Purchase and sale transactions may have slowed in the economic downturn, but opportunities are plentiful for those with realistic expectations.
“The bottom line is that deals are still getting done in this environment,” says Michael St. Peter, an attorney with Levenfeld Pearlstein, LLC. “There is a lot of cash on the sidelines that investors are looking to put to use in privately held businesses.”
Both buyers and sellers can still find the right deal, he says. They just have to work a little harder to do so.
Smart Business spoke with St. Peter about how to find good deals in difficult times and how to safeguard against bad deals.
How can a business owner find the funds now to get deals done?
Traditional bank lending is tight in the current environment, but it is still open to quality borrowers with strong cash flow and low leverage. Generally, traditional bank lending is more available now than it was six months ago at the height of the panic.
Also, private equity firms are more open to partnering with entrepreneurs and strategic investors now than they were a couple of years ago because there is less traditional financing available for those private equity firms to finance the entire transaction.
Finally, alternative funding sources are becoming more readily available: high-net-worth individuals, family offices or hedge funds that may be looking to make a minority investment in a private business; loans from accounts receivable factors or asset-based lenders; small business association loans; and seller notes, which is the seller of a business extending the financing necessary to purchase the business.
How can potential buyers access these funds?
Potential buyers need to be willing to shop their deal to different banks and financing sources, including alternative financing sources. Compared to a couple of years ago, financing sources are less likely to come knocking on the buyer’s door.
Traditional banks are hungry for deposits to increase their deposit base. If a potential buyer has cash, parking that cash at a potential lending bank creates an advantage in being approved for a loan.
Entrepreneurs can talk to their banker about obtaining a Small Business Administration loan for a potential acquisition but need to be prepared to provide personal assets as collateral.
Where can potential buyers find opportunities to purchase assets at attractive prices?
Valuations of many private companies are at historically low levels, just like publicly traded equities. Smaller competitors and larger businesses that may be looking to shed noncore assets or businesses are a good place for a potential buyer to start.
There are also distressed businesses that may not survive this downturn or that have already filed for bankruptcy protection. Several forums are available for a potential buyer looking to purchase distressed assets, including Section 363 sales, UCC sales, assignments for the benefit of creditors and state receivership auctions. The financial adviser, investment banker or lawyer of potential buyers may be able to introduce them to these types of opportunities.
What are some common pitfalls to avoid in purchase and sale transactions?
For buyers, the most common pitfall is taking shortcuts in the due diligence process. Also, buyers make the mistake of not closely analyzing the working capital needs of the target business. It could be a quality business with significant growth potential, but without enough working capital to fuel that growth, the business is likely to fail.
Another pitfall is the failure to protect the target company’s intellectual property and human capital — its employees — with appropriate noncompetition, employment and intellectual property agreements.
Finally, taking on too much leverage in an acquisition really hamstrings the business from day one.
For sellers, a common pitfall is not ensuring that the business is ready to be taken to market. The business needs to have its corporate and tax records, customer contracts and employee-restrictive covenants all in order.
Another common pitfall for sellers is not having realistic expectations about the valuation of their business. This can be a difficult thing for sellers because they spent a lifetime building a business, and by selling now, they are likely to get a lower price than they would have received for that business at the height of the last economic cycle.
How can buyers and sellers guard against these pitfalls?
For both sides, conducting candid negotiations on the purchase price and working capital requirements early in the process helps to avoid misunderstandings or surprises later.
For buyers, obtain monthly financial statements from the target through the closing of the transaction and watch for negative trends. Make sure that fulsome representations and warranties are made by the seller in the purchase and sale agreement, and pay attention to agreements with employees to ensure that those employees are properly incentivized after the closing.
For sellers, seek appropriate caps on the indemnification obligations to limit exposure after closing, and if declining sales trends or other surprises do occur during the negotiation process, examine the possibility of an earn-out or a hold-back of the purchase price rather than an outright reduction of the purchase price.
Michael St. Peter is an attorney with the Corporate Practice Group at Levenfeld Pearlstein, LLC. Reach him at (312) 476-7508 or firstname.lastname@example.org.