Liquidity Strategies that Span the Business Cycle – August 31, 2015 by Randy Myeroff

It’s no surprise that with the availability of capital back to normal levels, and then some, and private equity firms continuing to invest in new opportunities, that the M&A market is experiencing a long-awaited surge. And middle-market companies remain right in the sweet spot of the activity. However, the decision to sell a company is still a very personal one that comes with many questions and options, both financial and non-financial.

We recently held a forum to help business owners think through the myriad considerations that require careful planning and diligence before, during and after the sale. Below are a few of the key insights our transactions, corporate finance and wealth management professionals shared with clients in attendance.

What Buyers Want
Justin Thomas, CPA, and a partner in Cohen & Company’s Transaction Services Group, discussed what private equity firms and strategic buyers want, and what sellers can expect.

Buyers are looking for a quality, cash-generating business (or one with great potential), strong leadership, reasonable value (generally driven by EBITDA), limited risk from pre-close issues and tax efficiency. Easy, bolt-on top line growth to help expand a product line, geographic reach, customer base or cross-selling opportunities are key for strategic buyers, who may be more likely to take future synergies into consideration in determining value.

On the other hand, private equity investors may be more prone to look for potential that can be unlocked by additional capital and/or new expertise, a business that is easily scalable or can be used as an attractive platform for growth or add-on to a current holding. Justin pointed out that a common misconception about private equity firms is that they simply want to come in and “clean house,” eliminating the incumbent team. In reality, most private equity firms act as financial sponsor and truly want and often need the team already in place, particularly a strong management team to continue running the business.

But it’s important to understand not only what buyers are looking for, but in what type of market they are operating. Recent middle-market trends include high valuations; increased scrutiny of the seller’s financial team, particularly when multiple levels of family are involved; and an increased use of reps and warranties insurance to add confidence to the deals. There are also common weaknesses being discovered frequently during due diligence of middle-market companies, including: 1) a high level of customer concentration, 2) inability to determine actual margins by product / customer, e.g., where is the profit actually coming from?, 3) outdated or underused ERP, 4) lack of accounting/financing resources, and 5) lack of rigor around state and local tax filings. All of these can significantly impact a deal.

Which type of buyer or deal is ultimately right for a seller will depend on their goals. But they must be prepared and have perseverance to get through the deal, and all of its checks and balances, to make it across the finish line.

Liquidity Alternatives
Jim Lisy, CFA, MBA, managing director of Cohen Capital Advisors, focused his presentation on liquidity options. Jim explained that many people think moving on means “all or nothing,” sell or don’t sell, and that just isn’t the case. There are a range of liquidity alternatives, each providing the seller a different level of control and cash.

The strategic sale, which allows for a complete transfer of ownership and maximizes cash at closing, also can allow owners to walk away from the company and future liabilities. A sale to a private equity firm, on the other hand, is generally a partial sale, with the cash at close being driven by multiples and some level of control maintained by the sellers. In this type of sale, the company’s valuation will depend on modeled returns, which generally target a 20-25% return on equity for investors. The third, often less considered option, is a recapitalization. This encompasses raising capital through debt from minority equity sources to make a special dividend, distribution or a buy-back of company stock. A recap is often used when there is a change in ownership, such as when a 20% partner wants to become 50% owner and doesn’t have the necessary capital. There is a limit on amount of cash available through this method, but the upside is it allows others to buy in while other owners begin to dial back their responsibilities.

Jim commented on the current state of the market — that strategic buyers are flush with cash to make acquisitions; private equity firms are enjoying a broad range of investors, from pension funds to wealthy individuals; and family offices are becoming major players. Mezzanine funds are also targeting opportunities (usually in companies with revenues of $5 million and up) to invest subordinated capital, with bond-type returns (rates are higher than a bank, but cheaper than the cost of equity). Whichever method is chosen, sellers can plan on approximately six months to complete the liquidity process, although planning for the event should start two years out.

Financial Independence for Individuals
Having an established financial plan in place before a sale is anywhere on the horizon is one way to make clear, informed decisions for your future, according to Tom Haught, CFP®, ChFC®, and president of Sequoia Financial Group, who addressed the group of attendees on the topic of financial independence. In fact, there are very few certainties when selling a business, but a dynamic plan can help prepare for the eventual transition and guide individuals as life moves along, removing variables and unknowns, helping them make quicker, impartial decisions when it comes to both financial and non-financial issues.

There are many areas to address and questions to answer when planning for an eventual sale, which, by the way, Haught advises to begin the planning process five to 10 years in advance of the monetization event. What is the goal after the transaction is complete? Start a new venture? Become more philanthropic? Travel and see the world? What about the transaction itself? Will the business be given to the family or sold outright?

Obviously each goal and decision can impact the long-term financial plan differently. Tom discussed in detail the many moving parts to achieving any of these goals, yet his overall advice was clear: plan, plan, plan, and then re-check the plan with advisors on a regular basis. A solid financial plan should encompass all aspects of an individual’s life, now and in the future. Individuals are encouraged to quantify what they know they have to spend money on now versus what they may need to spend it on in the future (e.g., car, club or insurance expenses previously covered by business). This type of in-depth analysis can be critical in determining what an individual needs to have in the future in order to find financial independence once the business is gone.


Contact Holly Price if you would like a copy of the event presentations. Contact Justin Thomas, Jim Lisy, Tom Haught or a member of your service team to discuss any of these topics further.

 

Though related entities, Sequoia Financial Group, LLC and its affiliates, and Cohen & Company, Ltd. are separate companies with common, but not identical ownership. Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Securities offered through ValMark Securities, Inc. Member FINRA, SIPC. 3500 Embassy Pkwy., Akron, OH 44333, 330-375-9480. Certain insurance products offered though Sequoia Financial Insurance Agency, LLC. Sequoia Financial Group, LLC and related entities are separate entities from ValMark Securities, Inc. Cohen & Company, Ltd and related entities are separate entities from ValMark Securities, Inc.