Diagnosing the “Symptoms” of a Ready Business Seller

  • July 1, 2018May 2, 2023
  • by admin

By John F. Herubin,
Managing Director

Our team at EdgePoint has advised and consulted with thousands of business owners throughout our combined careers in preparation for a potential sale. We have guided hundreds of these owners through a marketing and sale process to a successful conclusion. Having accumulated this wealth of experience from interviewing all these owners, we are often asked how we know during our discussions when a business owner is ready to commit to sell their business.

Much like a physician prior to an examination, we ask a series of questions of a prospective seller. Based on our extensive experience, the three high-level questions we ask to determine readiness are whether the market, the business, and the owner are ready.

The easiest question of the three to answer in today’s merger and acquisition environment is whether the market is ready. By almost every measurable metric, with limited exceptions, we have not seen a more favorable seller’s market for at least 20 years. The abundance of investable cash (through private equity, strategic buyers, and family offices), a favorable bank lending environment, historically low tax rates, a plethora of buyers, a positive business climate, and a dearth of quality sellers, have combined to create a favorable “perfect storm” for sellers.

The second question of whether the business is ready is more specific to each individual circumstance. Making this determination is also more quantitative and measurable. Organizing and optimizing areas of the company that will positively impact value include operational, financial, legal, tax, and sales and marketing functions. For example, we can assess and determine whether hiring a key employee or buying a new piece of equipment prior to sale will create quantifiable value. We can also espouse the benefits of upgrading financial statements, identifying key employees, and cleaning up obsolete inventory prior to a sale process. Once the decision to undertake and implement these actions is completed, the answer to our second question is also “yes”.

The third, and most subjective assessment our “diagnosis” entails, is determining whether the owner is ready. There are many emotional, personal, financial, family, employee, community, and legacy related considerations for owners to consider before committing to a sale. Our many discussions over the years have educated us, much like a physician, to listen for specific clues or “symptoms” that we hear often which will lead to a “diagnosis” that the owner appears ready to sell.

We repeatedly hear the following “symptoms” which often indicate that an owner is ready:

  • “I’m Tired”– this owner often started the business and it has grown over the years to where their daily responsibilities and activities have outgrown their capabilities to manage the operations. They are also fatigued from navigating the economic cycles of their business. They feel “stuck” and are often unaware of the sale options available in today’s market to provide them resources to alleviate their burdens.
  • “This is not as much fun as it used to be”– this owner/founder started out as an engineer and loved tinkering with their product, liked working on the shop floor to create products, or liked sales and managing customer relationships. As the business has grown, their responsibilities have expanded to include HR, international sales, increased regulations and legal complexities, e-commerce, etc. The business has become more complicated and they yearn for a situation that will enable them to continue doing more of what they most enjoy. Again, they are unaware of the many sale options that will enable them to achieve this goal.
  • “My Mom and Dad worked hard to grow this business, but I don’t have the same emotional equity invested that they did”– this owner often knows today’s M&A market is active, and they are intrigued by a potential liquidity event. They might have younger children or interests outside the business that their parents did not. A sale would enable them to pursue these other interests. They are also concerned about maintaining employees and their family legacy in the community.
  • “I take several weeks off every winter down south and the business still runs without me”– this owner has oftentimes created a strong management team that enables the business to operate without their daily input. This owner may desire to de-risk the concentration of their wealth in the company through a sale process. A strong management team will likely be an attractive attribute to potential buyers.

Ironically, we have found that age is not necessarily a key “symptom” that indicates readiness. The average age of our sell side clients over the past five years is 54 years old. We are currently representing owners in their 30’s and trying to discern the readiness of owners in their 80’s who are still engaged and having “fun”.

Although not an exact science, there are many additional factors that we assess once we complete our initial discussions with owners. As investment banking “doctors” the above “symptoms”, which we repeatedly hear, often affirm our initial diagnosis of a “ready” seller.

© Copyrighted by John Herubin, Managing Director of EdgePoint Capital, merger & acquisition advisors. John can be reached at 216-342-5865 or on the web at www.edgepoint.com.

Growth of Family Offices in Private Equity

  • April 1, 2018February 14, 2022
  • by admin

By EdgePoint

There are several types of buyers in M&A sell-side transactions. One group is strategic buyers who are companies that are in the industry of the seller, and could either be direct competitors or in an ancillary business that would be complementary with the seller’s business. A second common group is financial buyers, which are typically thought of as “private equity groups” or PEGs, which are a group of investment professionals with capital that typically purchase a portfolio of companies in which they own the majority of the equity, but the management teams actually run the day to day operations of the business.

PEGs actually come in many forms, but the most common is a traditional 10-year fund. 10-year funds are generally a group of investment professionals representing the PEG firm, which acts as the general partner, and they raise capital from limited partners (LPs) such as pension funds, endowments, asset managers, or high net worth individuals. They have a 10-year time horizon to put the committed capital to work and return those funds with profit to the LPs. During that time, they need to find privately held companies to purchase, buy them, grow them, and then sell them all within the prescribed 10-year fund timeframe (with some limited ability to extend). If the fund general partners are successful and make a return for their investors, they are able to raise additional successive funds, and the cycle continues. On average, funds may hold their investment companies for five years due to the timing pressure of returning capital and showing returns early enough to raise the subsequent funds. Because PEG firm professionals make their money from fees for managing and investing the committed capital plus a portion of the upside return on the investments that they make, PEG funds need to continue raising funds or their firm and income streams would end. This means that they have pressure to sell companies that have further growth potential to satisfy their fund timing or capital raising initiatives. Fund professionals lament about how difficult it is to find, chase, bid on, win, and close these investments in good growing companies, only to have to prematurely sell and start all over with a different company that may not have the upside of the one they were just forced to sell.

Because of the time pressure of working within a timed fund, many private equity professionals are choosing to go the “fundless” approach and either raise money on each transaction from LPs that know them from prior investments, or have an alternative source of capital that doesn’t necessarily have the same timing. Evergreen funds recycle the money that is returned to the LPs so that the investment pool doesn’t expire. Funds raised by groups of high net worth individuals may not have the timing pressure as a fund with pension or endowment investors.

Another source of capital that has emerged somewhat recently and been growing in popularity for many of these timing reasons is Family Offices participating in the private equity buyout arena. Family offices are private wealth management advisory firms that serve high-net-worth investors. Family offices can invest on their own or in conjunction with other family offices, usually through a separate “private equity” entity that is funded by the family capital. One big advantage to most family office buyout structures is that they have no specific “hold” period, which means they can hold an investment for as long as there is opportunity for growth and return on investment. Just because they have a theoretically unlimited hold period doesn’t mean that they will hold it forever. Family offices generally have private equity professionals and/or investment advisors running their private company investments and will look to take advantage of opportunistic transactions as well. What separates them from the funds is that they don’t have the pressure to exit prematurely when there is still strong growth in the forecast. They are often considered “patient capital” relative to traditional PEGs. This aspect is appealing to many sellers.

Whatever the source of capital, private equity represents a large and growing opportunity for business owners to partner with professionals experienced in growing businesses. They bring resources both in capital and strategically to the companies that they partner with, and allow the business owners to take risk capital off the table while staying involved in the business for as long as they would like to contribute, and allow them to step out of the company knowing their succession plan is being handled by equity-aligned partners who have helped in this transition many times before.

Common considerations for partnering with private equity when EdgePoint advises business owners include:

  • The seller is able to cash out 80-100% in a transaction with an opportunity to reinvest equity alongside PEG (with a 3-5x their money expectation in 5 years – “second bite of the apple”)
  • Private equity buyers provide the highest valuation in many auction processes
  • As-Is and Where-is Transaction – Employee continuity and Company culture are maintained post-transaction (legacy maintained)
  • Seller and/or executive management team can continue to operate the business with day-to-day control
  • A private equity will form a board of directors comprised of relevant industry executives and business leaders to facilitate strategic growth and leverage relationships
  • Because of the leveraged roll-over, owners can roll 10-20% of their proceeds to secure 20-49% of equity in the new entity
  • A private equity transaction allows the Seller to dictate his or her own terms for continued employment with built-in succession help or retirement in the near term following the transaction
  • Owners treated more like “senior partners” than employees post-transaction.

Family office backed private equity is strong and growing. A survey of 139 single-family offices from Grant Thornton found that 86% of those that already invest in private equity want to increase their commitments over the next three years. The survey found the median office has $276 million in investable assets, and the 109 offices that have invested in private equity since 2009 have allocated more than $8 billion in capital both in committed capital funds and direct investments. Slightly more than two-thirds invest in funds and just over half invest directly in Companies. Another 29% co-invest with funds directly, but alongside funds. Many family offices were funded by operating businesses that made the family wealthy, so there is a good fit and understanding of business owners. In some cases, there can by synergy or industry knowledge with the family office’s operating business as well.

Whatever the source of capital – committed capital funds or family office capital, private equity represents a flexible and potentially valuable transition option for business owners considering transition. Committed capital funds are abundant and eager to put capital to work and will often be the highest valuation even when in competition with strategic buyers, and can add strategic-like value post-transaction. Because of their longer hold timeframes, family offices provide the flexibility of longer term strategies and organic growth alongside a deep capital provider that may also have knowledge and experience in the industry. Both sources of capital offer a flexible and potentially lucrative transition option, without the perceived competitive issues that come with strategic buyers. This expansion of the buyer universe that has been occurring has contributed significantly to the robust and active sellers’ market that currently exists.

© Copyrighted by EdgePoint. Tom Zucker can be reached at 216-342-5858 or at tzucker@edgepoint.com

A Primer: Reps and Warranties Insurance

  • April 1, 2018August 3, 2021
  • by admin

By Matt Keefe,
Managing Director

Once a business owner has come to grips with selling his or her business, and once the buyer and seller have agreed to the key terms, then the legal documentation and closing phase of the M&A process begins. Inevitably, the documentation and closing phase can be frustrating and stressful for both the buyer and seller and can cause deals to stall, or sometimes even die. One aspect of documentation that usually creates issues is the negotiation of the escrow amount related to potential breaches of Representations and Warranties, or more often referred to as “Reps & Warranties” (Reps & Warranties is a term to describe the assertions that a seller makes to a buyer in a sale.) Fortunately, there is a burgeoning insurance product that is significantly alleviating the hassles tied to breaches of Reps & Warranties.

What are typical breaches that would cause a buyer to file a claim and seek compensation? Oswald Insurance, one of the nation’s largest independent insurance brokerage firms, conducted an analysis to identify Reps and Warranties claims by breach type. The results of that analysis are set forth below:

Before Reps & Warranties insurance was available, a buyer of a business would offset a portion of the potential risk related to breaches by asking the seller to hold-back, or escrow, a percentage of the total transaction value. This created a well-defined process whereby the buyer could file a claim against the escrowed amount to recoup a portion of the purchase price if a material breach was found. Typically, the escrow represented 5-10% of the total purchase price and was in place for six to eighteen months.

That was how it happened before Reps & Warranties Insurance came along. Now, Reps & Warranties Insurance is being used in lieu of the indemnity agreements that require escrowed funds. While Reps & Warranties Insurance is not a standard practice in all M&A transactions, the insurance product is being utilize more and more…for good reason.

Reps and Warranties Insurance provides benefits to both buyers and sellers. For buyers, as Chris Jones, Managing Director and Founder of Align Capital Partners, states, “Reps & Warranties Insurance allows us to provide more cash to the seller at closing (making our bid more attractive) and significantly increases the efficiency of legal documentation.” Other benefits to buyers include potential for protection beyond the traditional indemnity period, ability to reduce collection concerns, and the opportunity to augment fraud protection.

Sellers also enjoy significant benefits from Reps & Warranties Insurance. First, like buyers, sellers can reduce legal costs by eliminating the negotiations over post-closing indemnity obligations. Second, and most importantly to sellers, Reps and Warranties Insurance eliminates the need for an escrow, therefore, maximizing the cash proceeds to the seller at closing.

Like any insurance product, there is a cost (premium) for the insurance and that cost is tied to the amount of coverage. The amount of coverage is determined by the deductible limit. For example, in a $100 million transaction, a 10% deductible policy provides $10 million of coverage. The premium can be purchased by the seller and/or the buyer. Premiums are priced based on coverage and are typically 2%-4% of the transaction value. Therefore, the cost of the $10 million of coverage may be $200,000 – $400,000

Since the inception of the Reps & Warranties insurance product, the speed at which a policy can be issued has increased significantly. It typically takes two weeks for a policy to be underwritten. This has also expanded the popularity of the solution

As M&A Advisors, we are always looking for tools to help expedite the process. EdgePoint has closed several recent transactions that employed R&W insurance and found, in all case, the benefits (for all parties) outweighed the cost. To learn more about how EdgePoint uses Reps & Warranties Insurance, or to learn more about EdgePoint’s M&A capabilities, please contact us at 800-217-7139.

© Copyrighted by Matt Keefe, Managing Director of EdgePoint Capital Advisors, merger & acquisition advisors. Matt can be reached at 216-342-5863 or on the web at www.edgepoint.com.

EdgePoint Adds Tom Stafford As Managing Director

  • January 1, 2018December 15, 2021
  • by admin

By Tom Zucker,
President

Cleveland, Ohio; January 22, 2018 – EdgePoint, a boutique investment banking firm located in Beachwood, Ohio, announced the appointment of Tom Stafford as Managing Director. In this role, Tom will be responsible for advising the firm’s clients in matters related to mergers, acquisitions and financing transactions.

Prior to joining EdgePoint, Tom spent nearly 14 years at KeyBanc Capital Markets, Inc. as a senior banker in the Mergers & Acquisitions and Financial Sponsor Groups. During his tenure at Key, Tom worked closely with privately held and publicly traded companies, leading the execution of middle market transactions across a range of industries, with an emphasis on businesses in the Industrial, Energy and Infrastructure sectors. His financial advisory experience includes buy and sell-side M&A transactions, public company mergers, fairness opinions, corporate divestitures, as well as a variety of debt and equity financings. With 18 years of investment banking experience, Tom brings a strong track record in executing middle market transactions.

“We are delighted to welcome Tom Stafford to the firm. Tom’s senior level expertise executing sell-side advisory transactions is an ideal fit for EdgePoint. Tom’s consultative approach to serving closely held businesses compliment his deep expertise and experience.” Said Tom Zucker, President and Founder of EdgePoint.

Mr. Stafford earned his MBA in Banking and Finance with distinction from the Weatherhead School of Management at Case Western Reserve University and earned his BA from the University of Michigan.

“The EdgePoint client centered service model and the strong market presence was compelling to my decision to join the firm. I am excited to be part of the EdgePoint team and to continue the significant growth of the firm. I look forward to building upon the momentum that Tom and the team have created,” said Tom Stafford.

EdgePoint specializes in advising middle market businesses and owners regarding mergers, acquisitions, management buyouts, and corporate divestitures. EdgePoint completed more than 20 transactions in the past 18 months. The firm has nineteen professionals.

EdgePoint is a registered broker dealer and a member of FINRA.

Contact:
Tom Zucker, President | 216.342-5858 | tzucker@edgepoint.com
Tom Stafford, Managing Director | 216.342.5775 | tstafford@edgepoint.com

Why Owners Wait to Sell Their Business

  • January 1, 2018May 3, 2023
  • by admin

By Tom Zucker,
President

During my thousands of conversations with closely-held business owners over the years, the most frequent question they ask is when to sell their business. Nowadays, nearly every M&A professional heralds the positive attributes of the market as an ideal time to sell a business. Low interest rates, favorable capital gains tax rates, business confidence, and demand pursuing acquisitions are just a few indicators that now may be a good time to sell. From a purely financial perspective, the decision to sell seems like an easy one. Unfortunately, for M&A advisors, the answer to the question of when to sell is not always so easy. Selling a family-owned business often involves a multitude of emotions, and other reasons that are often much more important to resolve than the financial considerations.

Based on more than two decades of advising closely held business owners, conversations around three distinct themes may help clarify emotional or non-financial factors to determine “when” is the optimal time: (1) defining what comes next; (2) determining whether the next generation is ready; and (3) identifying unfinished business.

Defining What Comes Next
A business owner’s position in the company and his or her life purpose often intertwine. To be sure, decades of leading a private company, and receiving accolades and prestige for one’s business accomplishments, is alluring. Countless books and seminars have addressed the idea of defining a compelling future and vision for the second half of one’s life. Unfortunately, many business owners missed those seminars and never read the right books. They were too busy growing and operating their business. The emotional preparation required of owners and their families for life after business ownership is a significant weakness of many business owners’ planning process. Without a compelling future to pursue, the decision to sell becomes strictly a monetary decision, which comes with the risk of disrupting a delicate family, emotional, and life balance.

I recall a conversation with the owner of a precision machining business. He founded the business in his mid-fifties, following a successful career at a similar business. In addition to building an outstanding business, the owner’s religious faith was the foundation of his business and personal life. For several years, his financial advisor had explored and clarified his charitable interests and post-ownership desires. In the owner’s final decades, he wanted to focus on his church and his family. The construction of a new chapel and establishment of missionary trips was his objective. He also wanted to help unify his family by funding exciting family vacations with the extended family. Hardly earth shattering, but for him it was clear, well defined and aligned with his values. I revisited with him a decade after he sold his business, then entering his eighties, and he reflected on his time in business and afterward. He shared with me that his family was stronger than ever and that the proceeds from the sale of his business helped to fund many missionary trips and even a multi-million-dollar chapel for his church. He was truly fulfilled and satisfied with his past decade and spoke with excitement about the future. He shared with me something that he hoped I would share with others: that he wished he had sold his business sooner. His years following the sale were more fulfilling than any other part of his life, and he realized that the value he needed to fulfill his objectives was far less than the overly conservative estimates. His prior planning enabled him to pursue this path with greater confidence.

Determining Whether the Next Generation is Ready
The desire to transition one’s business to the next generation is compelling and often-desired outcome for a business owner. The education, training, and experience required to prepare the next generation for owning and leading the business can seem daunting. Unlike the previous generation, the children of business owners are less willing and capable to assume the leadership role. Further, many children today would prefer jobs in more glamorous industries. An unprepared son or daughter is often a reality for business owners who hope their children will run the business in the future.

We assisted one business owner on his journey as he faced this transition issue. His son, then in his late twenties, had pursued a career in an industry outside of the family business. After several years, the father persuaded the son to return home and join the family business. The son quickly learned the lesson that respect is earned and not given. The son’s progress was not conforming with the owner’s timetable. After reviewing the owner’s options with him, we decided that a minority recapitalization with a financial buyer (i.e., a private equity group) would achieve the desired liquidity while also providing a group of skilled business operators and a formal corporate structure to assist in his son’s development. The recapitalization was a success; the father received enough capital to satisfy his retirement goals and, with guidance from the new partners, the son advanced into a skilled business operator and successfully repurchased full ownership seven years later.

Identifying Unfinished Business
For owners, the ability to grow a business to a certain revenue level, achieve a targeted sell price, or reach another qualitative goal are just a few achievements that justify waiting to sell the business. Whether it is pride, ego, or simply a drive to excel, these reasons are often important to a business owner and can delay or obscure the best time to pursue a sale.

I vividly recall a conversation with a chemical distributor about a decade ago. Although the business was performing well and the M&A market was attractive, the owner was not ready to sell, citing unfinished business. Puzzled, I inquired further as to what was left to accomplish. He shared a conversation with his former employer about the day that he left to start his own company. In his parting words to his former boss, he exclaimed, “I will grow my business to be larger than yours!” This emotional promise to his former employer served as a motivational driver throughout the history of his company. When I spoke to him, his company’s revenue was within $5 million of exceeding his goal. He decided to wait to sell his business in the fall of 2007, based upon this emotional rationale. Unfortunately, the recession hit his industry hard and his business and leadership teams were unequipped to handle the tumultuous ride. The company filed for bankruptcy protection two years later, and he was out of business just a short time later. The bitter lesson illustrates how sometimes emotional or non-analytical goals are obstacles to properly timing a sale.

These stories illustrate just a few of the non-financial considerations that owners face when making the decision to sell their business. From the self-actualized owner to the prideful and bankrupt owner, it is evident that a skilled advisory team is necessary to navigate these risky waters.

© Copyrighted by Tom Zucker, President of EdgePoint Capital Advisors, merger & acquisition advisors. Tom can be reached at 216-342-5858 or on the web at www.edgepoint.com.