“The times they are a-changin’.”
So sang Bob Dylan in his seminal 1964 folk hit. While Dylan’s lyrics reflected the societal upheaval that swirled around him and the world during the turbulent ‘60s, his words are no less applicable to today’s mergers and acquisitions (M&A) realm.
Indeed, if there’s one constant in M&A, it’s change. Businesses change. Executives, managers and staff come and go. Markets fluctuate. Regulations are enacted. Political landscapes shift. Consumer tastes never remain constant for long. And technology marches ever onward.
All this and more impacts every business profoundly. As these factors occur, a business’ multiple – i.e., a factor used to estimate a company’s value in the eyes of the market – evolves accordingly. The better a business performs based on any number of key metrics, the better its multiple is in the eyes of the market.
Members of our Skoda Minotti Transaction Advisory Services Group are often asked, “So, what are multiples these days?” It seems like a straightforward question. Yet, unless you work daily in the M&A space, it’s difficult to pin down the answer to that question.. There are so many variables that factor into a response, including, but not limited to: industry, size of company, location, risk assessment, and EBITDA margins. There’s rarely even consensus among M&A advisors as to current multiple levels; from vast personal experience, we can vouch for the fact that we debate this to no end.
That said, the general consensus is that multiples are increasing in 2017.
Before we go any further, a more detailed explanation of multiples is in order. We won’t go too deep; but we want to help ensure that you understand the concept to an extent that can help you apply it to your acquisition strategy.
By a strict Divestopia definition, “A multiple or “multiplier” is applied to a specific financial metric of a company to calculate the business’ valuation or assess its reasonability. The most common financial metrics that multiples are applied to include:
- Net earnings
If a multiple is applied to a pre-debt number, like EBITDA, EBIT or revenue, the resulting valuation is the estimated enterprise value. If the multiple is applied to an after debt number, such as net earnings, the resulting valuation is the estimated equity value. A multiple is referred to as “4 times”, “4x” or “4 turns,” as an example, which would refer to EBITDA being multiplied times 4 to yield the estimated valuation of a company.”1
1 Source: divestopia.com.
Essentially, a multiple is viewed as a measurement of risk. The higher the multiple, the less risk a buyer perceives in a potential transaction—and as a result, the more they may be willing to pay for that investment.
As you might imagine, multiples affect parties on both sides of the acquisition game—buyers and sellers. For business owners who seek an exit strategy – be it through a third-party sale, management buyout, sale to existing partner(s), employee stock ownership program (ESOP), recapitalization, or even liquidation, priority should be placed on increasing their business’ multiple to the fullest extent possible. Generally, companies with EBITDA above 10 percent of revenue can sell for premiums. If you are a business owner and believe you can improve your EBITDA levels above 10 percent, it might be worth it to invest as necessary in strategic initiatives. You might also identify a partner to help achieve this task.
Then there are considerations unique to buyers. As sellers attempt to maximize the value of their business and thus increase multiples, buyers are focused on the opposite—in other words, businesses with upside potential and low current multiples. That’s a tall order in today’s market, which most experts agree is a strong seller’s market.
Domestic Market Analysis
The condition of today’s domestic market depends entirely on your perspective. If you’re a seller, it’s a historically strong market to showcase your company. Conversely, if you seek to acquire a domestic business, your challenge will be monumentally difficult. Currently, there are precious few domestic acquisition targets of sufficient size and multiples to feed the appetite of the acquisition pool. As a result, many would-be acquirers are moving downstream from their historical criteria and considering smaller businesses with more realistic multiples.
This situation is expected to persist at least for the next 12 months or so. However, it won’t last forever. Many Baby Boomers have already reached retirement age, and the remaining numbers aren’t far behind. In five to 10 years, Boomer business owners will dilute the market with their businesses, so the pendulum is likely to balance out somewhat. But for the time being, the current market landscape compels buyers to rethink (1) how they find and source deals, and (2) how they can reduce deal costs in order to reduce their risks. As Dylan’s immortal words suggest, the M&A world is a-changin’. Buyers (and sellers) must therefore adapt their approaches and find creative ways to keep deal costs down and maximize their returns.
In that spirit, we are seeing increased acquisition activity in two primary areas:
Today’s domestic acquisition market is a seller’s paradise; investors are actively looking to put their money to work, which results in significant competition. In this seller’s market, even modestly attractive companies are fetching premium valuations from an unusually large buyer pool. For many domestic buyers, moving beyond the U.S. for potential acquisitions may seem expensive. However, you can enter selected markets with potentially lower buyer competition, which could keep the purchase price in check. Some keys to remember when contemplating an international transaction:
- Use time efficiently
- Manage language differences and streamline communications
- Understand relevant industry and acquisition-specific terminology
- Build an appropriate advisory team
Here are some tips to help guide your efforts should you choose to pursue the international route:
Keep the train rolling down the tracks: For any acquisition – and international acquisitions in particular – keeping momentum going throughout the deal is critical to closing the transaction. Depending on where the various parties – i.e., you and them – are located, the window for talking with advisors and sellers in different time zones may be small during the day, thus making it difficult to connect at unscheduled times. Therefore, be prompt in responding to requests or questions, whichever side of the transaction you are on.
Avoid slang, jargon and words that may muddy the waters: When speaking and/or writing to people in other countries, be sure to not use slang words and expressions. Be clear in your questions and requests. Lack of clarity can result in requests for clarification flying back and forth between parties, which wastes time and energy, often engenders ill will and ultimately bogs down transactions.
Do your homework on relevant terminology: Be familiar with different terminology used in other countries. What we view as standard M&A terms here in the U.S. might mean nothing to someone in another country—or something entirely different.
Identify capable advisors early on: You will likely need foreign advisors to supplement your domestic advisory team. Research advisors in your target countries in advance. In many cases, your local advisors will be connected to their international counterparts. Your team needs to be in place as early as possible in the transaction.
With international acquisitions, every stage of the transaction takes longer because of the issues raised in the earlier points. But international acquisitions offer a potentially fruitful avenue to grow your business, provided you plan appropriately and execute tactically.
With the Trump administration still in its early stages, it remains to be seen whether international transactions will be affected by shifts in regulations, tax or tariff issues, or even market conditions.
One final note on international transactions: It’s critical to not lose sight of why you’re pursuing a particular deal. While an international transaction could make economic sense, it must be squarely aligned with your M&A strategy.
A few years ago, we were approached by a client who sought a minority investor to help grow their business. After conducting research and assessing current market conditions, we explained to our client that finding a minority investor would be quite difficult. In fact, even with our extensive network of contacts, we had no buyers/investor that were interested in discussing minority transactions at that time. Given today’s strong seller’s market, many buyers/investors have changed their tune.
For example, Tampa, Florida-based KLH Capital LP (KLH) is taking advantage of this disparity and has raised a fund that will complete both minority and majority transactions. KLH’s Kyle Madden states that a minority recapitalization can address a number of situations and is particularly compelling to entrepreneurs who are growing their businesses and want the advantages of a private equity partner without giving up a majority of their ownership and financial upside.
This type of transaction is also useful when multiple owners have differing personal and professional goals. For example, a retiring or inactive owner may desire liquidity, while other business partners or family members are still working to build the company. Minority investment can also be a solution when an untimely death necessitates liquidity for estate taxes.
It is important to get the word out to business owners that, in today’s domestic market environment, this option is becoming increasingly viable. Depending on the owner or owners’ situation, a minority transaction could provide additional exit options. KLH has found that minority transactions offer many potential benefits, including:
- The ability to retain operational control and a majority of common equity ownership
- Greater economic participation in future growth via a large equity position
- The potential to regain 100 percent equity ownership through a future recapitalization
- The benefits of leverage and tax advantages associated with debt
- Lower debt/leverage ratios relative to a majority or full sale
- Elimination of personal guarantee requirements
- Strategic help from experienced financial partner
- A flexible balance sheet optimized for growth
- The ability to provide greater incentives to key management and family members
Currently, competition in the minority space is limited, which bodes well for buyers. Yet, business owners should be aware of all of their exit options. Whether an owner knows which exit option is best for them or not, the times keep a-changin’, so keeping all exit options open helps that owner stay flexible.
Do you have questions about M&A markets, developing an M&A strategy, or are there other transactional challenges you face? Please contact Ken Haffey, CPA, CVA, CGMA, CFP, at 440-449-6800, email Ken or visit http://vlas.skodaminotti.com/valuation/merger-and-acquisition-valuation.