News

Are We At the Peak of the Sellers’ Market?

By Michael Friar, Ascend Strategic Partners Business Brokers and M&A Advisors, July 2016

The past few years have been an excellent time for business owners to sell and this should continue for at least another year. Interest rates are low, private equity groups (PEG’s) and strategic buyers have trillions of investable cash (dry powder) to invest and are hungry for acquisitions that can be grown or will be accretive (give them instant value) to their businesses. Additionally, there is a lot of interest in US companies from foreign buyers that are willing to pay a higher price to gain access to the US market. For those companies who were properly prepared and ready for sale these past few years, the financial rewards were evident in valuations at high multiples.

Are we at the peak of the sellers’ market? The “good times” for selling a mid-market company cannot last forever, but we believe 2016 will continue to be strong. Currently, multiples for businesses with adjusted EBITDA (normalized earnings before interest, taxes, depreciation and discretionary expenses) between $1 million and $5 million range from 5 to 8 times EBITDA. Businesses with adjusted EBITDA above $5 million can have multiples as high as 8-10+. For business owners thinking about an exit strategy, the next 12-18 months may be the best time to take advantage of current market conditions and prepare their companies for a transaction. At Ascend Business Brokers, we advise owners to “run their business like they will own it forever, but be prepared to sell it tomorrow.

As a seller, there are also numerous options to take cash off the table while retaining partial ownership in the company. The sale to a PEG is an ideal option. This allows the business owner to sell a portion of the company, get cash out of the business, reduce personal risk, yet still be able to help grow and guide the company. The goal of a PEG is to obtain a 200%-400% return on investment within a 3-5 year period. Therefore, any co-ownership with them could be very profitable to the seller down the road (second bite of the apple).

Preparing for Sale

At Ascend Business Brokers, we understand the set of value drivers that buyers find most important when evaluating a prospective acquisition. For a business owner getting ready to sell their company, a key point is preparation. In order for a business owner to maximize their value, they need to ensure that their value drivers are as strong as possible.

Value drivers include:

  1. Experience and depth of the management team
  2. Gross margins and EBITDA margins (high margin companies usually sell for more)
  3. Sales trends (year over year growth)
  4. Repeat customers and recurring revenue (i.e. long-term contracts)
  5. Normalizing EBITDA (as ex-CPA’s we are excellent at this)
  6. Balance sheet strength (especially working capital and leverage ratio’s)
  7. Product/service differentiation or reputation
  8. Minimizing customer concentration (customers comprising 10% or higher of revenue could negatively affect valuations. However, often there are ways to mitigate these issues)
  9. Growth opportunities

Another item that could materially affect a valuation and deal structure is the type of tax entity a company has. LLC’s and S-Corp’s permit the seller’s gain to be taxed once at the individual level, while also allowing the buyer to write-off the purchase price over time. This could save the buyer 20% or more of the purchase which increases the value to all parties. A C Corp does not allow for this. In most instances, businesses should try and convert from a C Corp prior to selling. There are many options to accomplish this with different results. Feel free to call and discuss possible plans which you can then work with your CPA’s on.

The strength of a company’s value drivers, along with recognizing and eliminating deal killers (inadequate/inaccurate accounting records, litigation, significant employee claims, etc.), will directly determine the value of your company.

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What is My Company Worth?

By Michael Friar, Ascend Strategic Partners Business Brokers and M&A Advisors, July 2016

When a business owner considers selling, the first thing they want to know is “How much is my company worth?”

As a Business Broker/M&A Advisor, I don’t like the question. I love it! It’s one of the easier questions to answer in the entire process of landing a new client. And the answer goes like this:

“I don’t know.”

These are not words I’m afraid to utter because I will look unprepared or somehow lacking knowledge in my profession. These are words I’m comfortable with because they are the truth, and they typically lead to deep discovery about your business.

Here is what I do know:

Valuation = How well your company is prepared for sale *+ how your company is strategically positioned and marketed + understanding the psychology of the deal to better know your buyers and how to negotiate with them + your ability to obtain multiple offers + recent successful sales in your general sector = Your Actual Value in the Current Marketplace.

Formal business valuations are very necessary for many reasons including S-Corp. conversions, estate tax planning, partner buy-outs, etc. However, this is not the way the M&A marketplace works. As a Business Broker/M&A Advisor, discovering real value comes from how you approach selling a company along with the company itself. Many Business Brokers/intermediaries don’t believe they have the ability to create additional value or reduce the value of your business. At Ascend Strategic Partners, we respectfully disagree.

Several years ago, Creditreport.com engaged Ascend after a two year long unsuccessful try in the marketplace with another firm. During our initial seven (7) month period, Ascend obtained two offers, one from Trans Union and the other from Equifax, each around $180 million. Is this the value of Creditreport.com? During this same period we had approached Experian twice with absolutely no luck in gaining their interest. However, between Ascends research and our industry knowledge, we knew changes were occurring within Experian and it was becoming evident a need for Creditreport.com was coming. We went back to Experian at just the right time and guess what? They were ready-$207.5 million ready! Additionally, with our CPA background, we were able to structure the LOI (letter of intent) in a manner in which the buyer also picked up net liabilities of our client totaling over $13 million. Therefore, the total purchase price exceeded $220 million. In my opinion, the value was what Ascend was able to obtain from Experian for Creditreport.com, not what the general marketplace originally said it was worth.

Communication and trust between a business owner and advisor is so important. No business is perfect. It’s the fundamental belief in your company’s potential or strategic fit that will drive a buyer to pay a higher price than the acquisition based on your historical cash flow alone. To be clear, your potential or strategic fit has to be factual, tangible, and achievable in order for the buyer to see and believe it. It is through this communication and trust in the seller-advisor relationship that the information is gained to achieve a clear vision for the buyer.

The question then really becomes: Can you find buyers who see your value?

Buying motivations differ greatly between corporate/strategic buyers and financial buyers (private equity groups/PEGs). Corporate buyers generally look at strategic fits. PEGs look at growth potential. Each buyer’s ability to see and capitalize on their objectives is vastly different. Our job as the Business Broker/M&A Advisor is to make the corporate buyers understand the strategic fit and the PEGs to see the growth possibilities. If done properly, you can maximize the value of your company for all prospective buyers.

How much is your business worth? I don’t know. Let’s sit down and talk about it!

* Previously published article-“Are We at the Peak of the Seller’s Market?” July 15, 2016

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Private Market M&A Update

The following is an update on Merger & Acquisition lending to Acquirers in the privately held sector. The net of it is, interest rates are getting better for good companies which means valuations are going up for them. Right now the supply of strong sellers is much lower than the demand of well capitalized buyers.

Though the pace of deal flow has picked up in Q2, buyers and lenders are still exceedingly liquid and hungry for new transactions and such is reflected in June’s pricing indications:

  • Senior Cash Flow Bank Pricing reduced 0.50% to L+3.50%-4.50%;
    Senior Cash Flow Non-Bank EBITDA <$10.0MM reduced 0.50% to L+6.00%-8.00%; Unitranche
    Pricing <$7.5MM EBITDA reduced 0.50% to L+8.00%-11.00%; and
  • Unitranche Pricing >$10.0MM EBITDA reduced 0.50% to L+7.00%-8.50%.

The reduction in the cost of capital would suggest that the market is not only becoming more competitive on pricing, but more liquid in general—this is decidedly not the case. To the contrary, notwithstanding the tighter pricing environment, investors report their credit committees are becoming more conservative respecting credit review and underwriting. The recent reduction in pricing is really more reflective of a small “flight to quality” as lenders compete aggressively for the more attractive M&A deals. Stated another way, as credit underwriting standards are tightening, lenders would rather take a lower return on a higher quality asset than yield on a lower quality asset.

Not surprisingly, this translates into a less competitive pricing environment for cyclical, storied, smaller, and marginal issuers. Though pricing may be more competitive for higher quality issuers, covenant structure and leverage tolerances are still subject to greater scrutiny and conservatism. While not a sea change in credit perspective per se, there seems to be an ever increasing constituency underwriting against what they believe to be a more volatile macroeconomic environment and cyclical downturn. Whereas most middle market commercial banks are still comfortable with underwriting to a 3.0x Senior Debt / 4.0x Total Debt leverage profile, factor in a smaller credit (less than $7.5 million of LTM EBITDA), a cyclical sector (automotive, aerospace, construction, etc.), or credit exposure (30.0%+ client concentration) and leverage quickly migrates to a 2.5x Senior Debt / 3.5x Total Debt profile.

Are lenders underwriting against a potential recession? The current data suggests that a recession is still unlikely (Q2 GDP is projected to be 2.5%), but a cyclical downturn is certainly supported by the most recent ISM Manufacturing and Non-Manufacturing reports as well as the headline employment data—this is not lost on any credit committee. As noted above, the Labor Market Conditions Index has been negative for five consecutive months, and it historically has gone negative about a year before a recession. The U.S. has experienced a recession every 6.1 years on average; it has been 8 years since the last one. Historically, if unemployment drops below 5.0% (we’re now at 4.7%) we go into a recession 73.0% of the time (see the “Unemployment Rate and Recession” graph—gray vertical bars represent each recession from 1945 to 2016).

If there is a single take away from this month’s data it is this: if you are planning a transaction in the future, it is critical to move sooner rather than later. Pricing remains exceedingly competitive for higher quality credits. Even though yields are higher for smaller, cyclical, or marginal credits, deals are still getting done on comparatively competitive terms (this is still a historically low yield environment). If U.S. macroeconomic activity continues to decline, or dips into recession territory, the credit markets will react accordingly—leverage tolerances will compress dramatically, spreads will widen, and the credit markets will be largely closed to those same smaller, cyclical, or marginal issuers.

To repeat, if a transaction is contemplated for an company, it is highly advantageous to get to market sooner rather than later. The risk to not moving forward could prove to be draconian and actually effect the valuation or preclude it all together at a later time.

Deal Component

Cash Flow Senior Debt
(x EBITDA)
<$7.5MM EBITDA 1.50x-2.50x
>$10.0MM EBITDA 2.50x-3.50x
>$20.0MM EBITDA 3.00x-4.00x
Total Debt Limit
(x EBITDA)
<$7.5MM EBITDA 3.00x-4.00x
>$10.0MM EBITDA 3.75x-4.50x
>$20.0MM EBITDA 4.00x-5.50x
Senior Cash Flow Pricing Bank: L+3.50%-4.50%
Non-Bank: <$10.0MM EBITDA L+6.00%-8.00%
Non-Bank: >$15.0MM EBITDA L+4.50%-6.50%
(potential for 0.50%-1.00% floor)
Second Lien Pricing (Avg) <$7.5MM EBITDA L+9.00%-12.00% floating
(0.50%-1.00% floor) >$10.0MM EBITDA L+7.50%-9.00% floating
(0.50%-1.00% floor) >$20.0MM EBITDA L+5.50%-7.50% floating
(0.50%-1.00% floor)
Subordinated Debt Pricing <$7.5MM EBITDA 12.00%-14.00%
>$10.0MM EBITDA 11.00%-13.00%
>$20.0MM EBITDA 10.00%-12.00%
Warrants limited to special situations;