who Will Buy My Business?”

By George Walden | Jun 22, 2017

Who Will Buy My Business?

As a Merger and Acquisition advisor I am often asked, “Who will buy my business?” As a rule, they fall into two primary generic categories and then several additional categories.

Mergers & Acquisitions Minute #12

A strategic buyer is typically an operating company that usually is competing in the product line or service sector you are in. You would often consider them a competitor, supplier and perhaps even a customer of your company. Bottom line is they usually have strong knowledge of your industry. They are usually looking for synergies or additions.
Strategic buyers don’t always need your management team, facilities, or back room services. They often bring their own capabilities to the table. Their goal is usually one of integration to their existing systems. They tend to be all or nothing in the acquisition meaning they will typically buy only a 100% of the company.

Financials buyers are typically looking for a return on investment. They are not necessarily industry oriented. In fact, they are often industry agnostic. They are usually looking for a stand-alone entity that they can add systems and build on. These financial engineers often use leverage to structure their transactions and place an emphasis on the company’s cash generating capabilities to service debt.
Often they buy additional companies to gain market share, mimicking a strategic buyer, and increase their return when they exist the investment. They are not operators and often want to get behind a management team to protect the operational viability of their investment.

An ESOP (Employee Stock Ownership Plan) is used to provide a market for the shares of a departing owner of a profitable, closely held company. The Company sets up a trust fund for their employees and contributes either cash to buy company stock, contributes shares directly to the plan, or have the plan borrow money to buy shares. There are usually favorable tax consequences to an ESOP benefitting both the owner exiting and for the company continuing forward.
Interestingly, there is a lot of anecdotal evidence that empowering your people often causes better performance of the company accelerating growth and earnings. You should consider an ESOP, when you want your company to continue through your people. When you want your employees to have a long term stake in the company. With an ESOP you can sell any portion of the company you want and even in certain instances retain control.

Sponsor your management team. Consider an MBO, a management lead buyout. If your team is capable and has the in house expertise to run your company, they are a terrific option for selling some or all of your company. The financial community likes nothing better than getting behind a team with a plan.
While traditional bank financing or debt can occasionally be difficult to obtain, private equity groups and seller financing can often bridge the gap and facilitate this form of transition.

Generational transition- I have had the privilege to represent company’s transitioning, by passing the company on to the next generation. They can be the perfect vehicle for continued legacy transition.
However, just because you were born into a business does not make you the best qualified to run it. The most common mistake I see in this form of transition is not treating the next generation as a true buyer for the company. In my opinion there should be an investment into company with the next generation buying their way into the family business.

There are many ways to transition your company when the time to sell occurs. The next few episodes we will dig deeper into what these types of transitions look like and at their individual characteristics.


Avoid the Hazards of Single Suitor Negotiation

By Jeff Wright | Jun 20, 2017

Here is an issue we see all the time. A company owner gets an attractive “offer” lobbed over the transom. He’s flattered, intrigued. He’s been thinking of scaling back, maybe even selling the business and this top dollar overture has his attention. He starts to invest in the possibility and decides there is no harm in taking a meeting. This sounds like a path to a big payday and happy outcome. Right? Well, probably not.

There is a saying in our business that “one buyer is no buyer.” And while that’s a bit black and white, it does reflect the importance that we as M&A Advisors place on having multiple buyers and competition.

Back to our company owner. He meets with this suitor. He shares financials and other information. He’s getting hooked into a process and invested in an outcome. The potential buyer asks for an exclusivity period. They ask for more and more information. Our seller has now invested significant time and psychic energy in this process. The buyer finds some dings in the business and begins to adjust the price (really, downward is the only direction the price goes in situations like this). Even after many months of this cycle of information requests and price reduction, our owner is reluctant to give up, given all work and hope he has into this. Most of the leverage is with the buyer, little with the seller.

Oh, the owner has also taken his eye off the business and performance is slipping.

In our experience, most situations like this never close, waste a lot of time and may even taint the company for future sale opportunities. We believe that receiving an attractive “offer” is the perfect time for an owner to take a step back and get some professional help. Strategic and financial buyers know how to buy companies. They have teams of experts. They love the opportunity to scoop up acquisitions without competition. The playing field is lopsided in their favor as most company owners have never sold a business and when they do, it will be a “first time/last time transaction involving their biggest asset.

At CFA, our mission is to work with company owners to see that they are fairly paid for their lifetime of work, the value they have created and the risks they have taken. Hiring CFA does several things to advance this cause.

  • We bring competition to the table. With our contacts and research, we can invariably find multiple qualified buyers that will be competitive on price and terms, and do so confidentially.
  • We create a sense of urgency, keeping all buyers on a tight timeline simultaneously throughout the process.
  • The owner can focus on the company’s performance as we manage the process and interactions with buyers.
  • Valuation can be driven UP, because we don’t put a price on the company. We let the buyers do that, and drive up valuation in an auction with each other.
  • Owners have an M&A expert on their side to help structure an advantageous transaction and navigate the numerous deal traps in the definitive agreements (escrows, indemnities, working capital adjustments, consulting agreements, earn-outs, etc.)

Buyers are particularly aggressive right now, with trillions of dollars to deploy and a limited supply of sellers in the market. Buyers are contacting owners directly more than ever with enticing “offers.” We advise owners to use this sellers’ market to their advantage and hire an M&A expert to help them achieve a high value and expeditious transaction.