John Binkley

A New Dawn for Deal Making?

June 5, 2020 By John Binkley

Back in April, I was delighted to learn that our team at Generational Group had closed our 900th transaction in company history. At any time this would be considered a fantastic milestone to pass, and I am of course incredibly grateful to the continued hard work of our associates and the wonderful support of our clients.

For us, every one of these 900 (and counting) transactions represents a business owner that we have helped secure their financial legacy, so that they can reap the rewards of their investment into their company and enjoy life beyond business.

Yet, considering the life-altering circumstances of the last few months, this achievement has a whole different meaning to me. It demonstrated that, even in these times of hardship, where families, communities and businesses have been changed forever, the resilience and commitment of entrepreneurs continues to hold firm.

Of course, the COVID-19 pandemic has changed deal making at least temporarily, which I will explore in this article. But, it is the perseverance of the entrepreneurial spirit, particularly within the middle market, that gives me a great deal of confidence for life beyond this crisis.

Optimism for the Future of Middle Market M&A

In my previous article, I highlighted several reasons why I remain confident in the foundations of our economy and the bullishness of buyers in the face of this unprecedented challenge. And I’m happy to report that a couple of months later, nothing has dampened this feeling. If anything, it’s grown even stronger!

The robustness of our banking system continues to be a source of comfort in these hard times for individuals, families and businesses, with central banks offering reassurance that they will be introducing measures to stimulate economic growth and protect incomes.

But beyond that, I’m encouraged by the attitudes of middle market entrepreneurs and their prospects for M&A activity after this pandemic. A survey of SME owners conducted by Permanent Equity recently revealed some reassuring statistics, including:

32% of owners surveyed said their companies’ revenue had remained stable or even expanded during the pandemic
40% expect their revenue will be back to 2019 levels within 6 months of life returning to some form of normality
76% believe their business will emerge from the COVID-19 crisis stronger than before

These are great signs for the resilience of the middle market, and indicates that these companies are not statically waiting for this all to blow over – they’re adapting to the “new normal” with changes like remote working and investments in technology, which will then benefit them once we have overcome this challenge.

That’s an attitude we’ve also taken at Generational, changing our practices to protect the health and wellbeing of our associates across the country while continuing to meet the needs of our clients in these unique circumstances.

Because, particularly in the lower middle market, transactions are still moving forward. While the press will often focus on the decline in billion-dollar deals due to the uncertainty COVID-19 has caused, the timeline to deliver ROI for smaller deals is significantly longer, meaning there’s less risk associated.

But how has deal making changed in the face of this new landscape? How could this affect a business owner’s approach to planning their exit?

Exit Planning in the COVID-19 Era

When discussing how COVID-19 has adjusted the deal making process, I think it’s vital to start with how we should determine a company’s value.

Regular readers of Generational Equity’s insights will likely be familiar with recasting. That is when a professional M&A firm will examine your financials to account for any one-time expenses that would not impact on its new owners. These can include:

Losses due to fire
Losses due to employee embezzlement
Other business disruptions beyond your control (floods, earthquakes, tsunamis)
Any of your compensation that was above fair market value
Travel and vacations for you and your family that the company expensed

This is a widely-accepted process and helps provide a more accurate picture of your company’s worth for a prospective owner. However, moving forward there will be another important element to include on this list: the loss of revenue or income as a result of COVID-19.

As Northern Trust reiterates in a recent article:

Moving forward, we expect the due diligence process to include questions that help buyers better understand the specific impact of COVID-19 on the business, and its general level of preparedness for a global pandemic.

By accounting for this unprecedented disruption when recasting your company, you can offset any concerns or doubts of buyers, and also increase the likelihood that you will maximize the value of your business sale.

Furthermore, if you are able to adapt your financial forecasts to demonstrate why your business won’t be greatly impacted by COVID-19, this can give you a significant competitive edge among potential buyers. Remember, private equity firms are still sitting on upwards of $2 trillion in dry powder – this still needs to be invested, and means a well-prepared company can still secure a premium on their business.

This recognition of COVID-19’s impact on business operations has led to the expansion of EBITDA to EBITDAC:

Earnings
Before
Interest
Taxes
Depreciation
Amortization
Coronavirus

No, this isn’t a bad joke – it is a reflection of the sizable effect that COVID-19 has left on many businesses across numerous industries.

As well as the transformation COVID-19 has had on determining business valuations, it’s important to consider how deals will be structured. We’ve spoken at length in the past about earn-outs and their prevalence in deal making, but in this new environment, they are likely to become even more sought-after.

Again, Northern Trust emphasizes this point, saying:

We also expect to see buyers paying a greater portion of the purchase price in the form of an “earn-out.” We believe sellers who adjust their mindset, show a willingness to be more flexible on deal terms, and who recognize that the transaction process is going to take longer in this new environment are likely to be at a competitive advantage.

This reinforces the need to be supported during your exit planning by a professional M&A firm, because this will help prevent any earn-out from being too heavily weighted in favor of the buyer: the deal structure also needs to benefit you (the seller).

The advice of an experienced M&A advisor will also give you a clearer picture of what deal structures are more beneficial than others. This could allow you to establish an earn-out structure that is actually more financially advantageous in the long-term than a more cut-and-dry transaction

Fundamentally, we are in challenging times when it comes to deal making and exit planning. Information seems to change every hour, and it is important that, as a seller, you are working with a true professional that has experience in closing deals no matter what the economic cycle and understands how to secure an optimal deal structure.

Maintaining Your Journey to Exit

I hope this has given you a greater understanding of how M&A activity is continuing to take place, and how deal making is evolving in order to meet the challenge.

Even in these difficult circumstances, dealmakers across the U.S. are striving to help push deals over the line, including our diligent associates at Generational, and I believe this should reassure business owners about their prospects of exiting both now and when COVID-19 has passed us by.

Above all else, I hope you take away from this the value of being supported through your exit plans by an experienced firm that has managed clients through all kinds of economic cycles. In trying times such as these, it is that experience and expertise that will keep your exit plans on track and keep you on course to an effective, satisfying exit.

If you want to keep up with the latest trends and news related to the economy and its impact on your approach to exit planning, I’d recommend subscribing to Generational’s regularly updated insights.

Until next time, I’d like to wish you, your family and your business nothing but the best as we continue to manage and overcome this challenge.

COVID-19 & Focusing on the Future for Middle Market M&A

April 17, 2020 By John Binkley

In a matter of weeks, COVID-19 has changed the world as we know it in unprecedented ways. From restrictions on travel and mobility, to employees globally working remotely to bypass the pandemic, life feels like it has been flipped upside-down.

The M&A industry has not been immune to this impact. COVID-19 has been at the heart of current economic uncertainty, and subsequently this has caused deal making activity to slow in the short-term. Fortunately, at Generational Group we have continued to safely press ahead with transactions even at this tumultuous time.

As a recent roundtable meeting hosted by Axial highlighted, many deals at the Letter of Intent (LOI) stage are either pushing forward with urgency, or left on ice for the time being. While right now it is impossible to predict how long these existing conditions will remain, I am optimistic that it is a challenge we as an industry will overcome, and return to a state of ‘business as usual’ in due course.

Here, I explore my reasons for staying positive in the face of this crisis, and why I expect the M&A landscape to return to its once-thriving state when we can put these circumstances behind us.

Our economic foundations remain strong

Firstly, while COVID-19 has unfortunately resulted in numerous businesses shuttering short-term and a steep rise in unemployment, the underlying fundamentals of our economy remain strong in the face of this extraordinary challenge.

This is different from the banking/financial crisis we endured in 2008. Corporate balance sheets remain strong, interest rates are staying low and there is capital available to support business growth and acquisitions. But perhaps most importantly of all, our banking system is stable and its reserves are well above Federal guidelines.

As a result, we can be confident that our economy will hold firm against this temporary pressure, and will over time return to a positive landscape for M&A acquisitions.

In addition, the launch of the $2 trillion CARES Act stimulus package has bolstered the prospects for businesses looking to retain and take care of their employees. By providing quick funds and relief for SMEs during this time of uncertainty, this will be critical in keeping companies operational and supporting their preparations for the recovery period.

Private equity is still sitting on a mountain of dry powder

As noted, there is undoubted turbulence in the M&A market right now, and this should be expected for a little while. However, we are still seeing substantial buyer interest in spite of these challenges, which is reinforced by the capital available to these groups.

Private equity firms are a prime example of a buyer group prepared for when the market stabilizes. As Bloomberg reports, they are sitting on a $2 trillion war-chest of dry powder, all of which can exclusively be devoted to M&A acquisitions and investments. This puts them in a strong position to actively pursue opportunities as we start to recover.

Furthermore, Bloomberg’s article also notes how companies in a variety of industries will likely prove extremely attractive prospects for business buyers on the other side of the COVID-19 crisis, due to these being largely unaffected from an economic growth standpoint.

Buyers are bullish about future acquisitions

Meanwhile, Pitchbook revealed that a recent survey conducted by Ernst & Young suggested that around 56% of executives actively plan to pursue acquisitions in the next 12 months, which, remarkably, is an increase from October’s figure of 52%.

This is excellent news for business owners considering their exit plans in this uncertain state of affairs, as this demonstrates that when the world starts returning to normal, we can expect a major uptick in deal activity. Companies who have managed these circumstances and dedicated time to planning their exit strategy stand to benefit the most from this.

Plus, this is especially true for lower middle market businesses, because as Pitchbook states:

“For now, many dealmakers are forgoing transformational mega-deals in favor of smaller, discounted acquisitions.”

While the short-term vision for M&A remains a difficult prospect as buyers and sellers seek out firmer footing, these findings fill me with confidence that there will be a flurry of activity and opportunities when there is greater clarity about this entire situation.

Use this time to perfect your exit strategy

Hopefully, this has helped you join me in believing that COVID-19 will present short-term challenges for M&A activity, but will not completely compromise the optimism both buyers and sellers entered 2020 with.

While I recognize this can be difficult to visualize considering the present environment, there are reasons to be upbeat about the future of the industry – and with it, your prospects of achieving an optimal exit.

Right now, my advice to business owners is to dedicate time to exit planning, especially if this is something you’ve not commenced with already. This anticipated slowdown of deal activity in the short-term gives you the opportunity to consider your next steps and build a buyer-ready business to coincide with when the world starts its recovery.

Remember, it will take 90-120 days to complete the critical first step in your exit journey – an initial business evaluation. Starting early with your exit strategy puts you in a strong position to effectively market to buyers preparing for normalcy to resume, and will help you secure an offer that accurately reflects the value of your company.

Our team at Generational Group can support you throughout this journey, even during these challenging times. Our associates continue to operate at their typically high standards, working remotely to ensure their safety while we continue to communicate with clients digitally. These include virtual versions of our informative exit planning meetings, where our experienced advisors break down the steps to maximizing the sale of a company.

I’d urge anyone to get in touch with our team to get a head start on their exit plans while activity is on a temporary slowdown – I’ve never met someone who regretted beginning this process earlier than they needed to.
Also, for more up-to-date information on how COVID-19 is affecting the M&A landscape – and what this means for prospective sellers – make sure you’re subscribed to Generational’s insights. With news fluctuating all the time on this topic, staying informed has never been more crucial.

Managing the Difficulties of Due Diligence in M&A

February 10, 2020 By John Binkley

There’s no doubting that 2019 was a strong year for M&A activity.

Our team at Generational Group benefited from the strength of the current seller’s market, once again ranking #1 for deals closed worth up to $25 million, and #2 for deals up to $100 million. And more insights into this active year have been spotlighted in Deloitte’s U.S. M&A Trends 2020 report.

Taking insight from 1,000 executives across the U.S., Deloitte’s report presented several important points about the current M&A landscape and what we can expect moving forward, including:

63% of respondents believe transaction activity will rise in 2020
Dealmakers are shifting their attention primarily to the domestic market due to concerns over trade instability
Corporations and private equity firms have access to record-setting capital reserves
Focus is changing from large (mega) deals and is more interested in deals within the middle market

All of these factors should give business owners contemplating their exit plans confidence that they can secure an optimal offer for their company in 2020. At the same time, it reminds us that this market won’t last forever, so it pays dividends to start planning while the market is still in favor of sellers.

Due Diligence Delays?

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But, the area of Deloitte’s report I’d like to focus on in this article is the insight they offered into due diligence. Their findings revealed that 47% of executives believe the due diligence process is now longer compared to five years ago.

According to Deloitte:

“Gartner says the average time to close an M&A deal has risen more than 30 percent in the past decade.” This development may be related to the greater complexity of deals, or it may be rooted in where we are, well into a long M&A cycle, which makes it harder to find good deals. Regulatory and policy uncertainties, along with information security concerns, may also play roles in extending the due diligence phase.

If you’ve never been through M&A due diligence before, in some ways I envy you. This is the 2-3 month period where prospective buyers meticulously assess a company that they’re interested in, to reassure them that:

The information the seller presented to them in their Offering Memorandum was correct; and
There is no great risk involved in acquiring/investing into the company in question.

Risk is a word buyers want to avoid in all circumstances. Due diligence is there to uncover and evaluate any areas where this is present. And, naturally, this means this is the period of the exit journey where negotiations are most likely to collapse for a variety of reasons.

The seller may become fatigued about the unceasing questions and discussions with the potential buyers. Or a buyer could find inconsistencies in their findings from the documentation they were provided by the seller, leading to a break down in trust.

In Deloitte’s report, they have highlighted that the increased complexity of deals and trying to juggle multiple buyers at once have caused the speed of this process to falter in recent years. But why exactly is due diligence such a marathon to contend with?

The Due Diligence Checklist

When discussing due diligence, I’m always reminded of a long-established turn of phrase:

A deal isn’t really a deal until it falls apart at least twice!

At Generational Equity, navigating the potentially treacherous waters of due diligence is something we’ve become adept to over the years. While no two M&A transactions are alike, this experience is invaluable to anticipating what issues a prospective buyer may have and how to respond to these to keep a deal on track.

Still, without a clear understanding of where the typical 200-300 due diligence questions will come from, exiting business owners can easily find themselves at loggerheads with buyers.

Areas that will be interrogated during due diligence include:

General Company Information – what is your company all about?
Financial Matters – how healthy is your business financially?
Products & Services – what is your company’s offering?
Property – what property does your organization own or lease?
Customers & Revenue Streams – how diverse and wide is your customer base?
Technology & Intellectual Property – what tangible and intangible assets do you have rights to?
Strategic & Cultural Fits – are your strategies in line with the buyer?
Employee Information – what are the skills and overall quality of your existing team?
Material Contracts – what contracts and other commitments do your company hold?
Tax Matters – is your company at risk of litigation or liabilities related to tax?
Insurance Coverage – how protected is your company through its insurance?
Antitrust & Regulatory Issues – has your company been under investigation for any antitrust problems in the past?
Cybersecurity – does your business have robust IT defenses and support?
Environmental Factors – is your company’s impact on the environment positive or negative?

This is just an overview of what you can anticipate from due diligence, which makes it no wonder that this already exhaustive process has gotten longer and longer over the years. So, when you want to ensure your exit is as smooth and streamlined as possible, what steps can you take to minimize the time it takes to complete this task?

Ways to Streamline the Due Diligence Process

Don’t mislead buyers in your documentation

First and foremost, be honest and accurate in the documentation you present your potential buyers.

While it is encouraged to recast your financials to provide a true reflection of your potential to buyers, flat out lying or subverting details is a real deal-breaker – buyers will find the discrepancies and call you out. This may lead to a loss in trust, resulting in a reduced offer from the buyer, or negotiations coming to a halt altogether.

Stay organized with documents and checklists

Collating and updating your core information in your Offering Memorandum is a painstaking process, but it saves a lot of time and headaches during due diligence.

If information is incomplete or missing, buyers won’t simply shrug and move on – they’ll do what they must to get a clear picture of your company. So starting early in collecting this data will likely reduce the time a buyer takes to understand your proposition.

Be prepared to answer and address risks

No matter how thoroughly and organized you have been in the build-up to this part of the exit process, due diligence will raise questions that you will need to answer about your company.

Preparation is everything at this stage of exiting a company – undergo internal checks to get a clearer idea of what queries your company might inspire, and identify any areas of risk so they can be addressed and remedied before potential buyers bring them to the table.

Work with a professional M&A firm

Finally and arguably most importantly, don’t go into the due diligence process alone. Our team at Generational Equity have estimated it can take at least 1,000 hours of your time to go from marketing your company to closing a transaction – much of it spent in due diligence.

Working with an M&A firm will mean you’re backed by people experienced in navigating this process, so you avoid any pitfalls, are kept focused during testing periods, and ensure any areas of risk are dealt with prior to buyers conducting their checks. It’s a tough road, but it’s easier to walk with someone alongside you.

In addition, the first phase in the Generational process is a thorough and complete evaluation of your business – a “mini” due diligence. This step is critical because we ferret out many issues that need to be addressed long before due diligence is started. This is one reason why we are one of the leading middle market M&A firms; buyers have confidence that when we bring them deals that we have done our own due diligence.

Approach Due Diligence with Confidence

As the due diligence process becomes more in-depth and comprehensive, knowing what to expect and having an experienced team by your side is crucial to making this difficult portion of the exit process as efficient and well-managed as possible.

Hopefully this has provided a deeper understanding so you can approach your exit with more assurance. If you’d like to learn more about what’s involved in due diligence, there are numerous articles on this topic in Generational Equity’s regularly updated insights.