This post was written by David Jaffe.
For lower middle market growth companies, there’s never been a better time to consider a sale or private equity recapitalization transaction. In a number of industries, multiples are approaching, if not surpassing, their pre-great recession highs, leverage is plentiful, rates are low and equity investors are actively looking to deploy late vintage capital.
If you’re thinking about selling, here are five time tested tips to achieve a successful transaction:
1. Companies are bought, not sold.
This old cliché is meant to convey a very simple point. Value is in the eye of the buyer, not the seller. That said, ignore all the advice that you should run your business with the exit in mind. Run and grow your business to provide products and services that are in high demand in the marketplace. If you do that consistently, exit opportunities will take care of themselves.
2. Prepare audited financial statements.
Whether your business is ultimately acquired by a larger competitor, a management group or a private equity fund, every buyer will insist on transparency into the financial operations of the company. Moreover, several components of the m&a transaction, most notably, the working capital reconciliation and third party acquisition debt financing, will depend on seller’s ability to provide reliable, quantifiable and consistently prepared historical financial information. Nothing slows a transaction down faster than the absence of reliable financial data.
3. EBITDA multiples ≠ Purchase Price.
So you were at the golf course and your partner in the country club championship told you that his neighbor Joe just sold his specialty pharmaceuticals business for 10x EBITDA. Your wheels start turning…if Joe got 10x, that means my company must be worth $XX million, right? Wrong.
The only thing people lie about on the golf course more than their handicap is their business success. Sellers often are disappointed when that original “whisper” number (or indicative price) shrinks after due diligence begins. Buyers will discount the purchase price for net long term debt, capital expenditures, working capital deficits, customer concentration and revenue volatility.
Focus on operating cash flow rather than EBITDA as a more accurate value proxy.
4. Understand the buyer’s motives for the deal.
If you are dealing with a corporate acquirer, they may be trying to assess whether it is cheaper to buy your company or to build it themselves. In other words, industry buyers will be looking at your company through the lens of incremental growth and try to determine whether buying your business is an easier, cheaper or faster route to growth than organic, internal expansion. This is the so-called “buy verses build” dichotomy.
If you are talking to a private equity investor, they may be looking for a new platform investment from which to launch a “rollup” or they may be nearing the end of the investment period in their current fund. Regardless of the context, in order to achieve the best possible outcome, you must try to remain objective and rational about the motivations of each particular buyer or investor. Understanding these factors can make a significant difference in the outcome of a transaction.
5. Don’t let the perfect be the enemy of the good.
In lower middle market m&a transactions there is a substantial asymmetry between the knowledge and experience of the seller and that of the buyer or investor. Among other reasons, this is largely due to the volume of transactions that the buyer/investor will have seen and participated in verses the relatively infrequent nature of m&a transactions that any particular seller will engage in (read “0” for most sellers). Having an experienced sell-side transactional lawyer on your side can really level the playing field. Good counsel will focus the negotiations on deal points that enhance value and will avoid unnecessary acrimony or misdirected emphasis on deal points that don’t add value. As a seller, it is important to engage experienced counsel to avail yourself of this advantage.
As good as the m&a market is, selling a company can be a difficult and complex process. Following these five tips will help to lighten your load as you embark on the journey from letter of intent to closing!
