A recent survey reported an active merger and acquisition (M&A) market for small businesses in 2018 — but many experts don't expect that momentum to last. Here's how valuation professionals can help business owners capitalize on today's sellers' market.
Limited Time Opportunity
The intense M&A activity that occurred in 2018 is expected to continue in 2019, according to the Q4 2018 Market Pulse Report. But 83% of business advisors surveyed don't expect the current M&A volume to last more than two years — and 32% predict the sellers' market to end this year.
The Market Pulse Report is a quarterly survey that evaluates market conditions for businesses with market values of up to $50 million. It's a joint effort of the International Business Brokers Association (a nonprofit trade association of business brokers), M&A Source (a professional association of middle-market M&A intermediaries) and Pepperdine Graziadio Business School.
In 2018, deal activity was driven, in part, by low interest rates and low unemployment. The latter makes it hard for businesses to grow from within, forcing them to look for outside growth opportunities. In addition to a skilled labor force, many buyers are looking for businesses with strong balance sheets.
The Market Pulse survey found that pricing multiples "remain strong in all categories, at or near market peak in some sectors." Compared to 2017, multiples have generally increased or remained stable. But pricing multiples aren't expected to grow in 2019. Many owners, including Baby Boomers nearing retirement, are planning their exit strategy before the next recession hits.
What Buyers Want
Business owners looking for an exit strategy can take steps to help maximize their selling prices. Examples of selling features that can help attract buyers include:
Clean financials. Nonessential items — such as underperforming segments, nonoperating assets, shareholder loans and minority investors — complicate deals. Consider removing these items from your balance sheet.
Sales are often based on multiples of earnings or earnings before interest, taxes, depreciation and amortization (EBITDA). Do what you can to maximize your bottom line. That includes cutting extraneous expenses and operating as lean as possible.
Buyers also want an income statement that requires minimal adjustments. For example, they're leery of businesses that commingle personal and business assets or that engage in above- or below-market-related party transactions (such as leases and relatives on the payroll).
Growth potential. Owners nearing retirement can't afford to rest on their laurels. Buyers are interested in a company's future potential. Selling for 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.
In the same vein, it's important to identify and minimize internal weaknesses (such as gaps in managerial expertise and internal control deficiencies) and external threats (such as increased government regulation and pending lawsuits). In short, proactive businesses are worth more than reactive ones.
Comprehensive due diligence. Buyers need 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, financial projections, fixed asset registers and inventory listings.
Many will even 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, enter into a confidentiality agreement to protect your proprietary information from leaking to a competitor.
Sweeten the Deal with Creative Terms
Business buyers and sellers rarely see eye-to-eye, at least initially. A major gap between a seller's asking price and a buyer's offer can sometime be bridged with creative deal terms.
For example, one popular solution is an earnout, where part of the selling price is contingent on the business achieving agreed-upon financial benchmarks over a specified time. Earnouts allow buyers to mitigate performance risks and give sellers an incentive to provide post-sale assistance.
Alternatively, some buyers may require the seller to stay on the payroll for three to five years to help smooth the transition to new management. Seller financing and installment sales also are gaining popularity in management buyouts and purchases by joint venture partners.
Eye on Market Value
While reading trade journals or attending business conferences, you might have heard of valuation rules of thumb, such as five times EBITDA or 1.5 times revenue. However, it's risky to set your asking price (or make an offer to purchase another business) based on these simplified formulas. They can sometimes be outdated, inaccurate or omit key information that could affect a business's market value.
The key is to evaluate real-world market data. Business valuation professionals have access to databases of thousands of comparable transactions that can be filtered and analyzed to develop pricing multiples to value your business. They also can project your company's future earnings and then use a discounted cash flow analysis to value it. Market value is just a starting point, however. Synergistic expectations — from cost-saving or revenue-boosting opportunities — may entice buyers to pay a premium above market value.
Contact a business valuation professional to discuss your options in today's bullish M&A. Even if you don't plan to sell any time soon, it's always smart to operate your business in sale-ready condition in case you change your mind — or you receive an offer that's too good to refuse.
WILLIAM P. ALLEN, CPA/ABV, CFE
Bill is a member of the American Institute of Certified Public Accountants accredited in Business Valuations (ABV); a Certified Fraud Examiner (CFE) accredited by the Association of Certified Fraud Examiners; and the New York State Society of Certified Public Accountants. He has more than 5 years' experience in public accounting serving both commercial businesses and nonprofit organizations. As a member of the Brisbane team, Bill is responsible for valuation, forensic accounting, and litigation support services. Bill is a graduate of Le Moyne College and has worked with our Firm since graduating in 2006.