Closing the Price Gap
The deal is getting down to the wire, the price differential is close, but the parties are not yet in agreement. Following are some ideas that might get the ball rolling and help bring the parties together.
- Let the seller retain the real estate and rent it to the buyer, thus reducing the price. The same could be done for major pieces of equipment. Let the seller lease them to the buyer reducing the price. The lease should, however, like most leases, provide for a buyout at the end.
- Structure a royalty on sales rather than an earnout on gross margins or EBIT.
- Have the parties create a subsidiary for the fastest growing part of the business in which the buyer and seller share 50/50.
- Let the buyers acquire 70 percent of the business with the requirement that they purchase 10 percent more each year on the same multiple of EBIT as in the 70 percent sale.
- Arrange a consulting agreement with the seller to provide additional compensation to be paid annually.
Certainly, any agreement or deal structure should be approved by the party’s professional advisors.
M&A Trends
A recent article in M&A Today offered some observations concerning current and future M&A trends.
“The business world is constantly changing. For the first half of the 20th century, vertical integration was the objective in which, oil companies, for example, owned the entire process from drilling to retailing at the gas station. From 1950 to 1980, diversification was in vogue. Recently, the trend is to outsource everything except the core business. One of the new business models known as the new profit imperative is to go downstream and get closer to the ultimate customer.”
Today’s M&A Climate
Many companies still look to acquisitions as the best way to increase both capability and market share. Acquisitions generally add complementary products, new technology or increase geographic coverage. Interestingly, today’s companies are investing in new ventures, while, at the same time; divesting themselves of some of their original businesses. Since these “original” businesses now have low margins and slow growth, they are being sold off. Quite a few of the large public companies have spun off some of their original core businesses. One company – Perkin Elmer – sold off all of its businesses including its name and reinvented itself as PE Biosystems.
“The previous M&A drivers, such as the need to grow externally as well as internally; the pressure for industries to consolidate; and the ongoing globalization, are all prevalent.”
Tomorrow’s M&A Climate
1. “Strategic acquirers will not only be more particular and demanding about the fit of the target company, but they will continue to divest divisions with the least potential or with low returns.” Edward C. Johnson of Fidelity Investments summed it up best: “My own rule of thumb is that a business has to be good for the customer (quality), good for the company (profitable), and good for the employees (rewarding). If we only achieve two out of three, we have not succeeded.”
2. Gone are the high prices of the late 1990s. “The structure of the transactions will have a higher cash component, but there will be an emphasis on more contingency factors or tighter representations and warranties in an attempt to minimize risks inherent in the deal.”
3. Intangibles will be more important than ever. Areas such as “the brand” will be more important. Branding represents a company’s “credibility, its true identity, its meaning, its uniqueness.”
4. “The use of strategic alliances and joint ventures will be used more frequently as a forerunner or in lieu of acquisitions.” Technology changes so quickly today that one company, especially in hi-tech, can’t do everything. Alliances and joint ventures provide earnings without the dilution of acquisitions.
5. The requirements of the new Sarbanes-Olxey regulations will impede a lot of acquisitions, according to industry experts. This increase in regulatory requirements due to this new law may not only slow down the process, but may actually kill a lot of deals. This is especially true when public companies acquire a privately held one. Sellers of these companies are going to provide a lot more audited financial information.
6. Over the years, many mergers and acquisitions have been within the same industry. There is a trend towards merging companies that can “piggy-back” ancillary services. The recent attempt by Comcast to merge with Disney is a good example – distribution merging with content. Another excellent example is General Electric. They manufacture jet engines, turbines, medical equipment, finance it through a GE finance unit, and then service it through another GE division. The trend seems to be that more manufacturing companies “will acquire relevant service companies as a way to capture more profitable businesses.”
More recently there has been a trend to outsource everything but the basic business. One thing is sure in the world of mergers and acquisitions – change will always be taking place. It is important that sellers and their advisors stay abreast of these constantly changing trends.
Read MoreHow Many Businesses Are There?
We suspect that the answer to this question depends on who you ask! The Internal Revenue Service (IRS) reports that they received some 24.8 million business tax returns for the year 1999. We can hear the joyful sounds emanating from new business brokers and those considering the profession. Wow, almost 25 million businesses! We can hear them adding up the commission dollars. This is a very misleading figure. Many of these tax returns are for hobby-type businesses, one-person consultants, writers, artists and the like. In fact, one source reports that there are 18 million non-employee businesses, and they account for only 2 percent of total sales. INC, in their Small Business issue, reports that Sole Owners generate only 3.3 percent of all revenues and have annual sales of about $38,000.
Home-Based Businesses
According to INC magazine, 61 percent of the firms in their 500 fastest-growing companies list started out as home-based businesses. And, on average, 15 months after they started, they moved to outside space.
We dont want to take anything away from these non-employee businesses, many of which are home-based, as obviously some of them will grow to be large businesses. Quite a few of these businesses, rather than have actual employees, use independent contractors or outsource work needed. Many others are making an excellent living for the owner, and still other owners are quite content with the results of their business. However, they are not the kind of businesses that business brokers and intermediaries normally sell. Certainly, there are a few exceptions — some one-person businesses generate sufficient revenues that would be quite salable. And, it’s not really that business brokers couldn’t sell them or that people wouldn’t buy them. Quite frankly, they are just not commissionable.
Most business brokers, out of necessity, have a minimum fee; adding $10,000 to a selling price of $10,000 would price many small businesses out of the marketplace. There may be a way of handling them, but these small businesses can’t afford full-service brokerage services. This is coupled with the fact that obviously many, many of these non-employee businesses dont generate enough profit, if any, to make them salable. A total annual sales of $38,000 isn’t going to create a lot of excitement among prospective business buyers.
What Is A Real Business?
As we have discussed earlier, we are really only interested in those businesses that have at least one employee. When we are asked how many businesses there are, we assume the person is asking how many possible businesses are available for sale. The above figures give a false impression of the overall marketplace of businesses that might be for sale at some point. Certainly, many of the businesses that have no employees might be available for sale, but most will not. Secondly, business brokers and intermediaries will most likely not be involved in a sale if one does occur. Since most people who call are interested in the business brokerage profession, very few of the businesses that file business income tax returns are really businesses that would sell, especially by business brokers.
Our feeling is that to qualify as a real business, it must have at least one employee. As we mentioned above, we suspect that some no-employee businesses use outsourcing rather than go through all of the red tape required by governmental agencies to have even one employee.
An article in the Boston Globe March 4, 2001 stated that there were 7.7 million small businesses with less than 100 employees. Last year’s Business Reference Guide reported that there were 5.5 million businesses with one employee or more. INC in their Small Business issue said that there were 5.8 million with at least one employee. One other source reported 7.2 million.
BizStats reported that there were 5.547 million businesses with at least one employee. We’re going with that figure.
Here Is A Further Breakdown:
4,467,900 represent 80.5% of the total and have sales under $1 million
790,600 represent 14.3% of the total and have sales of $1-5 million
265,600 represent 4.8% of the total and have sales of $5-100 million
23,311 represent 0.4% of the total and have sales of $100 million +
Total Businesses =5,547,400
*Courtesy: BizStats
Here’s A Breakdown By Type of Business:
Services – 40% (87.8% Of Those Have Revenues Under A Million)
Retail – 19.8% (80.3% Of Those Have Revenues Under A Million)
Wholesale – 7.5% (50.7% Of Those Have Revenues Under A Million)
Manufacturing – 6.0% (61% Of Those Have Revenues Under A Million)
Construction – 12% (81% Of Those Have Revenues Under A Million)
Finance, Insurance & Real Estate – 8.3% (83% Of Those Have Revenues Under A Million)
Transportation/Utilities – 3.9% (81.3% Of Those Have Revenues Under A Million)
Agriculture & Mining – 2.4% (89.8% Of Those Have Revenues Under A Million)
Size Breakdown of Businesses
Here is a common and much-used breakdown by the federal government:
Small Business Administration (SBA):
Very Small Business = 19 or fewer employees
Small Business = 20 to 99 employees
Medium-Size Business = 100 to 499 employees
Large Business = 500+ employees
