Why economic challenges could make now the right time for M&A
If you are evaluating ways to grow your business, acquiring another business may be an option. With the economy in a unique position, and tens of thousands of small businesses in the United States up for sale, knowing what to look for when it comes to M&A and how to undertake a business acquisition will allow you to make sure your business is prepared to take advantage of the opportunity.
The COVID-19 pandemic has been challenging for many small businesses. What’s more, many boomer-generation business owners whose businesses have endured this period now feel ready to retire. According to the U.S. Census Bureau, boomers own 2.34 million small businesses in the United States and employ more than 25 million people. This generational retirement “tsunami,” as dubbed by the Pew Research Center, has overwhelmed the economy as these business owners retire or make plans to retire within the next 10 years.
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Unlike a competitively priced home, which may sell within a matter of days, studies show that it takes an average of eight to ten months to sell a small business, and in recent years, this timeframe has been increasing annually, according to the California Association of Business Brokers. This is even the case for successful, cash-flowing small businesses, thus posing an opportunity for those looking for creative ways to grow.
If you are considering buying a business, there are two buyer scenarios. First, you may be a strategic buyer, seeking to realize synergies by combining or running another company in the same or a related industry as your existing business — that is, growing your business through acquisition. Or, you may be a financial buyer: a company or individual without a company in the industry but with interest in purchasing as a financial investment.
Whether you are a strategic or financial buyer, there are ways you can determine, “Is it time to buy?”
Understand your borrowing options
There are many financing options available to those looking to acquire a small business. Most notably, favorable lending terms are found in U.S. Small Business Administration (SBA) loans, which exist specifically to help qualified small businesses obtain capital for expansion or operations.
Another increasingly popular financing option is seller financing, in which the seller allows the buyer to pay off a fraction of the price of the business over time with interest. Although this is a more complex transaction, it can be beneficial to both the buyer and seller. When the seller is acting as the “lender,” they have a vested interest in the business and demonstrate confidence that the business can continue to be profitable in years to come.
Ask the right questions when researching the business you are interested in
The first numbers you will be presented with when you examine the potential ROI for a business purchase include the company’s annual gross revenue and profit, as well as its EBITDA (earnings before interest, taxes, depreciation and amortization). You should also request at least three years of profit and loss statements so you can reconcile the two and get a sense of where dollars are coming from and going. Depending on the size of the transaction, it may make sense in some cases to engage a reputable accounting firm to perform a Quality of Earnings report.
These numbers offer important insight into a business’s financial performance, but are only the tip of the iceberg when determining if a business is the right investment for you.
For the full picture, the due diligence process includes vetting additional financial documents, including interpreting past tax returns, with the help of your accountant or financial advisor.
Next, you will want to find out how involved the current owner is on a day-to-day basis. If you are a financial buyer, remember that buying a business means buying all aspects of the operation, which includes its employees, liability and day-to-day management needs. Is there high turnover of employees or management? Look deeper into any trends to uncover potential red flags. If the owner is the principal operator, you will need to factor in finding a new operator so that your investment in the business is a passive one. If the owner is absent and the business is already a passive investment, there is less of an incentive for that individual to step away.
For strategic buyers, this is when you will evaluate whether a business is the right fit for yours. It may take months or even years to find the right company to merge with your culture and bring the right balance to help your business grow.
Often, a seller will want to ensure you are the right person or entity to take over the business. After dedicating their time and expertise — even a lifetime — to their business, the owner naturally cares to find a buyer who will maintain the organization’s integrity and take care of its employees. Do your research to truly understand their business and be able to articulate how the sale will benefit you both.
In small business situations where clientele are loyal to the owner, it’s common to experience a drop off in business when you first take ownership. This is something to factor in when you run the numbers and forecast your ROI in the first years.
Enlist a strong team of advisors
If you don’t already have advisors who you consult on financial and strategic decisions, now is the time to find trustworthy experts who can guide you through the acquisition process.
• An accountant will help you review and vet the business’s financial documents and determine whether purchasing the business is the right financial decision for you.
• Your lawyer, or in some cases a specialized merger and acquisition (M&A) lawyer, is needed to help you prepare contractual documents such as a letter of intent, term sheet, other corporate governance documents and also ensure you meet the requirements held by your bank or other investors.
• A banker who has experience in M&A deals and knows your business can help ensure a smooth transaction, help with the valuation of your business and, along with your accountant, help ensure the purchase is a smart financial choice given your individualized situation.
• If this is your first business acquisition, a small business consultant can explain the steps of the acquisition process and prepare you for each step.
• Similarly, a broker can help immensely if you are new to acquisitions. In addition to guiding you through the process from start to finish, a broker can also help you find off-market deals. There are many ways to find businesses for sale, but depending on what you are looking for, a broker who knows the local market can bring extra insight.
Last, if you are a strategic buyer, make sure you are ready to acquire another business
Before you can close an acquisition deal, you will need to prepare fairly extensive documentation. To ensure you are ready to sign when the right opportunity arises, there are several ways you can prepare your business now:
1. Organize and complete your finances on a monthly basis. Financial institutions or investors will ask for your trailing 12-month set of books, so review your finances for accuracy and prepare these documents ahead of time.
2. Work with your financial advisors to assess your business’s financial wellbeing. Are you profitable? Is your business clean from a corporate governance perspective? Your advisors are there to help you ensure the answer to these questions is yes.
3. Pass a background check. Before a deal is finalized, banks and investors will want to know your history, so plan for this level of scrutiny.
Acquiring a business can be a strategic next step to grow your business or your portfolio. With a solid understanding of your financial wellbeing and a clear vision for your future, you will be prepared to make decisions to get you further on the path to your long-term goals.
Author: Brian Crisp is Arizona region president at Enterprise Bank & Trust. For more than 30 years, Enterprise Bank & Trust has primarily focused on serving the lifetime financial needs of privately-held businesses, their owner families and other success-minded individuals.