How to Divest Part of a Company

/in , , /by Al Statz

Selling a division or line of business is often more complex than selling an entire company. If you’re like most private business owners, you have never sold a business, let alone carved out and divested part of one. This article shares some of what I’ve learned about planning and executing a successful divestiture during my 20+ years of investment banking.

In my experience, most divestitures are intentional efforts to generate liquidity or streamline and strengthen core business operations. Often, the divested unit is underperforming and out of alignment with the company’s strategic direction.

Sometimes the asset to be divested is a distinct business unit with its own P&L and minimal overlap with the selling company’s main business. Other times, the asset is significantly integrated with the company’s primary business and some amount of “disentanglement” is needed before it can be reliably marketed and sold for an attractive price.

Spinning off the business into a standalone entity before a sale might even be necessary. From a buyer’s perspective, stand-alone or near-stand-alone entities are more attractive investment opportunities — because they are easier to value, perform due diligence on, and integrate. And since sellers want the buyer to take on and operate the acquired entity as soon as possible, a presale spin-off by the seller should be given consideration.

An entangled business is more challenging to acquire, and therefore sell, because of the added risk of misunderstanding exactly how the target business functions and the risk of making mistakes in the carveout/integration process. Also, consider that buyers will need to make significant investments beyond the purchase consideration. Plus, the pool of potential buyers is generally much smaller for a significantly entangled business.

When selling an entangled business, sellers must often enter into a Transition Services Agreement (TSA) that extends beyond the sale closing. This is an agreement in which the seller agrees to provide certain services to the buyer to maintain business continuity until the buyer is fully prepared to operate the acquired business.

Before attempting a divestiture, it’s worth having an experienced M&A advisor, business attorney and CPA help you conduct due diligence to assess the value and sale readiness of the assets or unit to be divested, and to identify potential challenges that are likely to arise during the sale process and whether a presale spin-off may be warranted. They will help you see the business through a buyer’s eyes and can help you develop a roadmap and budget for a successful divesture.

The divestiture’s purpose and expected financial benefits to the parent and its shareholders should be clear, and potential risks should be well understood. Your team will need to determine the specific assets and liabilities to be transferred, and each entity’s expected future cash flows. The acquisition costs and incremental investments required of an acquirer must also be estimated to arrive at a justifiable valuation. Sellers may decide to delay a sale to boost the group’s performance and show a track record of results before beginning the sale process.

For the sale process you’ll need reasonably accurate and reliable proforma financial statements. You’ll need to provide figures from the parent company’s books to show a buyer how expenses have been allocated.  It pays to be diligent and thoughtful in your preparation. Sloppiness here can lead to no deal and wasted time and money.

Beyond financial considerations, the “separation review” must consider business processes, customers and vendors, equipment, facilities, IT systems, IP, brand and market perception, leadership and governance, tribal knowledge, employee retention and engagement, and more. Acquirers pay a premium when they confidently understand a target business and clearly see how it will fit into their operations, support their strategic goals, and accelerate their future growth.

You’ll also need a strategy for communicating the spin-off and/or divestiture plans to key stakeholders, including employees, shareholders, suppliers, and customers. This will help ensure a successful transition and minimize disruption and potential harm to the business.

In a divesture, think of an M&A advisor as a strategic short-term member of your executive team. They help you develop a winning strategy and manage the entire process — performing financial modeling and valuation, preparing detailed and compelling offering materials, identifying best-fit buyers, conducting buyer outreach, attracting multiple bids and negotiating deal terms, facilitating due diligence, and liaising with attorneys and diligence providers.

All these efforts ensure that the divestiture is completed smoothly and efficiently. Preparation is key. You’d be surprised how challenging it is to maintain deal momentum while still unravelling organizational and operational entanglements.

In conclusion, divesting part of a business is a complex endeavor requiring thoughtful planning and precise execution. Following these steps will increase your odds of closing a deal and achieving your desired outcomes.

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Al Statz is president and founder of Exit Strategies Group, Inc. For further information on divesting a business unit or to discuss a potential need, confidentially, contact Al at 707-781-8580 or alstatz@exitstrategiesgroup.com.

Why boomer business owners should watch M&A cycles

/in , , /by Al Statz

Approximately 20% of private business owners are over the age of 65. Another 30% are between the ages of 55 and 64, according to estimates from the Census Bureau Annual Business Survey.

If we’re going by age trends alone, that suggests roughly half of America’s businesses will transition ownership in the next five to 10 years. This will be the largest transfer of wealth the nation has ever seen in such a short period of time.

Right now we’re in a strong seller’s market. Despite the economic uncertainty, rising interest rates and world turmoil, mergers and acquisitions has not cooled down much. It’s economics 101, supply and demand, and there are just more buyers than sellers on the market.

Between private equity and corporate balance sheets, there is more than $8.5 trillion in “dry powder” waiting to be invested in corporate growth and acquisitions. That’s at least $6.84 trillion in cash and short-term investments on corporate balance sheets, and $1.8 trillion in uncommitted capital in private equity funds, according to reports from S&P Global.

Corporations have added 20% to their balance sheets since 2019, and private equity continues to up the ante with record fundraising year over year. All that cash drives up demand and increases value for business sellers.

At some point, though, supply and demand could flip. Right now, experts estimate 10,000 baby boomers are retiring daily. By some estimates, roughly 15% of them own businesses. That’s 1500 additional businesses looking for new ownership every day – and only a small fraction of those will get passed along to a second generation.

By the tail end of this cycle, we could end up in a buyers’ market with more boomers selling their businesses than buying.  Business owners who get ahead of the trend will be in the best position to take advantage of positive market conditions.

Take these steps to increase your chances of a successful sale:

Plan:

It’s tough to maximize value when you’re burned out, so aim to sell while you’re still energized by the business. The average sale takes nine months to a year, not including post-sale transition time.

Instead of planning your retirement around a certain age, you can often reap greater rewards by timing a sale around your business value. Get a regular valuation so you know what your business is worth in the current market.

If age is still your primary deciding factor, begin planning several years in advance. With enough time, your advisors can provide leadership, cash flow and tax positioning strategies that will help you net the most out of a sale.

Prepare emotionally:

Don’t underestimate the emotional impact of selling your business. Leaving an ownership role is hard, especially if you’ve built your business from the ground up.

Many baby boomers struggle to step away when the time comes. Decide how you will define the next chapter in your life. It’s important to have something you’re “retiring to” instead of just something you are “retiring from.”

Seek advice from mentors and peers who have made a similar transition. Talk through what it means to give up your identity as a business owner. For many, it’s easier to make that transition if they already have other strong plans and commitments.

Make selling part of your succession plan:

Don’t have next generation leaders ready to take over the business? Leadership team not prepared to buy you out? Consider how selling your business can play a role in your succession plan.

When selling to private equity, for example, you can often arrange for family members or other key managers to receive an ownership stake in the business. This can be a great way to set your next generation leadership up for success, with strong connections and financial backing behind them.

These arrangements can protect you both financially and emotionally – without the specter of money and debt hanging between you and your family.

Consider staying on after a sale:

Sellers can often negotiate a full-time or part-time advisory role and phase into retirement. Employment contracts can make your business more attractive (and more valuable) to private equity buyers who need experienced leaders in place to maintain operations while they fuel new growth.

The long-predicted seller tsunami is coming. Business was strong before the pandemic, but the crisis put everyone in a short-term holding pattern. With recession fears ahead, people are taking this opportunity to go out on a high note – while they still can.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip: Niche companies can bring top dollar

/in , /by Al Statz

It’s often better to be #1 or #2 in a smaller/narrower market than a minor player in a larger/broader market.

By targeting and dominating a distinct segment of a market, you help ensure that potential customers think of you first (brand recognition) and continually choose you, again and again. Dominant players usually have lower cost of customer acquisition, first call/last look with customers, and other advantages that drive profit margins up and accelerate growth.

Niche businesses with high profit margins are generally more valuable than businesses with lower profit margins – even if they have same total profit. Higher margins means more cash flow to pay debt service or reinvest in future growth. Low margins, on the other hand, can mean less operational wiggle room and increased risk. 

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Advisor Tip: Employee retention adds business value

/in , /by Al Statz

“To win in the marketplace, you must first win in the workplace.” Those words of Doug Conant, former CEO of Campbell Soup Company, ring particularly true today.

The talent market was tight before the pandemic, but now we’re in a critical state. Finding employees is a challenge for every company. And if you’re selling your business, it might be the buyer’s top concern.

Employee issues buyers care about right now: turnover, training, cross-coverage, salary/wage increases, age/retirement plans, employment agreements, location (working from home, not local?), and leadership potential.

Talk to us about how key employees can impact market value. We can share what we’re seeing in your industry and help you evaluate the ROI of certain retention strategies – such as providing critical staff with minority equity shares or retention bonuses.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Market Pulse – Quarter 4, 2021

/in , , /by Al Statz

Seller’s Market

Presented by IBBA & M&A Source

A seller’s market occurs when demand exceeds supply. There are more interested, active buyers than there are quality deals on the market. In a seller’s market, buyer’s compete in order to win deals. This typically translates to increased values and more favorable deal terms for the seller.

In Q4 2021, seller market sentiment rebounded, setting a new peak in all but the $5M-$50M sector.

“Business confidence, and competition, is high. It’s amazing how fast we rebounded to record levels,” said Anthony Citrolo, managing partner of The NYBB Group. “This is the strongest upwarad swing we’ve seen in any 12-month period.”

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Small business values up in 2021

/in , /by Al Statz

Business values increased in 2021, despite ongoing challenges from the pandemic, talent shortages, and supply chain disruption. Deal activity continued at an intense pace, with advisors across the country reporting increases in both incoming deal flow and completed engagements.

More advisors characterized this as a seller’s market than nearly any other time in the last decade, according to the year-end Market Pulse report from IBBA and the M&A Source. Buyer confidence is high, as is competition for quality deals.

Businesses with enterprise value of $5 million to $50 million earned an average multiple of 6.0x EBITDA (a survey peak), realizing an average final sale price at 113% of the internal target benchmark. Multiples remained at or near market peak throughout the Main Street and lower middle market.

Meanwhile, time to close shrank in nearly all market segments. Time to close was likely facilitated by the high rate of buyer competition as well as a push to get deals closed before year-end.

The year end is always a hot time to get deals done as buyers and sellers push to meet self-imposed deadlines. We also know a number of sellers entered the market in early 2021, planning to get ahead of potential increases in capital gains taxes. Many of those deals would have had accepted offers and been in due diligence by the time it became clear tax changes were not yet coming.

Main Street activity

In the Main Street market last year, individual buyers accounted for 71% of business transitions. Of those, 40% were first time buyers and 31% were repeat business owners or what we call “serial entrepreneurs.”

Another 26% of Main Street buyers were existing companies. These are the strategic buyers acquiring other businesses as a way to expand or eliminate competition. A small percentage, just 3%, were private equity acquisitions.

While market definitions vary, businesses are generally considered “Main Street” if they have an enterprise value of less than $2 million. The majority of the transactions that happen in this sector are small, less than $500,000.

In 2021, the most active industries trading hands in the Main Street market were personal services (15%), construction (12%), business services (12%), consumer goods/retail (12%), and restaurants (11%). This represents a small drop-in restaurant activity, likely due to ongoing fallout from the pandemic.

Of those Main Street sellers who went to market in 2021, 53% were preparing for retirement. Another 11% were selling as part of a recapitalization. In a recap, the seller (or sometimes their management team) keeps some level of equity stake in the business while a buyer infuses new capital for growth. Other reasons Main Street sellers went to market included burnout, health issues, relocation, and family issues.

Lower middle market activity

In the lower middle market, where businesses are valued between $2 million and $50 million, the buyer pool shifts. Here individuals accounted for a third (34%) of buyers in 2021, relatively on trend with past years.

The number of individuals buying businesses in 2021 is notable given the highly competitive talent market. It’s likely these buyers (and Main Street buyers, too) could have their choice of employment opportunities. And yet there remains a definite draw to being a business owner. People still want to build something of their own and control their own destiny, even in a job seeker’s market.

Existing companies accounted for 40% of lower middle market transitions in 2021. Generally, these companies have strong balance sheets and are looking to acquisition as a way to grow at a time when organic growth is difficult due to talent shortages.

Private equity continues to remain active in the lower middle market, accounting for 24% of all business transitions. Private equity buyers generate financial returns by acquiring businesses. They typically plan to hold a business for 5 to 7 years, often acquiring similar types of businesses to bolt on, before reselling a larger, more lucrative operation.

These financial buyers tend to focus their efforts on middle market opportunities of $50 million or more. But with competition for those larger deals running hot, we see many firms ticking their attention down to the lower middle market. Here it’s possible to find deals that are large enough to make a difference in their portfolio and yet small enough to go unnoticed by some of their competitors.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

Six Benefits of Monitoring Company Value

/in , /by Al Statz

Even if your business is not for sale, monitoring its market value can be incredibly helpful. This article describes six ways that understanding value over the life of a closely held business benefits shareholders, directors and managers.

1. Value Report Card

Like financial statements, an annual independent business valuation is a type of report card on company health. CEO’s can use this report card to educate, align and focus executive teams on maximizing enterprise value. Owners and boards of directors can use it to hold management accountable for value creation.

2. Equity Transaction Enabler

Having a business appraised periodically enables equity transactions. I am talking about buy-sell transactions between shareholders, redeeming stock of retiring owners, and buy-ins by managers, key employees, family, or investors, to name a few.  Most experienced business attorneys will tell you that not agreeing on valuation is the #1 impediment to successfully completing these transactions.  An independent business valuation is usually the fastest route to an agreement on value.

3. Shareholder Agreement Test

A business valuation can be used to test the composition of your shareholder buy-sell agreement from a valuation perspective. In our experience, there are as many faulty buy-sell agreements out there as there are good ones. By faulty I mean that the valuation terms are incorrect or ambiguous, or produce unfair share values, which ultimately leads to surprises, divisiveness, and disputes among shareholders. Also, all buy-sell agreements, regardless of how well-written, lose relevance over time and should be tested periodically. A valuation expert can identify potential problems and recommend solutions.

4. Versatile Planning Tool

A comprehensive valuation report can provide a solid foundation for strategic planning and a roadmap to increasing value. Shareholders can use periodic valuations for their own retirement planning, estate planning, buying life insurance, and maintaining appropriate liquidity for future buyouts. Without an accurate valuation, these planning activities involve a lot more guesswork.

5. Executive Education

The very act of going through a valuation process is educational for owners and leadership teams. They will see what information goes into the valuation and learn what factors are driving or detracting from business value. Experiencing the valuation process also prepares them for what will happen if the buy-sell agreement is triggered or if the company becomes involved in an acquisition.

6. Compliance

You may be aware that ESOP companies are required by law to obtain an annual independent valuation of their shares.  Companies that have stock option plans are required to have regular valuations for IRC 409A and financial reporting purposes. Companies that have executive teams whose compensation is tied to company value through the use of stock appreciation rights or phantom stock plans need valuations as well.

Getting This One Done!

An experienced business appraiser can usually recommend the appropriate scope of analysis and reporting for your intended use and circumstances after a brief phone call with you. In many cases, a full scope business valuation (appraisal) is necessary or strongly recommended. In other cases, a limited scope calculation of value may be sufficient. At issue are accuracy, the knowledge of intended users, credibility, compliance requirements and cost.

Working with the same valuation analyst (appraiser) over time has additional benefits.  Your team gets to know and trust the valuation expert. The expert’s knowledge of the company and its industry grows, and they become better able to offer insights into improving business operations, financial results, enterprise value, sale readiness and marketability. Also, valuation updates are generally faster, less expensive and more consistent.

Al Statz is the founder and president of Exit Strategies Group. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, Al can be reached at 707-781-8580 or alstatz@exitstrategiesgroup.com.

From 60 days to 6 months: Why you need an M&A attorney

/in , /by Al Statz

We had a signed letter of intent in April and were set to close the transaction in June – until the seller’s lawyer got in the way. What should have taken 60 days ballooned into a full six months. Luckily, it still closed.

Why you need an M&A attorney

When selling your business, the M&A attorney looks out for your best interests. They help you understand the risks involved and how to mitigate them. They know how to translate legal jargon into plain language and help you evaluate the pros and cons of various deal structures and terms.

An M&A attorney is part negotiator, part contract lawyer, part educator. They work with your broker or investment advisor to provide input on deal structure and value. They draft and review all pertinent contracts, including deal terms, the transferability of existing client and vendor contracts, real estate contracts, warranty liabilities and more.

Finally, they’re there to advise you on your rights and responsibilities in the transaction. Even if you are selling 100% of the business, you will likely have certain continued liabilities and operational obligations after the transfer.

Why you need a specialist

Its exceedingly difficult for general practice lawyers to have the experience to move a deal forward effectively and efficiently. M&A transactions are increasingly complex agreements, and different deal structures can present challenging legal issues. Has your general practice attorney ever completed an M&A transaction using an F reorganization or 338 election? In today’s world of sophisticated buyers, its likely you will get offers with some of these provisions.

A seasoned M&A attorney has seen it all before. They know the language, the sticking points, and all the ways a deal can go wrong. What’s more, they understand negotiations and how to protect their client’s interests without blowing up the opportunity. The right attorney is a deal maker, not a deal breaker, and will keep a transaction moving forward – as long as it meets your goals.

Why our deal took six months instead of 60 days

In this particular transaction, the client insisted on working with their real estate attorney. The lawyer had handled a few smaller Main Street transactions before, but nothing of this size or complexity.

To complicate matters, our client was a type-A engineer who wanted to take a deep dive into the legal issues and understand them all on his own terms. That process certainly would have been smoother if he’d had an attorney who understood the transaction issues himself.

Instead of drawing on experience to educate the client and make recommendations, the attorney simply laid out the challenges and asked the client to provide direction. He brought more fear than clarity to the process.

To top it off, the attorney was a one-man-show. That meant when he took a vacation or had to spend a week in court, all work stopped. There was no one else in his office who could keep the process moving forward.

All in all, this attorney was learning on the job. But instead of paying for his education, he got to charge his client an extra-large “tuition” bill in the process.

Why faster is better

We were fortunate to be working with a patient buyer who stuck with this deal to the end. This buyer did not offer the highest price (it was the second highest), but it was clear from the outset that they’d be the most lenient and tolerant of the seller’s need for total analysis and control. Having that right fit can be the difference between a deal that gets closed and one that falls apart.

The other saving grace is that the seller had an extremely stable business. The employees were well-tenured and most revenue was under contract.

What’s more typical, though, when negotiations drag on, is that something negative or positive happens (e.g., a key employee leaves, big contract loss/gain) and either party tries to renegotiate the deal. Emotions run high and it gets increasingly likely someone will throw up their hands and walk away.

That adds up to a lot of lost time, money, and momentum on either side of the equation. Once the seller accepts an offer, it’s in everyone’s best interest to keep the deal moving forward – and that means you need specialized legal support who knows how to get that done.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.

M&A Deal Terms: Average Capital Structure

/in , /by Al Statz

The following chart from GF Data shows the average capital structure over the past 5 years for middle market business acquisitions. Equity contributions have varied only slightly over that time, in the range of 46% to 49%. Overall there was a slight rise during COVID, but nothing major. There are two different stories based on deal size however. In the $10-50 million total enterprise value (TEV) bracket, average equity contribution dropped. However, for deals in the $50 to 250 million TEV range, average equity share remained at or reached the mid-50s, suggesting the room for continued valuation increases is greater on sub-$50 million deals.

GF Data collects and publishes proprietary business valuation, volume, leverage and key deal term data on private equity sponsored merger and acquisition transactions with enterprise values of $10 to 250 million. GF Data gives M&A deal participants and advisors more reliable external information to use in valuing companies and negotiating transactions.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com.

 

M&A in 2022: Is this the year to sell?

/in , /by Al Statz

If you’re a business owner, you’ve probably had a rough couple of years – and the challenges aren’t over. While COVID-19 may be weakening its grip, talent shortages, supply chain issues, and inflation are still very much at play.

And yet, the economy is surging. Many of the business owners we talk to have all the work they can handle and strong balance sheets. So on the plus side, performance is good. On the negative, managing the business is really challenging.

If you’re analyzing the pros and cons and wondering if 2022 is the year to sell, here are some things you should know:

Buyers outnumber sellers

The buyer pool is as strong as it’s ever been, and there are significantly more buyers than sellers. Private equity has been driving demand and will continue to do so for the foreseeable future. This group of buyers is exceedingly well capitalized and needs to put their investors’ dollars to work.

Meanwhile, we expect to see corporate buyers ramping up their acquisitions. After a couple of years sitting back and waiting things out, these buyers are feeling a new sense of urgency. With the tight talent market limiting organic growth, companies will be looking to acquisition as a way to expand and evolve.

In terms of making an offer, strategic buyers could offer higher values because of the synergies that can be gained from a merger. And yet, private equity is up against deadlines to place their money in new investments. Pit these active buyer pools against each other and the battle should be pretty good.

Values are at an all-time high

Sellers are realizing record valuations right now. According to GF Data, a company that collects data on privately held M&A transactions, multiples for Q3 2021 hit the highest level they’ve seen in their 16-year history.

Lending is strong

Banks are looking to put their money to work in the same way buyers are. What we’re hearing from lenders is that their traditional clients are flush with cash. So instead of extending lines of credit to their established customer base, they’re out there looking for new loans to make.

Money is cheap. So even though valuations are high, buyers can still meet those prices with a smaller equity stake. According to GF Data, buyers’ total debt as a multiple of EBITDA “surged” by half a percentage point in Q3 2021 – a significant increase by debt standards.

Tax increases are still a danger

We didn’t see an increase in capital gains in 2021, but there’s a sense that it’s still coming. If the Democrats win the mid-term elections, some analysts predict we’ll see an increase in 2023.

The threat of tax increases sent sellers to market in 2021, hoping to get out in time. Now, we’ve basically reset the clock for another year. Business owners who sell today face a 20% tax burden, but if predictions come to pass, we could see capital gains rates increase by an additional 5% or more.

Business inventory will grow

With the uncertainties of the last two years, many sellers have been waiting on the sidelines. That exacerbated supply and demand issues and heightened competition for quality businesses.

But now the economy is going strong, and the market is gaining a new sense of equilibrium as we all learn to live with the lingering specter of COVID-19. As confidence increases, more business owners will enter the market. If you were planning to sell soon, it might be a good idea to act before supply increases.

Deal support teams are stretched

Deal teams are always running full bore in Q4. Between due diligence, financial reports, environmental inspections, contract negotiations, lending, etc., it can take a lot of third-party service providers to move a transition through to closing.

As one buyer’s banker told us, “We’re committed to getting this deal done. But this transaction is twelfth in line.” (And it isn’t a very big bank!) Sellers that don’t move fast enough could run the risk of missing their ‘close-by-year-end’ goals.

Selling your business is likely the largest financial transaction you’ll make in your life, and there are a lot of variables to consider. It’s a good idea to keep tabs on your business value as the market changes. Talk to advisors who can evaluate your unique business and circumstances. Find out what the numbers look like for a sale in 2022. You may have some big decisions ahead.

For advice on exit planning or selling a business, contact Al Statz, CEO of Exit Strategies Group, Inc., at alstatz@exitstrategiesgroup.com. Exit Strategies Group is a partner in the Cornerstone International Alliance.