Mid Market Staircase Photograph

“Seems like a good offer, so let’s take a closer look.”

Cartoonized photo of PH and PaulThere is a shortage of supply of middle market businesses available for acquisition. That is why prices are high and private equity firms are selling their best portfolio companies. As an owner/operator, there are some days when you have to wonder about what price would tempt you to sell the business. Your readiness depends on your specific circumstances. You may have family shareholders or other partners to consider, and they may or may not be able to understand how you (as boss) gauge the competitive landscape, but there comes a time when cashing-in has great appeal. Once you decide to listen to that strategic partner who has asked you repeatedly or the private equity firm that assures you that they are different (special), it is essential to know what you could actually achieve and how it would work if you choose to pursue a deal. We help business owners know what is possible and how to negotiate the best deal. That begins with a focus on valuation and purchase price in the context of the proceeds to the seller. Here is how you can avoid surprises.

There are plenty of sources that quote acquisition purchase price multiples for middle market businesses and there is usually at least some meaningful intelligence on deal valuation for relevant companies. What isn’t so easy to find is what really matters for determining net proceeds to the seller. You may ask, “multiple of what, exactly?… trailing adjusted earnings or a current full year?… and what balance sheet adjustments might apply?… how are working capital and capital expenditures factored into cash flow? … what strings are attached to a buyout offer?”

The most straightforward deal is the purchase and sale of the assets and business of a company on a cash-free and debt free basis. That may seem simple enough, but somehow it usually becomes less simple before all is said and done. It is generally assumed that the seller is an S-Corp or LLC or that the C-Corp will elect 338(h)(10) constructive liquidation so that the seller is essentially a pass-through entity for tax purposes. Delivering a debt-free business in an asset sale structure leaves the seller responsible for repayment of all interest-bearing debt and allows the buyer to record acquired assets at fair value (including intangibles and goodwill) for tax benefits to cushion the purchase price. We think any analysis of price should be in the context of what balance sheet reference point accompanies the price and what price adjustment mechanism will apply.

The usual focus for what a purchase price multiple is applied to is normalized EBITDA (that is trailing 12 month pretax earnings with depreciation and amortization expense added back plus other expenses such as owner’s compensation in excess of market cost and one-time items not necessary going forward). Adjustments to “normalize” earnings range from the fairly obvious to the quite creative. Sellers seek to maximize the EBITDA (the cash flow proxy) and maximize the multiple of EBITDA (purchase price multiple) so that the whole company valuation is as high as possible. The high end of a range is the reward for consistency, growth potential, the depth of continuing management and critical mass which also translates into market position and size. Bigger is always better when it comes to multiples in M&A. The reason is that the relatively bigger middle market company attracts a broader range of suitors and debt financing options.

Understanding the determination of purchase price multiple is tricky because each of the parties has different needs to rationalize the price as a good deal. Buyers tend to look at the multiple in terms of what they expect to earn and they do whatever they can to have the seller appreciate that the focus has to be on what the seller has produced, not what the buyer might earn. Few sellers actually realize that the buyer has incremental expenses as well as potential savings. Private business owners tend to look at the amount of money they receive rather than the multiple of earnings. The offer is a price and the multiple is a relative value indication in evaluating price. Lenders tend to look at the cash flow and the fixed charge coverage based on the specific capital structure of the buyer. The bottom line is always a measure of how much money the seller takes home.

Deal problems usually arise in the purchase price adjustments which become the focus of negotiations during the definitive agreement stage. That is why the evaluation of bids in auctions includes consideration of the mark-up to the seller-drafted asset purchase agreement. The two most unpopular culprits are balance sheet liabilities not accepted by the buyer and adjustments which always seem to reduce price. It is fairly easy to accept that the buyer will not become responsible for any funded debt (bank debt, capital leases, shareholder loans). Those liabilities must be repaid by the seller from the proceeds paid to the seller by the buyer. It is the contingent liabilities and other exposure such as third-party claims of intellectual property infringement which can eat into the sale proceeds post-closing that can be particularly troubling.

Balance sheet adjustments (price reductions) resulting from working capital requirements and previously unbooked liabilities identified by the buyer during due diligence after exclusivity has been granted (reserves for product warranty, litigation, pension obligations) are usually more straight forward (but not less painful) than likely indemnification claims over one to two years post-closing. The former type of balance sheet adjustments occur at closing or soon after. Holdbacks vary up to 15% of the purchase price and can be stepped down based on specific terms. Responsibility post-closing for excluded items such as discontinued business units and employee obligations can further reduce the value of a transaction to the seller. What matters most are the net proceeds to the seller after all deductions from the purchase price. That’s not always as straightforward as conversations early in the process might suggest and it may be quite sometime after closing before you really know.

Purchase price frequently involves deferred components such as seller notes, continuing ownership and/or earn-out based on post-closing performance. These further complicate matters. Subtleties such as the capital structure of the buyer are very important in determining the financial risk of deferred payout and equity upside. The second bite at the apple can be sweet as long as the terms are well understood. Owners/operators are increasingly asked to roll over a portion of the purchase price into a continuing equity stake in the company with its new owners. That can usually be accomplished with pretax proceeds. What sometimes makes it hard to evaluate the potential upside is the capital structure which may include junior debt capital and preferred equity which have priority claims on the future value.

None of these items should discourage owner/operators from entertaining offers to buy their business. Midmarket is here to help you evaluate alternatives and make the most of what can be achieved. We have the expertise to arm you with the relevant knowledge, to anticipate issues specific to your company and to avoid surprises. We bring what you need to be comfortable that you are fully informed and able to make the best deal possible. We further distinguish ourselves by being easier to do business with than our competitors. Our terms and the cost for our services are based on an independent consulting model with flexibility not available elsewhere. Call us to learn more about how we can serve you.

What really happens at the Dealmaking Table?

P3220394-CroppedKnowing what to expect helps owner/entrepreneurs produce better dealmaking results and avoid getting boxed into bad situations. Savvy buy-siders try to keep owners focused on the glory (and gloss over what could be gory) while reeling them in. Not until the hook is set and backing out would be painful do their technicians hammer on the issues that become costly adjustments.

Whether the deal is for the sale of a business, the purchase of another, raising debt or equity, buying out a partner or striking a strategic alliance, the process always becomes more complicated than originally envisioned. While there is no shortage of capital for independent private companies and family owned businesses, actually completing fair deals and keeping everybody happy is the hard part. Here are some insights on what to expect and how to protect your interests.

Timing is rarely convenient for owners who haven’t been actively planning for a deal. The trigger for action is often an incoming call which is either flattering or frightening. A respected industry leader wants to talk about doing something together or a major revenue source begins to stumble. A new product line takes off and draws attention or a partner wants out when cash flow can’t support more borrowing or the hit to equity.

The discipline of tidying-up before a turn at the dealmaking table will minimize surprises, reduce anxiety and may be the only way to be able to close the deal. If you can’t do that, at least recognize it and begin to deal with issues on your own terms so that you don’t hand control of them to someone else unless you want that to happen.

In many instances, the historical financial results and some measure of management’s plans have been shared under a confidentiality agreement before the principals sit down together. In an auction sale process, the buy-side will have been required to provide a valuation range in order to be invited to talk. For an investment or credit facility, review of background information is common for determining level of interest in meeting with management.

Financial fundamentals always matter. Since the earnings proxy so commonly has adjustments or a story attached, the focus of conversation about earnings should be on their make-up and quality so that approached to valuation can be validated. While relative value is a multiple of EBITDA, price is a dollar value and structure determines how price translates into after tax proceeds. The difference between 6.0x and 8.0x and 10.0x is a function of market position and quality of management within a framework of opportunity size and deal competition. Size of company is a major factor in valuation.

The buy-side will determine what they will pay for an acquisition (price amount, not multiple) or how to backstop an investment (liquidation preference to cover downside and supercharge upside). Lenders will focus on the measure of availability and cap with the protection of fixed charges coverage and selective veto power.

This all gets a little trickier if the recent fundamentals (most importantly earnings) don’t support the sell-side or issuer valuation expectations or the credit request. If these problems can be overcome, they may require compromise and creative structuring.

Most published accounts of deals are biased because people like to talk about their successes rather than the tough issues that kept other deals from getting to the finish line. Taking an objective view to anticipate and resolve the trapdoor issues before or at the outset of negotiations pays great dividends before the power-leverage shifts away from the business owner. Signing a general letter of intent or term sheet and hoping for the best inevitably leads to disappointment. Avoid getting backed into a corner by clarifying dealbreakers early.

Tell-tale signs of an owner’s mindset often limit value or discourage interest without their even knowing it. This is generally less damaging in a change of control deal, but can sink an equity investment or strategic alliance when the other party recognizes the danger of reliance on an entrepreneur who isn’t ready or capable of the psychological adjustment to serve the best interests of all the owners. More deals die because the money loses faith in the owner than for any other reason.

Chances are that the other party is a more frequent participant in the type of transaction on the table. If they are a public company or private equity firm or bank, they usually have less flexibility in what they can live with than independent business owners can readily appreciate. The rigidity is evidenced more by terms than by pricing. Entrepreneurs are cocktail-napkin-May-blog2more comfortable living with risk than investors and lenders governed by an independent board or approval committee with fiduciary responsibility.

A corporate financial advisor with a track record of success in helping business owners address all of these concerns can be worth their weight in gold. When you decide to go to the dealmaking table, give us a chance to help you make it as rewarding as possible.

Open Season for Corporate Hunger Games

Graphic for blog April 2012 JPEG croppedCorporate buyers committed to growth through acquisition are stepping up their game to win the favor of owners of successful middle market companies. Although business owners strive to be meaningful players on the competitive scorecard, they often don’t actively prepare for the time when bigger players approach them. Most acquisition deals for entrepreneurs and family businesses are ignited by an incoming call from a senior executive at a larger company you know and respect. You may not be actively planning to sell, but you might consider the option when the buy-side is most eager to make an offer you may not want to refuse.

If you own a good business, you are not impressed by the idea that your company is an attractive target for a strategic buyer or a private equity fund with an agenda that you fit nicely into. What you may not know is exactly how real the alternatives are for grabbing the brass ring and having a shot at sweetening the profit in a deal. That is where MidMarket can add value for you to maximize those opportunities.

A common mistake by owners is assuming that the buy-side interest will be there whenever they decide to go to market. The fact is that a variety of factors outside of your control have an impact on the attractiveness of your company. You should be cautious about assuming that the market will be interested whenever it suits you. We suggest striking while the iron is hot.

What the majority of entrepreneurs and family businesses so often fail to appreciate is that people who own businesses for a living (corporate buyers and private equity firms) are fundamentally different from people who happen to own and work at the business they own. Professional ownership is motivated by the opportunities to grow and monetize the business, so different standards for measuring success apply. Unless you have actually participated in an ownership group involving a corporate owner or private equity owner, you most likely don’t really know their game. We can provide that input for your benefit so that you manage the interaction with prospective buyers or investors.

What is not surprising it that your competitors are plotting to succeed at your expense. They may not be as nimble as you or as capable, but they are very real and you must be ready to anticipate and respond to their actions. Strategic deals often trigger further activity and can also limit options. All the more reason to be out in front of your competitors on these matters.BeReady-blog

MidMarket can help you to take advantage of this surge in corporate acquisitions and ownership transactions. Just call us if you are interested in how we can be helpful. Contact us for a no-strings attached assessment of your situation.

Three years on and we are nearly 100% better…

chart-final-webThree years ago today the public equity market bottomed after a harrowing fall that slammed the broader financial markets. The first few months of 2009 tested the mettle of nearly all of us who rely on the smooth functioning of markets to provide capital for business owners. Stability has been restored and the private market is both flush and eager to invest. Professional owners of middle market companies are already in full swing taking advantage of opportunities to recapitalize at record prices. Fundamental improvement in several industry sectors has opened the market on a broad basis.

What are professional owners? They are asset managers who invest in private companies for the purpose of building and trading them for profit. They differ from most other private company owners because they have a laser focus on planning and executing to increase value that can be monetized. They concentrate on organizational muscle to strengthen management teams and systems, and then meticulously monitor progress toward the goal of sustainable growth at maximum margins. They come in all shapes and sizes and seek both minority investments as well as control positions. Even the control investors love for sellers to have a piece of the upside.

How about the rest of us? Most businesses under entrepreneurial or family control are at least a little less disciplined for a variety of reasons. The main reason is they don’t expect to be in the market in the near term and they mistakenly think that investors or strategic buyers will overlook their being out of shape. Then some market development or personal priority change motivates the discretionary participant to want their business to be judged as worthy as those of the professional owners. They don’t say it that way; they just expect a premium valuation that is as good as a similar company that has been groomed for maximum value. That is when it is most apparent that the biggest rewards go to those who run their businesses like professional owners.

Why does any of that matter? The stability and maturity that has been achieved in the market for investment in private companies combined with the predictability that is finally in place has opened more alternatives than ever for business owners to raise capital and monetize some or all of their illiquid value. Manageable volatility will continue and of course there are continuing economic and political risks. Nevertheless, conditions are positive and on the uptick; very real opportunities are there if you want to pursue them.

cocktail-napkin-blogLet’s appreciate that we have survived and have emerged smarter and tougher than most of us were three years ago. Ask yourself whether you have an interest in knowing just what growth financing and liquidity options are available for your business. MidMarket is here to help you take advantage of opportunities you might not even know are waiting for you. In the meantime, today’s anniversary is one that we can all celebrate!

Is the Year of the Dragon your time to slay China problems

02-2012-blogTelu Tsai and Jian Zhang from MidMarket enjoyed the New Year festivities along with their families here and in China. This week begins a particularly important year in China as people anticipate the once a decade leadership change as the second year of the 12th Five-Year Plan takes shape.

Is your business invested in China through a joint venture or wholly-owned foreign enterprise? Is it performing as reasonably expected? Chances are you have concerns about how it really going and whether it could be improved. If you are invested in China then you undoubtedly faced some dragons in your path to success. We have encountered a few with our own joint venture experience.

If you are thinking about investing in China this year, you will benefit from the insight of those that have gone before you. Whether it be a JV, WOFE, greenfield operation, acquisition or strategic alliance, you can avoid missteps, anticipate issues and strengthen your strategic position with guidance from those who have relevant experience.

Imagine the impact of dramatically improving the performance of your China operations or savings from launching the investment based on the strongest footing. We can help with both of those situations because we have the talent and the passion to serve our clients’ best interest. We have the experience in China to help you be more successful there.

MidMarket is a valuable resource to North American /European companies and investor groups with interests in China. Those investments range from joint ventures/subsidiaries to potential investments such as equity stakes or acquisitions. MidMarket offers financial professionals experienced in Western corporate transactions/markets who are natural born Mandarin speakers comfortable traveling in China with clients interested in in-depth interaction with Chinese executives and government officials that are not fluent in English.

Telu Tsai is a partner at MidMarket mainly based in Philadelphia and frequently travels to China on behalf of the firm and our clients. Jian Zhang is a director at MidMarket and will be based in Beijing for the next few months supporting a Chinese client raise growth there. They are supported by Patrick Hurley in Philadelphia and Song Hong in Tianjin. MidMarket serves clients in Beijing, Shanghai, Harbin, Guangdong and Tianjin as well as various other major markets and secondary markets throughout China.

  1. MidMarket provides these services for Western clients already invested in China.
    1. Improving the quality, reliability and usefulness of financial planning and reporting.
    2. Pinpointing and defining operational problems in order to take action to improve performance.
    3. Working with Chinese and Western managers on strategic business planning and accountability.
    4. Assistance in obtaining bank debt and equity financing in China and optimizing inbound financing.
    5. Planning and implementing divestiture exit strategies and investor liquidity programs.
  2. MidMarket provides these services for Western clients considering investing in China.
    1. Identification of strategic corporate partners/ co-investors/acquisition candidates.
    2. Due diligence investigation/confirmation in China and assistance in negotiations for prospective investments and acquisitions in China.
    3. Clarifying necessary local, provincial and central governmental approvals (and/or regulatory and tax), timing and process considerations.
    4. Establishing and maintaining relations between Western corporate/investor with key Chinese influencers relevant to the company’s success.
  3. MidMarket provides these services for Chinese clients.
    1. Assistance in corporate financial dealings with Western corporations and investors.
    2. Identification of prospective Western investments, acquisitions and corporate relationships.
    3. Assistance to Chinese government in developing and maintaining strategic relationships (i.e. ACG)
    4. Educational programs (in the U.S. and China) for senior management and customized internships for exceptional mid-level managers.

So whether your business is already invested in China or consider it to be a near term priority, MidMarket can help you to make the most of the Year of the Dragon. Call us to talk about how we can help.

CallTelu-box3MidMarket’s value proposition is to bring our knowledge and insight to conduct a thoughtful analysis that you can use to accomplish your goals. We deliver relevant market data and valuable information along with sound independent advice aimed only at your best interests. We do that on a timely and cost effective basis that in no way limits your flexibility or ties you to a commitment to us. Let us show you what we have done for so many business owners for over 30 years and how we can make that valuable resource work for your advantage.