Although the only certainty in today’s economy is its uncertainty, mergers and acquisitions in the middle market (broadly defined as transactions less than $500 million) continue to occur, albeit at a slower pace.

Business owners make the decision to sell or explore strategic alternatives for a variety of reasons, including diversification, succession planning, estate and tax planning, personal liquidity, the threat of competition, and, in some cases, a desire to form a partnership to foster growth.

As buyers and sellers adapt to today’s market in an effort to ensure transactions close, a number of M&A trends have emerged, including:

• Private equity firms acquiring minority stakes
• Seller assistance in financing transactions, usually in the form of a seller note
• Larger equity positions in the capital structure (sometimes up to 100%) rather than debt
• Earn-outs, which serve to incentivize shareholders while reducing buyer risk

Now more than ever, business owners and management teams alike must be aware of several key near- and long-term preparations that can maximize the value of their businesses, increase buyer interest, contain transaction timelines, and increase the likelihood that attractive financing will be attainable.
 

Near-Term Preparations

Effective preparation begins by asking the following questions: What is the risk profile of the company? Is the infrastructure in place to achieve its growth plans? What are the potential deal breakers? In conjunction with developing answers to these questions, business owners should consider the following:

• Enlist a reputable accounting firm to review or audit
• the financial statements — this will shorten the due diligence process.
• Prepare supportable financial projections with defined avenues to growth — having a credible plan to achieve projections is just as important as the projections themselves.
• Develop a 12-month budget that can be tracked against actual results — did the company and management meet, exceed, or fall short of expectations?
• Develop a clear understanding of margins and profitability trends, differentiating between waste and value-add while identifying key performance indicators and tracking metrics. Unfortunately, many companies simply focus on revenue, ignoring what is actually being contributed to the bottom line.
• Update the company website — an updated website can significantly improve the marketability of the company.
• Perform reverse due diligence — anticipate how buyers will view the company and be prepared to confront any potential issues upfront.
• Have realistic valuation expectations — understand how the market will value the business.

 

Long-Term Preparations

• Develop a strong and deep management team — does management have industry expertise, a proven track record, and a defendable business plan?
• Diversify your supplier and customer base — large concentrations are viewed by both buyers and capital providers as considerable risks.
• Develop strong inventory controls to improve your company’s cash conversion cycle — are accounts receivable, inventory, and payable days in line with industry averages?
• Reinvest in the business and personnel to achieve growth.
• Reduce the company’s leverage — high leverage may restrict buyers’ ability to finance the transaction. Buyers may also be willing to pay more for a company that is able to operate with lower total assets.

Businesses should also assess the feasibility of forming an advisory board to assist management with operational and strategic directives. Although advisory boards are not as common in the middle market, they can be extremely valuable by offering fresh perspectives from an independent, objective viewpoint. A well-selected advisory board is typically made up of five to eight individuals across varying business disciplines including attorneys, investment bankers, accountants, industry professionals, and potentially one or two members of the company’s management team. The goal is to have a set of skills and experience for the management team to leverage. 

Now May Be the Optimal Time

Business owners should consider following the above recommendations in advance of engaging in a transaction. Doing so will maximize value and interest in a sale process and ultimately reduce the risk profile of the company. Even today, if properly prepared, companies can garner premium valuations.
Regardless of whether you have considered a transaction, it is never too early (or late) to meet with an advisor to discuss strategic alternatives. Now may be the optimal time.