Planning ahead can increase sale value of a small business
Owners who look to sell must think of who might acquire it, deal structure
Ed KirkJuly 28th, 2011
A Pew Research survey conducted last summer found that 60 percent of employed adults ages 51 to 60 may delay their retirement due to the recession, and that 35 percent of those 62 and older already have pushed back their retirement date.
Business owners who have a substantial portion of their net worth tied up in a small business and are counting on selling it to fund their retirement are concerned about business values, whether acquirers are available, and what a deal structure might look like in this market.
As we are all aware, economic conditions have had a significant impact on most privately held businesses over the past three years. Over this same time period, we have seen the pace of mergers and acquisitions slow to a point not seen in many years. Fortunately, many small businesses have seen a turnaround and have experienced positive trends in 2010 and continuing into 2011. Even as the economy continues to recover, it can be an attractive time to sell a business or, at a minimum, implement some initiatives that will make the business more valuable in the future.
Types of buyers
Not surprisingly, the value of a business-at least when it comes time to sell-is based on what an acquirer is willing to pay for it. Valuation methodology is a completely separate topic, but supply and demand ultimately decide the value of a business, so it%u2019s important to understand how active acquirers have been in this market.
Acquirers generally fall into three groups: strategic/corporate, private equity, and individuals. Many strategic acquirers have shored up their balance sheets recently and perceive the current economic climate as an opportunity to expand or diversify their own business. So while some business owners believe that the only buyers right now are bottom feeders, this is definitely not the case.
Average earnings before interest, tax, depreciation, and amortization, a gauge of a company%u2019s performance known as EBITDA, have decreased somewhat since 2007; however, strong companies are still being fairly priced and aggressively pursued. Finally, some companies and industries have become even more attractive because they have proven their resiliency during the economic downturn. Health care, technology, and certain manufacturing companies are enjoying this kind of increased attention.
Private-equity groups also have cash to spend and are looking for opportunities. According to the Alliance of Merger & Acquisition Advisors and PitchBook Data Inc., the amount of capital available for investment from U.S. private equity groups is near an all-time high with $477 billion in overhang, which is the difference between the amount of funds raised during the past few years and the equity invested.
Individual buyers have been slower to return than the other two groups of acquirers. This is most likely due to lower risk tolerance, more challenging credit conditions, and perhaps losses in their own businesses or investment portfolios.
Deal structure and financing
Acquisition financing is more difficult to obtain than it was a few years ago. The environment, however, is improving, and transactions are still getting done as lenders seek to finance deals with strong fundamentals. However, lenders are being more particular when approving buyers. They are looking for buyers who have relevant experience, a clear business plan, and collateral assets.
SBA loan activity for business acquisitions has picked up from 2010 levels. In addition, the SBA 7(a) limits were raised from $2 million to $5 million last year, making it easier to finance acquisitions in this size range. Access to financing is not a problem, according to Bob Heffner of Rocky Mountain Capital LLC, and although smaller acquisitions can still be financed with loan-to-value ratios in the 70 percent-to-75 percent range, ratios in the 60 percent-to-65 percent range are more common for deals exceeding $2 million.
Positive business trends are important, and many lenders are interested in seeing at least a full year of proven growth or stabilization on the books before they will approve financing. In some cases, transactions may require more seller financing than was required in the past, so business owners may need to factor this into their planning. Even so, the goal in a business sale should be to get substantially cashed out at closing.
The quality of a business is still the primary factor for attracting buyers. Now more than ever, acquirers are attracted to profitable companies with strong gross margins, loyal customers, tenured employees and management, and attractive growth potential.
The time to sell is when the business is steady or growing, the employee base or management team is stable, and perhaps most importantly, when an owner is ready, based on his or her personal and financial objectives. This means sellers should understand what the market may be willing to pay for their business and should plan ahead with a professional adviser to help determine the best time to sell.
Waiting a few years as the economy continues to recover is a valid strategy for owners who have a longer-term retirement horizon, in which case this may be an ideal time for planning an eventual sale. Business owners cannot control the economic environment or the market conditions, so they should focus on the internal factors that can make a business more attractive. These factors include management succession, diversification of revenue, competitive or strategic advantages, opportunities for growth, and transparent financial records, among others.
Trends are important when determining the right time to sell. Consequently, this may be a good time to implement a system for tracking certain metrics and trends. Positive trends can demonstrate predictable or recurring revenue streams, and the ability to track such trends on a quarterly or even a monthly basis can be valuable. The exact metrics to track depend on the type of business; in general, track sources of revenue by customer, product or service, and geography, as well as detailed costs and any other metrics that may be unique to a company or industry.
If you are contemplating a transition-regardless of whether it involves passing the company on to family members, structuring a buyout by employees, or selling it to a third party-you should be asking and answering a host of specific questions. Planning ahead and following a well-executed process can increase the value of a business by 10 percent to 30 percent.