Common Deal Structures to Expect in the Lower Middle Market

gap analysis

Owning a business is a dream for many people. Not only do you get to be your own boss, but you can also build considerable wealth and income streams if your business is successful. While it can be a lot of fun to grow your business into a successful one, there may come a time when you want to sell the company. If you are going to sell a lower middle market business, which typically includes businesses with $5 million to $50 million in annual revenue, there are various deal structures that you should expect to see.

Expected Valuation and Offer Price

One of the most anticipated deal structure points in any lower middle market business is the valuation and purchase price of the organization. A lower middle market valuation will typically be based on a multiple of the business’s EBITDA. Depending on the type of business you operate, this can range from 4x to 8x EBITDA. Generally, larger businesses with more stable EBITDA will also command higher multiples. A valuation will also factor in business and industry trends, customer concentration, EBITDA add-backs, and other items.

There are also situations when the purchase price could be structured in tranches. If you have a growing business, the buyer may want to see growth projections come to fruition before the full purchase price takes place. Due to this, they may negotiate an initial purchase price and a forward-looking purchase price based on a multiple of future EBITDA or revenue. Understanding the final purchase price amount and when it will be received is very important.

Reps and Warranties Insurance

Reps and warranties are integral to any transaction. When evaluating your business, a buyer will do extensive diligence. While some of this work can be validated with third-party reports, other pieces of information require trust in your answers. When you are completing a sale, you must sign various documents stating everything you are telling the buyer is accurate. You will likely be required to sign indemnification documents early in the process to indemnify the buyer for misrepresentations.

Due to its importance, some buyers may require rep and warranty (R&W) insurance. This coverage will provide support if the buyer suffers a loss due to incorrect information received during the diligence process. Sellers are often expected to provide any necessary information to allow the buyer to obtain this coverage. This generally will need to be in-hand prior to the close of the transaction.

Transaction Structure

Another point that will be negotiated during any lower middle market transaction is the structure of the deal. The two most common types of transactions are asset and stock purchases. With an asset purchase, the buyer will acquire specific company-owned assets. This transaction can offer more flexibility to the buyer about how to structure the organization moving forward.

Another common type of transaction is a stock purchase. With this type of purchase, the buyer will acquire the business in its entirety, including all of the assets and liabilities that your business may have. For a seller, this could be a cleaner ending and closing of the organization. There are also tax implications for both options that should be understood before entering into a final agreement.

Non-Compete and Operations of the Business Transition

Another important structural point to be aware of when selling a middle-market business is how operations will be transitioned. Any middle-market business will rely heavily on the leadership set by ownership and key managers. As a result, it is very common for the buyer to require the owners and managers to stay on for a period of time to ensure a smooth transition. This will often include providing a consulting fee for a period of time. You should also expect to sign a non-compete agreement, which will preclude you from starting a competing business or trying to win back past clients for a set period of time.

Closing and Post-Closing Conditions

When a lower-middle-market acquisition occurs, there are bound to be closing and post-closing conditions. The closing conditions will normally be required to be completed in advance of the transaction closing date. These items normally include providing all necessary diligence information. Post-closing items are then required to be completed by a certain date spelled out in the purchase and sale agreement.

Financing Impact

If you are going to sell your business, you will also be subject to the buyer acquiring financing. As lower middle market businesses typically sell for millions of dollars, the buyer typically will not complete the purchase in cash. A buyer could take out various types of financing, including term loans, delayed draw term loans, working capital lines of credit, and capital improvement loans. Depending on the structure, you could receive the entire purchase price of the business up front, or you may only receive a portion at closing, and the balance will be earned out later.

In some cases, you may also be asked to provide seller financing. In this situation, some of the proceeds you receive via a sale will be held back and issued to the buyer as a loan. This loan will typically be subordinated to any bank loan and is typically unsecured. It is important to understand the full structure of this provision and assess any risks you are taking.

If you are going to sell a business in the lower middle market, it is always a good idea to work with an advisor. An M&A advisor can offer a variety of services that will help prepare your business for sale to improve its valuation, market it to potential buyers, and even help you negotiate a final sales price and deal terms. This can help ensure you get the best outcome when selling your business.

Quantive’s sell-side M&A Advisory team helps our clients lead transactions while also acting as valuation experts and value growth advisors. Our passion for working with CEO Founders has allowed us to perfect our advisory process. Quantive has successfully executed over 150+ transactions–get in touch with our expert advisory team today to get started.



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