|
|
|
Bringing Your M.O. to an M&A
Mergers and acquisitions shape strategic thinking for owners of entrepreneurial and family businesses
|
Business New Haven
5/3/1999
By: John E. Hyde
|
National headlines and stock news routinely announce mega-deals involving Fortune 500 companies and aspiring Internet companies. Hype aside, mergers and acquisitions have gained popularity during recent years as a strategy to maximize the value of privately-owned companies.
Unlike public companies seeking to acquire the earnings of the target company, private companies may be motivated by other goals in addition to profits: to fill capacity, or gain new customers and capabilities. For a closely-held firm, the motivation to sell or merge may stem from the desire to get the owner's capital out of a business, and to gain the business advantages and employee benefits that accrue to a larger organization.
The following mergers and acquisition issues affect entrepreneurial and family businesses, both on a regional basis and in the greater New Haven marketplace.
'Make/Buy' Analysis: Supporting Valuation Beyond the Financial Statement
Since companies can attempt to grow by hiring salespeople and investing in additional equipment, acquisitions are frequently viewed in terms of make/buy decisions.
Many business owners think their financial statements do not reflect the true value of their business. One way to overcome this barrier is to demonstrate to the acquirer that the cost of starting a comparable enterprise is so great that it is less expensive and less risky to buy the existing business for a premium price. The current tight labor market in Connecticut supports the make/buy proposition, since acquirers probably would find it difficult to hire qualified employees for a new operation. In fact, excellence in personnel is a factor that can add to a company's valuation.
Focus on the strategic benefits. A document-publishing company of $6 million in annual sales concluded a transaction which valued their business at $3 million, despite only a year and a half of strong profitability. They convinced the larger, acquiring company that the advantages of combining the companies accomplished strategic objectives that justified the high price.
In addition to the favorable purchase price, the sellers received employment contracts with incentives to share in the upside potential. Essentially, the owner cashed out his capital at top dollar (six times earnings) and kept his hand in the game.
Never Set An Asking Price
An asking price is appropriate for many small businesses, but the owner of a business with strategic value runs the risk of cutting off the potential high end of an offer for the company.
Steve Berman, an attorney in the New Haven office of Berman & Sable, relates a recent experience in which his client sold its color separation/pre-press business for nearly $8 million more than anticipated. The strategic acquirer paid nearly 1.2 times the gross sales of the target company, paying part of the transaction with publicly-traded stock of the acquirer.
By contrast, a well-known independent lumber dealer in Hartford County was unsuccessful in selling its business, in part because potential acquirers received sticker shock when word was given about the owner's asking price. The $10 million annual sales business was profitable and may have deserved the valuation; however, the tactical miscue helped create a negative psychology.
Unlocking Capital
Tied Up In A Business
Sellers may be interested in transitioning out of their company if they are having trouble competing. Some owners lack the capital to keep up with changing technology, while others believe that customer demands, personnel problems, and bank concerns compound frustrations caused by a rapidly changing operating environment.
If the company stays independent, the capital tied up in receivables, inventory and equipment must remain on the balance sheet and at risk. A sale or merger becomes a means of getting the shareholder's capital out of the business.
For troubled companies, a managed liquidation can turn the assets into cash but the owner should attempt to gain value for the intangibles - customers, personnel, market presence - by transitioning the business into a new home.
Excess Capacity: Increasing Sales and Asset Utilization
Capacity-minded acquirers look to add customers, personnel and selected assets. It makes sense that capacity-motivated acquirers rarely pay a multiple of earnings because they are not trying to buy a complete business.
Typically, the acquiring company buys assets at a fair price and hires the seller as an employee. The employment arrangements may include base salary, regular commissions and benefits. Sellers who become employees often receive extra payments for retaining customers. These so-called royalty payments can range from three to ten percent depending on industry-accepted levels of profitability, and can last for six to 48 months. However, some acquirers will negotiate conditions - such as a minimum level of sales or a percentage increase in sales - that must be satisfied to trigger the royalty payments.
Negotiating Who
Bears The Risk
Asset sales combined with royalty payments place the risk of future performance on the seller. Wise acquirers will provide the seller with reassurance that their capability, pricing and customer service will meet customer expectations.
A state-of-the-art facility demonstrates that the acquirer has the infrastructure to keep up its end of the deal. Strong name recognition in the marketplace, a track record of similar transactions, and the financial stability of a respected family-owned firm or publicly-traded corporation also contribute to achieving the seller's trust.
Look For an Industry
Roll-Up To Get a Premium Price
A number of industries (e.g., retail building supply, commercial printing, auto parts distribution, equipment rental, computer outsourcing) are consolidating through roll-up transactions in which smaller players are combined into larger corporate organizations.
An example from the computer outsourcing industry: The owner of a Connecticut firm went from owning 100 percent of a business that may have been worth between $4 million and $6 million in the private markets to owning shares of a public company that were worth around $15 million. The sponsor identified ten companies each with about $10 million in annual sales, contributing $1 million in earnings. The sponsor included the Connecticut company in the roll-up. Wall Street then valued the combined entity at 15 times earnings, which placed a market capitalization of $150 million on the company overnight.
Through the roll-up, each owner received a negotiated percentage of the combined company, and we were able to negotiate a higher price for our client on the basis of their rapid growth rate compared to other candidates. BNH
John Hyde is founder and a principal of Rampart Financial Group LLC (800-575-0006), which helps owners of entrepreneurial and family businesses to reorganize financially, obtain financing, restructure, merge, acquire companies and sell their operations.
|
Go FirstGo PreviousGo
NextGo LastGo
to Index
|
|
