In the next decade there will be a sharp rise in the number of business owners seeking retirement, with estimates from CIBC World Markets in 2012 predicting 50% of owners will try to sell their business during this time. Options for an exit strategy can be categorized in three ways: sell to outsiders, sell to managers or pass on to family. The good news for owners is it’s still a seller’s market – making mergers, acquisitions and management buyouts very appealing. But what does it take to successfully sell?
Currently, investors are looking for better returns than are available in bonds, real estate and stocks, and are attracted to private equity. Banks are offering credit at historically low interest rates and aggressively seeking market share after a period of risk aversion. However, the level of buyer and financing interest varies by size and the quality of business, and can be segmented by earnings level:
- Middle-market companies with earnings before interest, taxes, depreciation and amortization (EBITDA) of $5 million to $15 million: In this category there are an abundance of interested buyers from private equity, family investment houses and strategic acquirers. In this range investment bankers are highly motivated to help you sell, on average, at EBITDA multiples of five to six times, with some as high as nine times. Debt financing is readily available with senior lenders providing up to four times EBITDA in senior term debt, at low rates and sometimes with extended repayment terms.
- Medium-sized companies with EBITDA of $2 million to $5 million: These businesses also have considerable interest from investors, although not as much from private equity funds. Here the buyers are more fragmented, ranging from high-net-worth individuals to competitors and industry consolidators.
- The lower middle-market deal could include a management buyout supported by a financial sponsor. Debt financing is available; although at lower leverage multiples ranging from two to 3.5 times EBITDA, sometimes supplemented by mezzanine finance for an extra turn of EBITDA. In this category valuations tend to range between 4.5 to 5.5 times EBITDA.
- Small to medium-sized enterprises (SMEs) with less than $2 million in EBITDA: the options are more limited for this segment, especially for small businesses with less than $1 million EBITDA. These companies do not attract institutional equity and the sphere of buyers will likely be competitors and management, either from within the company or from someone looking to buy a business. These businesses are trading for 3.5 to 4.5 times EBITDA, and debt is available but at lower levels – especially for businesses with low tangible assets and for buyers with low net worth or less experience in owning a business. For these transactions, the financing mix usually involves some subordinated or mezzanine debt, which carries a higher interest rate.
In cases where the buyer is a third party, such as a competitor, acquisitions typically involve some level of vendor financing, ranging between 15% and 45%.
This is due to the buyer wanting to align the interests of the vendor with his or her own. The vendor financing is usually in the form of a note, repayable over a fixed term with interest paid quarterly; however, earn-outs are becoming more popular as a way to bridge the difference in opinions on valuation. One acquisitive client of mine remarked, “You tell me the price, and I will tell you the terms.”
Expect to see more management buyouts for SMEs over the next decade, because they’re an attractive investment for the management team, investors and lenders. There is an advantage to the owner by allowing the transition of ownership over time, if desired, using options as a way to buy in over five to 10 years and culminating in a sale. They are relatively low-risk deals for financing partners because the management continues and may bring renewed, creative energy to expand the business.
Vendors may prefer a strategic acquirer to get a higher price, but they may not have a choice if the business is too small. On average, management buyouts sell for about one times EBITDA less than strategic acquisitions.
There is no doubt that financing for mergers and acquisitions is becoming more available and offered on better terms.
While the going is good, I am advising my clients to lock in their management team and build their succession plan, because, demographically speaking, time is against them.
This is the third in a series of columns on financing startups, growing companies and acquisitions. •
Robert Napoli ([email protected]) is vice-president of First West Capital, a division of First West Credit Union that finances acquisitions, buyouts and growth. He is also past president of ACG British Columbia, an association for deal-making and corporate finance professionals. His column appears monthly in Business in Vancouver.
