Despite the slow and uneven economic recovery, mergers and acquisition activity has continued to flourish. In good times, business owners look to sell at higher prices, while in bad times buyers are on hand to snatch up a good deal on distressed companies with potential.
“This is the sixth or seventh year of accelerated growth in the mergers and acquisitions [M&A] field,” says Steve Cohen, an attorney at the Devine Millimet law firm in Manchester where he chairs a 14-member team of M&A specialists. “Most M&As in the New Hampshire market are outright sales and purchases of businesses,” he continues. “Less than five percent of the in-state M&A activity is, in my opinion, structured as mergers—that is, two or more companies combined into one surviving company.”
In an acquisition, the business owner walks away with cash and sometimes deferred payments, while in a merger the owners exchange stock in one company for stock in a larger enterprise, he explains. “Merging with competitors is difficult since they’re leery about sharing any information about pricing, gross margins, customer identities and vendors, and other confidential and proprietary information in case the deal doesn’t go through,” Cohen says.
During the Great Recession (2007 through 2009), a number of large corporations that had cash on hand were able to cherry-pick distressed NH companies. Since 2010, however, the M&A market in NH and much of New England has been active, Cohen says. Given the low rates of return offered by banks and the risks associated with public markets, lots of cash and financial commitments have flowed into private equity firms, chasing the opportunity for higher returns. National, regional and community banks also have cash available for debt financing of mergers and acquisitions, he says.
This has business owners that want to sell their companies looking for higher purchase prices, as EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) are rising. EBITDA is typically used as a measure of available cash flow, efficiency and profitability. EBITDA has been rising because, following the last recession, business has been good within many industries.
“The higher the EBITDA, the higher the purchase prices for businesses,” Cohen points out. “In-state quantitative data is not readily available, but I’d say that plastics and manufacturing have led the acquisitions’ activity in New Hampshire, with fewer bank mergers than many imagine.”
Exit Planning
Over the next decade some 10 million baby boomers nationally, now ages 51 to 69, are expected to sell their businesses. Although some will gift or sell their businesses to their children, most look for buyers to whom they’re not related, including strategic buyers and private equity firms. Some will also implement employee stock ownership plans (ESOPs) to allow employees to acquire their companies. The segment of the M&A market growing most rapidly is companies in the $2 million to $20 million range.
Both Cohen and attorney Angela Martin, vice-chair of Devine Millimet’s M&A group, emphasize the importance of proper planning and pre-positioning a company before putting it up for sale.
Ideally, business owners will develop their exit strategy over a seven- to 10-year timeline, says Donald Crane, CPA, a partner in Crane & Bell CPAs in Lancaster. This gives ample time to develop a consistent history of profitability and professionalism.
“Potential sellers are often conflicted about putting their business up for sale, thinking, ‘How can anybody else really do it justice?’” Crane says. “As we work with our business tax clients we take a holistic approach, helping them relate their business to the rest of their life and the arc of that trajectory.”
Cohen says that buyers look at three main criteria:
Quality and dependability of earnings: Buyers want to see if there is an over reliance on one or only a few customers.
Quality of personnel: Buyers are looking at the willingness of key players to stay on and the seller’s willingness to sign a non-compete agreement.
Quality of operations: Buyers are looking at markers of quality (such as ISO international standards), the protection of intellectual property and superior quality control of goods and services.
Certain sellers can also benefit by commissioning market studies in advance of a sale transaction so they can then adapt their business model to reach previously unrecognized growth potential.
Call the CPA
Both Devine Millimet attorneys highlight the importance of having CPA audited or reviewed financial statements. With audited financial statements, the CPA provides a high, but not absolute, level of assurance about whether the financial statements are free of material misstatement. With reviewed financial statements, the CPA provides limited assurance that the information provided and summarized in the financial statements is presented without any material changes that would be misleading. CPAs can also provide compilations, which use only information provided by the owners of the business and offer no assurance of the company’s financial health.
“Buyers would prefer [a] CPA-audited or at least reviewed financial statement, but an audit costs a company more than a review and a review more than a compilation,” Cohen says.
An audit involves the most work, so the cost is much higher than a review or a compilation, the least costly and least detailed. Sellers should decide which option to pursue based on their own objectives as well the advice of their M&A team. “Having a nice bound statement of a company’s financial position, signed by a CPA, provides a high level of credibility to a buyer,” Crane says.
However, “many business owners request a lower standard of review from their CPAs unless their bank or lending source requires a higher standard of financial statements as a condition of their agreeing to finance the business,” Cohen says.
Before entering into an M&A agreement, examine whether it will be advantageous to separate any real estate holdings from business operations by establishing two separate business entities. This can provide greater flexibility for potential buyers, Cohen says. Sellers who continue to own the real estate and lease it to the buyer can reap tax opportunities, Cohen and Crane point out. In addition to the continued cash flow generated by leasing the real estate, the business seller is able to depreciate the real estate and take it as a deduction on their tax return.
Of course, finding the right buyer is also key. Businesses and business advisors work with business brokers to find buyers, Crane says. Business owners also need to be realistic about what kind of deal they can expect, says O.J. Robinson, a certified business intermediary (CBI) at CenterPoint Business Advisors in Franconia. “Owners often have a distorted view of value, thinking it’s related to what they paid and how hard they’ve worked, rather than its profitability,” he says.
Given the large number of baby boomers, there could be more sellers than qualified buyers willing to take a risk in the coming years. “That’s why I tell my clients that it’s important they differentiate themselves from other businesses likely to be on the market,” Crane says. He lists a number of ways to achieve that goal: Find a particular niche or specialty that competitors don’t have; be among the industry profit leaders; show consistent sales growth, even if not at an astronomical rate; demonstrate superiority among peers in areas of quality, delivery, customer service and customer retention; and maintain clean, easily accessible financial and business records. “Basically avoid mediocrity by paying attention to the needs of customers, employees and suppliers,” Crane says.
Sealing the Deal
Robinson says creativity is key to success. He should know. He not only advises businesses on mergers and acquisitions, he’s been through them himself. Robinson is an investor and president of the Whale’s Tale Waterpark in Lincoln. He recalls when he and other investors realized how long it would take to expand the water park and decided instead to merge with an existing business, Alpine Adventures, which features zip lines and off-road vehicles. As a result of the merger, “we created a complementary ‘Dip and Zip’ attraction that draws customers under a much wider range of weather conditions.”
Sellers must decide whether they are willing and able to consider financing a portion of the sale, that is, “taking back paper”— a promissory note—as opposed to receiving all cash, Cohen says. There can be tax advantages in spreading out capital gains, but there’s also the risk of default, Crane warns, potentially leading to a retired seller having to take back the business. As an example, the CPA says, “A seller agrees to sell the business to a buyer for $1 million. If it’s a cash deal, the entire gain will be taxable in the year of sale, with much of the gain probably taxed at higher or the highest tax rates. If the seller takes back a note, however, then the gain can be recognized over the term of the note based on principal payments collected on the note each year. As a result, the gain may be taxed at much lower rates than would apply to a cash sale. And the seller can collect interest on the note that reasonably replaces the rate of return he or she might have gotten by investing the proceeds of the cash sale.”
However, he adds, the risk of default by the buyer can be counteracted by a seller retaining a mortgage on real estate or a security interest in equipment sold or a personal guaranty from the buyer.
Before looking for a buyer, Crane advises sellers to get a well-researched valuation by a CPA. “It’s when there is an active potential buyer that it gets really fun,” Crane says. “That’s when you need a good team of professionals. The attorney—a critical player who works to get the best deal possible—is generally the quarterback. There’s a lot more involved than price, including all the specific details that are negotiated for inclusion in a purchase and sale agreement.”
A good CPA is also important, especially with regards to federal and state tax ramifications, Cohen points out. “There can be a push and pull between buyer and seller on how the total sales price is allocated that can affect financing and depreciation and the seller’s taxes,” Crane says. How much of the purchase price should be placed in escrow is another issue, he says. The buyer will often require a partial escrow to ensure that the seller’s representations and warranties are true, accurate and complete, Martin says.
Business brokers, investment bankers, value growth advisers, and various kinds of consultants are also often part of the seller’s team. A good attorney and M&A team can make a big difference, stitching it back together when a buyer and seller hit an impasse.
Although the closing is not done until all the documents are signed, Crane notes, “The closing itself is usually anticlimactic and now often done remotely.” Cohen says, “The good old days of multi-day and all-day closings are largely a thing of the past.”
Cohen says the biggest mistake made in M&As is “not preparing the business, its records and operations for the sale. These steps should be taken before starting the process and interviewing business brokers and investment bankers. Deals crater for a variety of reasons, but the biggest reason is rushing forward with a letter of intent without thinking through all aspects of the purchase and sales transaction.”
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