Consolidation is inevitable in maturing industries. As an M&A advisor working with owners of private wholesale distribution, manufacturing and industrial service companies, one of the questions I am often asked is whether it is better from a valuation perspective to sell early in a consolidation phase, or hold off. It depends of course, but generally earlier is better, all else being equal.

I’ll explain why, but first I want to point out that industry consolidation isn’t always at the top of a seller’s list of sale timing considerations. More important factors may be:

What is your exit time frame?

Next year or two? Three to five years? Five or more years? The answer is often driven by your financial needs and that of your partners. Obviously, as with any investment, the shorter the holding period, the more conservative one should be with respect to anticipated returns. Maybe today’s value isn’t quite what you think it can be in a few years – but eliminating risk may be worth a lower price tag.

For sellers who want to stay and manage the acquired/merged business or serve in a strategic (e.g. corporate development) role, that tail of income is above and beyond the sale consideration. Sellers who want to buy a boat and sail to the Bahamas had better have a strong executive team in place to lock in value. If not, their company will likely be passed on by the buyer for another acquisition with stronger leadership, and they may lose out on that strategic premium.

Is your company performing well?

Last I checked, cash flow was still king when it comes to acquisition values. If your business is performing well relative to industry peers and further improvement is likely, now may be your best opportunity to maximize value in a sale or recapitalization. If not, you’ll have to decide if and how you and your leadership team are going to improve performance and by when. And, by the way, what is your track record of achieving past projections?

Is the macro-environment favorable?

Does the economic outlook portend for several more years of strong economic growth, or is there increasing uncertainty or signs of an imminent slow down?

If the former is the case, perhaps you have time to continue to grow revenue and profit margins to increase value and better position your business for a future sale. If a downturn is likely, are you prepared financially and mentally to wait it out and try achieving liquidity several years from now? If that’s not appealing, maybe now’s the time to take some or all of your chips off the table.

Conditions can change quickly for all sorts of reasons and you can be stuck, not just with a reduced valuation, but with closed private capital markets altogether. M&A came to a sudden halt in early 2020 and late 2022, and remember what happened in the wake of The Great Recession.

Why earlier is usually better.

To make my answer more tangible, consider the example of independent industrial distributors, where national or global players are executing acquisition-based growth strategies. Driving consolidation may be mergers and product line expansions by upstream manufacturers (suppliers) and vendor reduction programs and consolidation among downstream customers.

1. If I’m an aspiring consolidator/acquirer, I’m willing to pay a nice premium for my first acquisition in a particular market – to attract the best of the options available and to secure that foothold ahead of my competitors. I may want to make a statement with regard to the quality of organization I intend to build. Hence, there is more of a strategic component in the valuation of platform acquisitions, whereas later add-on acquisitions may be more about simply adding market coverage and earnings.
2. Further, the first couple of acquisition targets are likely to have more to say (and be credited for) relative to the manufacturers they are aligned with. As the map fills in, later acquisitions may be forced to discard certain lines and replace them with others to conform to the acquiring organization – which destroys value. Count on acquirers considering the lost profits, risk and costs of making those transitions when assessing the value of an acquisition.
3. Early on, there are likely to be more strategic acquirers available. As the market consolidates further, the number of viable strategic match-ups will decline, which may favor the remaining buyers and reduce the likelihood of a strategic premium for sellers. Eventually, the only option for the last few independents standing may be to sell to pure financial buyers – such as their management teams or private investors, or private equity groups if the independent is large and profitable enough and positioned for strong future growth. For some owners this is perfectly acceptable, for others it is not.
4. Then there is the expectation that consolidators will have competitive advantages over independent operators – such as access to and influence with best-in-class suppliers, ability to attract and retain talent, proprietary products and solutions, investments in technology and online platforms, buying power, lower admin costs, access to growth capital, financial stability, etc. To the extent true (which sometimes it’s not true because there are also competitive disadvantages) the market share and value of the remaining independents will gradually deteriorate.
5. Disintermediation is a constant threat to wholesale distributors, as manufacturers seek to expand their profit margins. This can take the form of direct salespeople serving large accounts or entire geographies, and online platforms. As industries mature, distribution’s market share tends to decrease as direct relationships increase, although this varies by segment.

Another attractive aspect of being one of the first few acquisitions in a roll-up is your team’s ability to shape culture and strategic direction. You have less influence as a late addition to a well established platform.

Conclusion

Going to market early in a consolidation phase is likely to produce a stronger valuation than waiting around, all else being equal. However, when evaluating their exit options, company owners should carefully consider shareholder needs, business performance and market conditions, in addition to what stage of maturity their industry is in.

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Al Statz is the founder and president of Exit Strategies Group, a leading lower middle market M&A advisory and business valuation firm. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, contact Al at 707-781-8580 or alstatz@exitstrategiesgroup.com.

 

No matter how motivated the buyer and seller, selling a business is always a challenge. There’s a lot that can go wrong, and deals can fall through at any time.

Delays are one of the biggest problems contributing to deal failure. The longer the process drags on, the more likely it is that a) someone gets fed up and moves on or b) something big will happen, economically or geopolitically, that disrupts the deal.

Here are three top delays that can be readily avoided when selling your business:

Messy financials.

Disorganized or simply non-standardized financials can cause significant slowdowns. If your bookkeeping doesn’t align with accepted practices, buyers will spend considerable time and money verifying your numbers.

Buyers don’t like making that investment only to find out your EBITDA is 20% less than stated. At this point, they generally expect to “retrade” the deal, adjusting their price or terms. This can lead to contentious negotiations or complete deal failure.

In the three years before a sale, it’s best to have your financial statements audited by your CPA firm. If you haven’t done that, you can have a Quality of Earnings report completed by a reputable third-party firm, separate from your standard CPA. Either approach will give buyers confidence, create transparency in your numbers, and allow the process to move ahead faster.

Surprise discoveries.

When selling your business, we say “go ugly early.” If you have skeletons in your closet, a customer that’s threatening to walk, ineligible workers on payroll… we need to disclose that to buyers sooner rather than later.

When surprise conditions are revealed too late in negotiations, it makes buyers wonder, “What else are they hiding?” Unexpected revelations can trigger additional due diligence, causing buyers to view your business as a source of risk and suspicion.

Inexperienced deal teams.

When it’s time to sell your business, you want a proven deal team in your corner – including an investment banker, a tax specialist, and an M&A attorney. Your regular CPA and attorney have their own roles to play, but you also need M&A specialists who understand what’s standard and customary in deal terms.

Inexperienced advisors tend to be both slow and overzealous. They work overtime to figure out what they don’t already know, and they tend to ask for unreasonable concessions which slow down negotiations.

Experienced M&A advisors can keep the process moving forward at an appropriate pace and minimize the impact of any complicating factors that arise. The old adage of “time kills all deals” holds true in M&A. The longer it takes to get to that closing table, the more expensive and tenuous the deal gets.

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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.

If you have certain employees who are critical to operations and would be hard to replace, take steps to secure them before a sale.

Noncompete contracts can be one way to reduce employee defections. Take a look at your employee agreements, too, and ensure you have appropriate non-disclosure and “no raid” covenants.

Give careful consideration to “stay bonuses” as well. Provide an incentive for employees to stay for a period of time post-closing. Talk with your advisors and buyers about other incentives, such as stock options, which can minimize defections.

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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.

You’ve decided to sell. Now how can you get the most for your business?

Real estate principles apply, so you’ll want to clean house and maximize your curb appeal. But that’s not all that goes into a successful business sale. You need to “clean up your act,” so to speak, and address some operational issues that may not have been a priority for you over the years.

Clean up your financials.

Many business owners run their monthly financials in QuickBooks or similar software. These financials may not be reconciled on a monthly basis which means you’re often correcting entries throughout the year.

Buyers need to rely on the numbers presented, so check your accuracy and correct errors so there are no surprises during the due diligence period. We see companies with placeholder or oddball accounts too – things like “See Accountant” or “Undeposited Funds.” These accounts should be reviewed and cleared out before presenting your financials to potential buyers.

Trim your working capital.

Working capital is always a negotiating point when selling your business.

A small business may be sold with no working capital beyond inventory. But for a lower middle market business (those with values greater than $5 million), buyers expect you to sell the business with enough working capital to operate.

There are different definitions of working capital depending on your specific scenario, but the most basic definition is Account Receivables(A/R) + Inventory – Account Payables (A/P). You’re generally better off when you can minimize working capital because it means you’ll take home more out of the business at the end of the day.

Look at your aged accounts receivable, and either try to collect on older balances or write them off. Send out invoices in a timely manner and work with customers, as appropriate, to bring those payments in faster.

Review accounts payable as well. Are you paying bills faster than you need to? It’s not uncommon to see long-standing business owners in a comfortable cash position get complacent about how they’re managing their working capital – paying bills quickly and collecting slowly. Think about how you can make the best use of other people’s money without jeopardizing relationships. It will pay off when it comes time to sell.

Clear out excess inventory.

We also see a fair number of businesses operating with excess inventory. When demand is strong and credit is cheap, many businesses use that credit to buy inventory. After all, the more inventory you have, the more flexibility you have in production, and the more responsive you can be to customer demand.

If you’re planning ahead, think about right-sizing your inventory in the last couple of years before you sell (good business information systems can help). Too much inventory inflates your working capital. If you don’t get disciplined about inventory, you can always try to tell buyers, “Yeah, you don’t really need that much.” We can make that argument, but it’s a fight to get an adjustment.

Inventory issues aren’t just about “excess” either. Sometimes the real problem is “dated.” if you’ve been squirreling away excess inventory for years, beware. Buyers may not pay for outdated inventories that you thought you might sell someday. Make sure your inventory is in salable condition and has value to a buyer.

Close out legal issues.

Check for outstanding judgments or legal issues that haven’t been resolved or taken off the county records. Your attorney can help perform a search and satisfy these issues, so they don’t slow down your business closing.

Pay attention to employee issues, as well. Do your best to resolve any pending suits, settlements, or workers comp matters.

Spruce up fixed assets.

Finally, take a critical look around. Is your signage in good shape? Are the shop and yard clean? Are you portraying a professional appearance with your buildings, vehicles, and equipment? Mess and disorganization can chase a buyer away.

Aging assets can also be a problem if they’re critical to the business. If a buyer thinks they will need to replace essential vehicles or equipment after closing, then this will definitely be reflected in their offer to purchase.

Then again, tread carefully when considering other major, non-essential purchases before the sale of your business. You need to run your business as if you are not selling it. However, making major investments right before you sell (to save tax dollars, for example), is usually not a smart move as in most cases you won’t recoup your money back out of your investment.

By Charles Dallas, Cornerstone International Alliance, GreenBay, Wisconsin

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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.