[Updated April 2021] Is the M&A Window Closing ?

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Note: We originally published this article in late 2019.  At the time our thinking had been “this has been one heck of a ride… but sooner or later the wheels are going to come off this hot deal market and the economy!”  Well… turns out we were partially correct.  Of course we didn’t see a global pandemic coming – but much of our thinking then is still applicable now.  What’s new though?  The (massive) impact of potential cap gains increases on a transaction.  Let’s dive back in.

The Current M&A Market

Depending on who you ask the M&A market is either totally lit or is… dreadful.  And here is the thing: everyone is right.  Are you working in a space that has been massively, negatively impacted by the pandemic?  You won’t be surprised to learn that the only activity there is in distressed (aka “fire sale”) transaction.  On the other hand in areas that have defended deals are still happening.  I can attest to the fact that the areas we focus (Data Science plays like AI / ML / DL, Cyber Security, and Federal) are all experiencing robust transaction markets.  For healthy companies we are seeing strong multiples and healthy auction environments.

And that’s the thing: a company that was well positioned for a transaction before that has maintained performance is still well positioned.

Which leads me to the headline question: is the M&A market still there, and should I consider selling now?  

(I’m going to save you the pain of the next umpteen paragraphs: short answer is that if you are performing AND you think you MIGHT want to exit in the next few years…. given the tax climate by all means you should roll right now.  But read on for the details!) 

Can You Afford to Sell Right Now?  

First off, this is hands down a generationally best sell side market.  If you want to sell a company and you can afford to, then by all means go to market.  How do you know if you can afford to sell right now? You need to answer two questions: what is the current value of my company?  And how much do I need? The former is best answered by a valuation – it’s a relatively modest investment to get clarity from an independent expert on how the market will price the asset you have built.  The second question should be answered by working with your financial planner. Getting granular on how your financial situation will look after the sale (using your current valuation as likely the largest input to that analysis) will help answer the question.  

Recapping: if what you have (i.e. the current value of your company) exceeds what you need (i.e. the capital that your financial plan requires in order to meet retirement goals), then by all means do-no-pass-go and go to market now.  

What Do I Gain by Waiting?  

For some folks the outcome of the first step will clear: you absolutely cannot afford to go to market. And clarity is great. But what seems to happen more often than not is a gray area. Perhaps the numbers are close but not quite there. That’s not a fun decision framework.

If you are in this category the real question is what do you gain by waiting? I’m constantly saying “the passage of time is not a strategy.” Waiting alone will not fix a value gap – we are already at the peak of the market. Values likely aren’t going to materially increase. Or put another way, there is at least an equal likelihood that values start to decrease.  

With this dynamic in mind, consider this: if you have an actual strategy to grow value and pursue that plan diligently, then waiting may make sense. On the other hand, if you are hoping that the market further matures and delivers a great value for your company… well I’d politely suggest that that isn’t the best strategy.    

Which brings me to taxes.

Impact of Capital Gains on a 2021 Transaction

So you’ve gone through the first decision point and concluded that you can afford to sell.  What happens if you delay that decision a bit?  You potentially face a big tax hit that is 100% out of your control.   For many companies that preponderance of their transaction is taxed at capital gains rates vs. ordinary income.  I’m going to do some rounding here (forgive me in advance if you are a tax person reading this) – but that currently means about a 20% tax rate.

The current proposals would bring that rate to ordinary income rates- ie approaching 40%. I.e. double the current rate.   My money is on it not going quite that high…. but on moving up significantly from the current rate.  So with that said assuming that the rate increase isn’t retroactive…. why on earth wait until AFTER that increase?  For all intents it’s found money to do a deal now.

So recapping – if you can afford to sell and want to… now is the time to go to market.  Waiting will likely move the goal posts on post-tax proceeds.

What is the Probability of Success?

Let’s assume that you decide to pursue a value growth strategy to close your value gap. How confident are you that you can execute on plan?  

Similarly, entrepreneurs are constantly chasing the next big thing. We all do this – the next big project, the upcoming contract win, or maybe the new product launch. Healthy businesses always have a next new thing- it’s what feeds the beast and underpins growth. But that same cycle can feel like a hamster wheel with owners constantly chasing the next increment of success.   

In either case, it’s time to start handicapping the likelihood of successful execution. On our end, when we work with clients on value engineering assignments we do just that: by correlating actual impacts to enterprise value to both the probability of success and time to execution we can start to understand how value might change over time.  For instance, a given initiative might result in an additional $250k of income, require 18 months of time, and have a high likelihood of success. If the market currently would value that company at 5x, that initiative is worth $1.25M in enterprise value.  

What is the Probability that the Market Turns First?

Of course all this assumes that we have time to execute.  The market, being a nebulous collection of individual participants, doesn’t care about our plans whatsoever.  Take our example from above. What would happen if you executed on plan and in 18 months … but the market turns and now prices the company at a 4x? Well… it’s not going to feel good, that’s for sure. See below: 

In our example – that quarter million dollars of hard fought gains would yield exactly zero dollars in improved enterprise value in a market downturn. That’s not to say it’s not a worthy project – the company would still be delivering those earnings back to shareholders. But in terms of pursuing a sale you very well could be literally missing the market.  

Takeaways

We are always talking about how “timeline is everything.” If you have a short term horizon you can only impact so many things. Your decision to go to market now means you aren’t going to massively increase enterprise value suddenly. And that’s okay if the numbers work for you – it’s a great market! If you do decide you need to wait – be it for that next big win or to put in some hard work – that’s okay too. Just understand that you are on the clock and that a market downturn may erase the gains you’ve been holding out for. Finally, if you run the numbers and realize that you need to grow value beyond what can reasonably be expected in the short-term then it’s time to buckle in for the next 3-5 years and enjoy the ride.  

Need some help working on this decision matrix? Drop us a line.

Are you Stuck in neutral?

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As people have settled into (my new, least-favorite phrase) the “New Normal” one of the trends that I’m seeing is companies and management setting thing’s on cruise control. The reasons are myriad, ranging from “I’m just happy we survived” to focusing on new roles as home-schooling teachers. In many cases there’s also a sense that growth and new initiatives are just not possible and are best delayed. That mentality is frankly simply giving in to a sense of ennui.

I think McKinsey put it best when they framed this as a crisis in which we have to safeguard our “lives” and “livelihoods.” Before we go further, it’s important that we acknowledge the toll this has taken on our lives. As of this writing, over 200k people in the U.S. have died as a result of this pandemic and millions more have lost jobs or suffered levels of emotional stress they’d never previously encountered. I don’t want to dismiss or minimize this. But, recovering our “livelihoods” requires bold moves from entrepreneurs. “Winners” don’t sit still. They recognize that every crisis brings opportunity with it — opportunity for value creation, revenue growth, and those, often lead to job creation. So, what are the “winners” doing? In our work, I see those companies doing 3 things:

Three ways we see “winners” competing right now

Repositioning the Workforce

A theme that we see from larger companies is a well-crafted culling of lower performing talent.

So how are you repositioning your workforce?  At this point most companies who’ve needed to made headcount adjustments.  But more importantly in the middle market / lower middle market we’ve seen a trend towards “re-homing” high performers in high need roles.  In some cases, the current environment has created an opportunity to move a person out of an existing assignment into a “Tiger Team” type role which is both pivotal to the organization and likely to last beyond the pandemic.    

Thanks to our new fondness for remote work, companies have also succeeded in onboarding remote talent from unlikely places.  Yesterday I spoke with a DC-based entrepreneur who managed to onboard a remote employee from Louisiana for a high-end software engineering role.  A year ago, that hire would have been all but impossible due to customer requirements.   The company has essentially conducted a Proof of Concept on staffing highly qualified remote technical staff at more competitive rates.  Now the company is rethinking their entire staffing strategy.        

Bottom line here is that continued uncertainty has created a unique opportunity to reposition staff and source talent that in new ways.   

Reevaluating Fixed Costs 

How do you feel about your leased office space right now?   I haven’t been to our HQ office in months and I can tell you that personally I’m feeling great!  Of course, it just so happens that we are sitting on an expiring lease and had been shopping around to upgrade that location.  (Sometimes procrastination does pay!)  Now maybe it’s dumb luck – at the same time I’ve spoken with plenty of companies that just signed leases that they now view as essentially worthless / expensive boat anchors.  Most companies would gladly reduce their space (and fixed cost) footprint right now.    

here’s the thing with fixed costs: when times are flush it’s easy to justify the “below the line” bloat that comes with adding fixed expenses.  But if, and I mean when that top line ticks down those easy decisions from 2019 suddenly feel terrible (and probably make you feel a little guilty for blowing off the CFO).  Case in point:  we work with a client that recently added significant production capacity (at the cost of several million dollars) on the expectation that they’d grown into it.  Not only have they not grown into it, it’s questionable as to whether the market segment they were targeting is going to recover in the near- to midterm.   

Of course, hindsight is 20/20, and it’s easy to second guess decisions post facto.  Part of being an entrepreneur is the willingness to take risks with the expectation of rewards.  But sitting here today we have no idea if we are going to see a second wave of lockdowns and business disruptions.  We should all remain in the mode of belt tightening, and we should continue to be ruthless in managing fixed spend.   

Identify (and attack) Competitive / Competitor Weak Points

Ruthlessly attack your weaknesses.  Ruthlessly attack your competitors. 

That’s right.  So, we are sitting here something like 6 months into this pandemic.  Everyone I know keeps using that same damn phrase “the new normal.”  You know what the new normal is for leaders?  For people in positions of responsibility and / or authority?  The new normal should be the same as every other day was during the old normal. What I mean by that is every single day we should be attacking our weaknesses.  We should be sizing things up, we should be measuring how we stand, and we should be diving in on hot fixes to address the biggest issues first.  It goes without saying that we should be doing the same thing within our competitive landscape.

Our current situation gives us all a unique opportunity.  In times of stress weaknesses start to show itself.  I’m willing to bet that each of us has been surprised in some way by which employees, friends, and family members have stepped up to the plate and put in the work…. Where others have been a shrinking violet that went softly into the night.  Stress and stressful situations shine a spotlight on weakness.  It’s time to take stock, identify and categorize those weaknesses, and attack them.   

What’s Next: Start Your FY21 Plan Early 

This all leads me to my last point.  If you like adventure my money is on 2021 being a blast.  We may (or may not) have a new political landscape- and all the attendant changes in tax law and policy and everything else.  We may (or may not) find ourselves in another series of lockdowns.  We most likely will find ourselves with a larger percentage of the workforce working from home.   

What does this mean for planning?  Start early.  Prepare contingencies.  Obviously, a year ago there weren’t a lot of folks planning for “what if my workforce suddenly goes 100% virtual?”  Well it’s time to work some optionality into your plan.  Taking it a step further, we should all probably be thinking about how FY20 has intruded on our plans – for growth, for profitability, for enterprise value- and for a potential exit.   

So, let’s do this.  Time to get moving!  

Upcoming “State of M&A” Webinar

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BLUF: We have an upcoming webinar on the current State of M&A. Please shoot us a note if you have topics in mind you’d like us to cover…

I’ll just go ahead and skip all the trite pleasantries about how we are in the “new normal” and get right to it: are you curious what is going on with M&A deals? I mean… it’s been quite a year, right?

It’s been nearly one year exactly since I wrote “Is the M&A Window Closing?” And it’s now going on 6 months since I did a whole host of webinars and events on “M&A and COVID.” When I wrote the “Window is Closing” article, my biggest concern at the time was not a specific threat to the M&A market – rather a general sense of foreboding that this market is just too good to be true. (Wishing I had taken the odds on “global pandemic” being the thing that tumbles the economy….)

In any event, the market has definitely changed. On one hand, M&A deals are still happening! On the other… a lot depends on the industry and the health of the target company. And even in those industries that remain healthy the logistics of running a “process,” interacting with buyers / sellers, and diligence has often materially changed. We’ll be discussing those issues and more with a few industry experts.

Stand by for event logistics / registration!

To Maximize Your Business Sale, Think Like a (Home) Buyer

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You’ve built a rock-solid business. All the pieces are there—a great product, decent revenue, an extraordinary team—along with plenty of apparent demand in the market. A sale seems all but inevitable. So why isn’t anyone buying?

Because every step of an M&A transaction is designed for buyers to eliminate sellers or reprice the deal.  To truly understand why, you’ll need to think like the person on the other end of the transaction. You’ll need to channel your inner buyer.

I’m not suggesting you immerse yourself in M&A literature or moonlight at a private equity firm. Your inner buyer is probably better developed than you realize. In fact, if you’ve ever purchased a home, you have essentially the perspective and experience you need.

Business Deals and Real Estate Deals: Not That Different

Consider the characteristics that make a home desirable or not: its size, its current condition, its potential future value, where it’s situated, the value of similar properties, and so forth. Virtually every factor influencing a real estate investment shows up in an M&A transaction as well.

Buyers are looking for assets that meet or exceed an extensive list of criteria. Like savvy home buyers, they’re not willing to settle or simply say “yes” to the first option presented. They’ll take any opportunity to negotiate down the asking price. And when they have a bad feeling about a situation, they’ll walk away.

Stage 1: Browsing and Screening

Home buyers usually start their journeys by browsing and evaluating real estate listings on sites such as Trulia and Zillow. This high-level overview is where the vast majority of options get weeded out. If a home doesn’t align with the buyer’s overall requirements—if it doesn’t have enough bedrooms, for example, or is far out of the buyer’s price range—it doesn’t warrant consideration.

The same general process occurs in M&A, although there’s no Trulia equivalent for business deals. Instead, prospective buyers obtain basic information about a target—such as its profit margin, industry, customers, brand, and geographic footprint—by contacting the organization directly or through a “Teaser” developed by an investment bank or other intermediary. Although they can’t collect much data at this point, any early insights inform the decision to move forward but shape the buyer’s strategy and expectations. A seller who makes a lackluster impression, appears disorganized, or fails to communicate in a timely matter can anticipate tough negotiations ahead. That is, if they ever hear from the buyer again.

Stage 2: The Initial Walkthrough

Next come on-site visits and earnest conversations with sellers. In real estate, a buyer will tour a location to ascertain its condition and begin to plan any remodeling. In addition to the obvious issues and red flags (e.g. structural damage, poor workmanship, faulty wiring), curb appeal matters  : Is the asset well-maintained and looked after? How is the neighborhood?

Business buyers make similar appraisals—of their targets, of their targets’ positions in their industries or markets, of the curb appeal of the deal, and of the organizational leaders in charge. While parties involved in M&A transactions certainly do conduct walkthroughs, conversations with a seller are perhaps more important than the physical state of a given facility or office. A buyer wants to know that the company is well-structured, well-run, performing at high capacity, and rooted in a sound business strategy. Problems in the company’s foundation, so to speak, can end a transaction or significantly diminish the buyer’s idea of an acceptable price.

Stage 3: Thorough Investigation

After communicating about the deal and discussing it with their families (or close advisors and stakeholders), the parties decide on terms and price. Before agreeing to the purchase, however, the buyer typically engages in an exhaustive investigation. A soon-to-be homeowner will complete a home inspection, looking at the property from top to bottom. If problems are found they might even hire a structural engineer, pest control expert, or another specialist. From bad water heaters to outstanding liens, issues discovered at this point may destroy a seller’s goodwill and lead the buyer to rescind the offer.

Businesses have their own skeletons in closets. Liabilities that crop up during late-stage due diligence can and do torpedo practically-consummated deals. Perhaps it’s a misvalued asset, or a pending lawsuit, or the absence of a contract with a major customer, or the departure of a key employee, or a compliance gap, or a severe operational inefficiency. Whatever form it takes, whenever it emerges during the transaction, any source of risk can motivate a buyer to demand a lower price or withdraw altogether.

Ready to Sell? Talk to a Professional First.

As a business seller, you’re at a natural disadvantage. As soon as the transaction begins, the value of your company—and your asking price—can only go down. The secret to maximizing your return is to think like a buyer. That means anticipating and addressing every possible liability proactively, before your business goes to market.

Most sellers don’t do this. They underestimate the effort involved in M&A and assume their businesses are ready for sale. Can you blame them? Owners should believe in their businesses. They can’t be objective—they’re too close.

That’s why valuation and M&A advisory professionals exist. At Quantive, we’ve developed a system that eliminates guesswork for sellers. Our Market Readiness Indicator gives you comprehensive insight into how and when to bring your business to market.

To learn more about the Market Readiness Indicator and see how we can empower you in the single biggest deal of your lifetime, schedule a call with one of our M&A and Valuation experts.

May Deal Announcement

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Quantive’s client Marlin Ventures was acquired by Consortium Management Group, Inc.

Marlin Ventures, a government contracts consulting firm, is renowned for its commitment to its clients’ success. Marlin Ventures provides a full range of business development and contract administration support “from capture to closeout”.

Terms of the transaction were not disclosed.

Matt Whitaker lead the transaction for Quantive.

March Deal Announcements

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It’s been a big month!  Two deal announcements for closings over the past few weeks.  Big congratulations to Matt Whitaker who advised on both.

Deep Learning Analytics acquired by General Dynamics Mission Systems

Our client Deep Learning Analytics (DLA) was acquired by GDMS.  DLA has extensive expertise in artificial intelligence including data science, research, machine learning, predictive analytics and software engineering. The company specializes in deploying deep learning algorithms on small and power efficient appliances and mobile devices. The company provides understandable data-driven answers to pressing business and research questions in the fields of energy, defense, education, social policy, biology and e-commerce by drawing on better data, better machine learning, and better insights.

Terms of the transaction were not disclosed.

Matt Whitaker lead the transaction for Quantive.

CKA Acquired

Quantive’s client CKA, LLC has been acquired.  CKA is a federal contractor providing a range of IT services, to include cyber security, enterprise data center operations, and cloud computing.

Terms of the transaction were not disclosed.

Matt Whitaker lead the transaction for Quantive.

 

About Quantive

Quantive is a veteran owned and operated financial services firm. We help entrepreneurs in a range of matters related to corporate value: business valuation, value growth, and M&A advisory. We have over 15 years of experience in a wide range of industries with a focus on the lower middle market.

5 Steps to Selling Your Business

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Selling a business can be a stressful event. Given the size of the asset – and likely it’s importance to your retirement – you can just imagine that there are going to be some white knuckle moments. To reduce your anxiety level and increase your odds of success, here are five items to consider as you ramp up for a sale.

1. Create a Plan

With very few exceptions, selling a business is a pretty complicated event.  Put aside your preconceptions from the last time you sold a house- this is different.  All company’s are unique animals and you have to treat them as such when approaching a sale.  The time for planning is before you ever get the business on the market or start talking to buyers.  Some items to consider:

  • How much money do you need from the sale?
  • How much time can you dedicate to managing the sale process?
  • Who are you going to tell about the impending sale?  Key employees?  Your accountant? No one?

2. Perform a Business Appraisal

You can’t possibly know if now is the right time to sell if you don’t have an idea of what your company is worth.  Even more, you certainly can’t effectively negotiate the purchase price if you don’t know the likely value.  Getting a professional appraisal complete – preferably by someone with both valuation and real world experience – puts you in the drivers seat when it comes to knowledge on value.  And worse case?  If the number doesn’t meet your needs it provides a roadmap to improving value.

3. Prep for the Sale

Selling your car?  You get it detailed.  Selling a house?  Good bet you’d spruce it up.  Why should a company be any different?  The only difference is the items that get spruced  The likely suspects are:

  • Clean up the financials.  No personal expenses, no funny business, and the fewer “adjustments” the better.
  • Literally, clean up.  First impressions on touring a messy business: either “I’m not buying this” or “I’m getting a discount”.
  • Lock up key employees.  No one wants to buy a company where the core “assets” might walk out the door post-closing.
  • Solidify Customers.  Recurring revenue is often the number one driver of value.
  • Demonstrate Growth.  Higher growth businesses get higher relative valuations. Period.

4. Hire a Team

So you’ve done some planning and done some sprucing, now it’s time to get in gear.  To get the sale done on your terms, carefully consider your advisors.  Depending on the size of the deal the team often includes:

  • Business Broker (for smaller companies) or M&A Intermediary (for larger deals)
  • Transaction Attorney (find one that does a lot of M&A work)
  • CPA
  • Financial Planner (for help answering the question “Is this enough?”)

5. Negotiate in Good Faith

Finally, once you have an offer on the table and a buyer in front of you, the surest path to closing is to negotiate in good faith. I can relate countless tales of sellers that sought to carve out every last penny…. only to see their dream deal evaporate.  Seriously – ask me.  I can tell this story all day long.  The lesson learned is that the best deals are the ones where both the buyer and seller expect to give a little bit.  Negotiate in good faith and expect – or demand-  that your counterpart does as well.

Wrapping It Up

You can’t approach selling a company like it is a house or a car.  It’s vastly more complicated, and in most cases vastly more central to your overall wealth.  Putting a plan in place, doing the hard work to prepare, and then executing with the right team is the clearest path to a closing.

Search Funds: The Goldilocks of Buyers?

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The M&A market is booming, and for entrepreneurs and family businesses seeking to capitalize on a historically great seller’s market, some are finding that the lack of long term planning is weighing on valuation.   As we approach the end of a historically great M&A market it’s important to start thinking about trading some smaller portion of value in return for a deal that closes while the market is still at its high point. Read more

State of GovCon M&A: 2018 Edition

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Despite declines in the overall market, M&A activity relating to government contractors has remained quite active. Within the larger trend of agency and military projects adhering to the current president’s priorities, here is a look at the major trends shaping the M&A landscape for government contracting. Read more