2020 Business Sales Continue Despite Covid-19 Challenges

2020 Business Sales Continue Despite Covid 19 Challenges

 

According to the 2020 3rd quarter survey conducted by the IBBA, M&A Source, and Pepperdine University, Intermediaries are reporting that many businesses are selling closer to their asking price than in 2019. We believe that larger businesses, those less affected by Covid and those valued between $1MM and $5MM, saw increased Buyer competition which resulted in sales much closer to their asking price. Conversely, those businesses impacted by the Covid shutdowns, such as retail and restaurants, were less sought after and therefore sold at lower than their asking price.

2020 Business Sales Continue Despite Covid 19 Challenges

 

What types of businesses are being purchased?
The top-selling types of businesses depend upon the size of the transaction. The top industry sectors in the $1-$50MM range were Construction, Business Services, Manufacturing, Wholesale, and Consumer Goods/Retail. Restaurants, not surprisingly, led the way in the under $500k range with Buyers finding opportunities in Asset Sales and lease assumptions to add locations.

 

Why are businesses being sold?
The number one reason owners state for selling their business is retirement, with owner burnout and new opportunities as secondary reasons. Some owners have decided that now is the time to sell rather than wait until the end of the pandemic, while others see more opportunity once the pandemic is resolved.

 

Considering selling your business?
Selling a business is a challenging yet rewarding experience. Today’s business for sale marketplace is more complex than years past. Standing out in the crowd to attract qualified buyers is the key to making a successful sale. Vanguard Resource Group, located in San Diego, has been helping business owners get top dollar for their businesses since 1989.

Our “secret” is hard work. When we represent a client, we do the hard, detailed work required well in advance of taking the company into the marketplace. We firmly believe that you only have one chance to make a good first impression on the Buyer, and that is where our up-front preparation makes the difference.

 

The difference between Business Brokers and Real Estate Brokers

Those involved with the selling of businesses in California are required to have a real estate license issued by the state.  This is the same license that is required to sell a home, a commercial property, or to be involved with property management. What does selling a house and selling a business have in common?  Other than sharing the same license, very little!

Real estate brokers deal with zoning, housing types, mortgage rates, flood zones, physical inspections, and the personalities involved with emotional buyers and sellers.  Business Brokers deal with financial statements, leases, covenants not to compete, and work with the other professionals involved with the transaction, such as Attorneys, CPAs, Wealth Managers, etc.

Residential Brokers list and sell houses. According to the National Association of Realtors, the average house sold had been on the market for 3 weeks.  Business Brokers list and sell businesses. According to Business Brokerage Press, the average time on the market for a business is a little over 7 months.

Real Estate Brokers typically advertise their property on a Multiple Listing Service (MLS) where brokers all over the state can see what is available.  Business Brokers, because the information about the business is more sensitive and confidential, must “make the market” for the business, rather than rely upon an MLS.  This can include advertising on websites, print media, direct solicitations to likely buyers, exposure to Private Equity Groups, etc.

The skillset and knowledge base necessary is vastly different between the two. So, if you are selling a home seek out those who are Realtors.  If you are selling a stand-alone commercial property without a business, then look for a commercial broker. And if you are selling a business, find a Certified Business Broker or Certified Business Intermediary.

Buying a Business is NOT like Playing Poker

You need to show your cards!

Buyers, when inquiring about a business, remember that you are asking for confidential information. Even the fact that the business is for sale is confidential and the premature exposure of the sale could damage the business and its owner. You of course will want to know the name, address, financial performance information, rental rates, etc. This information is not available to the general public, so the seller or their broker will want you to sign a non-disclosure agreement, plus know more about you prior to releasing that information.

Our firm, plus most other professional business brokerage offices, will want to at least have some basic contact information, know a little bit about your background, and have some representation from you that you have the financial capacity to complete the transaction.  Most of the time with small businesses, this doesn’t mean providing your tax returns or bank statements, but rather just a signed buyer profile stating that you have a certain amount of money to work with. This seems like a fair request given the information that will be provided by the seller. Of course, for larger businesses, both the broker and the Seller will want to know more details about how you propose to acquire the business.

What happens if you fill out the NDA with your address listed as the local UPS Store, no telephone number, and a Gmail address that is Vikingking@yahoo.com? The Seller or the Broker has no way to know who you really are and are very likely to not provide you with the information. Same for the financial representation. A bunch of zeros or N/A’s inserted on the buyer profile doesn’t exactly provide comfort to the Seller and again, will likely result in no response from the Seller or the Broker.

Now, I certainly understand a buyer’s reluctance to provide their financial information if the advertisement is vague and has no financial information.  I too would be irritated if I saw an ad for a “Service Company” asking $500,000, with no revenues or earnings listed, and no other description. Besides the fact that I would never have inquired about such a vague ad, to begin with, I certainly wouldn’t want to provide detailed information about myself not knowing even the type of business or if it’s profitable. But if by the ad you can determine its likely a fit, then it’s time to “show your cards,” or at least enough of them to show that you have a hand that can play in this game.

Earn Outs In The Sale Of A Business–A Bridge To A Deal

It won’t surprise anyone to know that the seller of a business almost always thinks that the business is worth more than the buyer is offering, just as it won’t surprise anyone to know that the buyer almost always thinks the seller is asking too much.  One way to close the deal gap to the satisfaction of both parties can be an earnout.

Internet-based Investopedia says an earnout is “…a contractual provision stating that the seller of a business is to obtain additional future compensation based on the business achieving certain future goals.”  It goes on to say that “…the future earnings are usually stated as a percentage of gross sales or earnings.”

Let’s take a look at our view of how an earnout might work in the real world.

The owner of San Diego Widgets wants to sell.  During last year’s recession, sales slipped to $8M from the previous year’s $10M, but the owner is convinced that the business is rebounding.  The buyer is skeptical.  For a number of reasons – not the least of which are the looming tax burdens on business sales due to take effect on January 1, 2011 – the seller thinks making a deal this year is in his best interest.  He wants $2M, but the buyer is only willing to pay $1.7M.  How can an earnout close the $300k gap?

The simplest way would be an earnout based upon a percentage of gross sales.  The buyer might agree to pay the seller 5% of gross sales over $8M each year for the three years following the closing.  If the company rebounds to $10M and remains at the $10M mark for the three years, the seller would receive 5% of $2M each year for three years.  This is an amount equal to the $300k deal difference.

Why does this work for both parties?  For the buyer, it protects the “downside.”  If the buyer is right, and the business does not rebound, the buyer is protected and has not “over-paid” for the business.

The seller, on the other hand, gets full value if he’s right and the business does rebound.  And to provide the seller with an incentive to take less now in exchange for the possibility of more later, the buyer has agreed to pay the seller an additional 2.5% on sales up to $12M.  That means that the seller could earn an additional $150k if the business jumps to $12M and stays there.  The buyer figures that the extra incentive will keep the seller interested in the success of the business and encourage him to help it grow.

So, an earnout can be a bridge to a deal.  But there are two important things to consider in structuring earnouts that will make the bridge dependable and easily crossed.

First and foremost, the parties should insist that the earnout be based upon an objective and readily ascertainable criterion or benchmark, such as gross revenues.  If the parties choose to use some other criterion, then the method whereby the less-objective criterion will be determined, and by whom it will be determined, should be specified.  For example, if “net income” is the criterion, it will be affected by discretionary decisions regarding capitalization, deferral of revenue, allocation of overhead expense, and salary levels applicable to senior managers.  Buyers and Sellers of small businesses should be cautioned that language such as “… in accordance with Generally Accepted Accounting Principles (GAAP)…” by itself is not sufficient and small businesses almost never have statements prepared according to GAAP.

Second, the sale agreement should specify what types of financial reports will be created, where will the records be maintained, who will maintain them, when will they be distributed to the seller, and on what schedule they will be made available.  The Seller shall have full and complete access to all financial records, including source documents and accountant’s work papers, and the agreement should also prescribe that the Seller may inquire directly of Buyer’s in-house and outside accountants and may obtain documents directly from them upon request.

There are, of course, other considerations, and an earnout is best structured with careful consideration and with the input of an attorney experienced in business transactions.

Private Equity: Sell Now, Keep Your Job, Retire Later

A lot of people know that Harvard University’s $23B endowment fund is famous for consistently out-performing the marketplace, but far fewer know that one key to the fund’s success is its astounding 15% investment in private equity.  Similarly, while many people know big-name private equity firms (“PEGs”) like Kohlberg, Kravis & Roberts (KKR)  made famous by the book and movie “Barbarians at the Gate,” a considerably smaller number know that there are today thousands of small- and medium-sized PEGs focused on buyouts of small- to mid-sized privately held companies.

 

It’s been estimated that collectively these funds represent well in excess of one billion dollars in capital available for the acquisition of these privately held businesses.  This is great news for the business owner whose firm is too large for the typical private investor, but too small to attract the KKR’s of the world.  Until the emergence of this new and growing private equity marketplace, the owners of these firms were typically limited to selling to their employees and/or family members or selling to a competitor.  Neither of these is an ideal option.

 

Selling to the kids or employees typically means an ESOP – Employee Stock Ownership Plan.  Since it’s extremely rare that children or employees have sufficient capital to purchase the business outright, the owner is typically left with substantial debt.  This means spending the next several years worrying about whether or not the company will flourish and meet its obligations.  Unfortunately, all too often, the company flounders and it does not.

 

Selling to competitors is equally unattractive.  Just alerting the competition that a company is for sale has serious potential for repercussions.  Competitors can be quick to use the company’s uncertain status to go aftermarket share and key employees, often with devastating results.  And even if they decide to buy the company itself, they almost never pay full value.

 

That’s what makes private equity so attractive: the opportunity to sell the company without assuming significant debt or alerting competitors.  And contrary to popular belief, the prices paid by private equity are more than competitive with the prices paid by strategic buyers.  In fact, the competition between private equity firms for acquisitions often pushes the dollar amounts to the very top of the scale.

 

So, what’s the hitch?  Why doesn’t everybody sell to a PEG?

 

The answer is simply this: PEGs aren’t interested in running companies; PEGs are interested in investing in companies.  That means that the company must have a management team in place or the owner must be willing to remain for a period of time while a management team is groomed and put into place.  Sometimes, that time period can be protracted:  PEGs know that the individual who got the company to the place that attracted their interest is often the best individual to ensure the company’s continued growth and success.  It’s only natural that they want that individual to hang around for a while to hedge their bet in its future.

 

So, what does this mean to the owner of a business that could be targeted by the PEGs?

 

For an owner thinking about retiring in three to five years, now is the time to sell.  By making a deal today, the business owner can have the best of both worlds: cash in the bank and a job until retirement that often comes with significant monetary incentives for growth.

 

 

 

 

 

 

 

 

 

 

 

 

 

Seller Discretionary Earnings-Calculating Your Earnings Correctly

What’s the first question the Buyer asks about your business? Usually, it’s “how much can I make if I own this business?”  For main street businesses, those transactions under $1,000,000 in transaction value, usually the Buyer is looking for “Sellers Discretionary Earnings.”

Seller’s Discretionary Earnings (SDE) is usually calculated as follows:

Net profit of the business, plus

Officer or Owner Salary, plus

Owner Perks such as country club memberships, etc., plus

Interest, depreciation, and amortization, plus

One- time extraordinary expenses

 

But the devil is in the details. So, make sure you don’t make the following mistakes:

  1. The owner’s salary can only be included if the Owner paid themselves through the business and expensed it on the income statement or tax return. Owner draw CANNOT be counted.
  2. Only ONE owner’s salary can be included. If there is more than one owner, or family members working in the business, a fair market wage must be included in the expenses.
  3. Only those Perks that do not impact the business can be adjusted. For example, if your customers rely upon the owner taking them out to dinners or sporting events, and without those perks, you could lose the business, then those must stay with the business. Same with the owner’s automobile expenses if they go to see clients, pick up things at Costco, make deliveries, etc.
  4. Usually, most interest can be “added back”, but not interest that will stay with the business after the sale. For example, interest costs on vehicle loans not being paid off at closing, flooring interest for businesses with large amounts of inventory, etc. cannot be adjusted out.
  5. Depreciation costs are usually an adjustment, but consideration must be given to those businesses with assets that depreciate quickly and are costly to replace. For example, a business with a fleet of 10 trucks and on average, a truck will last 10 years, you need to consider leaving in enough depreciation to cover the cost for one truck being replaced each year.
  6. One-time expenses are just that—ONE TIME. These can be items like the cost to design a new company logo which may never be done again. Or to rebuild a storage shed after a fire that was a once in a lifetime occurrence. It is NOT the cost to replace the carpet in a restaurant that traditionally is replaced every three years. (you could amortize that cost over the useful life instead of it impacting one year in particular)

Every business is different, so buyers and sellers really need to use common sense and fairness in computing SDE. And buyers need to remember, this is the SELLER’s Discretionary income, not Buyers! SDE is a snapshot of the Sellers operation, and how the buyer operates the business will determine THEIR SDE.

What You Need to Know About Foreign Buyers

There is a potentially lucrative group of buyers that many sellers don’t initially think about.  We are talking about foreign buyers.  While there are some hurdles to working with these types of buyers, it is important to note that there are many huge advantages as well.  Let’s take a closer look.

How Are Foreign Buyers Different? 

At the top of the list of ways in which foreign buyers are different is that they are often seeking a visa.  Another commonality among foreign buyers, one that will surprise many, is that they may want access to the U.S. educational system. 

It is common for foreign buyers to want to buy a business so that they can get their children into a particular U.S. school district or college.  Sometimes the desire to be eligible for state tuition also plays a role in the selection of a business and the decision-making process.  In this sense, business location takes on a level of importance that it might not have for domestic buyers. 

It is important to keep in mind that there are cultural and business differences that play a role with foreign buyers.  Everything from a different use of business terminology to expectations can play a role.  This could impact negotiations. 

What About Visas and Immigration?

One of the most important things to remember is that foreign buyers are often navigating the complex world of visas and immigration.  Whether or not a visa is issued can dramatically impact whether or not a deal ultimately takes place.  This fact is often built into agreements.  For example, a purchase condition may be conditional upon visa approval.  Nonrefundable deposits may also play a role in the process.

What Do Foreign Buyers Really Want? 

Foreign buyers have been impacted by the pandemic too.  Yet, some factors remain unchanged.  Not too surprisingly, they will want to see that a business is profitable.  In this regard, you should be able to showcase profitability in a clear fashion.  You can expect foreign buyers to want to see tax returns and all the typical documentation that you’d need to provide to any buyer.

A second factor that foreign buyers are interested in is longevity.  If your business has successfully operated for decades, this will be a major advantage.  

Ultimately, most of what domestic buyers are looking for in a business will translate over to what foreign buyers are seeking as well.  With that stated, however, there are factors that are often unique to foreign buyers.  As mentioned above, navigating the often-complex visa process can add a wrinkle to the entire process.

Copyright: Business Brokerage Press, Inc.

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Essential Meeting Tips for Buyers & Sellers

The buyer-seller meeting is quite often a “make or break” meeting.  Your business broker or M&A Advisor will do everything possible to ensure that this meeting goes as well as possible. 

It is vitally important to realize that rarely is there an offer before buyers and sellers actually meet.  The all-important offer usually comes directly after this all-important meeting.  As a result, you want to ensure that meetings are as positive and productive as possible.

Buyers need to understand how the process of selling a business works and what is expected of them from the process.  Buyers also need to understand that following their broker’s advice will increase the chances of a successful outcome. 

Sellers should be ready to be honest and forthcoming during the meeting.  They also want to be sure to not say or do anything that could come across as a strong-armed sales tactic. 

Asking the Right Questions

If you are a buyer preparing to meet a business owner for the first time, you’ll want to make sure any questions you ask are appropriate and logical.  It is important for buyers to place themselves in the shoes of the other party. 

Buyers also shouldn’t show up to the buyer-seller meeting without having done their homework.  So be sure to do a little planning ahead so that you are ready to go with good questions that show you understand the business. 

Building a Positive Relationship

Buyers should, of course, plan to be polite and respectful.  They should also be prepared to avoid discussing politics and religion, which often can be flashpoints for confrontation.  When sellers don’t like prospective buyers, then the odds are good that they will also not place trust in them.  

For most sellers, their business is a legacy.  It quite often represents years, or even decades, of hard work.  Needless to say, sellers value their businesses.  Many will feel as though it reflects them personally, at least in some fashion.  Buyers should keep these facts in mind when dealing with sellers.  A failure to follow these guidelines could lead to ill will between buyers and sellers and negatively impact the chances of success.

Sellers Should Be Truthful

Sellers also have a significant role in the process.  While it is true that sellers are trying to sell their business, they don’t want to come across as a salesperson.  Instead, sellers should try to be as real and honest as possible.

Every business has some level of competition.  With this in mind, sellers should not pretend that there is zero competition.  A savvy buyer will be more than a little skeptical.

The key to a successful outcome is for business brokers and M&A Advisors to work with their buyers and sellers well in advance and make sure that they understand what is expected and how best to approach the buyer-seller meeting.  With the right preparation, the odds of success will skyrocket.

Copyright: Business Brokerage Press, Inc.

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The Main Street Lending Program

There is no doubt that the COVID-19 situation seems to change with each and every day.  The disruption and chaos that the pandemic has injected into both daily life and business is obvious.  Just as it is often difficult to keep track of the ebbs and flows of the pandemic, the same can be stated for keeping up to speed on the government’s response and what options exist to assist companies of all sizes. 

 In this article, we’ll turn our attention to an overlooked area of the government’s pandemic response and how businesses can use a whole new lending platform to navigate the choppy waters. 

As the pandemic continues, you will want to be aware of the main street lending program, which is a whole new lending platform.  It was designed for businesses that were financially sound prior to the pandemic.  Authorized under the CARE Act, the main street lending program is quite attractive for an array of reasons.  Let’s take a closer look at what makes this program almost too good to be true.

This lender delivered program is a commercial loan.  Unlike the PPP, there is no forgivable component.  However, the main street lending program does have one remarkable feature that will certainly grab the attention of all kinds of businesses.  It can be used to refinance existing debt at a rate of around 3%.  With that stated, it is also important to note that businesses cannot refinance existing debt with the current lender.  Instead, a new lender must be found.  Generally, loans are a minimum of a quarter million dollars and have a five-year term.  In another piece of good news, there is a two-year payment deferment period.

The main street lending program can be used in a variety of ways.  In short, the program is not simply for refinancing existing debt.  Additionally, there is no penalty for prepayment.  The way the program works is that lenders make the loans and then sell 95% of the loan value to the Fed.  This of course means that the lender is only required to retain 5% of the loan on their balance sheet.  The end result is that lenders can dramatically expand the amount of loans they can make.

Whether it is the PPP or a program like the main street lending program, there are solid options available to help you.  Businesses looking to restructure debt or put an infusion of cash to good use may find that the main street lending program offers a very flexible loan with great interest rates.

Copyright: Business Brokerage Press, Inc.

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Seller Financing: It Makes Dollars and Sense

When contemplating the sale of a business, an important option to consider is seller financing.  Many potential buyers don’t have the necessary capital or lender resources to pay cash.  Even if they do, they are often reluctant to put such a hefty sum of cash into what, for them, is a new and untried venture.

Why the hesitation?  The typical buyer feels that, if the business is really all that it’s “advertised” to be, it should pay for itself.  Buyers often interpret the seller’s insistence on all cash as a lack of confidence–in the business, in the buyer’s chances to succeed, or both.

The buyer’s interpretation has some basis in fact.  The primary reason sellers shy away from offering terms is their fear that the buyer will be unsuccessful.  If the buyer should cease payments–for any reason–the seller would be forced either to take back the business or forfeit the balance of the note.

The seller who operates under the influence of this fear should take a hard look at the upside of seller financing.  Statistics show that sellers receive a significantly higher purchase price if they decide to accept terms.  On average, a seller who sells for all cash receives approximately 70 percent of the asking price.  This adds up to approximately 16 percent difference on a business listed for $150,000, meaning that the seller who is willing to accept terms will receive approximately $24,000 more than the seller who is asking for all cash.

Even with these compelling reasons to accept terms, sellers may still be reluctant.  Selling a business can be perceived as a once-in-a-lifetime opportunity to hit the cash jackpot.  Therefore, it is important to note that seller financing has advantages that, in many instances, far outweigh the immediate satisfaction of cash-in-hand.

  •  Seller financing greatly increases the chances that the business will sell.
  • The seller offering terms will command a much higher price.
  • The interest on a seller-financed deal will add significantly to the actual selling price. (For example, a seller carry-back note at eight percent carried over nine years will double the amount carried.  Over a nine-year period, $100,000 at eight percent will result in the seller receiving $200,000.)
  • With interest rates currently the lowest in years, sellers can get a much higher rate from a buyer than they can get from any financial institution.
  • The tax consequences of accepting terms can be much more advantageous than those of an all-cash sale.
  • Financing the sale helps assure the success of both the sale and the business, since the buyer will perceive the offer of terms as a vote of confidence.

Obviously, there are no guarantees that the buyer will be successful in operating the business.  However, it is well to note that, in most transactions, buyers are putting a substantial amount of personal cash on the line–in many cases, their entire capital.  Although this investment doesn’t insure success, it does mean that the buyer will work hard to support such a commitment.

There are many ways to structure the seller-financed sale that make sense for both buyer and seller. Creative financing is an area where your business broker professional can be of help. He or she can recommend a variety of payment plans that, in many cases, can mean the difference between a successful transaction and one that is not. Serious sellers owe it to themselves to consider financing the sale. By lending a helping hand to buyers, they will, in most cases, be helping themselves as well.

Copyright: Business Brokerage Press, Inc.

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