Maximizing Value in Middle Market M&A

Strategies for Success in Uncertain Economic Times

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While the U.S. economy is still advancing and many of the underlying economic indicators are still positive, there is no doubt that we are in an uncertain economic environment. Rising interest rates, inflation, supply chain issues, global political turmoil, and tightening credit from commercial lenders have all created headwinds for the overall economic environment. Additionally, these headwinds have created more apprehension for buyers of middle market deals. While the headlines in the media sound quite ominous, there is still plenty of money chasing deals, and financing sources are readily available for an acquisition. If you are considering a sale in this environment, you can achieve strong results and reach a successful conclusion. That said, given the economic headwinds, the room for error in a transaction process has tightened. Listed below are seven key factors which you should help mitigate potential pitfalls during a transaction in this environment.


1. Hire Your Transaction Team Well in Advance of Starting a Sale Process

Middle market business owners typically decide to sell their business and then work to hire a transaction team to start the sale process. This type of decision usually occurs 7 to 9 months prior to the business being sold. This timing does not leave the transaction team with much time to suggest value-enhancing changes to the business. Most transaction professionals will advise you to assemble your team well in advance of launching the sale process. Every company is different, however, allowing 1 to 2 years prior to a sale transaction allows your advisers to suggest meaningful changes to your business to maximize value and heighten the probability of a successful outcome. Many of the focus points for your transaction team will be mentioned in the following points of this article.


2. Clean Up Your Financials

Your financial statements will be the starting point of the valuation discussion for your business. If these financials are unreliable, confusing, or require a lot of adjustments to present a normalized GAAP statement, it will slow down the process and be a detriment to value. If you are contemplating a sale of your business, you should start the process of getting audited financials put in place. Additionally, it is common to hire an accounting firm to complete a quality of earnings report prior to starting a sale process. This type of report will mimic the buyer’s diligence process and highlight areas of concern or suggested adjustments to the company’s financial statements. You want to own this part of the process. Many business owners try to save on the cost of an audit or quality of earnings report. Ultimately, the cost will be many times larger if you do not control the narrative on your financial performance and the basis of value.


3. Settle Lawsuits or Contractual Disagreements

Selling a business is difficult. In this environment, selling a business with active litigation or a contractual disagreement could be a showstopper. The uncertainty around the outcome of these issues tends to heighten the valuation gap between buyers and sellers. A common theme we witness in the current market results from inflation and the need to pass cost increases onto customers. Oftentimes we are working with companies who saw their costs spiral upward during 2022 and early 2023 because of inflationary pressures. At the same time, they could be locked into fixed contract pricing with their customers. The company typically tries to pass along the rising costs, however, the customer is under no pressure to accept these costs. While this is part of doing business, it will highlight to buyers the potential risk of this company in an inflationary environment. If these types of issues are significantly impacting your business, it might make sense to work through these issues prior to starting a sale process. Additionally, if the company is working through litigation issues, it could delay the process of the sale transaction.


4. Eliminate Noise in Your Business

It is common for sellers to show their historical revenue, gross margin, and EBITDA (earnings before interest, taxes, depreciation and amortization). It is also quite common to show adjusted EBITDA. Adjusted EBITDA reflects the company’s financials on an adjusted basis, reflecting non-recurring items that are common in a private business. They could include: 1) family members on the payroll who aren’t that active in the business; 2) running personal expenses through the company; 3) paying above or below market rent on the building that they own in a separate company; 4) above market compensation to the owners; and 5) other expenses that the buyer wouldn’t continue once the business is sold. All of these add backs are not uncommon. That said, in this economic environment, this adds a level of scrutiny that heightens the difficulty of getting a deal over the finish line. If you have the time, clean up these add backs prior to going to market. If you can show a year of financials without having to make significant adjustments, it will help provide credibility to your financials and business operations.


5. Understand the Bottle Necks to Getting a Deal Done and Develop a Plan

Most transactions have certain factors which can slow down a sale process or cause a long-term delay. Many of these issues are known prior to starting a process. Given the time and proper focus, these potential bottlenecks can be resolved prior to going to market. Common issues that are typical include: 1) 3rd party consents that need to be obtained prior to closing; 2) working capital disagreements; 3) Employment contracts for key employees; 4) non-compete agreements; 5) Rollover equity requirement for key selling shareholders; 6) Potential concern around the validity of independent contractors used by the company and the associated liability if they are deemed not to be independent; and 7) (non-market) legal agreement demands which owners might request as part of the transaction.


6. Know the Buyers and the Value you Add to Each Buyer

The value of your business can be different depending on the buyer. On a typical deal that we broadly market, the valuation range could vary by 25-75 percent depending on the buyer. Each buyer has a unique view of the value of your business. A good advisor will understand this dynamic and spend time building a synergy or value driver view that is specific to that buyer or group of buyers. While it is common for the buyer to know the synergies related to acquiring your business, they might not understand the full scope of synergies available by combining the businesses. Doing a thorough analysis of these synergies not only highlights the opportunity, but it will also push the conversation toward the upside opportunity vs. how the business operated historically. In these uncertain times, showing a strong growth opportunity will provide a strong base of interested parties while driving value to an optimal position. Failure to do this type of analysis transfers the premium value opportunity from the seller to the buyer.


7. Timing is Everything

There is an often-used line in M&A deal making, “Time kills all deals”. The basis of this typically refers to not wasting time during a deal process, once you have a deal in hand. Delays can kill a deal. While this statement has a lot of merit, it is only capturing part of the story. There are optimal markets to sell a business as well as sub-optimal markets. Different industries are typically in favor at different points of an economic cycle. In the current environment, there are still plenty of premium valuation deals getting done. These deals fall into certain industries (e.g. business or residential services) or have a certain characterization. If a business owner has flexibility, they should approach the market when the characteristics of the market are optimal for their business. For example, a deal with cyclical revenue cycles, supply chain issues, and declining margins will be much better off waiting until they can resolve their cost and supply chain issues. Going to market in today’s environment will be met with a muted response. A common pitfall that we see with private business owners is this paradox: When the business is running at peak performance, the owner has no interest in selling; when the business is hitting hard times, they are more inclined to seek an exit. This thinking should be reversed. The best time to consider selling is when the business is operating at peak levels. Like investors in the stock market, when the market is in a bull market, it is hard to see the negative side of the story. When it is in a bear market, it is hard to see the positive long-term vision. Owners of private businesses have the same approach to selling their businesses. Time does kill deals; it also could make an average deal into a great one.

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Bob Coury

CEO & Managing Director

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