Deals Closed in 2014 – Statistical Analysis

Approximately 50% deals took between four months to six months to close in 2014. See illustration below. Based on this distribution, on an average, a business will take 8.5 months to sell. The time required to sell a business depends on a number of factors including type of business and asking price for the business and type of buyer. Types of business include Manufacturing, Business services, Consumer goods & services, Health care & biotech, Wholesale & distribution and several others. There are two types of buyer’s strategic buyer and financial buyer. Understanding the buyer type is perhaps the single most important factor when it comes to engaging a buyer and negotiating a deal.

Time to sell Business

There are several reasons a business transaction may fall through. Top three reasons are valuation gap in pricing (29%), insufficient cash flow (22%), and lack of capital to finance (12%). Valuation gap is responsible for almost 30% deals not going through. Both the buyer and seller must complete valuation of the business independently and come up with a valuation range. If there is an overlap then zone of probable agreement (ZOPA) exists and there is a good chance the two parties will find a number during negotiations.

Insufficient cash-flow and lack of capital to finance is another major reason to deals do not go through. It is important to qualify buyers before negotiating a deal.

Reasons For Failing

Of the 30% deals that did not go through because of valuation gap, 65% of the deals had a gap between 10% and 30%. As expected the numbers deals failing for less than 10% gap is very low. When the numbers are so close the buyers and sellers should generally be able to agree on a number and come to a deal.

About 50% are strategic buyers and 50% are financial buyers. Financial buyers will not negotiate much as they have to stick to their financial models. Strategic buyers on the other hand have longer term view and may have synergies with existing assets. On a an average, 21% strategic buyers paid 0-10% more and 29% paid 11-20% more.

Valuation Gap Business Deals

For these reasons it is critical for sellers clearly understand the buyer persona. Financial buyers look for value and evaluate business financial statements in detail. They leave very little room for premium and remain close to the valuation price. They are driven by Return on Investment (ROI) and use large amounts of financing. A financial buyer may not hold the business for long. They may fix the business, improve the financial statements and sell the business.

Strategic buyers on the other hand tend to stay in the business for long periods of time. They may buy the business to enter into a new market, increase market share or foreclose a competitor from acquiring the business. In terms of duration, strategic deals are also done much faster. Strategic deals are preferred because they are done within six months, there are lower chances of valuation gap pricing issues and seller may walk away with a small premium between 10% and 30%.

 

Private Capital Report (Part 1)

The following are highlights relevant to facilitating private capital deals extracted from the Pepperdine University Private Capital Markets Report 2014. The report covers all privately held companies and not just main street businesses with revenue between $0 and $5 Million.

Business Types

Approximately 20 % of all transactions closed in the last 12 months (from a sample of 120 deals) involved manufacturing, business services (17%) and consumer goods and services (12%).Other business types in the mix included Manufacturing, Business services, Consumer goods & services, Financial services & real estate, Information technology, Health care & biotech, Wholesale & Distribution, Basic materials & energy, Media & entertainment, Construction & engineering.

Closing Rates

More than 30% of deals put in the market were not transacted. The top three reasons for deals not closing were valuation gap (26 %), unreasonable seller or buyer demand (21 %), economic uncertainty (12 %), and insufficient cash flow (12 %). Other reasons deals did not close include insufficient cash flow, Lack of capital finance and seller misrepresentation. For deals that did not close because of valuation gap, the gap was between 20% and 30%. 84% of deals required between 6 months and 12 months. The median time required to complete a deal seems to be between 8 to 10 months.

Typical items required to close a deal include reviewing Business Plans (1st quartile), meeting with the business and all stake holders (2nd quartile), creating proposal letters, term sheets and signing the letter of intent (3rd quartile).

Valuation

The most popular methods used to value privately held businesses were: Recast (adjusted) EBITDA multiple (58 %), Revenue multiple (13 %) and EBITDA (unadjusted) multiple (10%). Other methods used to value privately held companies include cash flow multiple (9%), Net income multiple (4%) and EBIT multiple (3%).  Overall, re-casted EBITDA multiple and EBITDA multiple account for more than 2/3rds of all valuations completed.

For example, manufacturing businesses with EBITDA between $0 and $1 Million had an average multiple of 3.8.  Across all business types the average multiple for companies with EBITDA between $0 and $1 Million was 4.2. The average multiple for a business type increases as the EBITDA increases. For example, construction businesses with EBITDA between $0 and $1 Million had an average multiple of 3, but with EBITDA between $11 and $25 Million had an average multiple of 10.

There was a shortage of capital for companies with less than 10 million EBITDA and excess of capital available for companies with more than 10 million EBITDA.

Deal Structure

Business deals can be structured using several instruments including Cash at Close, Seller Financing, Earn out, Mezzanine Financing and Seller Retained Equity.  Approximately 40% of deals closed included contingent earn-outs covenants. Other financial instruments used to close deals included Seller Financing (30%), lowered multiple of EBITDA (20%), Rollover (17%) and adjusted amount of equity sold (13%).

One must determine the buyer person before negotiating a deal. Buyer personas include financial buyers, strategic buyers, passive investors, life-style buyers and so on.  One would expect strategic buyers to pay a premium, but report found 29% businesses sold to a strategic buyer did not witness a premium. 52% if businesses sold to a strategic buyer witnessed a premium of 1% to 20%.

Business Environment

The most important issues currently facing privately held businesses are Domestic economic uncertainty (34%), Access to capital (24%), Government regulation and taxes (20%), Political uncertainty / elections (9%), Global economic uncertainty (6%) and Inflation (3%). Domestic economy and government regulation are the biggest issues facing private held small and medium sized businesses followed by access to capital.  For smaller privately held companies, one would expect the main issues would be domestic uncertainty, access to capital and competition.

Determine Reason for Selling a Business

Reasons For SellingIn addition to understanding the business buyer persona, It is also important to understand a business owners motivation to sell a business. Business owners put in a of time, sweat and equity into building a business. Therefore, selling a business is could be an emotional experience for the seller. Businesses are sold for several reasons and similar to understanding the buyer persona, understanding the reason behind the sale can go a long way with negotiations and structuring the business deal. Regardless of determining the business buyer type and reason to sell, business valuation is the most important element for setting the price. Business valuation is pivotal and both the business buyer and business seller must get the business values, preferably using an independent business valuation professional. Additionally, both parties must use multiple valuation techniques to determine the intrinsic value of a business. Now that we have emphasized the importance of business valuation, the following are the most important reasons businesses are sold:

Retirement

Many business owners are in the demographic that will soon be retiring. As per US and Canadian statistics agencies, more than 20% of the population will be over 65 by 2026. For Baby Boomers (people born between 1946 and 1964) business owners, selling their business is the most popular exit strategy to retire. As a business owner, there may be a glut of businesses coming to the market, which is good news for business buyers but may reduce valuation for business sellers.

Owner Fatigue

Business owner fatigue and burnout is the most common reason a business is sold. Additionally, business owners who have owned and operated their business for several years are also bored by the businesses operations. Restaurants, Coffee shops are examples of businesses that may be profitable with potential for growth but the business owner may be selling because of boredom.

Personal and Family Problems

Major changes in a business owner’s personal or family life can be an important reason to sell a business. For example, the business owners spouse or kids may be relocating. Divorce may be another reason to seek a business exit.

Divestment

Majority of a business owners wealth is tied up in one company. A business owner may sell a part or all of his company to diversify. A balanced portfolio is a critical risk mitigation strategy.

New Challenges

The business owner may have found other businesses to pursue that have higher growth rates or profitability.

Buyer Interest

The old adage “Everything is for sale at the right price” applies to businesses as well. A strategic buyer may be willing to pay a premium for a business to gain from synergies, eliminating competition, gaining market share or several other reasons. For the business owner it is an opportunity to capitalize their hard work for a premium.

Competitive Threats

The business may be struggling because of competitive threats. In many cases a business has been around for several years and has not innovated. In many cases business owners may exit the business, which creates a good opportunity for business buyers if they can turn the business around.

Market Timing

Business valuation is the most important criteria to determine the transaction price. Assuming costs are constant, valuation is directly proportional to revenue, earnings and cash flow – depending on the valuation technique used. When the economy is strong, businesses have the highest valuation and it is a good time to exit. The best time to sell a business is when a business has been up for three years and the best time buy a business is in the third year of an economic downturn.

Lack of vision

Perhaps the worst reason to sell a business if lack or vision. In many cases business owners go instant gratification and losing out on long-term growth from the business.

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Determine Business Buyer Persona

Business for SaleDo develop a negotiating strategy the business seller needs to understand the buyer of the business (Seller Due-Diligence). There are several types of business buyer personas where the buyer can be an individual or a business.

Financial Buyers – Financial buyers look for value, spruce up the business and then sell it. Financial buyers are looking for profitability or signs of profitability and stability that are right around the corner. Sometimes they are looking to merge a business with another to benefit from synergies (Synergistic Buyer) with another similar operation in the industry. Financial buyers analyze the businesses numbers in great detail and calculate the price using valuation metrics and comparable deals. They are most driven by proven return on investment (ROI) and tend to get large amounts of financing to purchase a company. In summary the objective of a financial buyer is to negotiate a deal where the deal can be paid of through operating profits, growth over time or immediate profits from some arbitrage.

PE groups raise capital raised through high net worth individuals, family trusts, pensions and others and are the most common type of financial buyers. Their objective is to maximize value for their investor pool.

Strategic buyers – Strategic Buyers look for buy and hold opportunities where they can enter new markets, increase the market share or foreclose some element of competition. Typically these buyers come from the industry (Industry Buyer) and understand the business and its marketplace. A strategic buyer may be a big company already operating in the industry and wants to acquire a business as a platform to enter a new market or to add new products and services to the marketing mix. Sometimes the purchase can be about getting people or management. Strategic buyers may pay more because they understand the value of the acquisition is more than the financial value of the business. The acquired business provides a new leverage. Strategic deals get done quicker and are usually preferred. Strategic business deals tend to be of larger sizes.

Special-Purpose buyers – There are many types of special-purpose buyers. They may be business buyers are private citizens doing private deals. The buyer may be a public company attempting to defend decreasing market share or defend market share from a competitor. In some cases these deals are emotional and the buyer just cannot stand by and watch a business being sold to someone else. For an emotional buyer, price is not the most critical factor in the sale.

In addition to the above classification, an individual buyer can be classified as:

Lifestyle Business – An individual buys a business that revolves around his / her hobbies, personal interest or social life. Sea sports, nigh-clubs, fashion shops, dancing schools are examples of life style businesses.

Owner / Manager – The business buyer wants to make a living and a profit from the business by operating the business.

Owner / Manager as required – The buyer is capable of running the business but does not want to manage the business personally on a day to day basis. Typically absentee owner businesses are non-cash businesses. Cash businesses like cafeterias and bars are very difficult to control without the owner.

Passive Investor – High net worth investors invest in businesses in the same way as they would have listed in shares, bonds and property. They usually hire professional management to run the business.

The business seller must identify the persona (or archetype) of the potential business buyer. Business buyers for main street businesses ($0 – $ 2MM) tend to be individuals who have experience in the sector or companies acquiring businesses for growth. Small main-street businesses with valuation of less than 500K are almost always individuals. First time buyers tend to buy smaller businesses that typically have a valuation of less than 500K.

Business buyers in the lower middle market ($2MM – $5MM) are dominated by strategic corporate buyers and private-equity groups. Private equity groups buy twice as many businesses as compared to strategic corporate buyers, so lower middle market businesses must target private equity groups. In the same vein, the best time to sell a lower middle market business is when private groups have raised a lot of money. As such, it helps to keep a watch on business cycles for private equity groups.

Why list a Business for Sale Online

Business OnlineBusiness for Sale listings used to be posted by business brokers and business owners in print media.  However, listing businesses for sale in print is rapidly declining for several reasons.

To start with space is limited and only a brief summary of business can be listed. If the user wants more information there is no mechanism for him to get it besides calling the business buyer. The print format is just not well suited for business for sale listings, which tends to be more complex and has several attributes attached to it. On BuySellBusinesses.com business sellers can list up 20 images, several videos and any number of documents. Additionally, business sellers can use deal-rooms, which allows business sellers to securely share documents with selected users only.

Print media tends to be expensive, slow with limited reach, so business brokers and business owners have to advertise in a publication for several months to get any attention. In that duration, changing the advertisement can be onerous and time consuming and because there is a physical media involved – expensive.

Online listings are confidential. Business for Sale listing on BuySellBusinesses.com can be set-up with varying levels of disclosure depending on the sellers requirement. The business seller cab decide what to include or exclude from the listing.

Finally, the most important reason print media does not work for business listings is because print readership is declining rapidly and readership not targeted. In the US, only 6% of time is spent on print media. Radio and TV, as an advertising medium, is just not suitable for business for sale listings.

MediaTime

Time Spent on Media

On the flip side, Internet and mobile account for 36% of time spent on Media. The Internet is the first place business buyer’s start the buying process and potential business buyers spend time researching and looking for businesses to buy on multiple sites. On an average, buyers can take between one to two years to complete the buying process and a large portion of the search is conducted online.

Internet traffic on http://www.buysellbusinesses.com/ is highly targeted because Google and Bing match keywords to Websites so that only relevant users are directed to the site. Dynamic nature of the Web allows business sellers to login to a site and de-list their business listing or change the content of their business listing at any time. Additionally, online sites allow business sellers to track and manage leads generated. When a potential business buyer asks for MORE information, the business seller receives the request and the lead instantly.

The ability to syndicate deals online and share business listings on social media is adding fire to the fuel for online business deals. Business deals can be syndicated through a trusted network, through email or through other business-for-sale sites.

Finally, the best part of listing online is the price. Online listings are cheaper than print media and http://www.buysellbusinesses.com/ and makes business listings even more inexpensive. Being mindful of these facts one can safely assume almost 100% business for sale listings will move online in the next few years.

Typical businesses listed online

Almost any business can be listed online, but given the semi-confidential nature of online listings it is best suited for main-street businesses (Businesses valued between $0 and $2 Million). Businesses commonly listed online include E-Commerce businesses, Health and fitness clubs, Websites, Convenience stores, Restaurants, Auto repair, Bars, Fast food franchises, Bakeries, Gas stations, Delis, Printing businesses, Pizza Delivery Businesses and several others.

Business for Sale Checklist

Gather Information for Business Valuation

Business brokers and sophisticated business buyers may use intrinsic valuation techniques for business valuation. They will project the free cash flow (FCF) from the business for the next few years and discount the cash flow projections to determine the intrinsic value. Additionally, business buyers will also try and estimate the value of a business by looking at values of similar businesses sold locally.

Selling a business is complex and the seller must take the time to plan and organize the exit. To assist with valuation and eventual sale, businesses need the following information.

  • Balance sheet, income statement and cash flow statement for 3 to 5 years
  • Corporate tax returns for 3 to 5 years
  • Value of inventory
  • List of capital expenses on fixtures and equipment
  • Customer and contact lists (Customer of Contact Management System)
  • List of employees
  • Copies of all leases, franchise agreements (if applicable)