The coming year holds its share of uncertainties, from the impact of rising interest rates to the billion dollar question: Will there be a recession? Spoiler alert: 91% of U.S. CEOs think that we’re headed for one. FourBridges Managing Director Andy Stockett weighs in on what it all means for business owners that are considering a sale in 2023. From what he’s currently seeing in the market to tips for those looking to sell, Andy covers the burning questions on every business owner’s mind right now. Watch the video interview, or read a full transcript below.

 

What’s the outlook for business sellers in 2023?

As we head into 2023, we still see steady transaction volume. We’ve looked at statistics going back to Q1 and Q2 of 2022, and it does look like the number of transactions closing in Q2 is off somewhat versus the prior year. There were 55 transactions that closed in Q2 among the database that our friends at GF Data sample, compared to 93 in Q2 of 2021. 

Some people say that this dip is a result of a breather from the torrid pace of sales back in Q4 2021 and Q1 of this year. So we’ll see if that plays out, or not. Even though the number of deals came down a little bit, the actual multiples held steady, so we haven’t seen any kind of a decrease in multiples or valuation metrics at this point.

What are you seeing at FourBridges?

At FourBridges, we’re actually fairly busy. We’ve got some transactions that are in the middle of being marketed, or close to being closed. Buyers still seem to be interested in deploying capital. We’re continuing to receive inquiries about what’s in our pipeline, and I think that’s being driven by the amount of private equity capital that was raised during this year, or the last couple of years.

In 2021, there were 389 new private equity funds that came to market, raising about 301 billion in capital. And so there’s a lot of dry powder that’s still out there — that’s capital that’s available to be invested in privately held companies. At the end of 2019, Pitchbook estimated there was 1,700 billion. There was 1,900 billion at the end of 2020, and there was 2,100 billion at the end of 2021.

What does that mean, exactly, and how does that impact business owners? A lot of it has to do with the structure of a private equity firm. In the first couple of years after a PE fund goes out and raises say a 500 million dollar fund. They get a management fee typically of 2% of that capital for the first couple of years. After that, it flips to being paid a percentage of capital that’s been deployed. So they can’t really go out and raise money and then just sit on it.

What would a recession mean for business sellers?

The impact on a potential seller in a recession would be driven primarily by what type of business they’re in and how their financial metrics are holding up. We’ve got a couple of industries we’re working in right now that are still performing solidly. One company is in the electrical control panel industry, which is going pretty strong — primarily driven by the onshoring of manufacturing back to the U.S. as people continue to de-risk the supply chain issues involved with Asia. Another driver in that industry is the need to upgrade the nation’s electrical grid as electric vehicles continue to proliferate.

For companies that have high quality financial performance, we think that there will still be a good pool of willing buyers.

How will rising interest rates impact business sales?

As everyone knows, the Fed has continued to raise interest rates in 2022. We haven’t really seen  much of an impact on headline valuations yet, but that will remain to be seen over the next few months or quarters. What we have seen is that some of the lenders seem to have pulled in their horns on some of their underwriting structures to finance buyers.

For instance, we had one transaction where the buyer felt that they could finance the deal just through a certain amount of equity and utilize senior debt for let’s say four times EBITDA, or cash flow. In the last quarter, things have tightened up a little bit to the point where the buyer is still willing to pay the headline price that they had given us in the LOI, but the capital structure is changing a little bit so that the amount that the senior lenders are willing to give is about three times cash flow, or EBITDA, and that requires them to either put in more equity on their own or to go to a mezzanine lender to fill that gap.

What can business owners do to prepare for a sale in the coming year?

In a climate like this where an owner may be scratching their head about whether to rush to market or not, it’s a great time to check under the hood and see if there are aspects of the business that need improving. One thing that we can’t stress enough is make sure your financial statements are in great shape.

We’ve had a number of situations where the top line number looks great, but then you get into the company and find that they’re maybe not doing inventory accounting properly. That can impact what the true cost of goods sold would be. Other hotspots can be revenue recognition policies, percentage of completion procedures, accruals for vacation, sales tax compliance in all states where business is conducted and whether bank statements are reconciled monthly.

There’s a lot of things that are not that difficult, and particularly for a company that’s got a good top line and good cash flow. Any investment that you can make in getting your books in order —  so that once all the happy talk is over, and they send in the accountants to do a “quality of earnings” — will pay out in spades and ensure you close a deal on the terms you originally agreed upon.

Why should business sellers partner with an advisor?

If you’re thinking about a sale in 2023, it’s a good time to start assembling a team of folks to help you through it. My career has been spent primarily in investment banking and merger and acquisition work, but I did take a detour into operating a business with a company that we grew to 90 million in revenues, and decided to sell. At that point in time my partners asked me, why can’t you handle the sale? And I said, well, it’s impossible to properly handle the complexities of a sale and still do what you’re supposed to do on a day-to-day basis. Attempts to do that on your own typically hurt the near term performance of the company and eventually impact the value you receive at the end of the process. And of key importance, the objective advice you get from a professional is invaluable.

Beyond just having an M&A advisor, be looking for a good corporate attorney to help you get your records in shape to ensure you are in compliance with key regulations. Tax planning with your CPA to make sure that your company is in good shape for a transaction is very important. And if there’s some estate planning work that you might want to do, that’s important as well. So it’s always good to try to get things in shape when the business is operating at a normal pace, versus having to do it when you’re in the middle of a transaction.

Any other advice for business owners considering a sale?

One other thing about selling the business that I probably ought to mention is make sure that you’re doing a review of your current management team. Some of our clients look for situations where they can partner with private equity, sell a certain percentage of it, but then remain very active in the business and take it to the next level over another four or five years. If a sale is completed at that time, an owner gets what we call “a second bite of the apple” that might be significantly more than what they received in the first transaction.

Most of our clients are looking for an exit where they’re getting out of the day-to-day management of the business. And if you really want to make sure that the value of your business is maximized, make sure you’ve got a good management team behind you. And that it’s a team that the potential buyer will feel will help them take it to the next level. In some instances, you may need to be there for a transition for three, six, nine months. Some buyers are comfortable going out to find a new CEO to bring in during that time, but you certainly need to have at least a good number two or a good solid management team beneath you.