Sell Side M&A: Learnings From The Trenches
“When a man with money meets a man with experience, the man with experience leaves with money and the man with money leaves with experience.” - Anonymous
This article is intended to give business executives an understanding of best practices that can lead to higher valuation in an M&A transaction. The purpose of this article is to help you look at your business as an acquirer might in valuing your company. The more attractive you can make your business to the acquirer, the better the chance that you will get a higher value for your business.
The softer economic times have made M&A more favorable to the buyers and consequently achieving desired multiples has become more challenging to the sellers. To maximize the transaction value, it is imperative that executives start exit planning one to three years before the anticipated exit. We recommend the following best practices in the buildup to the transaction:
1. Maximize Cash Flow: After strategic fit, cash flow is the single largest value driver for most businesses. Think of ways to improve your EBITDA on a sustainable basis. Since acquirers may be suspicious of short term jumps in cash flow, be careful the cash flow gains are from sustainable sources and not from one time gimmicks. Once an acquirer starts doubting your credibility, the due diligence increases and the acquirer will make changes to valuation to adjust for the risk.
2. Ensure High Quality Record Keeping: Good bookkeeping reduces the perceived risk in a deal and also tells acquirers a lot about how the business was run. Exit planning also means that it is time to get Junior and other family members off the payroll if they have no meaningful role in the company. In general, all discretionary or non-business expenses need to come off the books or be clearly categorized for an easy audit. Having a set of clean, easily auditable books inspires confidence and simplifies the due diligence and negotiation process.
3. Avoid Customer Concentration: Acquirers get nervous about businesses where a high percentage of business comes from a handful of customers. Any customer who represents more than 10% of revenues or profits should ideally be covered by long term contracts. If acquirers perceive undue risk in revenue, you need to be prepared to accept lower valuation or a substantial part of the transaction price tied to earn-outs.
4. Maximize Recurring Revenue Streams: Acquirers love predictable and low risk revenue streams. Any long term contracts, annual service/licensing fees, and other recurring revenue streams make business more desirable and fetch a higher multiple in the marketplace. In service oriented business, converting predictable customer support calls into recurring revenue stream can turn a business liability into an asset.
5. Build Barriers To Entry: Acquirers place higher value on a business with unique products, services, or distribution systems than a business whose offerings are considered generic. What is unique about your business? With so much competition all around you, why is your business difficult to copy? Why will the acquirer have as much success with the business as you have had? Is it because of intellectual property, regulation, “difficult to get” contracts, or something else? These barriers make your businesses more valuable than your competitor’s with similar cash flow. Think of ways in which your product/service is unique and why it should be valuable to an acquirer. Having an edge and having the ability to communicate the edge can do wonders to your business’s valuation.
6. Seek, Track & Document Industry Exposure: Perceived industry leadership is an intangible that can enhance your company’s valuation. Keep a record of newspaper stories, articles in trade magazines, mentions on local TV, or any other mention of your company in print or any other media. Your business is more valuable if your company is perceived as being a leader in the industry and is sought after for its expertise. Asking your employees to write articles and asking them to keep in touch with press not only helps drive your business and image but also helps improve your valuation.
7. Create & Track a Tactical and Strategic Plan: A written growth plan that clearly documents the areas the company can grow can be an asset to an acquirer. Length of the document is not as important as the content. A well written 2 or 3 page document is sufficient if it conveys the essence of the growth plan. A good forecast backed up by management presentations with examples on why the company would achieve the forecasts is extremely powerful. However, sellers should be aware that any forecasts that do not materialize as planned during the M&A process can have substantial negative impact on the sales price. Any negative deviation between actual results and original forecasts may make the transaction economics untenable to the acquirer.
8. Ensure Management Depth: Acquirers buy a business that they hope will be thriving and growing after the sale. It is tough for an acquirer to place a high value on your business if you are the sole decision maker in the company and the business depends largely on your skill set (or the skillset of other exiting employees). Developing your staff so that they can run the business independently will not give considerable amount of leisure and flexibility but can pay big dividends when it is time to sell. If you are concerned about your key employees leaving, it may be good idea to consider employment contracts, stock grants and other incentives that give them a reason to stay long term. If possible, start working on staff related issues at least a year before you plan to start the sales process.
9. Clean Up The Operations: It is imperative that executives review business operations and ensure peak performance in every aspect of the business. This may involve things such as sprucing up the facilities, ensuring all aspects of the business are in compliance of required rules and regulations, and ensuring that key operational metrics are up to industry standards. It is important for management to have the business operating at peak performance prior to sale.
10. Hire an M&A advisor: A typical mid-market acquirer is an experienced corporate entity with professional M&A advisors, lawyers, CPAs, and industry experts on their team. It is imperative that business owners hire a competent M&A advisor and build an exit team very early in the exit planning process to bring the required experience to the table. Lack of a good team that can balance the experience of the acquirer can be very expensive to a seller.
The most important take away from this article should be that following best practices can give you and your M&A advisor a considerable upper hand during the negotiation process and significantly affect your company’s EBITDA multiple. If the EBITDA of your business is $5 million, the difference between being paid a multiple of 6 and a multiple of 8 is $10M in pre-tax earnings. Not bad for doing a little bit of homework!
Chak Reddy is a Mergers and Acquisitions Advisor with Elite Mergers & Acquisitions, Inc. Elite Mergers & Acquisitions specializes in selling businesses with revenues between $1 million and $100 million. Mr. Reddy is a business M&A and Marketing expert, and is the chief deal maker at Elite. He can be reached at 916-220-3052 or by email at email@example.com.
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