Beyond Market Multiples
Great news! After a long drought of M&A activity, the market for private companies is showing signs of life and recovery. If you own, operate or advise a middle market company, $5 million to $500 million in revenue, what does this mean for you and your clients when thinking about shareholder liquidity or selling the business? And how can you improve the odds of getting a deal done?
From a private equity perspective, the dollars invested in middle market companies more than doubled from 2009 to 2010. Publicly traded strategic buyers like the S and P 500 companies have historical levels of cash, and are seeking to deploy part of this hoard to generate significant revenue through external growth initiatives like acquisitions, which can provide access to new customers, higher margin product lines, new technologies and entrepreneurial talent. The same concept applies to what private equity refers to as tuck-in or bolt-on acquisitions for larger existing portfolio companies.
While the number of transactions is increasing and appears to be rebounding, the character of the market and deals is different from that of the pre-Great-Recession vintage. In the period of 2004 to early 2008, there was significantly less scrutiny in underwriting and financing transactions. Today, the performance bar has been raised high with a flight to quality. Transactions are being done with only the very best industry players within a market; and these companies are able to garner valuation multiples at nearly 2008 levels. However, the average and lower performing businesses will likely find greatly depressed multiples, or worse, no interest from buyers or investors at all.
Thus the quandary—What is the typical middle-market company to do to create a partial or complete exit for its owners? Here is an approach that has proven successful in increasing the value of a company before the sale and enhancing the likelihood that a transaction will occur:
1. Start the process by clarifying the objectives and desires of the owners. The game plan for creating an exit needs to be aligned with the ambitions of the shareholders. For example, are any of the shareholders active in the business, and if so, do they want to continue with the company? An important part of this step is to align the expectations of the shareholders by gaining a realistic understanding of the current value of the business based on the reset-rules of the economy and the company’s recent performance.
2. Determine how the company really compares to the industry in terms of financial performance (i.e. profit margins, sales growth rates, productivity, etc…), competitive position, growth strategy, customer base and concentration, and talent. In effect, conduct what a buyer may call “strategic due diligence” on your business and grade your performance.
3. Shore up the fundamentals. Why sell your company and leave untapped value for the buyer—value that you can realize by making some of the predictable improvements that a buyer will make? Do it before you sell. Develop and implement initiatives to address the gaps and weaknesses uncovered by the diligence mentioned above. This step, by itself, can create a significant premium in value for the average business. Keep in mind that making performance improvements takes time. It may take from a few months to over a year to complete, so plan ahead.
4. Think about your business from the buyer’s perspective. Your company is an investment. What is the growth opportunity and strategic value beyond today’s numbers? Even with your house in order and a strong foundation, what investments could be made by management if more capital was made available to further increase the value of your business? What actions can the business take to validate this new investment opportunity and reduce the associated risk? Being prepared to answer these questions, having thought about the outcome and taking steps to make it real can allow the shareholders to sell the business not just on the value of today, but to capture and participate in the value creation moving forward.
The overall objective in positioning for an eventual sale, recapitalization or ownership transition is to address the low-hanging fruit, in terms of operational performance and strategic position, and shore-up the critical value drivers, fundamentally making the business stronger. And, in the process, identify the longer-term investment opportunities for the business, the break-out strategies, and the initiatives that will allow for geometric increase in value if the company has access to additional capital. This then allows you to lead the sale process with a robust investment opportunity beyond the foundation that exits today.
Kenneth H. Marks is the founder and a managing partner of High Rock Partners, providing growth-transition leadership, advisory and investment. He is the lead author of the Handbook of Financing Growth published by John Wiley & Sons (HandbookofFinancingGrowth.com). You can reach him at khmarks@HighRockPartners.com.