Q2 2018 M&A Update: Selling an Austin Icon, A Case Study

Selling an Austin Business

Back in 2005, our firm was engaged by the founder of a well-known Austin business that had been in existence for over 30 years. The company had revenue in excess of $10,000,000, an established brand, and a total of 75 employees. They had been very profitable, debt free, and the owner (then 70) owned the building and production yard. The general manager wanted to retire, and would remain with the business until it was sold, but this situation triggered the owner’s desire to sell.

We prepared a valuation analysis using the three approaches to value and methodology that were appropriate for this industry and size of business. Unfortunately, the seller’s valuation expectations were above the value range we suggested. His contention was that 30 years of consistent advertising had resulted in significant brand recognition in the marketplace, which should support a “goodwill” value in excess of our valuation. 

While we agreed with that statement, the fact is that valuation of this size and type of business was primarily based upon revenue and earnings. There was no trademark, patent, or other intellectual property, just a great reputation that allowed him to charge a premium above his competitors. That premium was reflected in the earnings of the business, and the valuation was well in excess of the asset value, so there was a significant goodwill component to the value we had computed.

The only hurdle was that this business was a C corporation, and most buyers wish to buy the operating assets of a business versus the stock. We prepared a Confidential Business Review and began marketing the business at the asking price suggested by the seller. The economy was robust, so as earnings were increasing so was the value, and we believed that we could eventually find the right buyer who would want to acquire the business. About seven months into the engagement, we received a reasonable offer for the business. We negotiated the price and terms of the transaction, the parties came to an agreement and we had a signed Letter of Intent (LOI) on a Friday.

Addressing the Four Fears of the Business Seller

However, on Monday, our client called and said he needed to come by the office. He arrived and quickly stated that he needed to “cancel the LOI” and keep running the business. After a few minutes of discussion, he agreed to think about that decision for a couple of days before we informed the buyer. On Thursday, he said he had changed his mind and he wanted to proceed with the LOI and the transaction. The following Monday he called and came by again, this time set on cancelling the LOI. We had a meeting with the buyer and our client explained that he was just not ready to sell, so we terminated the LOI. We let things quiet down for a couple of weeks, and then set up a meeting to discuss the change of heart.

In that meeting, we discussed what we call “The Four Fears of the Business Seller.”

  • I am going to run out of money before I die. We suggest you meet with a financial planner, and have them prepare a financial plan that provides the answer to that question, and peace of mind.
  • I don’t know what I will do after I sell my company. I don’t play golf, fish or hunt, and I worry I will be bored after the sale.
  • I will not be president of XYZ Company, with 75 people reporting to me, and so will lose my personal esteem.
  • I didn’t receive Fair Market Value for my business.

We took a break for a month, to let the seller address some of these fears, then resumed marketing the business. With the increase in earnings, we found a smart buyer who actually determined that buying the stock of the business at asking price was a wise financial move given that the corporation had no debt. Our seller had audited financial statements, so due diligence went smoothly and all parties were happy with the transaction.

The lesson from this transaction was that a business owner really needs to be comfortable with their exit plan prior to going to market. While this seller’s transaction went well, even at 70 he was having second thoughts as he didn’t have his plan firmly in place. The sale of the business is such an emotionally charged process for many owners that there is quite often a moment when they question the transaction.

The ebb and flow of selling a business can create a significant amount of anxiety and uncertainty for all those involved. Each transaction uncovers its own unique challenges, and part of being a trusted intermediary involves being proactive and effectively navigating through multiple road blocks to achieve our client’s objective. Selling a company is a transfer of assets. Selling your passion is a transfer of emotions.

Ten Ways to Maximize the Value of Your Business

Maximize the Value of Your Business

Achieving the maximum value for the business when it sells is the goal of every business owner.

A business has value when it can exist separately and apart from its owners, when it has taken on a structure and culture of its own, or where there are processes, methods, products, property rights or anything else that allows the business to continue as its own entity. 

These ten ideas can help you determine if you are on the right track: 

1. Develop a strong, stable management team 

A business with a strong management team, allowing for key activities to operate independent of the owner, will command a higher price. The depth and stability of the management team are extremely important factors in the valuation analysis by a buyer. In many businesses, sales and marketing may be very dependent upon the owner, and this can be a significant value detractor. If most of the key account relationships reside with the owner, buyers will factor this risk into the valuation or the deal structure. Part of the price may become contingent upon the owner remaining with the business to maintain continuing customer relationships. 

2. Demonstrate sustainability of earnings 

Revenue and earnings that have been steadily growing over several years, versus earnings that fluctuate dramatically, will drive a higher valuation. Year over year growth demonstrates a solid operation that is gaining new customers and/or market share. Dramatic fluctuations in revenue typically indicate that either product demand may be subject to outside factors, or the business has experienced problems, indicating management is not stable. It makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics, increased demand for the company’s products, new product lines, market plans, growth through acquisition, and expansion through augmenting territory, product lines, manufacturing capacity, etc. 

3. Develop systems and procedures 

A business must exist separate and apart from the daily actions of its owner to have a valuation, including goodwill, over and above the asset valuation. An owner who takes a week off at least one or two times per year, is exhibiting confidence in the systems and procedures of the business to function while they are away. If the owner is seldom or never away from the business for any length of time, buyers will question the strength of the operating systems, and the management team. The amount of goodwill that a buyer is willing to include in the purchase price will be dependent upon systems and procedures. 

4. Maintain excellent financial records 

Sloppy financials are a worry for both buyers and lenders. Valuation will be based primarily upon the numbers and the more reliable the financial statements, the more chance they will hold up in due diligence. If your business has revenue in excess of $10,000,000, audited financials will be worth the investment. In the absence of audited financials, reviewed financials are preferable over internal financials, as the presentation, account classifications, footnotes, and organization of the statements, in general, will be much more professional than internally prepared financials. 

5. Minimize personal expenses paid by the business 

When the financials are “clean,” with very few “add backs” related to owner’s personal expenses paid through the business, buyers and lenders believe the numbers are more credible. Asking a buyer to believe that various expenses that have been paid by the company are in fact “not necessary” for the business creates uncertainty. Uncertainty is the enemy of a successful sale transaction. When the EBITDA computation is partially based on excessive “add backs” to earnings, the seller will be hard pressed to obtain a favorable valuation. 

6. Transition Planning 

When a seller has a definite plan to “phase out” of the operation, whether that is over one year, or three to five years, the buyer recognizes that sound planning has occurred. The process of developing this transition plan will often generate excellent suggestions for improvement in management’s role in the everyday operations of the business. Many sellers begin to outline their “job description” as part of this process, which highlights areas where there is a need to delegate more to the management team. Quite often this activity will result in improvements to the organization structure of the business and produce tangible benefits. 

7. Diversified Customer Base 

Customer concentration is a significant value detractor. When the revenue from any one customer accounts for over 20-25% of the total revenue of the business, the business will be valued at a discount. Losing 20-25% of revenue in most businesses will typically wipe out most or all of the profit of the operation, so this risk may not be ignored. When the buyer’s valuation is prepared, and this risk is factored into the valuation analysis, the goodwill included in the valuation of the business will be dramatically altered. Working to diversify the customer base will result in significant increases in the value of the business. 

8. Solid Reputation in the Marketplace 

Business acquirers are constantly searching for the leading business in the industry and many sellers refer to their business as an “industry leader”. Savvy buyers can mine the internet for information about what customers actually think about most businesses. It is very easy for buyers to access multiple websites that give “feedback” from customers about businesses; buyers will attend trade shows, industry conferences, and multiple other events, quietly asking competitors and suppliers about a company, using multiple techniques to determine what customers think about a business. 

9. Diversified Base of Suppliers 

A very narrow base of suppliers, or extreme dependence upon one supplier, may cause a decrease in valuation. Many business owners routinely buy from multiple sources; just to manage the risk that one supplier may experience shortages or interruptions in supply. This extends to the labor pool as well, if the business needs specialized skills, such as in healthcare. “What happens if…” is a typical question a buyer may ask – and many sellers do not have a ready answer for that question. 

10. Stable Facility of Operations 

A business may or may not be dependent upon its location, but a buyer will not want to take the risk of moving the business right after the purchase. The business should have the right to remain in their current facility for at least 3 – 5 years through an existing lease, or ownership of the building. The location may be critical to a retail operation or restaurant, but also important to a wholesale or manufacturing operation. Many times key employees live close by, and the buyer having to relocate the business may place loyal employees in peril. If the lease is about to expire, and the buyer will have to renegotiate the lease right after closing, this situation creates uncertainty, which reduces the valuation. Lease options are an excellent method to remove this uncertainty, whereby the business has the right, but not the obligation to extend their lease beyond the current term. 

Q1 2018 M&A Update: How the Tax Cuts and Jobs Act Will Impact Private Company Valuations

Business owners have been asking how the new Tax Cuts and Jobs Act (TCJA) will impact private company valuations. CPA’s, attorneys, and business valuation experts have composed analyses, and we will summarize the significant areas that impact our clients – the owners of privately held businesses.

In general, most businesses will pay less in federal income tax due to lower tax rates beginning in 2018, which translates into higher after-tax profits and after-tax cash flow. As businesses are typically valued using EBITDA, which is computed “pre-tax”, most of the valuation methods would not change. However, one valuation method, Discounted Cash Flow, would be affected.  Those businesses that are primarily valued using this method could experience an increase in value, although in most cases, not as much as one might think. In any case, we would not anticipate changes in the tax law to have a significant impact on transaction valuations.

When valuing a private business, experts must consider the economic conditions, industry trends, and regulatory environment that exist on the valuation date. In addition, the access to and cost of capital for a transaction, consisting of debt and equity weigh heavily into the equation. Currently, the market is very strong, and debt is relatively inexpensive, so that component of the equation is favorable. For the purpose of this discussion, we will limit the valuation impacts to those affecting the value of an enterprise stated on a “cash free” and “debt-free” basis.

Discounted Cash Flow (DCF) method and weighted cost of capital (WACC)

The most notable impact will pertain to the Discounted Cash Flow (DCF) method of valuation and on the computation of the weighted average cost of capital (WACC). Free cash flow for a “C” corporation specifically will increase by the reduction in the tax rate from 35% to 21% - which computes to a 40% reduction in the rate. While EBITDA is computed by adding back depreciation and taxes to net income, taxes paid must be deducted from EBITDA when forecasting free cash flow in a DCF computation. This means that with taxes reduced, future cash flows will increase. While depreciation is added back, capital expenditures are deducted from future free cash flow. However, the new tax law contains enhanced depreciation tax breaks, which will typically be used by businesses to take advantage of growth opportunities and increase future cash flow. The amount of this increase cannot be estimated in the DCF analysis.

The next variable which affects DCF valuation is the weighted cost of capital (WACC), which is impacted by both the cost of equity and the cost of debt. The after-tax cost of debt is computed by deducting the tax savings from the interest paid, so lowering the tax rate actually raises the cost of debt component of WACC. While the new law includes a limitation on the amount of interest that can be deducted for taxes, companies with less than $25million in revenue are exempt from the interest expense limitation. The pre-tax cost of debt is generally less expensive than the cost of equity, so the mix of debt to equity on future estimated cash flow will affect the DCF valuation also. While the future cash flow and the cost of debt will both increase with the new tax law, it is generally true that valuations using the DCF method should increase based upon the new tax law.

The effect on the market approach for private companies is more difficult to estimate, as this method relies on actual transaction history, and there is very little transaction history post passage in 2018. A general statement is that there should be some positive impact, as buyers are buying the future, and the tax law will lower taxes on “C” corporations, and certain types of pass-through entities.

If all else remains constant in the business, the new tax laws should have a positive impact on valuations, although the amount is difficult to determine. However, a business with demonstrated growth opportunities, a solid management team, and consistent profits will still command the most interest from acquirers, regardless of changes in tax laws. For additional information on the valuation of closely held businesses, please contact the professionals at Corporate Investment.


Build to Sell

You, as a business owner, should have the goal of creating the most value possible in your business. Likewise, an owner should be thinking about their exit strategy from the day they start or acquire the business.

As a wise business owner you will build to sell and time your exit to coincide with the most value created in your business. The psychology involved is much like selling in the stock market – the time to sell is when things are going great, not when they are spiraling downward.

Your business has value when it can exist separately and apart from its owners, when it has taken on a structure and culture of its own, or where there are processes, methods, products, property rights or anything else that allows the business to continue as a going concern as its own entity.

Other things you can do to increase value are: Make certain you have verifiable cash flow. The more cash the business can prove that it generates annually, the more value your business will have to a buyer. That means keeping accurate financial records in the business that can be verified during the due diligence part of the business sale process.

If your business has a history of sustained annual growth it will have increased value to a buyer. If your company is growing profitably at very strong, consistent rates of growth and you can accurately project those rates to continue or even increase in the future, then you have created a lot of value in your business. Likewise, if your company is perceived as recession resistant and you can show years where you have not only weathered a bad economy but have actually grown during troubled times, then you have created more value for a buyer.

Your reputation and image in the marketplace also create value. If you have branded your company and it is recognized and well spoken of in the community then you have added value to your sale. Along with a great reputation you should naturally have customer loyalty with many continuing customers. This gives a buyer comfort that the business will continue to have revenue from customers after the sale and this certainty adds value for the buyer.

You will add value to your company if your customer base is diverse. Buyers are fearful of one giant customer controlling much of the company revenue because there is great risk to the buyer should that one large customer take their business elsewhere after the sale. You should mitigate this concern by adding numerous customers and working to lower the percentage that any one customer controls of the company’s revenue.

Your operational policies and procedures can add value to the business if they are well-conceived and provide a good roadmap to operating your business for new employees and new business owners. That means you should have good systems in place and provide logical training that gets people up to speed quickly when taking on new tasks or business operations.

By hiring and retaining great people in your business you can add much value. The more management depth and breadth that exists in the business, the more valuable the business is to a buyer.

Your market size and penetration rate also affects your business value. Buyers want significant upside potential so the larger the market the greater the value. Also, if the buyer perceives an  ability to obtain a higher penetration into the market after the sale,  the value of the acquisition increases.  

It is also useful to look at what decreases value in order to avoid certain pitfalls. For instance, worn out assets are not desirable to the acquirer. Another value detractor is earnings that are unpredictable, rising and falling drastically from year-to-year. This uncertainty will give a buyer concern and lower the value of your company, as well as the ability to finance the acquisition. If your revenue and profits are descending instead of ascending, the value of your business is declining as well.

A business owner should develop a realistic expectation of the value of the business as it relates to the earnings. Earnings drive value and they must support the price of the business.

You want to create value above and beyond just the value of the tangible assets of the business. This value is referred  to as the goodwill of your business and can include many things such as: your customer relationships, advertising campaigns and marketing materials, computer databases, contracts, training procedures, trademarks, copyrights, trade secrets, supplier list, management, tooling, name recognition, location, reputation, delivery systems, proprietary designs,  loyal customer base, low employee turnover, know-how, credit files, favorable financing, employee manual, procedures and policy manual, skilled employees, technologically advanced equipment, and favorable comparison to industry ratio’s to name a few items considered as part of goodwill. We sometimes refer to these assets as “Phantom Assets” because they tend to be hidden and must be uncovered when analyzing the value of your business. Some of the items in the list simply add value to your business while others are actually considered intangible assets applicable to Code Section 197 of the IRS – Amortization of Goodwill and Certain other Intangibles.

At Corporate Investment, our grasp of intangible elements as well as our thorough analysis of your historical financial performance enables us to fairly value your business in the current marketplace.

Understanding what creates value, and how to present those items in a positive manner, is the role of the intermediary. When you have built a significant amount of value into your business and are ready to proceed with the sale,  the professionals at Corporate Investment stand ready to assist in this complex marketing, financial and legal transaction. 

A Race Against Time: Exit Planning

Successful, active business owners seldom slow down. Many business owners are both great at planning (for their businesses) and terrible at planning (for themselves).  There are so many great business challenges to tackle, planning for your personal ownership future can get pushed to the back burner.  We all know that the only things likely to reduce your pace are death or terminal burn-out. This is not to imply that you are not well intentioned; quite the contrary. You may be so well intentioned that you’ve taken on more responsibility than you can possibly complete.

Today, our goal is not to alter the number of hours in your workday but to alter your mindset. To do that, let’s look at a fictional business owner.

Renaldo LeMond owned a growing hospitality services business. As business increased, he hired more employees and learned to delegate. Both these improvements freed up time to sell more, to manage more, and to grow the business more.

No matter how much Renaldo delegated, there were always additional tasks and new priorities. Renaldo’s daily activities left no time to plan. Even if he had had the time, Renaldo really didn’t know how to create a plan founded on a clear vision, backed by definite plans that created definable steps subject to deadlines and accountability.

This was Renaldo’s situation when he was approached by a would-be buyer for his business. Renaldo hadn’t actively considered selling his business, but at age 49, he was beginning to think that life after work might have something to offer. He was open to talking about and exploring the idea of selling his business because business growth, and more importantly, profitability, had been slowing for years.

Renaldo found an hour in his schedule to talk to the interested buyer. In only 60 minutes, Renaldo’s blinders were removed and his priorities were turned upside-down.
The buyer turned out to be a large national company seeking to establish a presence in Renaldo’s community. It was interested in Renaldo’s business because of its reputation as well as its broad and diversified customer base. The buyer was looking to acquire a business that could grow with little other than financial support.

Naturally, it sought a business with a good management structure because, like most buyers, it did not have its own management team to place in the business. Renaldo, however, had not attracted or retained solid management (nor had he created a plan to do so). His business lacked this most basic Value Driver.

Like many buyers, this buyer also looked for two additional Value Drivers: increasing cash flow and sustainable systems throughout the organization (from Human Resources to marketing and sales to work flow). Renaldo quickly realized that his business was a hodgepodge of separate systems each created to patch a particular problem.

Finally, the buyer asked Renaldo to describe his plans for growing the business. Renaldo had none. What this buyer and Renaldo now understood was that this business revolved around Renaldo.

As Renaldo left the meeting, he expected that, given his company’s deficiencies, he would receive a low offer from the buyer. He waited weeks but no low offer was forthcoming. In fact, the buyer simply disappeared.

The message to all of us is clear: Unless a business is ready to be sold, many buyers, especially financial buyers, are not interested. They have neither the time nor the in-house talent to correct deficiencies. The look for (and pay top dollar for) businesses that are poised for ownership transition.

It is a fact of life for owners that unless you work on your business, rather than in your business, you will never find time to plan for your future and for the future of the business.

Is there a way to change your priorities before your 60 minutes with a prospective buyer? Of course. You simply acquire new knowledge (about Exit Planning) and apply it to your life.

Exit Planning requires time: time not only to create the plan but also time to implement it and to achieve measurable results. That timeline may be considerably longer than you anticipate because, in creating an Exit Plan, you need to rely on others who are also busy (minimally an attorney, CPA, and financial planning professional). Additionally, you can not anticipate all of the issues that might arise, and it is unlikely that everyone you work with is as motivated or experienced as you are. Finally, and inevitably, not everything will go as planned.

Exit Planning encompasses all sorts of planning: your growth, strategic, tactical and ownership succession planning for your business, as well as your personal financial, and estate planning. By wrapping business, estate, and personal (or family) planning into one process, Exit Planning is all-encompassing rather than a subset of the planning that you are sure you will one day undertake. In short, there is much to do.

It may be helpful here to recognize that planning, properly undertaken, can help enrich your business as well as your personal life. According to Brian Tracy, "A clear vision, backed by definite plans, gives you a tremendous feeling of confidence and personal power." And, in the case of Exit Planning, it works, too. Find out more about exit planning.

The example provided is hypothetical and for illustrative purposes only. It includes fictitious names and does not represent any particular person or entity. Copyright © 2016 Business Enterprise Institute, Inc., All rights reserved.

Providing Due Diligence

As a business owner your main function is to keep your business running profitably.  However, when an offer is made and accepted through a letter of intent for the purchase of your business, another priority is established – providing due diligence information to the prospective buyer.

You, as the business owner, want to have a team assembled who are competent and knowledgeable professionals familiar with the process of selling a business.  Your accountant/CPA, transaction attorney (not the guy that handled your brother’s divorce), financial advisor and professional business broker (preferably with the designations of BCB - Board Certified Broker and CBI - Certified Business Intermediary) are the team members you want assisting you.

Your professional business broker should be the “quarterback” in controlling and managing the tasks that others are performing in the due diligence process.  The broker will prepare a timeline with milestones that should be part of the letter of intent.  The timeline should be adhered to if at all possible.  Time is a killer in business sale transactions. 

It is to your benefit to have as much due diligence information and documents available as possible prior to the start of the process. Again, time is a killer in deals and you don’t want your slow response to seem as an indication of not wanting to complete the due diligence list.

What will a prospective buyer want to see before they complete the purchase of your business?  Due diligence check lists can consist of one page of information developed by an individual buyer or 30 pages from a private equity group or corporate entity.

Each deal varies, but at a minimum tax returns for at least the last three years as well as the profit and loss statements that were used in preparing the tax returns. Customer lists, vendor contacts and when to meet key employees must be managed carefully.

Your professional business broker will also be in a better position to advise you on when, what kind and how much information to release.  Some buyers find a boilerplate list of due diligence items on a web site. Your broker can remind them that some information is not pertinent to a business like yours. 

“Year to date” profit and loss statements will be expected as well as an up to date balance sheet for the most recent reporting period.

It is best to disclose early any potential “red flag” problem(s).  Pending litigation, outstanding liens or judgments, major personnel problems or loss of major customers are all items that prospective buyers do not like to find as surprises.  Such problems that pop up may cause renegotiation of the price or be grounds for cancellation of the letter of intent.

Remember, even though you are in the midst of selling your business you do not want to mentally “check out” or become “retired in place”.  You should continue to run it as if you were going to keep it for another five years.  You don’t want the buyer to change their mind if something happens during due diligence that negatively affects the business and you have disengaged from the daily operations.

Let your professional sell side M&A advisors work with you and the buyer to make the due diligence process smooth.

Q3 2017 M&A Update: Who Will Buy Your Business?

Businesses with enterprise values above $10 million are primarily sold to institutional investors. Those acquirers fall into two broad categories: financial and strategic. This article discusses the four most common types of financial buyers, sources of funding, and investment horizons.

Private Equity Group, or PEG. A private equity group, or firm, is an investment management company that provides financial backing and makes investments in operating companies through a variety of investment strategies including leveraged buyout, venture capital, and growth capital. The PEG is responsible for finding suitable business opportunities, screening those opportunities, and selecting ones to pursue. A Committed Fund is the most common of the following three PEGs.

PEG Committed Fund or a fund with committed capital has set up a “Fund” which receives money from institutional investors, such as pension funds, college endowment funds, and high net worth individuals. Corporate Investment recently worked with a private equity fund that invested money from a high profile college’s endowment fund. The private equity group reviews the acquisition candidates, selects the desirable ones, manages the acquisition, and monitors the investment in the business. Each “Fund” typically has a defined investment horizon, which is typically 5 - 7 years, meaning the investors anticipate receiving their capital back and related returns in that time frame. The managers of the “Fund” are typically paid a management fee and participate in the gains realized on the investments made by the “Fund.”

A Fundless Sponsor or independent sponsor is a type of capital group or individual seeking acquisition candidates without having the equity financing required to complete the transaction up front (hence, they are “fundless”). Fundless sponsors raise the equity required to fund an acquisition after they have executed a letter of intent (“LOI”). Fundless sponsors may consist of a single individual or group of individuals with years of experience in investment banking and traditional private equity, who accumulated a significant amount of capital. They will then split off and operate a small office, and with their track record, there are other investors that will invest alongside them in business acquisitions. The typical investment horizon for fundless sponsors is also 5 - 7 years, but may be longer.

Search Funds are vehicles for entrepreneurs to raise funds from investors interested in making private equity investments. In the first two examples shown here, the PEG wants to rely on existing  management to continue to run the business day-to-day. In the search fund model, a small group of investors back an operating manager(s) to search for a target company to acquire. The manager typically has an established track record in a specific industry, and wishes to take over day-to-day management. Search funds may have a longer investment horizon, and be more flexible.

Now – the new kids on the block:

Family Offices are a relatively new entrant into the financial acquirer mix. These are private wealth management advisory firms that serve ultra-high-net-worth investors. They are different from traditional wealth management shops in that they offer a total outsourced solution to managing the financial and investment side of an affluent individual or family. Family offices serve multi-role functionality as well as wealth management, including, accounting, security, and property management. Family Offices can be Single Family or more recently, Multi Family offices. More recently, many family offices have hired an experienced professional from a traditional private equity firm to search for companies to acquire. Corporate Investment recently dealt with two large family offices who have hired individuals from private equity firms to help them source, acquire, and manage their acquisitions of entire companies. They typically have a longer investment hold period than traditional funded private equity firms.


Our client, the seller, must align their objectives in the transaction with the right type of purchaser.  Knowledge of the type of funding, risk of being able to close, and investment time horizon of purchasers must be taken into account for us to successfully achieve our client’s goals.

An understanding of the types of institutional buyers is very important, as private equity buyers are now actively investing in lower middle market companies. Over the past 8 years, significant institutional funds have been committed to private equity firms, and the competition for middle market companies (revenue above $100 million) has increased dramatically, leading many firms to lower their sights and seek investments in lower middle market companies.

There are about 350,000 companies with annual revenues between $5 million and $100 million, compared with less than 30,000 companies with revenues above $100 million, according to Forbes magazine. “Interest in the lower middle market has grown substantially,” according to Probitas Partners Private Equity Institutional Investors Trends for 2017 Survey. “In 2017, 63 percent of institutional investors said they are focusing on the U.S. small market buyout sector.” (Mergers & Acquisitions magazine, October 2017).

This development is extremely positive for Central Texas business owners, as the competition for a well managed, profitable business to acquire leads to attractive transactions.

Is a Private Equity Group the Best Buyer for Your Business?

Private Equity Groups (PEGs) are currently purchasing middle market businesses at record levels. Middle market companies typically have annual sales of $3 to $100 million, and values from $5 to $50 million.

Most of these middle market businesses are family owned, and selling to a Private Equity Group is a viable exit strategy for the owner wanting to take some or all of their chips off the table. Private Equity Groups are investment funds set up to purchase businesses with stable operating histories and cash flow, grow them for 5-7 years, then sell for a profit.

Returns on real estate investment have fallen to 8% or less, and many investors are now looking for alternatives. That money is flowing into Private Equity Groups at record levels, with investors hoping for returns of 20-30%. PEGs typically invest in established businesses, not impacted heavily by technology. What are types of businesses are they looking for?

Cambria Group, based in Menlo Park, CA, describe themselves as a “private investment company which acquires and invests in small and mid size businesses with established operating histories. The firm seeks four critical elements in every situation – 1) a fundamentally sound and durable business with a history of profitability, 2) availability of a strong management team, 3) a fair purchase price in relation to historical performance, and 4) opportunities for management and Cambria to add value to the business over time.”

A common philosophy heard is "defensible market niche, strong management team, and proven track record,” all of which indicate a solid business. Less interest has been shown by PEGs in recent years in turnaround companies in distressed situations.

PEGs will often purchase 100% of the company, letting the owner retire and cash out his or her equity in the business. Many younger owners just want to take some chips off the table and are happy to combine their valuable knowledge and experience with the equity infusion of the PEG to continue to grow the business. This is a win/win strategy, with the PEG getting an experienced manager with a proven track record, and the owner typically cashing out 80% - 90%, and getting a second bite of the apple five to seven years down the road on a subsequent transaction, as the PEG exits the investment.

PEGs review hundreds of opportunities and purchase less than 10%. “We look at 100 Executive Summaries for every 10 that we actually meet with the owner,” said Vincent Foster, of Main Street Capital Partners. “We will then typically make 5-6 offers on businesses for every transaction we close. We rely on the M&A professional to analyze and present the business to us in a coherent manner.”

An intermediary will typically spend 30 to 45 days to prepare an in-depth Confidential Information Memorandum of the business, which may be 25 to 60 pages in length. This document will analyze growth opportunities, historical financial performance, organizational strengths, and market information. The initial contact with the PEG is accomplished with a one or two page Blind Profile of the business, without disclosing the name of the Company. The intermediary then asks the purchaser to sign a Confidentiality Agreement, and have the necessary qualifications before being sent the entire Confidential Information Memorandum.

Walt Lipski, CBI, M&AMI, of Fox and Fin in Phoenix, president of the M & A Source, states, “We have not seen market conditions such as the ones existing today, driven by excess investment capital, low interest rates, and low tax rates, in many years, and savvy owners wanting to cash out for maximum values should be wary of waiting too long.”

Multiples of EBITDA – What Factors Turn a 3x into a 5x?

We all know that “money doesn’t grow on trees.”  

And neither does business value.  You can’t just wait until you are ready to leave your business to find out how much “value” you need or want and how much “value” exists in your business.  By then it will be too late.  The tree metaphor is relevant, though.  Value is something that you can grow, nourish and ultimately harvest in your business.  Let’s look at an example.

Picture three identical companies each engaged in moving time-sensitive freight for customers. All have a national presence, $2M in EBITDA (Earnings Before Interest, Tax Depreciation and Amortization) and about $25M in annual sales. It would be logical to assume that they all have about the same value.

In fact, one had little value, one sold for 3.5 times EBITDA and one sold for 5.5 times EBITDA.  The difference in value was $3M to $7M to $11M. Neither gross sales nor EBITDA alone determined the price and terms of these deals.  The key to the variation in purchase prices was the presence or absence of value drivers in the companies as well as the ability of these value drivers to survive the owner’s departure.

Value drivers are internal characteristics of a company that buyers look for in acquisitions. You’ll see that it doesn’t matter if you plan to keep your business forever, transition it to family members, sell it to your management team or find an outside buyer - value drivers can give you more options, more flexibility and more money from your ownership interest. Strong value drivers are those that are effective and will continue to operate once the original owner departs.  Consequently, those are the value drivers that increase both EBITDA and the multiple of EBITDA buyers may be willing to pay.

We may measure the effectiveness of value drivers in two ways:  1) their positive contribution to cash flow and 2) their ability to continue to contribute to cash flow under new ownership.

Think of it this way: why would anyone want to buy your business if its continued success is dependent on you-the departing owner? Buyers are more likely to pay top dollar for businesses that will not miss a beat when the original owner is no longer in charge.

Success in business is determined not by how well you run the business, but by how well the business runs without you.

Let’s look at the three freight-moving companies more closely to see what motivated buyers either to open their wallets or walk on by.

Company A:  

The owner/operator was responsible for management, operations and his personal and industry contacts were the source for new business. All roads ran through the owner so without him, the business had little value.

Company B:  

This company had a capable management team.  Many of its systems and procedures were state-of-the-art.  There was, however, one glaring weakness: the major customer, responsible for over 50 percent of the company’s revenue, had a decades’ long relationship with the company’s owner, not with the company.

Buyers are much less likely to pay millions for customer accounts that can, and indeed often do, go elsewhere the day after they find out the owner has sold the business.

Company C:

Finding the owner of Company C wasn’t easy.  She spent weeks on vacation or visiting grandchildren and when she was in town, was engaged in a variety of civic and charitable activities.  She made workplace appearances only sporadically and left operations in the hands of her stable, effective management team.

She had deliberately created plenty of diversification in her company’s customer base knowing that one day she’d sell the business.  She had thought about what she would look for in an acquisition so had included customer diversification as one of many attributes or value drivers she wanted in her company. She understood that value drivers were necessary to maximize sale-ability as well as the sale price and amount of cash she could demand from a buyer.

Interested buyers were delighted that she had changed her role in the company over the years so that a new owner could step in, almost unnoticed.  

There are a number of value drivers that are critically important to today’s buyers.  The value drivers that are most important to your business may or may not be the same as those that were identified for Company C.  What we can say with some certainty is that value drivers can help your business value grow to bring you closer to the value that you need.  If you are interested in learning more about them, we will be happy to sit down with you and talk about how value drivers might improve your business value.

Corporate Investment is unique in that we take a holistic approach to working with business owners. Exit planning is a part of our process. We help business owners plan for one of the biggest financial events of their lives - the transition out of their business. 

Experienced Austin Financial Executives Robert (Bob) Kay and Laine Holman Affiliate with Corporate Investment

Robert (Bob) Kay, an experienced executive in finance, investments, private equity intermediary, banking, and private business management, and his long-time business associate, Laine Holman, a seasoned CFO, have joined Corporate Investment, an Austin-based financial advisory firm specializing in mergers and acquisitions and business sales.

“We are excited to join Corporate Investment and use our years of experience in business operations, deal making, capital raising and private equity investing to help our clients,” said Kay. “Corporate Investment has a well earned reputation in the region as business intermediary and merger and acquisition experts. With mergers and acquisitions picking up steam in Central Texas, we are in the right place to help owners get the most value from their transactions,” Kay added.

Most recently, Mr. Kay has led Excelleration Partners, an early stage growth company consultancy and capital raising advisor, after having served for six years as EVP/COO/CFO at Drilling Info, Inc., an online oil and gas data provider. While at Drilling Info, Bob partnered with CEO Allen Gilmer in leading the company through an explosive growth phase and eventual control sale to a NYC-based private equity fund.  

 Prior to his most recent career stop as Consulting CFO to Durbin and Bennett Tax Advisors, Mr. Holman served as CFO to The Kucera Companies, a full-service commercial real estate company from 2003-2011. Kay and Holman partnered during the 1980s and 1990s within several business entities controlled by Robert W. Hughes and the Prime Cable family of companies.

Serving as a M&A team at Corporate Investment, Kay and Holman will lead clients through the sale preparation and sale of their businesses. Their diverse and combined business experiences have provided them deep experience and insight into the business sales process.

 A native of Austin, Mr. Kay earned a BBA in General Business with an accounting concentration from The University of Texas in 1974. Mr. Holman is a native of Taylor, Texas, and is an Honors graduate in Accounting from UT Austin in 1981.

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