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acquisitions
Just How Much is Your Business Worth?
The Point: If you are thinking about selling your business, then you’ll need to identify just how much is your business worth! This article is intended to offer perspective to the small business owner looking to sell their company. Specifically, we’ll attempt to shed some light on how businesses are valued. There are a lot of elements that go into what a business will sell for and we’ll attempt to hit the high-points… Enjoy!
Earnings
The monetary health of your organization will certainly be a substantial consideration for prospective purchasers’ decision on what they will spend for the business. Earning, EBITDA, Cash Flow or Net Income are basically what the owner makes from the company, including their income, perks, benefits, and net income.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) resembles cash flow, however it deducts what it would cost to pay a common CEO in this market to run the business. This might vary from the actual income that the existing owner makes. EBITDA is what the business would produce for their financier after paying the typical income to a President that would run the Company for the financier.
The factor that Cash Flow and EBITDA are vital is that what individuals want to pay is frequently based upon a number of annual cash flows or EBITDA. These multiples can differ considerably depending upon lots of considerations. If 2 business’s net earnings are both $500,000, one business may offer for 3 times the yearly money circulation ($1,500,000), and another may offer for 5 times annual money circulation ($2,500,000). Why?
We will check out a few of the aspects that can impact what kind of multiple (3x or 5x from the above example) a buyer will utilize to identify what they will use for the company and what other aspects besides Net Income purchasers may utilize to identify the listing price of a business.
Market
The market that a business is in definitely plays a part in what multiples prospective purchasers are ready to pay for a company. Even within technology, a company that sells their own proprietary software will usually sell for more than a company that sells IT Services or acts as a reseller of other companies’ technology. The multiple is meant to be a multiplier of risk.
There are still many factors that go into what someone will pay. A Profitable construction company might sell for a lot more than a software company, depending on other factors such as size, number of years in business, long-term contracts, etc.
Size of the Company
In general, the bigger and more lucrative an organization is, the greater the multiple of rate to profits is. A company that has an annual net cash flow of $200,000 might sell for 2.5 times Cash flow ($500,000). Depending upon the information, a business that has capital of $5 Million may cost 7x Cash circulation ($35 Million).
There are a lot more aspects to this, however this is an illustration of the quantity of the profits likewise factoring into the numbers that purchasers will spend for a company. Valuing a company is part art and part science to integrate all of the elements that enter into a possible list price of a Company. We’ll continue with other elements that will enter into it.
Synergies in a Merger or Acquisition
Getting a purchaser or purchasers that have excellent synergies with acquiring a business can be an outstanding method to increase worth in the sale of a business and result in a greater cost paid. There are a great deal of various methods which you can have a synergistic purchaser. We’ll detail synergistic possibilities from purchasers in the very same market and purchasers in numerous markets.
Expense Reduction: A purchaser within the exact same market that can minimize expenses by integrating a few of the overhead. Whether that overhead is the financial investment in underutilized devices, area, or workers, when underutilized properties are more totally made use of, there can be a boost in the combined profits by lowering expenses without minimizing profits.
More Services to Cross Sell: More typical than expense decrease is synergies that lead to a revenue boost through a boost in combined profits. An example of this is where a civil engineering firm acquires a Land Surveyor company, and now they can cross-sell their existing client base to supply more services to each other’s clients and increase the combined earnings. They can win larger jobs where the bid involves both areas of expertise of the combined companies so that they don’t need to use subcontractors and can better control the quality and costs of the projects conducted.
Making the Most of Each Other’s Strengths: An example of this would be an acquisition of a little software application business that has actually established excellent brand-new innovation, however does not have a big sales force. This could be acquired by either an IT Services or Software business that has a big sales force and relationships with IT Departments at their existing clients, however maybe their services have actually ended up being outdated over time. The mix of these 2 companies would have the ability to quickly offer the brand-new innovation and permit the more recognized company a business development course that it would not have otherwise.
Financier’s Contacts and Strategy: Synergistic mergers do not always require the mix of 2 business. Sometimes, you can have a rich business owner or personal equity company that can obtain a business in a market where they have contacts that they can utilize to present an obtained company and get them into some big consumers that they would not have access to. A knowledgeable financier’s understanding of a market might likewise result in vital suggestions on how a business must continue to grow its Company beneficially.
Patterns
How to Value a Business
The trends in your business will affect the valuation of your Company. On average, they will pay a higher multiple for a company that is trending up compared to one that is trending down.
The net income and revenue might vary a lot from year to year. In this case, some prospective purchasers may average the last 3 or 4 year’s earnings, or they might utilize a weighted average where more weight is provided to the most recent yearly monetary outcomes.
Purchasers will attempt to examine what an affordable projection is for a business in the coming years based upon its patterns and other aspects, such as what the general patterns of the market are and external elements.
Consumer Density
If two companies are both making a net income of $1 Million and Company #1 has 300 customers with no one customer making up 10% of their revenue and Company #2 has 20 customers with their top customer making up 40% of their revenue, typically Company #1 will sell for more than Company #2.
Company B can still be sold; however, in some cases, they will have to decide between a lower sale price and a higher sale price that includes an earn-out. It is a way for the buyer to pay more and have the seller assume part of the risk if their largest customer doesn’t continue on with them.
Recurring Revenue
If a business has repeating earnings, this will normally make it more valuable. Repeating income can happen in various markets. An example would be 2 manufacturing businesses.
Business #1 primarily does brand-new widget manufacturing. When brand-new advancements are being developed, they do the manufacturing for these advancements. Business #2 has long-lasting clients that they have continuous relationships with and expense reimbursement from them on a monthly basis.
If their consumer retention is high and both Company #1 and Company #2 make the exact same quantity of earnings, generally Company #2 will cost more since they have repeating earnings with long-lasting clients that they have actually kept. This lowers the danger in a purchaser’s mind that the income (revenue) will decrease.
Team Member Skills and Accountabilities / Responsibilities
Prospective Buyers will think about the abilities and duties of the workers when figuring out the worth of the Company. If business is based around the owner’s abilities and the owner has all of the relationships with the consumers, this will be a greater considerable threat aspect when the owner moves-on, and normally, the owner will be required to remain on with the organization for a more prolonged shift duration.
A plus is if there is a strong second-in-command. This management structure under an owner where workers report to the department supervisors rather than everybody reporting to the owner. If there are salesmen that deal with client relations and other necessary functions in the Company, this is likewise a plus.
Business Reputation
What if your reputation isn’t that great in the marketplace? It doesn’t mean that the Company can’t be sold, but it may mean that the Company will sell for a lower valuation. For example, if online reviews of the Company are outstanding, this will be a plus and put buyers more at ease as opposed to if reviews were terrible.
Agreements or Contracts
As previously mentioned, beneficial long-lasting agreements or contracts with clients (and workers) is a plus. The length of the contracts will likewise be an element to consider. If there is a brief contract, if a brand-new business buyer can get a beneficial long-lasting agreement put in place, this would alleviate the brief (or expiring) contract if the area is vital to business. Business buyers will look at any contracts with clients that may be favorable or unfavorable as the term of the contract are set to expire. In some cases, the buyer may have to buy the corporate stock to ensure the transferability of the contracts.
Full Disclosure of Seller’s Discretionary Earnings (SDE)
If the monetary info and other details on the business are plainly set out and easy to understand, this is handy. It works to plainly determine what the owner’s wage, benefits, and advantages are so the purchasers can get a genuine understanding of what the owner is making.
In discussion with the buyer, it helps to be open and honest about the business to give potential buyers an understanding of not only the opportunities but any challenges they might face. No company is perfect, so it’s best to be honest in answering any questions.
Alignment
There is no accounting for the alignment between buyer and seller until they meet and get to know one another. A Seller that is easy to get along with and work with makes it easier for potential buyers to pay a premium price for a business.
Dealing with Business Brokers / Mergers & Acquisitions Companies
If you are considering buying or selling a business, it helps to work with an experienced Business Brokerage firm. A good Business Broker / Mergers & Acquisitions firm can help both buyer and seller to work out a price that makes sense for both parties. CAUTION – Keep in mind that typically the Broker solely works for the seller of the business. Therefore, it might be beneficial to coordinate with a buy-side Broker or M&A firm to represent the interests of the buyer.
Sam Palazzolo
Selling Your Business to Tip of the Spear Ventures
If you are thinking about selling your organization and your organization fits within our Acquisition Criteria (“”), then we should talk. Contact us at Selections@TipoftheSpearVentures.com.
Selling a Small Business – 5 Tips for Baby Boomers Approaching Retirement
The Point: As a small business owner, you pour your blood, sweat, and tears into your business! The day-in/day-out challenges associated with leading a business as it’s owner are supposed to be offset by the “golden” years of selling it and retiring. As the largest demographic in our society, the Baby Boomers, approach their exit it appears as though the golden years are turning to rust before our very eyes! So, in this post we’ll explore selling a small business with 5 tips for Baby Boomers approaching retirement… Enjoy! (NOTE: While the focus of this article is on Baby Boomers, it can be applied to any small business owner looking to successfully exit!)
The Baby Boomers
Baby Boomers born between 1946 and 1964 represent an estimated 73 million people in our society (The second-largest age group after their children, the Millennials, born from 1982 to 2000). Baby Boomers represent 41% of small business owners or franchise owners (Second to Gen X’ers born between 1965 and 1980 at 44%).
This demographic rapidly approaching retirement age (generally thought of as age 62 – the age at which a person is expected or required to cease work and is usually the age at which they may be entitled to receive superannuation or other government benefits, like a state pension). As they achieve this milestone, few appear to be financially ready/able to successfully retire. The top two reasons being that (1) they were the first generation expected to establish for themselves self-retirement tools/savings as opposed to government provisions and (2) the economic recession from 2008 reducing significant savings (if any were established).
Baby Boomer Small Business Owners
Statistics reflect that almost 40% of Baby Boomer small business owners feel they don’t have the financial confidence to retire before they’re 65, let alone three years earlier at 62! What’s more, a recent study suggests a full 72% don’t even have an exit strategy. Exit strategies for small business owners typically consist of the following (in popularity order):
- Liquidation
- Liquidation Over Time
- Keep Your Business in the Family (i.e., Succession Planning)
- Sell Your Business to Managers and/or Employees (i.e., Employee Stock Ownership Planning – ESOP)
- Sell the Business in the Open Market (i.e., Mergers)
- Sell to Another Business (i.e., Acquisitions)
- The IPO (Initial Public Offering)
Tips for Baby Boomers Selling Their Small Business for Retirement
As an active acquirer of small businesses (You can view my firms Acquisition Criteria here: https://tipofthespearventures.com/acquisitions/), I’ve compiled the following five (5) strategies or tips for successfully selling the Baby Boomer owned small business. (Note: As a somewhat conservative investor, I caution against the “all-your-eggs-in-one-basket” mentality when it comes to selling your business ahead of retirement).
Tip #1 – Diversify Your Money
One of the biggest strategies I see small business owners do is hinge their entire retirement on the sale of their business. A better strategy consists of acting well before the sale. It is important that small business owners take money out of the business from a personal standpoint and invest those funds no less than three years prior to an anticipated sale. Typically, most businesses will provide the most recent years financial statements as part of the financial packet to prospective buyers. Statements that reflect anomalies are scrutinized, leading to a sale multiple (3-5x) that will be less than or undesirable.
Tip #2 – Financial Statement Cleaning
Along those lines, the organization’s financial statements are the foundation reviewed during acquisition due diligence when selling any business. Updating the core documents like profit and loss statements can make a big difference to anyone exploring the enterprise.
Updated balance sheets and tax returns for at least the last three fiscal years is crucial in projecting the best financial position possible. The goal being to make sure everything ties together, making sense to potential acquirers and being easy to understand.
Tip #3 – Removing Yourself from the Business
Do you have staffing that’s able to run the business after your exit? As an active Owner Investor (as opposed to Owner Operator) I typically look for organizations that have depth of staff that will allow the organization under new leadership to continue on without current ownership running the entity day-in/day-out. Easing the transition here means hiring employees that will stay as the face of your business when the ownership changes. This strategy allows small business owners to potentially increase the value of their business and the likelihood it will sell.
Tip #4 – Operational Documentation
Having an Operational Guide is important for every business to successfully operate/run. These Operational Guides are critical details for manufacturing, distribution and sales. This guide that is written down and documented makes it easier for the new buyer to pick-up where the old owner left off and drive the organization forward. They also make it easier/less stressful for those employees remaining with the business.
Tip #5 – Identify Legal Barriers
Identifying if the sale of your business is an Asset (when a buyer is interested in purchasing the operating assets of a business instead of stock shares) or Stock (shareholders of the target company receive shares in the acquiring company as payment, rather than cash) sale will ease the exit process. Removing any of the legal hurdles can make the road to a sale less difficult for acquisition. For example, one that we keep coming up against is the transfer of the lease (Landlords using the sale of the business as an opportunity to renegotiate leases and up the rent can be viewed as undesirable to potential buyers).
SUMMARY
In this post, we’ve explored selling a small business with 5 tips for Baby Boomers approaching retirement along with 5 tips. All of these strategies are desirable for potential acquirers. As such, Baby Boomers looking to sell their business should look to complete them to position their business as they look to exit into their golden years of retirement.
Sam Palazzolo
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Mergers & Acquisitions: Slowing Down to Speed Up! Part 2
The Point: When it comes to Mergers & Acquisitions, speeding up isn’t the answer. In fact, I typically see that if those that lead M&A would simply slow down, they actually achieve their objectives more quickly! So how then do Mergers & Acquisitions leaders and their teams slow down for success? In this two-part post (You can read Part 1 by CLICKING HERE), we’ll explore exactly how slowing down to speed up can be achieved in Mergers & Acquisitions… Enjoy!
In Part 1 of this post on “Mergers & Acquisitions: Slowing Down to Speed Up!” we explored how slowing down to speed up can be achieved in Mergers & Acquisitions. Specifically, we reviewed the effect of COVID-19 on M&A, a six (6) stage Mergers & Acquisitions Strategy, and how slowing down to speed up can result in M&A success. Here in Part 2, we will continue the discussion on potential challenges and how to navigate them.
Pricing Flexibility and Fairness
As mentioned in Part 1, a key issue when negotiating an M&A deal is the agreed to pricing mechanism or structure of the deal and related adjustments to be made. Know this: There is almost always a difference between what the Seller believes is the appropriate price and what they Buyer believes they should have to pay for a business. This valuation gap should contain contingency planning on how to deal with differences in lock box (fixed price plus an interest component), working capital, capex, and net debt adjustments and Seller Discretionary Earning – SDE or earnout.
The Breakup Clause or MAC
As a Buyer of businesses, we typically like to include clauses that allow for a clean “breakup” if need be. There’s considerable time and investment made, and nothing is worse than an ugly breakup! Including a Material Adverse Change (MAC) condition whereby “walk-away” privileges are preserved.
Keep in mind that a MAC should be used as a Buyer’s protection tool in the event significant differentiation presents itself in asset deterioration versus stated condition for example. A MAC should not be utilized as a “cool down” or buyer’s remorse prevention tool.
Targeted Due Diligence
The main issues identified for the business should be included in a targeted due diligence approach. This approach could be further supported by identifying and putting into place Representations and a Warranty & Insurance policy. These policies are used in Mergers and Acquisitions to protect against losses arising due to the Seller’s breach of certain representations made in the acquisition agreement.
With so much to consider when it comes to a Mergers and Acquisitions due diligence initiative, where should you start? In other words, if you don’t have a target to aim for, you’ll never know if you hit or miss it! Consider this due diligence moment as one similar to a VC exploring a Series B round investment. Here then is a list of 8 items to target as a part of your due diligence:
- Corporate Records and Charter Documents
- Business Plan and Financials
- Intellectual Property
- Security Issuances and Agreements Concerning Securities
- Material Agreements
- Information Regarding Disputes and Potential Litigation
- Information Regarding Employees and Employee Benefits
- Equity Grants
Competitive Analysis
A competitive analysis is a strategy where you identify major competitors and research their products, sales, and marketing strategies. By doing this, you can create solid business strategies that improve upon competitor’s market position. We recommend conducting a Competitive Analysis as part of your due diligence, primarily because you’ll need to identify the current role the organization plays within the existing business climate, as well as where potential lies.
In conducting a SWOT Analysis (Strengths, Weaknesses, Opportunities, and Threats), we recommend a deep-dive on competitors. You’ll need to identify who you’re really competing with so you can compare data accurately (An apple vs apple comparison, even if it’s two different varieties of apple is better than an apple vs orange comparison). Specifically, you’ll want to identify:
- Who are your direct competitors (Those competitors you that offer a product or service that could pass as a similar substitute for yours, and that operate in your same geographic area).
- Who are your indirect competitors (Those that provide products/services that are not the same as yours, but could satisfy the same customer need or solve the same problem).
Competitor analysis is something that you’ll also want to revise throughout the years of ownership. Why? The market can and will shift anytime, and if you’re not constantly surveying the competitive landscape, you won’t be aware of changes until it’s too late.
SUMMARY
In this post, Mergers & Acquisitions: Slowing Down to Speed Up! Part 2, we explored how slowing down to speed up can be achieved in Mergers & Acquisitions. Specifically, we reviewed Pricing Flexibility and Fairness, The Breakup Clause or MAC, Targeted Due Diligence, and Competitive Analysis.
Sam Palazzolo
Mergers & Acquisitions: Slowing Down to Speed Up! Part 1
The Point: When it comes to Mergers & Acquisitions, speeding up isn’t the answer. In fact, I typically see that if those that lead M&A would simply slow down, they actually achieve their objectives faster! So how then do Mergers & Acquisitions leaders and their teams slow down for success? In this two-part post, we’ll explore exactly how slowing down to speed up can be achieved in Mergers & Acquisitions… Enjoy!
The Effect of COVID-19 on M&A
The pandemic has certainly had its impact on the economy. From lockdown mandates to the rebooting of the economy (and sometime unfortunate re-lockdown occurrences), we’re seeing a major effect on the bottom lines of organizations we’ve determined as prospective M&A market verticals. Even with the hope of antivirus on the not too distant horizon (hopefully!), there exists a number of companies that will be pressured by creditors to divest assets to pay down debt and avoid going into business rescue (or liquidation), or to assist in funding ongoing operations due to a cash flow crunch.
With abbreviated timelines, M&A activity now additionally has certain legal and commercial challenges for both buyer and seller at play. Think asset preparation for sale issues give the shortened timeline, providing the buyer with accurate information and time to conduct thorough due diligence ultimately sets the stage for deeper valuation gap analysis.
If money is made during the initial acquisition moment, the buyer must mobilize funding for quick deployment while the seller balances the need for speed and complexity of the divesting process.
Mergers & Acquisitions Strategy
In order to speed up, we’re going to have to slow down. A strategy to help accomplish that is to view the Mergers & Acquisitions Strategy from the Seller’s perspective. With the Seller’s perspective in mind then, the following is a six (6) stage strategy a Seller could employ to make the transaction a reality:
- Business Valuation – What multiple (typically 3-5x) applied against what financial term (Cash flow, Seller Discretionary Earning – SDE, and/or EBITDA)? Additionally, taking into account current COVID-19 financial performance considering revenue, expenses, and liquidity are important business valuation determinants.
- Deal Structure – What will the proper deal structure look like? From a financing perspective, will it be made up all/parts institutional/non-institutional financing (Banks, Private Equity – PE, Family Office funding), seller financing, and/or buyer funding? Additionally, will there be a need for the seller to provide a transitional services agreement whereby they agree to stay/run the entity during the transitional period typically of 3-36 months?
- Business Listing/Auction – As a seller, you’d like to receive the most money for your years of service to an organization. What is the best route to get the most money then? Typically, we approach organizations not listed for sale prior to them listing their business. With these Sellers, they typically don’t know how much their business is worth. Introducing them to a valuation service can be beneficial in determining the value of their entity as well as a potential source for realistic listing of the company. In some situations, businesses are already listed for sale on sites such as BizBuySell.com. Lastly, in distressed situations a business will go to an auction sale process.
- Legality – There typically is involved a series of professional advisors (I wrote about surrounding yourself during the M&A process in a post that you can read by CLICKING HERE). Know that as a seller disposing of assets sometimes there is a need for disclosure of key regulatory approvals that may be required to implement the divestment. Understanding these issues enables a seller to (1) be forthright about any problems associated with the organization’s assts and (2) accelerate the due diligence timeline towards the creation of an acquisition agreement.
- Buyer Qualifications – Who is going to be the ideal buyer of the business? Most owners have a variety of Buyers approach for acquisition. However, not all Buyers are created equal, and therefore should not be considered as such. Typically, there is a Buyer profile that can eliminate potential Buyers and provide a strategy for who the owner ideally would like to see carry on their legacy.
- Leveraging Technology – If the pandemic has taught us one thing, it’s that virtual meetings can maximize your efficiency if conducted properly. Therefore, leveraging technology (virtual meetings, email with clear communications, etc.) can greatly enhance the offerings value to Buyers.
Slowing Down to Speed Up for M&A Success!
So what is your goal regarding established Acquisition Strategy (You can read Tip of the Spear Ventures Acquisition Strategy by CLICKING HERE). Our goal at TIP is to acquire one (1) business each quarter. That’s a lofty goal, and requires numerous business explorations to be conducted each month. But with such a goal, we know that speeding up isn’t the answer. In fact, we’ve found that if we simply slow down the acquisition process we achieve our objective more quickly.
Speeding up wasn’t the answer for us! With speed came a host of issues, such as increasing complexity, unnecessary energy consumption, and overlooking of key due diligence criteria. We also found that we were quick to “fall in love” only to be heartbroken because we overlooked obvious signs that the business wasn’t a good fit for our portfolio.
By slowing down, we were able to go deeper in our due diligence. As a result, we dealt more effectively with the typical increased levels of complexity, overcame easier the obstacles/challenges that presented themselves along the way, and used far less energy. Not only were we able to go deeper, but speed was attained so that we could go faster towards achieving our goals/objectives.
SUMMARY
In this post, Mergers & Acquisitions: Slowing Down to Speed Up! Part 1, we explored how slowing down to speed up can be achieved in Mergers & Acquisitions. Specifically, we reviewed the effect of COVID-19 on M&A, a six (6) stage Mergers & Acquisitions Strategy, and how slowing down to speed up can result in M&A success.
Sam Palazzolo
PS – In “Mergers & Acquisitions: Slowing Down to Speed Up! Part 2” we’ll discuss Pricing Flexibility and Fairness, The Breakup Clause or MAC, Targeted Due Diligence, and Competitive Analysis. You can read it by CLICKING HERE.