Selling a business is always an uncertain journey, but it is even more precarious in the middle of a pandemic and during dramatic changes in the political landscape. Both have had a disruptive effect on the merger and acquisition market. The Milwaukee Business Journal recently sat down with a panel of experts to talk about the potential ramifications on owners who are looking to sell their businesses.
TIMOTHY REARDON: What is the current status of the Milwaukee region’s merger and acquisition market, and how has it been impacted by COVID? Are you finding that people are more or less willing to buy and sell?
JOE BRAIER: I think 2021 will be a banner year for mergers and acquisitions, because there has been a little bit of a backup due to COVID. The biggest concern on the sell side is potential tax hikes, and I think that is going to be driving a lot of business owners to the market. As far as buyers and sellers, it is very much a seller’s market. We have lots of buyers, but not a lot of inventory (businesses for sale on the open market).
KRISSTINA EBNER: I agree. We saw things slow down in Q2 and Q3, but after Labor Day, M&A activity picked up. In general, I do not think that COVID has impacted whether people are more or less willing to sell. I think sellers are thinking about the same variables – whether they can get a healthy valuation for their company, whether they can invest their sale proceeds somewhere else and get a higher return and whether there are buyers.
KELLY RENZ: There is still an appetite to sell, as long as the business owner doesn’t think they are being penalized because of the pandemic. If they have taken a hit in revenue, they want to know how long it is going to take before COVID is no longer having a negative impact on their valuation.
REARDON: How has COVID changed the timeline for completing deals or the way valuations are structured (i.e., multiples and other valuations, due diligence, warranties and legal considerations)?
EBNER: I think that deals are continuing on the same timeline we typically see, which is roughly 60 days from signed LOI (letter of intent) to closing. I think COVID has extended the timeline a bit, because buyers are spending more time on financial due diligence. They really want to understand how permanent any revenue spikes or dips will be. We are definitely seeing an uptick in the use of earn-outs, which buyers and sellers are using to bridge the gap on valuation. They give buyers some protection that they are not overpaying, and the seller gets the potential upside of a pre-pandemic valuation. However, earn-outs are difficult to negotiate and many result in post-closing disputes.
BRAIER: Valuation is both art and science. The science part focuses on the financials and what future projections will look like. The artistic aspect is taking a look at the qualitative analysis of each business, understanding it’s industry, and determining how COVID has affected not only the business but the industry.
RENZ: One of the things we have seen in the seller’s preparation process is a little bit more due diligence inside their organization – better, more thorough forecasting to really scrutinize what they are putting forth for their valuation and to make sure they will be able to earn their earn-outs moving forward.
REARDON: How is the economic uncertainty impacting business owners’ strategic decisions and their preparations for mergers and acquisitions? Do you think business owners are pulling back, and what types of things are they doing?
RENZ: I think they are more likely to hit pause instead of stop. Last year was a whipsaw as people tried to figure out what was happening. Now that we have a better idea of COVID and less political uncertainty, people are more confident about making decisions. The only exception I have seen is in areas that were really hit hard. I have a couple of restaurant clients who are going to hold a little longer because they cannot sufficiently forecast their revenue.
BRAIER: The acquisitions relying on bank financing, there will be a longer timeframe for the bank’s due diligence process. I am seeing as much as 75 to 90 days from letter of intent to closing. Banks really want to understand how COVID has affected the business.
EBNER: From a legal perspective, we are not seeing a tremendous amount changing in terms of due diligence. There are some obvious areas where more attention is being paid, such as workplace health and safety. Does the business have those pieces in place? Are they following CDC guidelines? Given the work-from-home environment, how are their IT systems set up? Are there potential supply chain risks? Sellers should be prepared to answer these questions.
REARDON: Are other factors, such as the availability of money and the political landscape, impacting mergers and acquisitions?
BRAIER: The SBA (Small Business Administration) has temporarily revised their underwriting guidelines where principal and interest payments are deferred for a borrower for up to six months of the initial loan. Meaning new ownership will not have to pay on the loan for their first six months of ownership, which will then assist in building up their cash flow. The SBA also is expected to provide a 90-percent guarantee to the bank, which is up from 75 percent now. That should increase banks’ willingness to provide more flexibility and is one of the reasons we expect 2021 to be a banner year.
EBNER: There was a lot of uncertainty last year, but I think with the long-awaited guidance from the SBA, buyers and sellers now have a pathway for how to deal with PPP loans in transactions. Sellers understand that they need to set up a cash escrow account with the SBA lender in the amount of the loan if it has not been forgiven pre-closing. Once it is forgiven, the cash is returned to the seller.
RENZ: There is no shortage of money out there to fund these deals. It is a sellers’ market, and there are some very creative things being done.
REARDON: What should business owners looking to sell their businesses be doing to strengthen and prepare their businesses for sale?
RENZ: It is no secret that a well-run organization fetches a higher price. They should have the right talent at the helm and make sure decision-making authority isn’t limited to just one person or a few people. Decision-making authority needs to be spread throughout the organization, and in order to do that, you have to have the right organizational structure in place. The same is true for client and customer relationships. If those are wrapped up in one or two individuals, that becomes a challenge. Businesses should also have a scorecard process they can use to measure how their business is trending. Buyers love knowing that you have a pulse on your business.
EBNER: We like to be working with sellers in advance as much as possible. There are always issues, and you want to uncover them before the buyer does. That gives you time to implement a mitigation strategy that will allow you to get ahead of the issue or avoid it altogether. Similarly, we like to get ahead of any third-party issues. For example, you may have a contract with a very important customer that cannot be assigned. Identifying that in advance gives you time to talk to that customer determine whether it will be problematic. There are lots of things to consider well in advance of a sale process.
REARDON: Joe, by the time you get involved, do you normally have time to prepare the business for sale or are you writing the offering memorandum and going to market?
BRAIER: It is a little bit of both. Sometimes we work with owners who anticipate selling in the next one to three years and want a plan on what to do before its time to bring it to the market. Others have already worked with people like Kelly and Krisstina and are ready to go. They just need us to take it to the open market in a confidential manner. In either scenario, our first step is always to sit down with the business owner and understand their overall goals and objectives and provide them with the necessary information to make an informed decision on when the right time to sell is.
REARDON: How far out should that planning begin, and who can business owners turn to for that support?
RENZ: Part of what we do is work with organizations on future planning. With a 10-year target, we usually know there is a potential sale on the horizon. We may even know that with a three-year picture. We coach our clients to engage people like Joe and Krisstina the moment a sale becomes a possibility at least two or three years in advance of a desire to sell so they have time to course-correct and stabilize operations and people issues inside the business. They need to get an educated plan and the right people in place.
BRAIER: You really need a team of advisors in your corner to make sure things are being done in the best, most efficient way possible to make sure the seller is fully protected.
EBNER: I would say that from a timing perspective, you need at least one year in order to get ahead of known issues. In terms of advisors, you obviously have to have a law firm and a strong accountant, whether internal or external. You need someone who can view your business as the buyer will so you can anticipate the questions a buyer might have. We also recommend to our clients that they get someone on their board with mergers and acquisitions experience because they can be a very valuable asset.
RENZ: Business owners tend to have a trusted network of advisors through their banking and legal relationships. While that is critical, it is important to have someone who can objectively look at the transaction as the buyer would – not someone who is one of your best friends. That can be a really difficult and emotional hurdle.
REARDON: What should owners be looking for in terms of the types of candidates to purchase their businesses? You hear people talk about financial buyers and strategic buyers. Give us your insight on who is out looking to buy businesses these days.
BRAIER: There are a variety of buyers. Private equity groups are well-educated and well-funded, and they are able to come in and take the business to the next level. Their objective is to grow and grow quickly. The next type of buyer is a synergistic company. An example would be an equipment manufacturer that buys a machine shop to do work it had been outsourcing. Another type of buyer is the direct competitor. You have to be very cautious about sharing information with them, especially if they are in your geographic area. We also deal with serial entrepreneurs who may be running three, four or five businesses. They are not private equity. They are just individuals who buy businesses and put CEOs in place to run it on a daily basis. The last and final type of buyer is the individual who works in corporate America. They have built up a good amount of wealth and are ready to leave and buy their own business. They may be looking at a seven- to 10-year window before they retire. Those are the different types of buyers, and we break down the advantages and disadvantages for each when we sit down with owners.
REARDON: Krisstina, what kinds of buyers have you seen in the last six months?
EBNER: Similarly, we see both strategic and private equity buyers. Private equity comes in a lot of flavors. There are also Special Purpose Acquisition Companies (SPACs). A SPAC is a newly created company that uses IPO proceeds and additional financing to fund the acquisition of a private company. It is basically a way to turn an acquisition target into a public company right away. I haven’t dealt with them personally, but SPACs had a banner year in 2020.
RENZ: The most common buyers for our clients are private equity or synergistic. Multi-generation businesses, where the parents are not going to be able to hand off to the next generation, attract private-equity buyers. We have seen an uptick in the synergistic, where the buyer is looking to get more efficiency and effectiveness out of its supply chain or processes.
REARDON: What is your long-term view of where the merger and acquisition market will be 12 to 18 months out?
EBNER: My long-term view of middle-market M&A is very positive. We’ve closed numerous transactions already this quarter, and I see more and more LOIs being executed. I think this will continue, unless we see significant inflation, major changes in tax policy, or some other adverse change in the economy.
RENZ: I would say the pent-up demand of 2020 will accelerate things this year. Companies that held back will push forward. The worst is behind us and the impact of potential taxes is going to drive a lot of the pace as we get further into the year.
BRAIER: I think 2021 is going to be a fantastic year to sell a business. The lull in Q2 and Q3 of last year created a traffic jam that is now starting to break open. Valuations market multiples are high, and sellers right now are able to leverage value, but I do not know how long they are going to stay there. We have been talking about there not being as many sellers as there are buyers, but the scales are going to tip as Baby Boomers finally decide to retire and put their businesses on the market. At that point, buyers will become more selective and I anticipate market multiples to drop.
REARDON: Any other thoughts?
BRAIER: Selling your business is probably one of the biggest decisions you are going to make. You want to have the best experts in your corner to help you make an informed decision and make sure you are fully protected throughout the process.
RENZ: As you look at potentially selling your business, make sure you have an objective view of how your company is actually running. Is it running like clockwork, like a system? Or is it running you instead? We can provide a realistic, almost due-diligence level of insight into what is really going on in your business. It can be an eye opener, but it also can be a chance to get ahead of the game and make the tweaks and fixes that need to be made before you sell.
EBNER: We’ve talked about doing due diligence on the seller, but the seller also needs to do reverse due diligence on the buyer. What is their track record? Have they changed their position on other transactions from the time they signed the LOI to when the deal closes? That is important to know.
TABLE of EXPERTS
TIMOTHY P. REARDON
President of the Association for Corporate Growth–Wisconsin and on its Board of Directors
Timothy P. Reardon is President of the Association for Corporate Growth–Wisconsin and on its board of directors. Tim is also a shareholder in Reinhart Boerner Van Deuren’s corporate law and tax practices. Tim provides legal advice to companies ranging from regional to national and global corporations, with particular emphasis on mergers and acquisitions, business counseling, capitalization and growth financing, and succession planning and exit strategies.
JOE BRAIER
President, Lakes Business Group
Joe Braier is the President of Lakes Business Group, a local Mergers and Acquisitions firm servicing business owners in Wisconsin and Illinois. As a certified business valuation analyst and top performing M&A Advisor, Joe has successfully assisted several business owners complete their exit strategy goals and objectives over the past 15+ years.
KRISSTINA EBNER
Shareholder in the Corporate/ M&A Group at Godfrey & Kahn
Krisstina Ebner is a shareholder in the Corporate/ M&A Group at Godfrey & Kahn. She has nearly 15 years of legal experience with a focus on mergers, acquisitions and other business combinations for public and private companies and private equity funds. Krisstina assists clients with general governance matters and regularly prepares and negotiates customer, supplier, consulting, employment, manufacturing, distribution and license agreements.
KELLY M. RENZ
Professional EOS Implementer®, CEO
Having led and started multiple businesses, Kelly believes that there is an art and science to running a great organization. She subscribes to building accountability to achieve results. Kelly is one of only 400 trained Professional EOS Implementers® globally because she enjoys working with entrepreneurs to get more of what they want from their businesses. She does that by providing a complete system with simple, practical tools to help owners and leaders get better at three things we call: Vision, Traction and Healthy.