MidMarket’s View: Protecting Your Flanks
As the private markets for acquisitions and financing remain more active than most might expect in these unsettled times, protecting the best interests of the owners of independent private company in those transactions is much more subtle than many of their advisors realize or truly appreciate.
Whether your objective is to raise debt or equity capital, to consider the sale of your business or the purchase of another, protecting your flanks is good business.
Sharp differences in how the pandemic has impacted various industries invalidate generalization about market conditions, company valuations and deal terms.
The fortunate group of COVID-friendly businesses (some tech, some online consumer goods and even some basic industrials) which are garnering most of the attention, while many others with long term merit struggle and often encounter either overly cautious or reluctant financing sources and prospective partners. We are actually encouraged by what is available for companies which may not realize what can be accomplished in this less-crowded environment.
Industry-specific trends for many businesses are likely to remain challenging for longer than most of us expected only a few months ago. But there are a variety of reasons why some owners of mature middle market businesses will either need or choose to pursue refinancing or a strategic transaction in the next several months.
Here are a few of the reasons for forging ahead in the current environment:
The unsolicited approach from an ideal buyer or investor on the basis of pre/post COVID earnings rather than current earnings.
Having the desire or need for additional funding or a strategic partner with more financial or non-financial resources.
Addressing differences amongst partners or various owners about timing for full or partial monetization of ownership interests.
Developments such as health issues of owner/manager themselves or within their family.
Financial pressures or strategic opportunities that simply can’t wait.
Headlines on financings or M&A deals rarely disclose detailed terms or the whole story on transactions. Pundits and various advisors often tout high relative value multiples and prices. They do not caution business owners about potential pitfalls or what is required from issuers and sellers in today’s markets.
There are predictable reactions to items that can make a meaningful difference in stress levels and financial outcomes.
Here are a few important items to factor into your thinking:
Your Data: The expectations bar for quality/depth of information is high. Being half-prepared slows the bidding, negotiations and process to completion. There are always issues and dealing with them before setting terms is better for everyone. You have to decide whether to take steps such as setting up a virtual dataroom and playing by the current rules for efficient dealmaking.
Your Plans: Documented plans for the current year and the intermediate term (2-3 years) are a basic requirement for financing and/or acquisitions in order to achieve best terms.
Structure & Terms: Valuation and price are inextricably linked to structure and terms. The strings attached vary by type of transaction but defining price adjustment mechanisms and tax treatment in advance of making or receiving an offer is always worth the effort and the cost to clarify.
Price: Most investors and buyers work to establish a price, not a multiple, and owners want a price rather than a formula. Valuation multiples are the result of a price, rather than the determinant of total value or price expressed in an offer.
Take Home: Price is the not what you actually get to take home before or after tax. It is not what applies in the same way for all shareholders. It is more often than not merely a reference point for beginning to sort through what determines what different owners receive.
Term Sheet: Make the effort to work with advisors to prepare a detailed term sheet that addresses all the main issues so that due diligence and documentation can be streamlined.
Contract: Most transactions involve negotiations which continue after a buyer or financing source has entered into a term sheet. Strive to find the balance between a clear detailed understanding by both parties without having a term sheet become overly lengthy.
Meet Your Forecasts: Missing short-term targets during a six-month process or shortly thereafter will disrupt valuation and shakes confidence in the longer term. Be thoughtful about forecasts.
Carveouts: Challenges and/or carve-outs from representations and warranties insurance should be identified early and addressed to avoid indemnification exposure.
Homework: If you haven’t already carefully read the type of financing agreements or purchase agreements that will apply to your transaction, make a point to slog through that so you are more than casually familiar with them.
Two Viewpoints: Put yourself in the other party’s shoes so you can understand their concerns and work to help them see things your way.
Valuation multiples of earnings have actually remained relatively high for companies fortunate enough to have growth in earnings, but that is of little help if the timing is elusive for your business to return to or exceed previous levels of profitability. The deal structure and specific terms in any type of loan or equity investment or ownership change really make all the difference in any given transaction.
Balance sheet issues such as working capital and satisfaction of liabilities aren’t reflected in multiples of earnings or even multiples of revenue. Tax consequences are often more complicated than expected.
Term sheets often don’t include detail on price adjustment provisions as well as non-price issues related to intellectual property, contingent liabilities, post-closing exposure and other items that can become significant.
There are many more items which owners of independent closely-held businesses should be aware of and build into their plans. Having the relevant market knowledge, corporate finance expertise and sensitivity of a seasoned advocate is more important and valuable than ever.
The confidence of your knowing the following will lead to your success:
What actually is reasonable for your business given your specific circumstances…
What can actually get done in the current market environment…
How to go about accomplishing the objective…
… will lead to your financial and personal goals.
We at MidMarket are here to put our expertise to work for you and to make a meaningful contribution to your success.
We’d be happy to meet with you in person or virtually to discuss your situation and to provide input (without charge) so that you can begin to determine whether to invite us to be part of your team.
We are easy to work with on either a time-based or outcome-based format.
We’ll bring a lifetime of relevant in-the-trenches experience to bear for you and we’ll protect your flanks as well as watch your back. Invite us to prove it. Thank you.
Patrick Hurley Telu Tsai Katherine Myers Graeme Howard