Report Predicts Hot M&A Market for Private Companies

Despite uncertainty about tax reform, last year was an impressive year for sales of private businesses — and that momentum is expected to pick up additional speed in 2018.

DS+B Team April 1, 2018

Small business transactions (valued at $50 million or less) set record highs in 2017 — in terms of volume and average pricing multiples, according to The Market Pulse Report (See “Survey Says…” below). In addition, 73% of brokers surveyed predict that sales of small businesses will continue to increase in the next 12 months.

Why are business brokers predicting such a robust mergers and acquisitions (M&A) market? They say current conditions are ripe for business sales:

  • The new tax law is expected to provide buyers with extra cash flow to spend on growth opportunities,
  • Interest rates remain low compared to historical levels (despite recent Federal Reserve hikes), and
  • The Small Business Administration lowered the down-payment requirement on business acquisitions from 25% to 10%.

If you’re planning to cash out in the next few years, consider these tips for making your business sale-ready.

 

1. Clean Up the Financials

Buyers are most interested in a target’s core competencies. Nonessential items — such as underperforming segments, non-operating assets, shareholder loans and minority investors — complicate a deal. Consider removing these items from your balance sheet.

Sales of privately held businesses are often based on multiples of earnings or earnings before interest, taxes, depreciation and amortization (EBITDA), or a seller’s discretionary earnings (SDE). So, do what you can to maximize your bottom line. Take steps including cutting extraneous expenses and operating as lean as possible.

Buyers also want an income statement that requires minimal adjustments. For example, they’re generally leery of businesses that count as expenses personal items (such as country club dues or vacations) or engage in related party transactions that are above or below market (such as leases and relatives on the payroll).

2. Emphasize Strengths and Opportunities

Private business owners nearing retirement may lose the drive to grow their businesses and, instead, operate their companies like a “cash cow.” But buyers are generally interested in a company’s future potential.

Achieving top dollar requires a tack-sharp sales team, a pipeline of research and development projects, well-maintained equipment and a marketing department that’s strategically positioning the company to take advantage of market changes and opportunities.

It’s no surprise that businesses sell for lower prices when they have higher risks. No company is perfect, but industry leaders identify internal weaknesses (such as gaps in managerial expertise and internal control deficiencies) and external threats (such as increased government regulation and pending lawsuits) as potential bumps in the sales process.

Honestly disclose shortcomings to potential buyers and then discuss steps you have taken to mitigate risks. Surprises that are unearthed during the buyer’s due diligence process can postpone closing and lower the selling price.

3. Prepare a Comprehensive Offer Package

Buyers want more than just financial statements and tax returns to conduct their due diligence. Depending on the industry and level of sophistication, they may ask for:

  • Marketing collateral,
  • Business plans and financial projections,
  • Fixed asset registers and inventory listings,
  • Working capital analyses,
  • Quality of earnings reports, and
  • Customer concentration analyses.

Many buyers will also ask for copies of major contracts, such as leases, insurance policies, franchise deals, employee noncompete agreements and loan documents. Before you give out any information or allow potential buyers to tour your facilities, work with your attorney to require a confidentiality agreement to protect your proprietary information.

During due diligence, buyers typically hone in on the last one to three years of performance. So, it pays to sell when your business is at its peak. Many business owners wait until they’re scaling back due to retirement or burnout, which can lower the amount buyers are willing to offer.

4. Consider Creative Deal Structures

Cash is king, but you may wind up with more in your pocket after taxes if you’re open to alternative deal terms. A business valuation professional can help you evaluate different ways to structure your sale to minimize taxes and maximize selling price.

For example, one popular element is an earnout, where part of the selling price is contingent on the business achieving specific financial benchmarks over a certain time. Earnouts allow buyers to mitigate performance risks and give sellers an incentive to provide post-sale assistance.

Some buyers also may want the owner to stay on the payroll for three to five years to help smooth the transition to new management. Seller financing, installment sales and equity participation also are gaining popularity in management buyouts and purchases by joint venture partners.


Survey Says…

The quarterly Market Pulse Survey evaluates market conditions for small businesses (with market values of up to $50 million).

This survey has been published since 1993. It’s a joint effort of the International Business Brokers Association (a non-profit trade association), M&A Source (a professional association of middle-market M&A intermediaries), and Pepperdine Graziadio Business School. The Q4 2017 survey was completed by 264 business brokers and advisors, representing 36 states and 227 transactions. Key findings from the most recent survey include:

 

Main Street
(Less than $2M in value
Lower Middle Market
($2M to $50M in value)
Which sectors are hot?  

1. Personal services (19%)

2. Restaurants (17%)

3. Business services (15%)

 

 

1. Manufacturing (23%)

2. Construction (15%)

3. Business services (14%)

 

Who’s buying?  

Individuals (71%)

Existing businesses (28%)

 

 

Individuals (40%)

Existing businesses (38%)

Private equity firms (18%)

 

 


Seller’s Market

Last year, the two main reasons for selling a business were retirement and burnout. On average, sellers realized 99% of the asking price in 2017, compared to a 90% realization rate in 2016.

In 2017, the average seller received more than 80% of the selling price in cash (from a combination of the buyer’s equity and senior debt financing). The rest of the deal typically consisted of:

    • Seller financing,
    • Earnouts (where part of the selling price is contingent on future performance),
    • Post-acquisition equity participation in the merged entity, or
    • A combination of these terms.

Seller financing is generally popular with Main Street businesses. But earnouts and equity participation is more common with lower middle market companies.


Need Help?

Time spent preparing your business for sale can significantly increase the value and reduce the time it takes to close. A business valuation professional can help you look beyond the value of equity reported on your balance sheet and industry rules of thumb.

For instance, valuators can provide data on comparable business sales and compute EBITDA or SDE multiples based on that data. Alternatively, they can perform a discounted cash flow analysis to help you understand how private equity investors may perceive your operations. These complex analyses help buyers set asking prices that are based on real market data, rather than gut instinct.

Contact a valuation professional to discuss your options in today’s hot M&A market. Value-added improvements made before your business goes on the market will help maximize its appeal to potential buyers.