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CIBC’s Commercial Banking podcast series, Conversations in Commercial Banking, understands that your business is a living, breathing entity in need of nurturing to continue to grow. Whether you’re looking to navigate a tough economy, tap into current industry trends or identify key tools to take you to the next level, our team of experts are here to equip you with the information you need to make your vision a reality.
Announcer:
Welcome to Conversations in Commercial Banking, a podcast series dedicated to the pressing financial topics facing middle market business leaders today. We bring in experts from all facets of our North American institution to provide actionable insights that help you navigate today's environment. Our discussions include industry trends, strategies to identify and manage risk and unlocking opportunities for growth, all with the purpose of helping you realize your ambitions. And now for this week's episode.
Ron Miller:
Hello, this is Ron Miller and I'm pleased to be your host today. I lead the investment banking team at CIBC Cleary Gull, which serves our middle market M&A clients across the United States. This episode will help you to find your answer to the inevitable question, what next for my business? The answer to this question is unique for every business owner, whether you're planning far in advance or if the sale is just around the corner, whether it's a decision to retire and pass the business to your children or stay on, we'll talk through the key considerations that every business owner should ponder before coming to that decision. Joining me today are two of my fellow investment bankers, John Peterson, managing director and Patrick Ringsred, executive director. Both John and Patrick have decades of experience helping owners of middle market companies navigate sale transactions. John and Patrick, welcome and thank you for joining me today.
John Peterson:
It's a pleasure to have an opportunity to speak to business owners on this subject. If enough of them will pay attention, we do a good enough job, it'll help us represent them in the future.
Ron Miller:
Thanks, John. Today we're going to cover four topics, preparing your business for sale, picking your advisor, types of buyers, and the market, is now a good time to sell? I'd like this to be an interactive conversation, I look forward to the discussion. The first topic is preparing for a sale. John, you have a lot of experience advising clients and preparing businesses for sale. Let's cover a couple topics here. Financial reporting, is an audit necessary and what reporting would you like to see in a business?
John Peterson:
In general, our answer regarding an audit would be, no, not necessary. And later on I think we'll talk about some nice to haves for selling a business, and I think an audit probably goes in that list. The first area that comes to mind regarding financial reporting that would be important for business owners to consider preparing for sale would be business analytics, sometimes referred to as KPIs. And specifically one of the big differences we see between entrepreneur owned companies versus professional institutionally owned companies is their ability to break down their success by outputs, inputs, relationships, whatever matters to a particular specific company. And by breakdown we mean revenue, profitability certainly to the gross margin level, possibly contribution margin or even EBITDA margin, and whether it's a sales breakdown, outputs by products or services, inputs such as capital, labor, activity or relationships like suppliers, distribution channel, the ability to articulate why and how a company makes money, what its history has been trends and opportunities is probably the single biggest place where we see companies having a gap running into a sale process.
Ron Miller:
Great. I think that's helpful. The audit alone or the summary numbers just don't really tell the story of how a business is operating in its markets and with it regard to specific customers.
John Peterson:
They don't. And in terms of implementing a comprehensive understanding of this breakdown, most of our entrepreneurial clients have a financial reporting staff, a CFO, a controller, accountant, whatever, who's sized and prepared to report on business results, not necessarily undertake a comprehensive analytics project. This is important and enough. If I were thinking about selling my business in a few years, I would seriously consider bringing in a temp CFO consultant or someone with expertise in the industry to help to create that program.
Ron Miller:
A lot of private companies run a lot through their income statement and they're not necessarily run to maximize profits. What about what we call add-backs and adjustments?
John Peterson:
This topic comes up in every sale process and the effort is to indicate ongoing profitability under independent ownership. The two categories of add-backs and adjustments we're typically identifying are non-recurring items and owner related items. Both of them can be either positive or negative. We have owners who overpay themselves relative to market, underpay relative to market for a variety of reasons. The next owner wants to look at ongoing profitability. It's really important to identify all of these add-backs and adjustments, and ideally they would be eliminated within years prior to the sale so that the business can be shown how it runs clean and independently without having to make add-backs and adjustments.
Ron Miller:
John, talk a little bit about tax and estate planning. I know that tax structure and transfer of stock can have material impacts on net proceeds.
John Peterson:
Tax structure for a transaction typically is more of a real time when the transaction is executed decision. There are a variety of provisions in the tax laws that frankly make it difficult to reconfigure a business to get a better income tax result on a sale shortly beforehand. The one notable exception I might mention would be a spinoff, split out, some kind of a carve out. Sometimes you see businesses that have unrelated profit streams that would be logically sold to separate buyers. It's usually very tax inefficient. Do that shortly before a sale.
That's something you would look at in terms of long range planning, but the bigger long range planning for taxes probably has more to do on the estate planning side. And there are some fairly exotic and aggressive techniques that can be used with enough time in advance of a sale really depending on the owner's need for assets, the family relationship and intentions regarding where assets would logically end up. And this is actually an area where the CIBC private wealth management team has some experience, not that they're experts per se in estate planning, but a lot of experience guiding people and creating relationships that will help them look at those opportunities beforehand.
Ron Miller:
It sounds like that estate planning, you can't be too early on estate planning where tax laws chains over time, and as you said, that's a little more real time.
John Peterson:
In general estate planning, estate tax laws are trending to be less favorable to wealthy people at the current time, so that would certainly be the case.
Ron Miller:
What about legal work before a transaction? Any legal due diligence you think owners should do before they contemplate a transaction?
John Peterson:
The phrase legal due diligence is very well-chosen to describe the type of opportunity to get ahead of things that could be become problematic if they're discovered real time while a transaction is being executed. These are issues like third party consents and approvals, regulatory approval, customer contracts, credit facilities, sometimes landlord approvals, maybe they can be addressed, maybe they can be obtained, maybe they can be eliminated far in advance as opposed to trying to get that negotiation underway at the same time you're in the process of selling a company. Another area that can very profitably looked at is, I'll call contingent liabilities, and these are things like intellectual property documentation and environmental analysis, employee matters such as confidentiality agreements, benefit plans, if there are any sale related compensation items for employees to be put into effect.
One place where we see many companies fall down, and this is not just the entrepreneur owned companies, is sales tax exposure. Lately we've seen that come up a number of times. People seem surprised and buyers always catch it. Another area where we're seeing a lot of activity has to do with, I'll call it the origin of a tax structure where all the I's dotted and the T's crossed when the LLC was formed or the S corporation was put together. A number of those full pauses if they exist, can be corrected with lead time, but very difficult to address if they're discovered in the middle of a transaction.
Ron Miller:
Those issues have come up so frequently lately. How about management? Are most of the companies prepared on succession and operating management going forward?
John Peterson:
This brings us back to the list I mentioned earlier in terms of nice to haves. Ideally the buyer, almost all buyers want to have management in place, subject matter experts on the company and continuity to preserve relationships and momentum before and after the sale. We rarely, literally almost never come across a buyer of any type, and I think Patrick will talk about types of buyers soon, that have excess management, people looking for jobs that can plug in. Almost always the company is more valuable, more attractive if there is management in place. Having said that, for the entrepreneurial company in particular, there's a limit to what can be done. In a perfect world, we'd have that ongoing continuous management. If that's not present when the company is sold, that has to be acknowledged and that means looking for a buyer that's willing to take on that challenge and understand those risks as part of the transaction.
Also on the nice to have category, and I think we're going to move on to another subject here in a minute, I mentioned the audit, that's not necessary usually to get a company sold. There is a high correlation between companies that have audits and companies that have good business analytics, but they're really separate subjects. There are other things like market studies, strategic plans, acquisition pipelines, all of which can add value to a business, but maybe those are details we should be discussing with specific business owners in the context of their company as opposed to generically.
Ron Miller:
John, that's a great background and a nice segue to my next topic, which is picking a financial advisor. Patrick, you've been involved in a number of pitches and deals over the years. What advice would you give business owners for when to start thinking about picking an advisor?
Patrick Ringsred:
When picking an advisor, one should think about the fact that a sale process when done well could take six to nine months. And as you're contemplating when you'd like the sale transaction be completed, you should accommodate for that process timing in your decision when you're beginning your decision. Certainly there's no real negative consequence to beginning to talk to investment bankers even further out than that, and that allows for them to develop a relationship with you and get a bit better understanding of the business over a period of time.
Ron Miller:
How do you find an investment banker?
Patrick Ringsred:
Oftentimes some great resources are your corporate attorney or accountant who may have had experiences with investment bankers. It's also worthwhile talking to other business executives in your network and even going out on the internet and looking for investment banks that may have a particular expertise that's relevant to your business.
Ron Miller:
Talk about the process of pitching. You don't just call a banker and they tell you what it's worth. It must take a lot of time and energy and information in order for that banker to create a quality pitch and advice.
Patrick Ringsred:
Often what happens is a business owner will invite several investment banks to put a pitch together. That pitch can take many forms, but often includes information on the relevant credentials for the investment bank, the deal team valuation, buyers, process and fees. As one might imagine there is some information flow that's required of the company and owner to inform that pitch, but that information is very valuable for the owner to understand what they should believe that investment bank can deliver for them and the buyer audience, the outcome, the timing, et cetera. And having more than one investment bank compete allows them to have some comparison and some options in their selection process.
Ron Miller:
I actually find it frustrating sometimes when a potential client calls and says, "In a week, can you pitch?" This is a huge lifelong decision and engaging an investment bank six months ahead of time or several months ahead of time to build that relationship, get that information, I think ends up with higher quality advice and selection of your partners. I've heard a lot of companies come to us and say, "Should I get a valuation done first?" What's your opinion of having a valuation firm, do that work before you try to pick an investment banker?
Patrick Ringsred:
Obviously as an investment makers, we're not estate planning experts, but the valuation you're referring to would be very useful for estate planning means the valuation that you would receive from investment banker may arrive at the same answer but goes about it a different way and has a different intent. Ultimately, that's to give the owner some perspective on the valuation they would receive from either, we will talk about this in a little bit, but the buyer audience, the private equity firms or strategic buyers.
Ron Miller:
Does an owner need an investment bank? Why pick an investment bank if you've got a logical acquirer that maybe you've been in conversation with?
Patrick Ringsred:
The way to think about this is business owner is very good at the business they're running and acknowledging that they may not be a good part-time investment banker or amateur investment banker and it's just akin to saying you wouldn't sell your house on your own, you'd use a real estate agent. In this regard, it's worthwhile to have an advisor both for the value from the process that's run, but also their knowledge and experience within the buyer universe and the industry, et cetera. There's multiple facets to the value provided by an investment banker in running the process and ultimately achieving a sale outcome.
Ron Miller:
I agree with that. I think it's pretty complicated and the leverage that a banker can bring to provide the right information and create competition is a really different skill than making widgets or providing a service. That's a good transition to a lot of owners come in and say they want a financial buyer or they don't want a financial buyer or a specific strategic buyer. How do you think of buyers and buyer categories just broadly?
Patrick Ringsred:
I think one of the important values we provide as investment makers, educating the owner on the buyer types their objectives, what they're trying to do, and then also in the context of we market companies all the time, and we have relationships with those buyer groups and when we outreach to them, we can create connectivity and get them involved in a process. Certainly informing a client on the buyer types may help them make a more informed decision ultimately on the buyer type they would like to sell to. It may also go more specific than that and get into what characteristics they're looking for in a buyer, and we have a lot of faith in a sale process, ultimately giving the owner options and the ability to pick the buyer that achieves their ultimate sale objective better.
Ron Miller:
Financial buyers often get a bad wrap. Do they want to quadruple the company and manage the business or do they tend to leave the business alone and just run it for cashflow?
Patrick Ringsred:
Good question. The financial buyers are ultimately raising money from endowments, pension funds, et cetera to deliver return, and they're targeting return over a five-year hold period. There is a wide dispersion within the financial buyer universe and they can be very passive, very active, certainly relying on your investment banker to help you understand which groups are which and how they interact is really important, but also to the business owner in a sale process, you'll have opportunities to interact with them and assess them yourself. Having that opportunity to garner understanding of again, who fits the best for your company is really important.
Ron Miller:
Talk a little bit about strategic buyers. Do they take apart the company and consolidate the business into another branch or do they try to grow that business? What's your experience with how strategic buyers behave?
Patrick Ringsred:
For well run, good companies, which are the companies that we represent, often what we find is that strategic buyers are looking to invest and grow that business, and that's generally the fastest way to create return for their shareholders. There's a well-worn or well-known path of messing with companies, messing with management. That's typically one of the fastest ways to lose money in deals. But again, it's also a benefit of running a sale process so that you're able to ascertain and inquire both with your investment maker and potentially yourself to determine who fulfills the objectives that you have for the sale process and making sure that the company ends up in the right hands in a go forward basis.
Ron Miller:
Which do you prefer?
Patrick Ringsred:
From a buyer category?
Ron Miller:
Yes. Do you favor financial buyers or strategic buyers?
Patrick Ringsred:
I think as an investment maker, we should understand what the client objectives are and ultimately the goal is client satisfaction. The buyer, the best way to think of as being indifferent from an investment maker perspective and very client focused on ultimately who the right partner is going to.
Ron Miller:
I was teasing you because I think the market really speaks and buyers behave really differently depending on the asset and the company and the market tells you what the right buyer is and right value and how different buyers do it. They're each so unique and I think some of these generalizations are a bit unfair.
Patrick Ringsred:
We have a lot of confidence in our process ultimately fleshing out the preferred partners, ultimately the winner oftentimes in value and terms, these other qualities, and there's just a natural matching experience that occurs in the sale process when it's done correctly.
Ron Miller:
ESOPs are getting a lot of press lately. It seems like there's a little bit of a growing trend towards ESOPs. What's your opinion of ESOPs as buyers?
Patrick Ringsred:
Certainly there's a nice dynamic with ESOPs. What we find though is that there's a limited, in the right circumstances, they can be the best outcome. Those circumstances are a bit narrow, but for that situation, they're a great solution for a business owner and obviously the employee ownership element is very attractive for the employees.
Ron Miller:
John, you've had some particular ESOP experience over your career. Anything to add to?
John Peterson:
In a way, Patrick referred to, under the right circumstances can be a great outcome for the company, for the employees and the owners, tax advantages, but there's a financing component. And the capital, the financing structures available to an ESOP purchase are just much more limited than other buyers and private equity buyers, strategic buyers typically have a lot more tools in the toolbox in terms of how to get a deal done that frankly may create a value disparity in some situations. But speaking of tools, I think we think of ESOPs as a means. It's not an objective. Think about what are the owner's objectives and there are situations where the ESOP is the best way to achieve them and other situations where it isn't. Perhaps agnostic, but I would echo Patrick's comment that in our experience it's a relatively narrow set of circumstances where it usually is the best.
Ron Miller:
I want turn to our last topic, which is the market and is now a good time to sell? We've covered a lot of ground on preparing for a sale, on picking advisors and buyer types, but John, is it a good market right now to sell?
John Peterson:
Without trying to be too much of a smart aleck, the question is which market? And the definition of the market is I think very malleable and suits the circumstances and some market parameters are practically irrelevant. Some are very, very important. Let me start with something that's very top of mind for everybody because it's covered by multiple media and that's the stock market. The correlation between stock market and whether it's a good time to sell a company is a positive correlation, but it's a very low correlation. The stock market has a lot of dynamics impacting it that are irrelevant to what would happen when a company is sold. I'd say that's not your indicator to look at. You look at the economy. In a strong economy, most businesses will be sold more, have more buyers, more interest, higher prices than an economy that's not as strong, but again, weak correlation as it relates to the prospects for selling any particular company.
And then you get the M&A market, there's data published, you start to get into the mergers and acquisitions world. The total volume of transactions reported globally or in the United States, the total number of deals, and these are gargantuan numbers, billions, hundreds of billions of dollars and thousands and thousands of transactions, which are interesting as it relates to any particular company, but again, not really determinative. I think currently the stock market is volatile, the signals on the economy are mixed. The M&A data is very, very strong, transaction volumes down year to date, but valuation multiples appearing to hold up quite well. Although honestly, that may be more a factor of the phenomenon that really good companies always seem to be able to find a buyer.
Ron Miller:
John, you didn't mention higher interest rates. Interest rates have gone up it, you didn't mention that as one of the factors in middle market M&A.
John Peterson:
Excellent point, and of all of the macro market factors that probably have an impact finance, not just interest rates, but also availability. And as merger and acquisition professionals, we pay a lot of attention to the cashflow multiples that banks and other lenders, mezzanine players, direct lending funds willing to lend as well as the interest rates. Honestly, it's probably credit availability more than interest rates at the margin that impacts the attractiveness of the M&A market. Credit availability right now is below the peak of maybe a year or two ago, but still quite high relative to normal terms. Again, supportive of the market, but the things that really matter and what if I was thinking about timing of when to sell a business, the things that really matter are what's going on in the industry and what's going on in the company?
And being able to pay attention and know what those trends are, demand, competition, consolidation within the industry, within the company, a number of the factors that we've talked about now I think really are what people should focus on in terms of from a timing standpoint. We've seen many times where people are waiting for all the plants to line up stock market economy, M&A market, industry, company dynamics, and it doesn't always work that way. It'd be great if you could, but better probably to focus on the bottom up company industry M&A market and so on.
Ron Miller:
I think that's a really profound point. When you're in billion dollar deals, a lot of time the credit availability and some of the macro trends are more important in a middle market company. The trends for M&A, there's more money chasing a stable or lower amount of deals. The M&A market's going to be good for a long time, even while there's noise around all the factors that you identified, but what's happening with the specific company in their market and their strategy and position just is more important than the last quarter turn or half turn of debt availability or the last hundred basis points of interest rates.
John Peterson:
Well said. And setting aside my comment about which market, which whichever market it is, it's a market supply and demand defined. And for now and frankly for the foreseeable future, the demand side for acquisitions is very high. When you think of that in terms of the amount of capital that's been raised by private equity for the purpose of buying companies and the amount of cash on corporate balance sheets that need to grow through inorganic strategies, it's a pretty good time right now.
Ron Miller:
We covered a lot of topics here on preparing for sale on buyers and on the markets. This takes quite a bit of time. How can CIBC help entrepreneurs navigate this process, which clearly takes years, not months?
John Peterson:
As part of CIBC, our middle market investment banking group is very happy to have the opportunity to look at businesses. Patrick described what a normal investment banking pitch looks like. A lot of that analysis and perspective it can be provided before it's time to start interviewing investment bankers and doing a pitch. And we are more than happy to roll up our sleeves and talk to a business owner. Usually confidentiality agreement is signed if it doesn't already exist with CIBC, exchange some information, offer some perspective, and offer some observations and start that dialogue early.
Ron Miller:
Great. I think I've heard four things from this conversation. If I were to sum it up, that it's really important to plan ahead and have the right team and that takes some time. That preparation for a sale, whether it be developing KPIs, having an audit of market study legal or accounting due diligence also can have an important impact. That understanding the buyers and the process are really important. And lastly, that CIBC really has a breadth of services that can help any entrepreneur navigate all of these dynamics, find the right partner and help entrepreneurs materialize or realize their financial ambitions. John and Patrick, thank you. As always, this has been a very enlightening hearing your insights into key market considerations about when and if you should sell your business. No matter what the circumstances selling a company you've put so much into can be daunting and sometimes emotionally draining.
You've provided some valuable insights and perspectives to ensure that that transaction is smooth. Thank you all for joining us on our podcast with a focus on selling your business. If you have any additional questions, please reach out to your relationship manager at CIBC. A well-executed transaction is made possible through collaboration with your banker and other business advisors by communicating early on, asking questions and sharing your ambitions for the future. In the meantime, check us out at us.cibc.com or across several social media platforms by searching @CIBC_US. Thanks for listening. We look forward to catching up again soon.
Announcer:
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