Inflation, rising interest rates, and the Ukrainian-Russian conflict are among the top concerns for business owners today. In light of this, should business owners pause their acquisition plans in 2022?
In a recent webinar, Oak Street Funding associates, Bruce Warren, Vice President of Sales, and Rob Roach, Commercial Underwriter, recommended business owners continue their acquisition plans. With a clear vision in mind, business owners who were considering growth by acquisition before the rate increase should continue to pursue that strategy following the best practices that we’ve learned lead to a successful outcome.
Influential Factors in M&A
In addition to rising interest rates, there are many other factors to consider such as the overall demographic of owners, the value of recurring revenue streams, and the relatively inexpensive cost of capital. Together, these factors indicate the strong acquisition market will continue in 2022. According to Bruce, acquisitions have traditionally increased organically every year and that trend is likely to continue. As the Baby Boomer generation ages, those business owners are looking to sell their businesses.
Not only are interest rates increasing, but so are multiples. According to Rob, “We’re seeing multiples of revenue and multiples of EBITDA continue to rise.” Recurring revenue streams are very valuable today and several factors are increasing those multiples such as increased difficulty to organically grow, fee structure compression, and business owners’ increased interest in scaling their business to become more efficient. Of course, this is beneficial primarily for sellers, but it shouldn’t discourage buyers. It merely means buyers may have to finance the deal differently than they would have in the past.
Structuring the Deal
With multiples at all-time highs, the deal structure must consider how much third-party debt the buyer can obtain without overleveraging. The buyer should evaluate how much equity they put into the deal, how much of an earn out or seller note will be determined, and the right amount of third-party debt. Alignment of all parties early in the process is vital to winning an acquisition with long-term success.
The deal structure must prioritize the book of business that often holds the key to the people and profits of the deal. Bruce said, “Because we lend money based on the book of business, we’re really monitoring the success of that book. When you're buying a firm, we want to make sure that the transition of the book is effective so clients don't leave, those revenues stay around, and the value of the firm or enterprise goes through the roof.”
We’ve found the best way to ensure that is to structure the deal so the seller and other key employees remain with the business for a while to help with the transition. The buyer should meet with key employees and major clients in the seller’s portfolio to begin building relationships. This will help ensure a smooth transfer of assets and client loyalty. Protecting the book of business is one of the best ways to ensure a winning deal.
Winning an Acquisition Deal
Once the structure is in place, Rob and Bruce shared some tips to ensure a winning deal. Bruce recommends buyers have what he calls “the financial house” in order when approaching a lender. “Have financial statements and tax returns readily available. But also consider the ancillary documents like non-compete agreements, client engagement letters, and non-solicit agreements with all employees, not just the selling owner. Intellectual property and client relationships are very important and should be protected.”
On the underwriting side, Rob evaluates how a business will fit into the buyer’s current company. He said, “One of the powerful things that a lender needs to understand is how the acquisition will affect the business going forward. What steps is the buyer taking to make sure the acquisition will be profitable?”
To win any deal, a great team is vital. Acquirers must surround themselves with partners that will help them success. Hire an experienced attorney familiar with acquisitions in your market and partner with a who lender really understands the nuances to your business and sees the value in your revenue streams. Both the buyer and seller have a lot of responsibility during an acquisition and both parties must prioritize communication to ensure a successful deal where everyone wins. The seller wins a maximum price for their sale, the buyer wins the seller’s book of business and employees, and the client wins a smooth transition with no disruption of service.
The market for acquisitions remains high despite the increasing rates and threats of geopolitical turmoil. If acquisition is the best strategy for a business owner to realize their vision of growth, they should continue to pursue that strategy. Rob advised, “Be patient, deliberate, and thoughtful. Not everything is going to be perfect during the acquisition process, but with the right plan, buyers can show their ability to handle bumps in the road.” Bruce seconded the advice to be patient and recommended buyers show discipline and stick with their plan. Business owners who follow this advice will win acquisitions in 2022.
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.
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