Bottom-line: Deals are still getting done in the lower middle market – you simply have to be prepared for some of the new realities AND have professional representation guide you through them.
Despite recent economic uncertainty, the market for the sale of private businesses has not dried up. Many private business sale transactions continue to move forward, though at a slower pace, and private equity firms in the U.S. have a significant amount of investor capital that they still need to invest in private enterprises.
This is a critical point that business owners need to realize: The motivation of buyers in the lower middle market is radically different than that of the billion-dollar deal buyers that get all the press (and which most now have deals on hold).
Because financial and strategic buyers that operate in the lower middle market have a much longer time horizon than simply the quarterly profit goals that the billion-dollar club must justify. Even in the lower middle market an ROI (return on investment) is necessary. However, for buyers in the lower middle market (generally deals valued below $100 million), the timeline is much longer, making COVID-19 recasting simply another hurdle to overcome (among the many in lower middle market deals during normal economic times).
We also expect to see buyers paying a greater portion of the purchase price in the form of an “earn-out.” This results in the business owner being paid over the course of several years, but only if the firm achieves certain predetermined performance targets. We believe sellers who adjust their mindset, show a willingness to be more flexible on deal terms, and who recognize that the transaction process is going to take longer in this new environment are likely to be at a competitive advantage.
Now earn-outs have been a deal making option since literally the beginning of the M&A industry decades ago. However, it is VITAL that the earn-out be crafted in such a way to benefit YOU in the long term, not just the buyer. An experienced M&A advisor will help prevent situations where the earn-out is based on items you have no control over and the buyer has 100% control (especially if you have very little management of operations post-sale).
Also, an M&A advisor like Generational Equity will guide you to determine which deal terms to be more flexible on than others. This is really key. For example, in many cases a structured deal with an earn-out can actually provide you with more cash in the longer-term.
However, again, you will need professional help to determine this. I cannot overstate this fact! This is one of the key reasons why exit planning professionals exist.
Finally, we come to the 900-pound Gorilla in the room: How to address a massive business interruption like COVID-19 in relation to business valuations. Northern Trust has some valuable input on this topic:
Moving forward, we expect the due diligence process to include questions that help buyers better understand the specific impact of COVID-19 on the business, and its general level of preparedness for a global pandemic. Review your business continuity plans now, so that in the event you decide to sell your business, you and your management team have anticipated buyers’ diligence questions. Buyers will expect responses that offer reassurance that your company is prepared for these contingencies.
As we mentioned a few weeks ago, a new accounting term has been created in the last few weeks:
Most business owners are familiar with the definition of EBITDA, the “C” has been added to address the impact on revenue/earnings by the Coronavirus. Ultimately, this all relates to a term known as “recasting”. If you can document how your business has been affected by and, even more importantly, how your team has effectively addressed the impact of COVID-19 on your operations, you will be well-prepared for questions that will arise during due diligence.
Since this is all new territory for most business owners (but not so for experienced dealmakers who have literally seen every possible business reversal under the sun), it really is crucial to hire a professional to guide you.
Let’s be honest: Professional business buyers are always looking for the best deal they can get with a seller. That is totally ethical and honest. However, for the next 6-12 months, buyers will be looking hard for any loophole which will help them get a greater ROI than ever.
The reason Generational Equity has developed such a solid reputation in the market over the years is that our dealmakers have the experience of closing deals in all economic cycles and, while doing so, PROTECTING THE FINANCIAL INTERESTS OF OUR CLIENTS!
This is so clear when you listen to what our clients have to say about our services:
And that is what it really all boils down to in the long run: How we can help you protect the generational wealth you have built in your business and allow you to maximize it upon exit, NO MATTER WHAT THE EXTERNAL CIRCUMSTANCES MAY BE!
So thank you again to our friends from Northern Trust for providing us with a fantastic overview of what business owners contemplating an exit need to be aware of for the next few months. What is clear is that entrepreneurs need help now with exit planning like never before.
Fortunately, as the leading lower middle market M&A firm in North America, we are here to guide you. If you would like to learn more about how we can, please call us at 972-232-1121 or provide us with your contact information and we will be in touch.
Remember that there is no wrong time to begin exit planning; the sooner you start the better. There are two types of business owners:
Those that PLAN to exit
Those that HAVE to exit
Which are you?
Carl Doerksen is the Director of Corporate Development at Generational Equity.
© 2020 Generational Equity, LLC All Rights Reserved
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