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Grow Your Business During This Recession

Monday, February 9th, 2009

Success Strategies For Business Executives In Recessions

 “ When Times Get Tough, the Tough Get Going” – Anonymous 

As the pundits debate if we are in a recession or in a depression, companies are looking forward to see what they can do to get back in to growth mode. We looked back at the learnings from the past recessions, and have come up with a list of things that have worked well in the past and are likely to work well again in the current environment.

1.         Improve cash flow. This is by far the most important thing to do for companies looking to survive and prosper in recessions. As simple as this may sound, increasing sales is not the only way to improve cash flow. We are constantly amazed by how lax businessmen and organizations become in good times and how much room there is for improvement. Some simple and effective ways to improve cash flow include:

Ø  ensure accurate book keeping and audit for abuse and theft

Ø  collect accounts receivable early and delay accounts payable without incurring penalties

Ø  clear out underperforming or unused assets and slow moving or stale inventory

Ø  delay capital purchases and look to coincide purchases with vendor sales

Ø  review payroll and other large expenses and look for cutbacks as appropriate

Ø  negotiate favorable rates and payment terms from suppliers or switch suppliers (easy targets include rent, insurance, workers comp, and telephone system)

Ø  purchase essential items in bulk to save shipping costs and get price breaks

Ø  charge customers upfront fees/payments where possible

2.         Maintain a good cash position. Since no one really knows when a recession ends and the next growth cycle starts, it is imperative that companies maintain a good cash position through the down cycle. Cash cushion is critical for a company and also puts the company in a strong position vis-à-vis suppliers and bankers.

3.         Consider an active acquisition strategy. During a recession, there will be a lot of good opportunities to expend cash to invest in undervalued assets or businesses that provide strong cash flow. Retain a competent advisor to develop and implement a cohesive acquisition plan.

4.         Understand how customers determine value in tough times. Tailor product offerings to more closely reflect the changed customer needs. The key is to provide more value to the customers without sacrificing margins. Look for creative product and service bundling opportunities and keep on constant lookout for ways to retain existing customers.  Keep in mind that attracting new customers is several times more expensive than retaining existing customers.

5.         Fine tune marketing campaigns. Recessionary time is typically not the best time to cut marketing spending but is the time to use the marketing budget more wisely to increase return and create a stronger brand. Look for competition that is unable to address client needs and go after their customers. Customer acquisition costs are much lower for you if your competitor is going out of business. Target some of the marketing dollars to go after customers of companies that are going out of business. For the stronger companies, recessions are the best time to gain market share.

6.         Negotiate long term supplier deals at below market rates. Can you get an extraordinary lease on a prime property because someone else went out of business and the landlord is desperate to get a tenant? Can you negotiate a favorable long term advertising rate? Recessions are the best times to lock in long term supplier deals. Good deals are nearly impossible to get when the market is hot.

7.         Build or improve your distribution/sales channels. In tough times, distributors and sales people are hungry for business. Current channels may be more receptive to your needs. Some desirable channels that were not open to your company before may open up. You may be able to negotiate more favorable terms from your existing distribution channel or get a stronger channel to replace your current channel more cost effectively.

8.         Stay away from general cuts across the board. Cuts, if needed, should be in areas that do not create value or business areas that are not part of the core business. Look to divest or outsource non-core operations and invest in areas that are the future growth areas of the company.

9.         Build employee loyalty. Employees will remember you for sticking with them through the tough times. Operate the business by emphasizing core values and leading by example. When tough decisions need to be made, solicit employee feedback.  Use slow times to invest in employee training and developing compelling marketing and sales strategies and tactics. Communicate profusely and make sure the morale stays high.

10.      Have a clear vision of where the company needs to be when the recession is over. Managing your business is a lot about allocation of resources and prioritizing where to prune and where to grow. Having a clear vision helps make tough choices that need to be made along the way.

Work out a solid plan. Implement it. Grow your business during this recession!

Posted in Finance, Local Market, M&A, Marketing, Miscellaneous, Valuation | No Comments »

How to Sell Your Distribution Business

Tuesday, April 29th, 2008

10 Step Plan To Exiting A Mid-Market Distribution Business

 

“He who fails to plan, plans to fail” – An old proverb 

You have worked hard for many years to build your distribution business. It has provided you income, satisfaction, prestige and purpose. Now is the time to do one final deal on the business and exit your business while making sure that that you get what you deserve.

A mid-market distribution business, the type of business you have, is typically characterized by strong customer relationships, good logistics and material management system, moderate amount of equipment, and sometimes a large amount of inventory. This combination of assets creates a unique set of challenges when it is time to sell.

Here is a 10-step plan to maximizing your return on the sale of your mid-market distribution business.

1.    Be aware that for a distribution company with a valuation in the $3 million to $100 million range, funding from the Small Business Administration is not feasible and there are very few individual buyers capable of financing this type of deal on personal credit. The most likely acquirer is another private company, a public company, or a PEG (see “Is Private Equity The Right Option For Your Business”). These are professional buyers who have experience from multiple deals. Hire a competent M&A advisor or an investment banker to bring deal making experience to the table. Acquirers think in terms of multiples of EBITDA for comparable companies when it comes to valuation. A good M&A specialist will help increase the EBITDA, ratchet up the multiple, and expose the strategic value of the business to get you more for your business. An M&A Advisor will also be keenly familiar with the tradeoffs necessary to maximize your after tax proceeds.

2.    Check if your corporate structure is the appropriate one for a business sale. Are you a C-Corp? S-Corp? LLC? Do you have multiple entities with multiple purposes? Regardless of the type of corporation(s) you have, if your distribution company has a large amount of depreciated assets, depreciation recapture may be a big issue for you. For distribution companies with a substantial amount of assets, being a C-Corp can be a major tax disadvantage as most acquirers prefer an asset sale to a stock sale. In a C-Corp asset sale you get taxed twice – once at the company level and once at the individual level! For most distribution company owners, it is worth getting your M&A advisor to fight for a stock sale.

3.    Make sure your books are in order and your financial statements are compiled, reviewed or audited as may be appropriate for your business. Your current bookkeeping practices and tax structure may be designed to keep your taxes low on an operating basis but they may not be right for exiting your business (see “What Every Business Owner Needs To Know About Taxes & Valuation”). If your CPA firm does not have any deal making experience, consider working with a firm that has the experience. In mid-market transactions, good tax advice may be worth hundreds of thousands, if not millions, of dollars.

4.    Retain the right attorney for the deal. An attorney with transactional experience as opposed to litigation experience is more likely to help put together a successful deal. Many deals collapse due to attorneys who are not familiar with transaction negotiations.

5.    Understand how your competition is performing and how you measure up. How good are your profit margins? How about inventory turns? Is your equipment outdated? Do you have a lot of dead inventory on the books? Some of the value in the deal comes from the acquirer’s perception of how you rate in your peer group. Excellent companies get excellent valuations and mediocre companies get mediocre valuations. A competent M&A advisor can also help package your company to get the best deal out of it.

6.    Reduce risk by diversifying the customer and supplier base. What percent of your business is tied to one customer? How dependent are you on one supplier? What can you do to ensure the customers and suppliers will continue to stay with the business after the business sale? Are your contracts being written so that they can stay with the business regardless of ownership changes?

7.    Understand and have a documented plan for your growth. How do you plan to grow? Wider product lines? More services? Increasing geographic coverage? What part of your business is online? How good is your website? Do you do business outside of the immediate geographic area? What differentiates you in non-local markets? A good growth plan makes sales projections more credible.

8.    Take steps to ensure that your distribution business transitions easily to the acquirer. What percent of your business is under contracts? Are they long term? How much of your business is recurring? Do you have any maintenance contracts? Do any of the supplier contracts provide meaningful exclusivity? Do you have a reliable sales team or do the customer relationships begin and end with you?

9.    Do you have any known latent liabilities? Legal actions? Workers comp issues? ESOP issues? Do you have reasonable insurance coverage or you exposed to that one shipment or warehouse catching fire and taking you down with it? If possible address these and other similar issues before putting the business up for sale. If not, discuss these with your M&A advisor to make sure that they do not become a drag on valuation or deal killers. Addressing these issues is especially important if you are seeking a tax advantageous stock sale.

10. Be cognizant of the fact that business valuations are not written in stone and there is a huge variability in what you can get for your business (see “The Myth Of Fair Business Valuation”). The more you would like to get for your business, the more planning and work your deal making team needs to do and the longer it is likely to take. Plan early if you want to maximize your return.

Good luck with your business sale and let us know if we can help you.

Posted in Exit Planning, Finance, M&A, Miscellaneous | 1 Comment »

Is Private Equity The Right Option For Your Business?

Tuesday, March 11th, 2008

What Private Equity Investors Look For In A Company

 

To understand what Private Equity Groups (PEGs) look for in a company, one needs to understand the meaning of Private Equity. So, what is Private Equity?

Private Equity is long-term, committed capital provided in the form of equity to help private companies grow and succeed. If your growing mid-market company is looking to expand, Private Equity could help. Private Equity could also help if you are trying to recapitalize the company, exit the company, or transition the company to new management.

Unlike debt financiers who require capital repayment plus interest on a set schedule, irrespective of your cash flow situation, Private Equity is invested in exchange for a stake in your company. After the equity infusion, you will have a smaller piece of the pie. However, within a few years, your piece of the pie could be worth considerably more than what you had before.

Private Equity investors’ returns are dependent on the growth and profitability of your business. If you succeed, they succeed. If you fail, they fail. PEG’s capital infusion and involvement have proven beneficial to companies and many companies have gone much further with Private Equity than they otherwise would have. PEGs will seek to increase a company’s value, without having to take day-to-day management control. In some cases, PEGs bring in their own management team and facilitate a management transition. Given the high amount of risk these investors incur, and the duration of their investment, PEGs invest in the business on the strength of the manager’s business plans, knowledge, trust and negotiations with him.

Generally speaking, unless a business can offer the prospect of significant growth within five years, it is unlikely to be of interest to a PEG. For some high growth companies and companies with limited “hard” assets, Private Equity may be the only option for capital.

However, Private Equity is not for every business. Private Equity may not be suitable for companies with limited capital needs, for companies with stable cash flow, or for companies with substantial hard assets. For these types of companies, debt financing may be a better alternative. Many small companies whose main purpose is to provide a good standard of living for their owners are also not suitable for Private Equity investment, as they are unlikely to provide the necessary financial returns to this type of investor.

Assuming the company is suitable for Private Equity investment, investors look at several criteria before providing the equity for your business.

Strong Management team

Unless the intended purpose of the equity transaction is management transition, the quality of the management team is by far the most important criterion for many Private Equity investors. Most investors do not invest in a company unless they are satisfied with the management team.

Growing Market Segment

The value added by Private Equity in many cases is their ability to grow the “pie” and in that context the growth potential in the target market segment is a very critical factor. PEGs also want to ensure that the company is well positioned to grow within the target market segment.

Realistic Growth/Expense Plan

Unrealistic planning will create a doubt in investors’ minds about the management’s business skills. Similarly, under budgeting for material, labor and equipment costs will reflect poorly on the management team.

Exit Route

The PEGs are in the deal for the long term but they need a workable exit to get their money back. The exit could be business sale, management buyout, IPO or something else. PEGs need to have the confidence that there is a clear, planned path to their exit.

Security

Unlike debt, equity investment does not come with any overt security collateral. To mitigate risk, PEGs typically require a seat on the company’s board and a codified management plan to protect the PEG’s interest.

Contingency Planning

No business grows without hiccups. Understanding what could go wrong and putting contingency plans in place to deal with specific situations can go a long way in gaining a PEG’s trust.

Reputation

PEGs check the business credit rating, the management team’s reputation, and enthusiasm and determination of the team before they invest. The best business ideas are not worth much without good people and PEG’s want to make sure that they are getting a strong, positive team with good marketplace reputation.

Good Rate of Return

When everything else checks out, it comes to terms. PEGs look for a good return for the capital they are risking on your venture. The return a PEG is willing to accept is a direct function of how desirable your deal is and how much competition exists for your deal.

In summary, PEG investors must be assured that the capital being deployed by them will yield the returns they are seeking. If the investment is considered worthwhile then there will be competition to do your deal. Competition often means you get a higher valuation, better deal terms for your company and more cash proceeds for you.

Posted in Deal Structure, Finance, M&A, Miscellaneous | No Comments »

Can You Afford To Employ A Dual Agent In A Business Sale?

Saturday, February 23rd, 2008

The pitfalls of hiring a dual agent in a business sale transaction

 

Most people have heard of dual agency in the context of a real estate transaction and have some awareness of the issues surrounding dual agency. In spite of the inherent conflict of interest, many people do not mind transacting residential or commercial property using a dual agent. The reason is pretty straight forward – while there is risk of not getting good representation, the downside is typically small. Property values are driven by comps and cap rates and in most cases, the amount of money left on the table is a small percent of the transaction value. The commodity nature and relative liquidity of real estate also helps make buyers and sellers comfortable with the risk level.

But does this logic apply to business sale transactions? Businesses, compared to real estate, are illiquid and the valuations and the ultimate closing prices vary dramatically from business to business. The deal amount can also change dramatically through the duration of a deal. In Business sale transactions, not having a fiduciary agent working for you can cost you plenty.

Let us start with an explanation of “fiduciary duty”. An agent used to represent a buyer or seller in a business transaction has a fiduciary duty. A fiduciary duty is the highest standard of care imposed at either equity or law. A fiduciary is expected to be extremely loyal to the principal. Among other responsibilities, a fiduciary must not put their personal interests before the duty and a fiduciary must not profit from the fiduciary position without express knowledge and consent of the principal. A fiduciary also has a duty to be in a situation where there is no personal conflict of interest and where there is no conflict of interest with another fiduciary duty.

In light of large sums of money at stake in a business transaction and these fiduciary responsibilities, let’s look at the three key issues faced by a dual agent in a business sale.

1.    Conflict of Interest

This is by far the most obvious and most damning part of being on both sides of a business sale transaction.  A business intermediary is obligated to serve the best interests of his or her principal.  Buyers and sellers by definition have conflicting interests. Who should the intermediary be loyal to? Is the agent looking after your best interests? Some agencies will tell customers that they will assign separate individuals to the buying side and selling side and create a Chinese wall.

In practice, the wall between the two sides in the same company, even in a large company with processes to cover this type of conflict of interest, let alone a typical small to mid market intermediary, is more akin to a sieve than Chinese wall. An agency in this situation is in violation of the standards of being a fiduciary.

2.    Advocacy

Any competent agent will tell you that, when two principles’ interests are in direct conflict, the agent cannot advise, advocate, or give allegiance to either party if such counsel gives one party an advantage over the other. Not remaining neutral or showing favoritism would be illegal and can make the agent liable to potential damages. A careful dual agent would shun the risk of advocacy and will tell you that they will be extremely careful to represent both parties equally and fairly.  In other words, both parties lose “advocacy” for their best interests! Is this what you pay your agent for? Wouldn’t you rather pay an agent that advocates your interests?

In practice, providing equal service to two parties is difficult and, even if the agent is highly ethical, agent’s biases and self interests may tip the scales in difficult situations.

3.    Sensitive Information

A business sale can take an extended amount of time and the seller or buyer may experience one or more personal events which, while not affecting the performance of the business being transacted, may have substantial impact on the negotiations.  The agent may become aware of this sensitive information which, if disclosed to the other party, could harm one party and benefit the other. If the agent has one principal, clearly the agent will develop a strategy to minimize the impact to the principal. How does a dual agent handle this type of information about a client?  Would you trust your sensitive information with a dual agent?

In practice, the agent ends up playing favorites or in a worst case scenario, one or both of the parties’ interests are sacrificed in the interest of “getting the deal done”.

Summary: Business sellers and buyers need to carefully pick their agent in a business sale transaction. Providing equal service to both clients is practically impossible in most deals.  In the best case scenario, neither the seller nor the buyer is getting an advocate. In the worst case scenario, one or both of the parties are being sacrificed. For this reason some states do not permit dual agency.  Much can be lost by employing agents who put themselves in the position of being dual agents and thus not living up to the fiduciary standards.

For most business owners, a business sale is a once in a lifetime event with significant impact on how well the family’s nest egg is feathered. With so much at stake, can you afford to employ a dual agent?

Posted in Finance, M&A, Marketing, Miscellaneous, Valuation | No Comments »

The Limitations of Using EBITDA for Mid Market Companies

Wednesday, February 20th, 2008

Looking behind the numbers

 

“Does management think the tooth fairy pays for capital expenditures?” – Warren Buffett 

EBITDA, follow-on to EBIT, was created by investment bankers to find out the true operating profitability of the company. EBITDA is a great tool to measure the profitability of companies with expensive assets that get depreciated over an extended period of time. Financiers look at EBITDA to measure the debt carrying capacity of the company. It is common to measure mid-market company profitability and cash flow using EBITDA and use EBITDA as the exclusive indicator of the business performance.

Each business has its own unique set of strengths, weaknesses, opportunities and threats, none of which can be captured by EBITDA or any other single metric. Intelligent business acquirers must consider the amount, the growth rate, and the variability of cash flow generated by the operations. EBITDA, when used properly, can be a helpful starting point in this regard. However, as you will see from the discussion below, EBITDA has several limitations when it is used for measuring cash flow.

To arrive at EBITDA for a business, acquirers add back Interest, Taxes, Depreciation, and Amortization to the Net Income of the company. Let’s look at each of the items in EBITDA to understand the rationale and limitation of these add backs:

v  Earnings

The most common mistake seen in EBITDA calculations is the inclusion of non-operational earnings in the earnings number. To start off the process, it is imperative that all non operating profits have been factored out of the earnings. Are one time real estate or other asset sales factored into the earnings calculations? How about warranty cost reserves and bad debt allowances? The earnings data needs to be scrubbed to make sure that the earnings number used in EBITDA reflects operating earnings.

v  Interest

Interest payments of a business are primarily a function of the company’s financing strategy and vary widely depending on the debt to equity ratio preferred by the ownership. The resulting leverage factor can artificially inflate or deflate the net income. While adding back interest makes sense in terms of identifying operating profitability, it does not make sense to add interest back in terms of cash flow. Interest payments are certainly a burden on the cash flow! To get a more meaningful measure of cash flow, it would be necessary to subtract from EBITDA the anticipated cost of financing under the new regime.

v  Taxes

Taxes are accounting and owner dependent and a pre tax view of the profits would be a better indicator of the operating profit stream. However, like interest payments, taxes are a real expense and estimated taxes under the new financing and operational structure should be factored into calculating the expected cash flow.

v  Depreciation

Depreciation is an accounting construct that provides for an indirect and backward looking measure of capital expenses. Depreciation expense can be a highly misleading indicator. The accounting treatment of depreciation for many businesses is substantially different from real world depreciation. For equipment intensive businesses, adjustments to EBITDA are almost always necessary to get a true picture of the earnings.

Since depreciation is a non cash expense, it makes sense to add the line item back for cash flow calculations. However, keep in mind that some of the depreciated items need to be replaced over time and new equipment needs to be added in. Any cash flow calculation should factor in the cost of the replacement equipment.

v  Amortization

Amortization is similar to depreciation except that what is being depreciated are intangible assets such as goodwill of the business – very likely from a past acquisition or startup costs. Barring a few rare exceptions, amortization can be fully added back for profitability and cash flow calculations.

In addition to the above, there are some other limitations to EBITDA. It is important to understand that EBITDA only accounts for two non-cash items – Depreciation and Amortization. There is no provision in EBITDA to adjust for some very important non-cash items such as stock grants, stock option grants, inventory value adjustments, bad debt allowances, and gift certificate redemption credits.

EBITDA also ignores the impact of changes in working capital. Increases in working capital consume cash and a business could have great EBITDA numbers but terrible cash flow numbers and could be on the verge of going out of business. To have a meaningful picture of the cash flow, acquirers need to review working capital changes to see if there are growth related issues or other working capital changes of significance and adjust cash flows accordingly.

In summary, acquirers should not rely exclusively on EBITDA or any other single metric to measure the performance of a business. To the extent EBITDA is used, acquirers should replace the removed interest, taxes, depreciation, and amortization from their earnings calculations with their own expected operating numbers to get a better picture of anticipated profitability and cash flow and the variability to the cash flow. This can be accomplished by:

– Substituting the Interest costs with expected capital costs under the anticipated capital structure

– Substituting the Tax items with their own tax-rate calculations under the new capital structure.

– Substituting Depreciation expense with an estimate of future capital expenditures.

– Amortization can be kept at zero unless there are extraordinary items that need to be factored in.

– Reviewing working capital changes and adjusting cash flows accordingly.

Posted in Finance, M&A, Miscellaneous, Tax Related, Valuation | No Comments »

Taxes & Valuation: Can You Have Your Cake And Eat It Too?

Monday, January 28th, 2008

What Every Business Owner Needs To Know About Taxes & Valuation

 

Inevitably, one day the time will come for a business owner to move on. The reason for the exit may be anything from retirement, health problems, burnout, or just taking some chips off the table.

Planning this exit can have a significant impact on how much the business owner takes home from the event. Maximizing the take home requires the business owner to present the business, especially the financial aspect, in the best possible light. Here is where paying attention to accounting details makes a difference.

Businesses typically spend an inordinate amount of time setting up and using accounting practices that reduce the owner’s tax liabilities. CPAs use various business ownership structures and techniques to defer/reduce the revenues or accelerate/inflate the expenses to help business reduce its tax burden. The unforeseen side effect of this exercise is that, to a potential acquirer, the profitability of the business may appear much smaller than what it really is. There may also be other after-sale tax consequences attributable to corporate structure and to depreciation. Business intermediaries “add-back” non-business, non-cash expenses and “recast” the financial statements to get a better picture of the finances, but in most cases this is more of a band-aid than a real solution.

Since most businesses trade in multiples of the business’s cash flow, the practices utilized to save the business a lot of money may result in an artificially low valuation when the business sells. Does this mean that business owners have to give up all of their tax benefits? Not really!

When it comes to taxes and valuation, there may be ways in which business owners can have their cake and eat it too. With advanced planning, a competent M&A advisor can help mitigate potential adverse affects at sale time. Some aspects of accounting that need to be revisited in preparation for an exit include:

–      Business ownership structure

–      Aggressive revenue deferrals or expense accelerations

–      Burdening the business with personal, family and other unrelated expenses

–      Commingling revenues/expenses of related businesses

–      Wasteful spending

–      Inaccurate inventory statements & inventory write downs

–      CapEx budgets

–      Off-the-record transactions

–      Accrued assets and liabilities

–      Nonperforming or underperforming assets on the balance sheet

–      Appreciated, overstated or understated assets on the balance sheet

–      Deciding on Compiled, Reviewed or Audited financial statements

Ideally a business owner planning his/her exit three to five years prior to the actual sale has the best opportunity to do the proper financial planning and make the financial records accurate and presentable.

However, it is never too late to plan for a sale and even a year’s worth of planning is better than no planning at all. Be aware that generally the more time the owner works the problem, the better the results will be.

Posted in Finance, M&A, Miscellaneous, Tax Related, Valuation | No Comments »

2008: Exit Planning For The Year Ahead

Thursday, January 17th, 2008

2007 is over! That is a welcome relief for many business owners.  After several years of solid growth, 2007 has been a harsh year for business executives. Empirical evidence suggests that a vast majority of businesses have seen their revenues stagnate or decline in 2007.

For Business owners who were planning to retire or cash out of their business for other reasons, 2007 was tough. Business was soft, long term interest rates were near 5 year highs, credit was hard to come by, and liquidity levels were low. All of these translated into a very negative environment for deal making especially in the housing, construction and retail industries. Business owners who had their businesses on the market saw less than stellar business valuations and, in several cases, found that their deals did not close as planned. Several other business owners who were planning on exiting held back – unwilling to face a reduced valuation and hoping things would be a bit better in the not so distant future.

As we look into 2008, it appears that we have not seen the bottom in the economy. Does this mean business owners should delay their exit/recapitalization decisions until late 2008 or 2009? Not necessarily!

When evaluating the consequences of environmental trends on the business sale/recapitalization process, it is useful to keep in mind that the business sale/recapitalization process for a mid market business can take about 12 months. Most acquirers/investors look carefully at business performance as they navigate through the deal process and positive trends along the way can be helpful in closing a deal and in getting the terms sought by the shareholders.

Here are some key factors business owners need to take into account while planning exit/recapitalization strategies this year:

Ø  Economy: While we have not seen the bottom in the economy, some segments of the market are starting to pick up. Most construction related businesses continue to be in the doldrums, but the prognosis for several other business categories is getting positive. Based on the commentary we are hearing from industry sources, it seems likely that most businesses will end 2008 with more positive trends than what they are seeing now. These positive trends can be beneficial to companies and shareholders with near term plans to exit or to recapitalize their businesses.

Ø  Interest Rates and Liquidity: Long term interest rates are inching downwards and credit is expected to get better as the year progresses. Twenty out of twenty top economists in a recent national poll forecasted interest rates to go down in the near term. Lower interest rates not only improve liquidity, but also have an effect of making valuations higher. Acquirers are likely to find a higher valuation more acceptable in a lower interest rate regime when they can finance the deal and still meet the cash flow metrics needed. Lower interest rates, coupled with improved liquidity, make the chances of putting together winning deals a lot more likely.

Ø  Taxes: Unfortunately, selling a business with a gain means that a business owner has to pay capital gains tax or ordinary income tax on the gain. Since capital gains are taxed at a lower rate than ordinary income, a competent business M&A specialist attempts to structure much of the gains from the sale of the business as capital gains. In the last few years, business owners have been beneficiaries of a historically low 15% Federal Capital Gains Tax Rate.  With an impending new administration in the White House in 2009, most tax experts believe that the low 15% Capital Gains Tax rate is unlikely to stay at that level and there is a substantial risk of the rate being changed to something higher. The prospect of increased Capital Gains Tax should be carefully thought through in the context of the business exit/recapitalization process.

Ø  Deal Making Opportunities: Acquirers are a lot more likely to buy a business in a flat to upwards trending market than in a downward trending market. Deal making opportunities should become more abundant as the economic trends reverse through the year. Deal making opportunities are also likely to be aplenty if the business is in a growth oriented segment, or if the business is of a type that can be desirable to foreign companies. With the US Dollar being extremely weak, foreign entities are actively looking to make synergistic acquisitions. It is unclear how long the weak dollar will last but the prognosis is for the dollar to continue to be weak for the near term.

All things considered, early 2008 would be an excellent time for business owners to review their exit or recapitalization strategies and determine how to approach the business sale/capitalization process for optimum financial return.

Posted in Deal Structure, Finance, M&A, Marketing, Miscellaneous, Tax Related, Valuation | No Comments »

Stock Sale Vs. Asset Sale

Thursday, January 17th, 2008

An Overview of Tradeoffs

 

There are two primary ways of structuring the sale of sale of mid-market companies: Stock Sale and Asset Sale. This document compared the trade offs involved with each of these approaches. Acquirers should keep in mind that regardless of the tradeoffs shown below, asset sales may not be practical in some cases for contractual or other reasons. In such cases, stock sale is the only way to go.

Stock Sale Vs. Asset Sale Table

 

 Asset Sale Stock Sale
Legal Risk No legal liability for the corporation prior to the purchase Legal liability for the corporation prior to the purchase can be mitigated if seller is willing to sign an indemnification agreement
Cash Flow Most of the assets purchased will be depreciable over 3-30 years with the average being approximately 10 years. This means that you may write off approximately a tenth of the purchase price every year. When you sell, you typically pay back the government for all the deductions you took.Advantage: Time value of money Low depreciable asset base means you do not get benefits of the excess depreciation you can take. On the upside, there is no depreciation recapture tax at the time of sale.
Governmental Administrative work to the extent you need to files Corporation, tax & employment application before the close of escrow. Corporation, tax & employment numbers & documentation in place – any changes can be done at a convenient time at your own pace.
Other Taxes Sales Tax on FF&E No Sales Tax
Employees Rehire employees – administrative hassle with hiring, benefits, payroll processing, etc. before the close of escrow Employee contracts continue. Any changes can me made at a convenient time and pace.
Workers Comp Workers comp rate could potentially be higher – sometimes significantly – you need to determine the impact and the net cost. Workers comp rates lower than yours? If so, you benefit from the lower cost and you may even be able to move some of your staff under this umbrella if it makes sense.
Customers May need to renew or renegotiate contracts Customer contracts likely to continue with minimum hassle
Vendors / Suppliers Re-establish contracts – negotiate transfer of leases and contracts – at the minimum you have administrative hassles and in some cases you may need to come up additional money for deposits. Vendor contracts continue. If any of the vendors offer superior services at better rates, you may move some of your existing business under the same umbrella.
Bulk Sale Need to conduct bulk sale in most cases – costs approximately $600 at current rates and takes about 20-25 days – this process delays the transaction. No need to do bulk sale – which means you close the transaction faster, cheaper and thus enjoying the benefits of the cash flow sooner. None of the creditors are aware of the transaction unless you choose to tell them.
Other Could consolidate book keeping, tax, and other regulatory filings with current entity to simplify operations. Need to continue the book keeping, tax, and other regulatory filings necessary to keep the entity in compliance.

 

Sellers and acquirers need to be aware that while several of these elements can be structured to the mutual benefit of both parties, some of the elements have less favorable impact to one of the parties and negations are necessary to structure a win-win deal.

Where it applies:

The intent behind establishing a type of sale (stock vs. asset) is to pick the most beneficial way to structure the transaction.

Posted in Deal Structure, Finance, M&A, Miscellaneous, Tax Related, Valuation | No Comments »

Valuing Companies With Erratic Earnings

Thursday, January 17th, 2008

What is the right metric?

 

A significant number of businesses that come to market do not have consistent stream of earnings. Inconsistent earnings history makes it difficult for acquirers to predict future earnings and create a valuation challenge. Using an “industry earnings multiple”, the most common metric used to value mid-market companies can be meaningless in these situations.

Which earnings number does one pick? The highest? The lowest? Most recent? The average? Weighted average?

On the surface, using weighted average may seem like an appealing answer. However, using weighted average typically leads to overvaluing or undervaluing the company by a substantial margin to the detriment of either the acquirer or the seller.

Assuming a reasonable earnings number can be picked using weighted averages, is “industry earnings multiple” a valid multiplier to arrive at a valuation? In not, how does one value these companies?  

A keen appreciation of financial methods and industry knowledge are essential to answer these questions. The first step in the process is to gain a clear understanding of the reasons for the earnings variability. Some common reasons for earnings variability are:

v  Economic changes in the target market

v  Development phase of the company

v  Large non-recurring income/expenses

v  Loss/gain of large customers

v  Entry/exit of major competitors

v  Changes in management or key employees

v  Changes in physical environment and target market

v  Substantial changes in level or amount of operating equipment or people

v  Changes in COGs that are out of line with changes in final product/service prices

Acquirers may see some of these reasons as problems that reduce the future earnings. They may also see some other reasons as opportunities that increase the future earnings. It is imperative that both the reasons and the impact be well understood early in the valuation process. Once the reasons are identified and their impact assessed, appropriate adjustments can be made to recast the financials to get a more meaningful picture of the company’s revenue and earnings stream. Quite often, these recasted numbers indicate a stable or predictable earnings or revenue stream.

If the earnings stream is predictable, the acquirer can use industry price/earnings multiples to arrive at a reasonable valuation.

If the earnings stream is somewhat erratic but the revenue stream is predictable, the valuation may have to rely more heavily on industry price/sales multiples.

If neither the earnings nor the revenues are predictable after recasting, the valuation process becomes highly subjective. In such a situation, the transaction price should either show a substantial discount to a market multiple or be tied to future performance of the business.

Posted in Deal Structure, Finance, M&A, Miscellaneous, Valuation | No Comments »

Business Broker, M&A Advisor Or Investment Banker?

Thursday, January 17th, 2008

Picking The Right Intermediary For The Sale Of Your Business

 

You are ready to sell your business. You ask around and find that some businesses are sold by Business Brokers, some by Mid-market M&A Advisors, and some others by investment bankers. The difference in intermediaries can make difference of 20% to 40% or more in what you can take away in many situations. So, picking the right intermediary can have a major impact on your nest egg. Which one of these is right intermediary for selling your business? Who should you use?

The following table shows the applicability of these intermediaries based on various metrics.

  Business Broker Mid-market M&A Advisor Investment Banker
Size Of Business

Less than $2M

$1M – $100M

$50M and higher
Type of Business

Mostly Retail

Distributors, Manufacturers, Healthcare, Technology, Large retail, B2B companies

Public or large private companies
Typical Representation

Seller & Buyer (DUAL AGENT)

Either Buyer Or Seller

Either Buyer Or Seller
Typical # Of Employees

Less than 10

Tens or Hundreds

Any size
Typical Acquirers

Individuals

Corporations, PEGs

Public Companies or Large PEGs
Typical Sale Type

Asset

Asset or Stock

Stock or Mixed
Business Valuation

Street Multiple / Rules of Thumb

Strategic Value, DCF

Strategic Value, DCF
Transaction  Complexity

Simple

Complex

Very Complex
Size of contracts

A few pages

Tens of pages

Hundreds of pages
Typical Fee Structure

10-12%

Double Lehman / Negotiated

Negotiated
Upfront Fees

No

Maybe

Yes
Typical Multiples

2-3x DCF

3-7x EBITDA

P/E>10

The deciding factor in selecting the right intermediary is type of business you have. For small companies with revenues under $1 million and for large companies with revenues over $100 million, the choices are obvious.

If your business is a small retail or service business and there is no strategic value in the business, any competent business broker may be able to get the job done. However, since there is a substantial  negotiating component in deals this size, your interests are likely to better served if you choose an intermediary to represent you exclusively (i.e. not a dual agent).

An M&A Advisor is the right choice if your business is larger, complex or has a high component of product or service specialization. A competent M&A Advisor can unlock the value in your business, represent you exclusively, and get your business the higher value it deserves. This is extremely important if your business has untapped strategic value or has intellectual property subject to a broad interpretation of value in the marketplace.

Posted in Deal Structure, Finance, M&A, Marketing, Miscellaneous, Valuation | 2 Comments »

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