Owners of entrepreneurial and family businesses should be careful about the banter of deal professionals about high relative value multiples and aggressive financing structures. They do not apply widely on a uniform basis, but there are ways to make them apply for you.
The often-referred barometer for conditions in the acquisitions market is a combination of EBITDA multiples and leverage multiples. Helpful as they can be for a discussion on valuation and borrowing capacity, these benchmarks rarely reflect the accrual sale proceeds and eligible advances on credit facilities.
There is wide consensus that a) there is a shortage of supply of independent non-sponsored middle market private companies for sale, and b) banks are once again eager to make loans. Strategic and private equity buyers are paying top dollar for strong companies and lenders are looking for new business for both expansion and funding shareholder liquidity transactions. This is a very good time for business owners to evaluate their options for financing and liquidity for shareholders. Doing that properly requires realism and a thorough understanding of all the moving and interrelated parts of the analysis.
While most business owners are not in the market to sell their business, it is almost certain that their companies have borrowing needs and may have further opportunities to invest in growth initiatives or even to make a strategic acquisition. It is worth knowing how both valuation and financing capacity apply for your company so that you can put the market references into a practical framework to rely upon as you plot strategies.
The M&A market is more transparent than ever, but also fickle and uneven so that sellers cannot take for granted that they will garner high multiples and loose terms. The willingness of the buyers to conform to a tightly managed sale process depends on the size and attractiveness of the target and access to vital due diligence material.
A large segment of the entrepreneurial and family-owned middle market is not comfortable loading a data room with information buyers need to flag issues that could lead to reduction of offer price or derail financing. As a result, most sellers are not able to require buyers to mark-up a purchase agreement as part of an offer.
Multiples can be misleading because when talking about them, sellers tend to exaggerate and buyers tend to be conservative to control expectations. The realm of add-backs and synergies is a creative place where persuasion and rationalization are finely tuned. Rude awakenings can also lurk if the buyer has the freedom to reshape what is being sold by way of carve-out marginal of business or create reserves that reduce price.
It often comes as a surprise to entrepreneurs and family-owned businesses that private equity firms on-balance are granted higher relative prices for businesses they sell and more aggressive financing terms for what they buy. It is really only logical that a party active as both a buyer and seller would be more attuned to the competitive dynamics of any market. It also only makes sense that an owner who follows the recipe for success…rigorous financial discipline, meaningful long term planning and top talent…will be rewarded when their business is offered for sale or seeking capital.
The value of a business that applies for a particular transaction is in many ways tied to the type and structure of the transaction. Raising growth equity is clearly very different from the sale of majority control, more as a result of structure and terms rather than price.
The balance sheet and actual free cash flow for the business have to be included for any value estimation to withstand the inevitable scrutiny of buyers and lenders. To rely on a multiple of EBITDA minus funded debt for estimated proceeds is unwise. Working capital and net asset adjustments can sink deals that may initially seem acceptable.
Lenders know that CFOs cut-and-paste the best features offered up by competitors vying to be selected for the financing. Senior debt multiples of EBITDA need to allow for working capital in addition to what does not remain in the company. Cash flow acquisition loans are virtually unavailable for businesses with less than $10 million in EBITDA and any kind of unsecured term loan is tough to snare.
Actual advance rates on fixed assets usually shock and disappoint borrowers as they become increasingly nauseous in reading through orderly liquidation appraisal reports. Even with working capital credit facilities, borrowers might not appreciate how eligibility and advance rates and excess availability requirements can squeeze actual borrowing availability.
The good news is that independent private companies are in high demand on every front. We would happy to provide our input on what you can do to take advantage of these opportunities.