Buying a good business is no easy task today. Money is pouring into the lower middle market from private equity houses, family offices, and independent sponsors competing against strategic buyers who can always beat out the most sophisticated financial sponsors by paying a little more. It is a seller’s market and good businesses that are put up for sale will be snatched away by the highest bidder. In the past fifteen years, the lower middle market landscape has become more intermediated than ever: it is rare to find a company that is for sale and is not represented by a broker or investment banker. Auctions are plentiful, competition between buyers is fierce, and valuation multiples have reached an all-time high.
In this highly competitive environment, with a low supply of quality businesses, how do you identify a good acquisition target for your business and persuade the owner to sell it to you? Mind Your Network.
As an operating executive or an entrepreneur, your connections to other business owners in your industry are invaluable. Use your network to its fullest extent. If you identify an acquisition target, find out if you are in any way connected to the owner. LinkedIn is a perfect tool to find connections. Turn a connection into a warm introduction. The right connection will bring you instant credibility. Getting to Yes.
Knowing who you are is not enough for a business owner to decide to close a deal: they need to trust you. Sometimes that’s what takes the most time in the acquisition process. Trusting someone does not come overnight. It might take a few months or even a few years. In M&A, time can be your friend and your enemy at the same time. Patience and determination are equal virtues to succeed in buying a good business today. Define What You Are After.
Maybe it’s simply a business with a repeatable business model, a good stable of customers with recurring contracts, and healthy profit margins. No business is perfect; an imperfection might be where the opportunity is or where another buyer might decide to stay away. Sales might have plateaued. The management team might be close to retirement. The sales force might have the wrong incentive plan. The accounting system does not provide timely financial results. What is your vision for the company going forward? Many times, it’s about getting the company reengaged into a new compelling strategic direction that energizes its employees. Identify the Key Players.
In any business, there are a handful of employees who makes the business go. It could be two sales people who maintain relationships with the company’s top customers. It could be the office manager who handles everything and answers all of your questions. These individuals are invaluable to the sustainability of the business. If one leaves, your short-term performance will suffer. Find them and make sure that they embrace your vision, because they will become change agents within the organization after you take over. Communicate Early and Often.
Any change brings confusion and anxiety amongst employees. The best way to avoid hearsay and naysayers is to communicate to your team as soon as the acquisition is completed, and then repeat your message as often as you can in small groups or individually, depending on the size of your company. Hire an Attorney and Tell the Seller to Hire One Too.
Obviously you need your own legal representation to draft and negotiate the definite purchase agreement. However, your counsel will do their best work if the other side is also represented by an experienced M&A attorney. The negotiations might be tougher, but at least you know you will eventually get to a deal. Trust, but Verify.
How do you define due diligence? In simple terms, it’s about validating the sellers’ representations about his/her business. You are trying to maintain a balance between building a relationship with someone you need to do a deal with, and checking everything they say along the way. EBITDA is Great, But Cash is King.
Your valuation might be based on a multiple of sales or EBITDA. However during the due diligence review, you should zero in on free cash flow, or essentially how much cash is left for the providers of capital (debt and equity). EBITDA is often used as a substitute for operating cash; free cash flow takes into account capital expenditures and paying for the increase in working capital needs. You should also compile weekly cash flow projections and estimate the minimum cash you need to leave in the business. The worse thing that could happen is that two days after your close you need to draw down on your line of credit to fund an entire payroll. Have a Plan.
Your plan should have goals that you are trying to accomplish short-term (first 90 days), mid-term (12-18 months), and long-term (5 years). Most people tend to try to do too much at once. The short-term column is full, while the mid-term and long-term columns might only have a handful of to-do’s. Be realistic with your goals: only the most urgent items should populate your short-term list. About the Author
Sylvie Gadant, CPA, is a partner with the firm’s Private Equity Practice and is the Transaction Advisory Services (TAS) practice leader. She coordinates and leads buy-side and sell-side due diligence engagements for private equity firms, independent sponsors, family offices, and strategic buyers. She can be reached at 973.218.0500 or at firstname.lastname@example.org
Citrin Cooperman is a full-service accounting and consulting firm with 10 locations throughout the Northeast United States. Visit us at www.citrincooperman.com.