Is a Tsunami Brewing in the M&A Market?

By John Herubin, Managing Director

There are several factors indicating that a large wave of sell side activity is on the near-term horizon. Much like a tsunami is created by earthquakes occurring below the ocean’s surface, sell side activity may be welling up below what is visible in the day-to-day financial markets.

As much as I don’t like using natural disasters as analogies, you don’t want to be an unsuspecting beach walker (unprepared closely held or family business owner) when the theoretical M&A tsunami hits. Preparation of your business will enable you to successfully ride the wave and not be swamped when it hits or sucked back out to sea when it retreats.

Investment bankers can act as a market seismologist/meteorologist to read and interpret the conditions and signals warning of an impending wave of activity (unlike the local television weather meteorologists, we must be correct more than 50% of the time to keep our jobs).

The last significant wave of sell side activity occurred in 2021 as many businesses recovered from the Covid pandemic in conjunction with the tremendous amounts of pent-up liquidity in the M&A markets that had been ready to purchase companies. This virtual Tectonic shift in financial market conditions resulted in peak amounts of volume and value for sellers at that time. Business owners who were prepared to take advantage of these conditions often realized unprecedented values upon the sale of their business.

As financial seismologists, our market seismometers are telling us that conditions in the financial markets are again ripe for another massive wave of activity in the foreseeable future.

These rumblings include the following:

  • Mature Private Equity (PE) funds seeking to sell existing portfolio company investments to generate returns for investors. Many PE funds are nearing the end of their holding periods for their investments and will be active sellers. This should spur a domino effect so that buyers of these companies will be looking for smaller “add-on” companies to increase their value and ultimately return on investment when they subsequently sell. This will make potential add-ons more attractive if properly prepared for sale.
  • We’re sensing from on-going conversations we have with privately held business owners, that they are happy having made it through the Covid pandemic and achieved pre-Covid levels of performance. This happiness comes with the self-realization that they are five years older and may not possess the stamina to withstand what may be the next financial/global crisis that could affect their business (future pandemics, war, election impacts, etc.). If the circumstances look favorable for a liquidity event, they are open to that possibility more now than five years ago.
  • PE fundraising has remained steady and growing in many sectors, which provides a ready market of buyers who are motivated to seek out either platform investments or subsequently add-ons. Recent surveys have indicated that significant “dry powder” (unspent investment capital) is available for buying attractive companies in the Industrials, Business Services, and Healthcare sectors (Antares Capital – July 2024).
  • The wave of activity can be accelerated by anticipated cuts in bank interest rates which will provide more affordable capital for purchases of companies thus contributing to the growing wave. Cheaper lending costs can also impact valuations, making better prepared privately owned companies more attractive and valuable to potential buyers.
  • Additional below the surface factors include potential changes to the Federal Estate Tax rates set to sunset at the end of 2025. Without further Congressional action, Federal estate tax rates are set to increase on January 1, 2026. Business owners have a quickly closing window to do tax planning in advance of a potential sale to minimize Federal estate and possibly income taxes. Failure to adequately address these issues may result in missing an opportunity to maximize value from a sale when the wave rolls by.
  • The proliferation and availability of information has expanded exponentially this century (I know, master of the obvious). Business owners even contemplating the possibility of a sale now or in the future are bombarded with information and solicitations. If you’ve never been in these tumultuous waters before, it’s wise to have a skilled guide to ensure you’re going to “Hang Ten” while navigating any M&A wave (I couldn’t bring myself to use a “Jaws” reference in deference to our highly valued PE partners).

Our best advice to business owners of all ages and regardless of their circumstances, is to always be prepared for a wave of activity. Many owners who had no intention of selling were tempted by the frothy market of 2021 to prudently consider a sale. Not having the business positioned in the best light to pursue that path can be financially costly.

Just like earthquakes that silently happen below the surface, there are other financial and non-financial early-warning signs telling you to be prepared and head to higher ground. Like the U.S. Geological service in a tsunami, a good advisor can help you know when the optimal time is to ride the wave.

I love looking at the ocean but would prefer to be safely on high-ground and well-prepared to ride out the tsunami when it arrives. The better prepared you are for the tsunami of sale activity that is anticipated to arrive, the greater the likelihood you will be high and dry when everything subsides.

If we get it wrong, we’ll blame it on Doppler Radar!

 

© Copyright 2024 by John Herubin, Managing Director, EdgePoint Capital, merger & acquisition advisors. All rights reserved. John can be reached at 216-342-5865 or on the web at www.edgepoint.com.

Pruning the Tree of Ownership: A Strategic Guide for…

By Tom Zucker, President

Business owners and entrepreneurs often fall back upon metaphors as they attempt to capture the essence of their work. The most pervasive of these is perhaps that of the tree. Investors plant seeds; companies grow and flower; businesses branch out. In all this time, the founder and owner acts as the painstaking arborist who nurses his or her organization from the tender sapling of an idea into a flourishing entity.

A very relevant analogy is that of pruning the ownership tree. As owners and founders grow older, they tend to step back and spend much less time and energy on the daily operations of their business. Ideally, a capable team fills most operational roles to a high degree and hence frees up the founder’s time for more strategic aspects.

It’s the founder’s role, however, in guiding the culture and strategic direction of the business that’s harder to replace. That’s why business ownership periodically needs trimming. An arborist will cut away old branches to provide space for new growth; similarly, business owners, from time to time, need to take a close look at their ownership structures.

When to Prune

Knowing when to prune the ownership tree is as important as knowing how. In this respect, some telling signs or key indicators include:

  1. Operational Plateau: Your ownership structure should be reassessed if business growth has become flat or plateaued. New insights can initiate a new spurt of growth.
  2. Leadership Transition: Founders or other important leaders of an organization, when preparing to retire or move back, need to set up new leaders; the integration must be complete, and ownership must be aligned to the future course of the firm.
  3. Strategic Shifts: If your business is refocusing or expanding into new markets, additional owners who bring experience and networks in the new space should be considered.

Focused Growth and Value Creation

Growth does, and can, come through shedding non-core assets and giving resources to the higher-value components of the business. Not all business is valued equally; some of its parts will be more highly valued than others. It is how we identify and grow high-growth, high-value parts of the business that will create additional value.

Business Structure Considerations

The trimming of the business must be in line with your overall strategy. Consider it from the following angles, then do the following:

  1. Distribution of Equity: Make sure that equity distribution supports active engagement from owners. Owners who are actively engaged should have the lion’s share to keep them committed to the company’s success.
  2. Governance: Strengthen governance structures so that while the ownership might be shifting, the strategic decisions are being made robustly. This could be achieved by establishing an advisory board or by strengthening the board of directors.
  3. Succession Planning: Establish a clear succession plan that describes how leadership and ownership transition will take place. Potential leaders within an organization must be identified, along with steps that can be taken toward developing and integrating them.

Pruning Methods

  1. Minority Recapitalizations: This would re-align ownership by minority recapitalization. It sells off minority stakes to key management employees or strategic financial partners to infuse new energy and resources into the business.
  2. Buy-Sell Agreements: Use buy-sell agreements to manage ownership transitions in as smooth a manner as possible. Such agreements can specify ahead of time how ownership changes are to be handled, thereby avoiding much uncertainty and potential conflict.
  3. Non-core assets divesting: Identify and divest non-core assets to make resources available for the business. This, in turn, will help the business to focus on its core competencies and high-value areas as drivers of growth and profitability.
  4. ESOPs: Implement Employee Stock Ownership Plans so that employees have ownership stakes in the company. This may also enhance their commitment by aligning their interests with the company’s success.

Practical Steps for Effective Pruning

The people and teams who have brought the company this far are not to be minimized. At the same time, certain business strategies require sunlight and room to bloom for the next phase of growth. This new growth doesn’t come with a guarantee, but failing to refine at all can result in disinterested and less capable ownership, ensuring the company’s potential is delayed.

It is understood that owners prize experience and their ability to remain somewhat removed from a business, but owners must be educated that this may come at a cost related to the future of their businesses. This is the very delicate process of refining the ownership tree: properly counseling with attorneys, certified public accountants, and mergers and acquisitions advisors.

By considering structures of ownership and focusing on the high value-added parts of the business, owners can make sure that enterprises continue to grow and become even more successful under the leadership of concerned and strategic leaders.

 

© Copyright 2024 by Paul Stefunek, Managing Director, EdgePoint Capital, merger & acquisition advisors. All rights reserved. Paul can be reached at 216-342-5855 or on the web at www.edgepoint.com.