After a long M&A drought, the private company M&A market is showing signs of life and recovery. If you own, operate or advise a middle market company, $5 million to $500 million in revenue, this will alter what you and your clients think about shareholder liquidity. Already, there are factors that should give lower- and middle-market sellers and dealmakers alike reason to harbor optimism.
From a private equity perspective, investment in middle market companies more than doubled from 2009 to 2010. Increasingly, they compete with publicly-traded strategic buyers with high levels of cash, which are seeking to deploy it to generate increased revenue through external growth initiatives. They need to access new customers, higher margin product lines, new technologies and entrepreneurial talent. The same applies to tuck-in or bolt-on acquisitions to support private equity firms’ larger portfolio companies.
While the number of transactions is increasing, the character of the market and deals is different from that of the pre-great-recession vintage. From 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; these companies are able to garner valuation multiples at near 2008 levels. The average and lower performing businesses will likely find greatly depressed multiples, or worse, no interest from buyers or investors at all.
So: what is the typical middle market company to do to create a partial or complete exit for its owners?
1. Clarify the objectives 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? Add value you can realize by making some of the predictable improvements that a buyer will make. 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 future growth opportunity and strategic value? Even with your house in order, 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 to reduce the associated risk? Being prepared to answer these questions and having weighed the outcome and taking steps to fulfill goals will let shareholders sell the business and capture value creation moving forward.
In positioning for a sale, recapitalization or ownership transition, the departing team must address the low-hanging fruit in terms of operational performance and strategic position, shore up critical value drivers and fundamentally making the business stronger. In the process identifying the longer-term investment opportunities for the business, break-out strategies and initiatives will allow for geometric increase in value if the company has access to additional capital. This 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 with High Rock Partners, providing growth-transition leadership, advisory and investment; all opinions expressed here are entirely his own. He is the lead author of the Handbook of Financing Growth published by John Wiley & Sons. He can reached here.