Exit and Growth Strategies for Middle Market Businesses

Archive for the ‘Corporate Finance’ Category

We Have No Debt

By Dan Vermeire | Apr 30, 2019

We Have No Debt. I hear this from some business owners, early in our first meeting.

It seems “Debt” has a bad reputation. As a family-owned business, “no debt” may sound like a stronger company. But, things are quite different when you consider a growth opportunity, or a transaction for the business. The fact is, debt should not be feared – it is fundamental in financial engineering – because it greatly increases the rate of return on the equity investments. Here’s what you should know about debt.

Different Types of Capital– a business should layer different types of investment in the capital stack, some layers are debt and some are equity. Why? Because each type has a different level of risk vs. return. So, to be most efficient, the company can be structured with the cheapest capital first, then the more expensive capital is used later. Of course, the company can only handle so much debt, and that is easily analyzed in the cash flow models. Here are the basic layers:

  • Senior debt, or “bank debt” is typically the cheapest, today around 5%. It is secured against assets and may involve a personal guarantee. It amortizes monthly, that is, you pay against the principal and interest monthly.
  • Sub-debt, or Mezzanine debt, is more flexible, but more expensive, today around 10-12% interest. Some Mezz debt may include warrants on stock as a sweetener. This type of debt is subordinate to any senior debt and is generally not secured by assets. The good news is that it is not paid monthly, and often, the interest is just rolled into the note – that means there is little or no strain on the monthly cash flow. This type of debt behaves very much like an equity investment in that it is paid when the business has the cash, typically when the business is bigger, in a future sale. The Mezz investor’s return is capped at the interest rate, and may be less than the equity return. But, the Mezz investor will get paid before any equity gets paid.
  • Preferred stock may be used and it behaves very much like Mezz debt. Typically there is an interest payment, which may be rolled into the stock, and it may have a feature to convert to common stock. Even though it has “stock” in its name, it behaves like debt.
  • Equity – last in the capital stack is equity, which is cash invested by the buyer. Today, most buyers expect 15-20% return on their equity investment, which is down significantly from prior years, because of the competitive nature of the M&A market. As you would expect, the equity does not have any returns, unless the company has paid off the debt and can declare a dividend, or in the case of a sale of the business. Equity can have an unlimited return – if the company sells for greater value, the equity holders reap the benefits. However, the equity investment is not secured and could be entirely at risk.

As you can see from the list above, only the senior debt is a burden to the company’s monthly cash flow. The rest can be viewed as different forms of “partner-investors” in the business. They win, to different degrees, as the business does well. And they can lose, to different degrees, if the business does poorly. Industry reports show that the average level of debt for transactions during 2018, on companies of $20M to $50M in valuation, was 3.9 times EBITDA. Most valuations are 6-8 times EBITDA, so you can see that some form of debt generally accounts for more than half of the capital stack.

The return for the different layers of capital can be illustrated this way. Think about a company that is valued at $30M, and is capitalized in 3 equal parts, $10M each of senior debt at 5%, Mezz debt at 10% and the rest in equity. Five years in the future, the business has paid the senior debt and sells for $36M, a modest 20% increase in value.
But how is that 20% return divided between each layer, per year? It would be: Senior 5%, Mezz 10%, and Equity about 40%. Which would you prefer?

Seller’s Options – in a business transaction, the seller also can participate in the new capital stack. In many deals, if the seller is not quite sure what he’ll do with all the proceeds, then he may consider the option to partially finance the transaction with a seller note, very similar to being a provider of Mezz debt. This may provide better returns than other investment options he is considering, post transaction.

Perhaps more importantly, the seller may choose to “rollover” some equity into the new capital stack. The rollover investment is done at the leveraged cost of equity, meaning after the debt is applied. In this case, the new debt is your friend, because you buy equity in the company at a discounted rate. For example, if the value of the company is $50M, that is what you would receive. If the buyers use $30M leverage, in a combination of senior and Mezz debt, then the new equity value is $20M. Then, you may choose to buy back in 30% of the equity, which would cost $6M at the leveraged rate, so your net proceeds would be $44M. Without any debt in the transaction, then 30% would cost $15M, and your net proceeds would be $35M, a difference of $9M to you.

In summary – don’t fear the name “debt”. Not all debt instruments are the same, and most don’t affect the monthly cash flow. How do you avoid any risk? By understanding the different types of debt and using them wisely, especially with a conservative cash flow model. Any good investment banker can work through the details with you.

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.

Tax Changes for M&A

By George Walden | May 30, 2018

It is that time of year, tax season is upon us and certainly on our minds. So how will the new 2017 Tax Reform Act affect M and A transactions?

I realize that taxes are not a subject that stimulates most people, but I’m certainly excited about what these changes mean for mergers and acquisitions. As you might guess, the most important change was the permanent reduction of the corporate tax rate from a graduated top rate of 35% to a flat, fixed rate of 21%. Additionally, the Alternative Minimum Tax was repealed.

These changes let companies control more of their earnings allowing them to potentially provide higher dividends to their shareholders, reinvest in capital assets and, of course, have available more money to purchase other companies.

Another important feature of the 27 Tax Reform Act is in many instances it diminishes the impact of double taxation on earnings and gains to shareholders. The act also extends the bonus depreciation rule to allow tax payers to deduct as much as 100% of the cost of most tangible assets such as machinery and equipment. This would allow the company to purchase new or used assets and fast track the write off. This does not apply to real estate and a couple of other asset categories.

For purchasers of companies, this means increased accelerated deductions. For sellers, exposure to increased depreciation recapture. The thought process is this type of deduction should cause an increase of asset transactions versus stock transaction for the buying market.


By George Walden | Apr 26, 2018

I’m going to talk about ESOP’s as a potential structure to be used by a business owner trying to sell his business. Why would you look at an ESOP, otherwise known as an employee stock ownership plan? Two major reasons.

One, legacy for your employees. Strategic and financial buyers often look to move businesses to make them more synergistic with other investments they have. If you form an ESOP, the company stays there, all those jobs stay there. All those people that helped you build that business, stayed there. Also there’s some empirical evidence that shows that employee owned companies do better and there’s fewer layoffs during recessions.

On a tax basis, the ESOP is a tax exempt entity. Therefore, no taxes are paid on the earnings that are generated through the company. This gives the company a significant advantage in terms of its cost of capital as it builds, as it builds its business going forward. Sellers can take advantage of certain other tax opportunities, such as a 1042 Exchange. So, from a ownership perspective, is something to really be considered. Particularly, if the business is a professional service business or has a specific contract with some vendor that they have to keep.

Why do you need to call an M&A Advisor?

By George Walden | Apr 16, 2018


Why do you need to call an M&A advisor when you get approached by a buyer?

There is a rule of thumb in my industry that I absolutely believe in. Your deal never, never, never gets worse with competition and I would submit, it never gets worse with good advisory. You would never want just one buyer for your house and believe for a minute that you were getting the highest value for your home. The same holds true for your business.

Think about it, just letting the buyer know you have an M&A advisor lets them know you have the potential for competition. If the buyer doesn’t deal fairly, you will have an advocate telling you this is not market and you can do better. Remember, the buyer will have their team. They will always be dealing from a position of knowledge and strength.

You have no idea how often we get told by buyers, we don’t like auctioned transactions. Why do you think they say that? They don’t like them because they usually have to pay more.

Here are just three of many reasons to get active advisory advice.

1. The clock is running: Another saying in my industry is “Time kills all deals”. Make sure the buyer has a sense of urgency. To many things can go wrong in a transaction that takes too much time. One common problem is your response to information requests may be taking too long, after all you have never done this before, and it makes you look like you don’t know what you are doing. Lack of preparation can may you look weaker as an owner. With too much time market conditions could change. If the business is starting to decline or the industry is capping or beginning a downturn all can affect the company valuation.

2. Advocacy: Having someone on your side in the promoting, negotiating and deal structure that understands what is current market, is very valuable. Coordinating the different offers and their variances can mean the difference between success and valuable dollars left on the table. The deal process, documentation, due diligence, legal issues, accounting issues, banking issues etc. can be very time consuming and grinding. This is at a time when you need to be focused on your business and performing to expectations. Many deal valuations go south due to the owner taking their eyes off the ball. What do you think happens to your valuation when the sales start to slip? I have never seen an owner told, we will pay you more because your business is not being managed correctly. Having an advisor who can act as your advocate and offload many of those issues, can be a very strong negotiating tool.

3. Expertise: Remember negotiations from a position of knowledge have a greater chance of success. The sale of a privately held company is a sophisticated process requiring knowledge, expertise and strong negotiation skills. Few business owners possess these traits at a level sufficient to complete a transaction.

In closing, while there are many good reasons for seeking an M&A advisor in a transaction, getting additional expertise, advocacy and creating a sense of urgency will improve your chances of success.

Interest Rates

By David Sinyard | Apr 09, 2018

The fed funds rates continue to increase. Two more increases are expected this year. When the fed raises rates, banks raise the prime rate and the result is an increased cost to borrowers, both consumer and corporate. Short term treasury rates have increased as well.

So what do higher rates in the US mean? Typically, the expected result is a stronger dollar. One might reasonably wonder, however, why higher U.S. market rates have not provided more support to the dollar. That is not occurring. Why? Because this time higher rates in the United States mean higher rates in the rest of the world, too. This is very clearly seen in the LIBOR markets where the spread between LIBOR (London Interbank Offered Rate) and the OIS (Overnight Index Swap) has increased significantly to levels last seen during the financial crisis of 2008. Why? The impact of the new tax laws is forcing repatriation of US dollars. Historically, they would buy treasury bills, commercial paper and bank CDs. Now the money is coming back to the US to pay taxes. The result is a significant reduction in the demand for short-term treasuries, which in turn will push rates higher.

“In Selling Your Business, It’s Not What You Get, It’s What You Keep”

By Jim Gerberman | Nov 29, 2017

After defeating the Romans in southern Italy at the Battle of Asculum in 279 BC, King Pyrrhus of Epirus, whose invading army had suffered irreplaceable casualties, responded to congratulations by saying: “If we are victorious in one more battle with the Romans, we shall be utterly ruined.” To this day, the phrase “Pyrrhic victory” has been used in business, sports, politics, warfare and other settings as an analogy for victories that come at a great cost. Winning the battle- but, losing the war.

Like many business owners, you’ve built a very nice business that has provided a great lifestyle. You’ve set the direction, funded the growth, shouldered the risk. However, in order to pursue further growth, you’ll need to spend more and assume additional risk. Through the value that you’ve built, your net worth is considerable but your assets are not very liquid. Whether you’re contemplating taking a few chips off the table by selling a piece of the business, transferring ownership to employees, your children or your partner, or selling outright to a third party, the associated transaction may likely result in your future livelihood being supported by the proceeds (what you keep) from the transaction.

Starting with the end in mind, it’s important for you and your trusted advisor team to understand what a successful outcome looks like.

  • What proceeds do you need in order to have the lifestyle you desire?
  • What role in the business do you prefer going forward?
  • What kind of acquirer(s) will need or want what you have?

An earlier article about Business Readiness® describes how to prepare both you and your business to optimize that outcome. By starting early in putting together your team of trusted advisors and by addressing and mitigating those areas of risk that will devalue your business in the eyes of a potential buyer, you set the stage for achieving a successful outcome. More importantly, you set the stage for dealing with the vicissitudes and uncertainties that occur along the path. Inevitably, things happen that can potentially derail the best of plans. As the boxer Mike Tyson has been known to say “Everyone has a plan until they get punched in the mouth”. It’s important for you and your team to know what battles are worth winning- more so than attempting to win every battle (especially those that come at a great cost).

Back to “what you keep”. Too many business owners define their desired outcome in terms of the “selling price”. Even worse, their idea of the right selling price may be influenced by something they’ve heard from a colleague who sold their business, the sentimental value that naturally derives from years of sweat equity, or based upon some other form of intrinsic value that they’ve developed…is it realistic? Will this provide what I need? If not, we have work to do. We need to begin with realistic expectations about the value that the market will place on the business. We also need to understand that there are many aspects (not related to the selling price) that can add to or erode your proceeds from a transaction. Some examples:

  • Deal structure, timing and basis of payments
  • Structure and basis of contingent payouts
  • Holdbacks, escrows, assumed liabilities
  • Working capital adjustments
  • Key people retention
  • Where applicable, taking advantage of gifting or other tax benefits…well ahead of initiating any process leading to a transaction

Which battles are worth fighting? To be clear, you do not need to win every battle to come out well ahead- particularly if the transaction is one where you as the selling business owner will now have a new financial and operational partner while remaining in a leadership role with the business going forward- either in a short, defined transition period or as a co-investing minority shareholder as described in a 2-step or “second-bite of the apple” process. As advocates for your cause, your trusted advisor team can help you make informed decisions about what to fight for…and how- achieving the results you desire while preserving important relationships. In the spirit of the early 20th century Italian diplomat and author- Daniele Varè, “Diplomacy is letting others have your way.”

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.


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 »