The merger and acquisition (M&A) market hasn't been immune to the chilling effects of the sharp rise in interest rates over the past 15 months.
But unlike most individuals, who have few options to ease the impact of soaring borrowing costs, business owners looking to sell have some flexibility to make their companies more attractive, according to Mike Benedict, a business transition advisor at BOK Financial®.
Benedict said companies can soften the harsher edges of today's financing environment if they:
- Have maintained a diverse customer base that generates recurring revenues,
- See multiple catalysts for further growth,
- Control valuable intellectual property assets and
- Aren't solely dependent on a few key individuals.
"There are various components to any deal, and one is obviously how much the debt is going to cost," Benedict said. "But the other components are risk-oriented and, if the risk premium can be compressed, that can help offset the interest rate piece of the deal."
Effectively assessing weaknesses and making improvements that will lead to better financial performance isn't usually a short-term initiative, however, so Benedict stresses that the broader landscape remains a secondary concern for owners looking to sell.
"On average, a company takes nine to 12 months to get ready to go to market and during those three or four economic quarters, a lot can change," he said. "Once the company is in ship shape, then we look at the M&A market conditions and, if it looks like a good time to go to market, then we say go with it.
"If it doesn't feel ideal, then we usually recommend the company holds off and keeps executing, so when the tides shift they'll be ready to go instead of taking another 12 months."
A see-saw market of late
Broadly speaking, Benedict said M&A activity rebounded sharply in late 2020 and through much of 2021 after drying up considerably following the Covid-19 pandemic's onset in March 2020. In early 2022, however, valuations faltered from late-2021 highs as supply chain issues, spiking inflation and the initial rise in interest rates gave buyers pause.
The valuation slump lasted through the first half of 2022, Benedict said, but started recovering in the third quarter and appears to be returning to pre-pandemic pricing levels.
|Year||Quarter||# Deals Reported by DealStats||Median EBITDA* Multiplier|
*EBITDA = earnings before interest, taxes, depreciation and amortization (used as an indicator of the overall profitability of a business).
"We've been hearing anecdotally that solid, attractive companies can still get a premium in today's market," he said. "But if they're not the best in class and they have issues they need to resolve, it's going to be more difficult to get a deal done at a reasonable valuation."
For example, a financial technology company working with Benedict's team has a well-diversified customer base providing recurring contract-based revenue streams, possesses key intellectual property assets and is run by a strong management team. Although interest rates remain a wild card, he's confident the company will be well-received by the M&A market in the second half of this year, given its appealing characteristics.
Conversely, one of his manufacturing industry clients is facing an uphill battle as it works to recover from the death of its founder and a sharp pandemic-related drop-off in business. Plus, the company's stingy tradition has been carried forward by the heir now running the business, delaying improvements that are sorely needed to make the outfit attractive to a buyer.
Resolve outstanding issues
Benedict specializes in companies with annual sales between $5 million and $50 million, many of which have provided a comfortable lifestyle for their owners for years. That's where disconnects with potential buyers tend to start.
"Every company, even those that have worked out very well for the longtime owners, has some kind of issues," he said.
"But it's a huge capital risk to buy a business, so a potential buyer will be very diligent in scrutinizing the business. and sometimes an owner is not quite ready to be scrutinized at that type of level."- Mike Benedict, business transition advisor at BOK Financial
Common issues include:
- Lack of a documented business plan. Essential details only exist in the owner's head.
- Less-than-robust financial reporting systems. Management suffers without deeper accounting insights.
- Over-reliance on a few key people. Buyers prefer a deep management bench featuring individuals who will keep leading the company into the future.
To help owners resolve such shortcomings—and others—Benedict recommends an upfront evaluation that objectively details the strengths and weaknesses of every aspect of the business. For example, BOK Financial works with Capitaliz to generate an extensive review that feeds into its controlled option sales process.
"If you're going to buy a car or house, you don't want to be surprised, so you run a credit check on yourself," Benedict said. "If an owner expresses interest in selling, I'll tell them 'let's evaluate what you have to see what the company's worth and what kind of work is needed to get it in shape to sell.'"
Planning for success
Ultimately, Benedict considers a structured go-to-sale approach as fundamental as the go-to-market strategy for a company's flagship product.
"I recently heard about a business that’s waiting for someone to show up and make the right offer—that's not a plan" Benedict said. "Running a disciplined process over time, however, will better position the company for sale, attract higher quality potential buyers and increase the transaction success rate."