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Why M&A Investors Are Moving To The Lower Middle Market

Article originally published October 9th, 2018, on Chief Executive:  https://chiefexecutive.net/ma-investors-moving-lower-middle-market/

Why M&A Investors Are Moving To The Lower Middle Market

Middle-market companies are some of the most sought—after assets, providing one of the best environments for M&A investors to create returns. With more companies to invest in, greater opportunities to improve companies, and lower valuations and barriers to entry, middle market companies are attractive to many private equity (PE) firms and strategic acquirers (strategics). However, that attractiveness comes with a cost – increased competition in an oversaturated middle market.

As a result, the lower middle market is gaining popularity among PE firms and strategics. This market segment is gaining traction due to the increased number of opportunities provided by the lower end of the market, along with other factors that make it an investors’ gold mine.

The Investment Sweet Spot 

Lower middle-market firms operate in highly fragmented and very profitable industries, making them prime targets for acquisition and consolidation. The lower middle market is classified as companies with annual revenues between $5 million and $100 million. Currently there are about 350,000 companies in this segment, compared to 25,000 companies with revenues between $100 million and $500 million (the middle market) and only a few thousand companies with revenues above $500 million (the upper middle market), according to Forbes. The lower revenue valuations for the lower middle market are balanced against the exponentially higher volume of opportunities.

Retiring With No Succession Plans

One cause of the increased number of M&A opportunities in the lower middle market is its large population of baby boomers. The owners and CEOs of lower middle-market companies are predominately of the baby boomer generation. Now retiring, and in some cases, facing mortality, these CEOs and owners find themselves without a succession plan in place. Many do not employ a full C-Suite of executives, and their children, a generation that has embraced higher education at a larger rate than generations prior, have found their own dreams as doctors, lawyers, engineers, and more. Those that would have traditionally taken the helm when their parents and grandparents retired have no interest in running the family business.

This lack of a succession plan, coupled with impending retirement, creates an urgency for these businesses to change hands, and bodes well for investors and corporations to acquire, consolidate and grow them.

Better Valuations in the Lower Middle Market

Though deals in the upper middle market are large, increasing competition for M&A targets are driving up valuations in this sector, making the hurdle rate for a return on those investments much higher and harder to obtain. By targeting the lower middle market instead, investors can acquire businesses at better valuations and grow those businesses to achieve the required return for their portfolios. However, the competition in the lower middle market is intensifying.

The 10-year average purchase price multiple for leveraged buyouts of businesses with enterprise values below $250 million is currently 7.3 times EBITDA, the highest it’s ever been.  While it is increasingly competitive as a buyer, new companies are born daily, growing up, and are ready for investment. In turn, investors are finding increased value in lower middle market portfolios, attracted to them for their returns, as these platforms can generate upwards of 50 percent invested capital return.

What This Means for You

So what does this mean for lower middle-market companies? It means there is a lot of capital in the market ready to be put to work. It is reported that 70 percent of businesses in the lower middle market are projected to change hands in the next 10 years. PE firms are chasing large portfolio returns, and strategics are using M&A to buy new products and services to remain competitive in their industries. Both of these market dynamics mean that deal flow and valuations will remain strong.

Therefore, business owners considering an exit need to be ready to move and react to opportunities quickly. The financial rewards can be extremely high, but owners need to know what they’re getting into and be thoroughly prepared. It is important to understand the motivations of investors and the potential synergies gained through a transaction in addition to the enterprise value. As they say, the whole is greater than the sum of its parts.

Understanding the full lower middle market M&A equation—from the hard numbers that showcase the opportunity in the segment, to the skills that will drive the most success with in it— is critical to fully embracing its potential. Those that begin doing so now will establish themselves fully in a market that, by design, is much more difficult to oversaturate due to its sheer volume.

When’s the Right Time to Sell Your Cannabis Company?

Article originally published October 1st, 2018, by Jonathan Small, of Green Entrepreneur:  https://www.greenentrepreneur.com/article/320908

When’s the Right Time to Sell Your Cannabis Company?

Five questions to ask yourself before taking the M&A plunge.

Beer giant Constellation Brands flipped lids last month when it announced a $4 billion investment into pot company Canopy Growth Corporation. This was one of the largest of a series of recent mergers and acquisitions in the cannabis industry that have many entrepreneurs seeing green.

“Right now, the Canadian companies are doing the majority of the M & As,” says Dena Jalbert, Founder and CEO of Align Business Advisory Services in Orlando. “A lot of this activity is taking place in what I call the industry fringe businesses  —  products like vaporizers, lights, software, and financial services.  As regulation lightens across the country, however, Jalbert says, “I think you’re going to see more of it happening with plant touching businesses.”

Are you ready to sell or merge? Better ask yourself these questions first.

Would You Have a Beer Together?

Jalbert recommends doing the “age-old likability test.” When meeting with potential partners, ask yourself, “Would I have a beer with this person?” You have to have a synergy because “it’s a marriage,” she says. Ask yourself if you feel good about these people when you walk into a room with them.

She tells the story of having a client who went with the highest offer, despite not liking the buyer. She tried to talk him out of it but he was insistent. The deal went through, but within months he clashed with his new bosses, who decided to let him go. “He went from owning his own business to six months later he was out of a job,” she says.

Do You Share a Vision?

“When you start your own business, you know what it is and what you want it to be,” says Jalbert. “It’s your baby.” But she warns that whomever is acquiring you “wants to help take your baby and grow it into an adult.”

Seventy percent of all M&As fail because companies just focus on just the asset. They want the widget, but that doesn’t work because companies are more than just widgets, they’re people.

“If you feel like that’s all they’re chasing, that’s a red flag,” says Jalbert. Other warning signs: If you aren’t given an opportunity to meet all the leadership. “You should be able to have access and have open conversations with leadership,” Jalbert says. You should also “be able to articulate freely how you fit into the greater picture.” If it’s a one-way street, then that’s a potential collision.

Is Your House In Order?

Make sure you’re really prepared to let a potential buyer look closely at your books. Jalbert says you will feel entirely exposed. They will ask you everything under the sun about your company. Know this might be the hardest thing you will ever do.

“When someone is doing due diligence on your company, it’s uncomfortable. I equate it to a colonoscopy,” says Cam Battley, Chief Finance Officer of Aurora Cannabis Inc.

Do You Have Access to Financial and Legal Experts?

“Don’t do this on your own,” warns Jalbert. You need to find attorneys and CPAs who really understand the business. Jalbert says she was once involved in a deal in which a client brought a personal injury lawyer with him to negotiate a contract. “Find an attorney who not only knows cannabis but understands mergers and acquisitions,” Jalbert says. Not all firms specialize in both — so do your research.  came with little to no information.

Same goes for financial assistance. No matter how much a whiz you are with numbers, cannabis is a whole different animal. Taxes, in particular, are very complicated — employer and income — depending on what state you’re in, and so are the laws and regulations around cannabis.”

Is The Timing Right?

When it comes to successful M&A deals, timing is everything. Jalbert breaks it down into two factors: macroeconomic timing and business performance timing.

The macroeconomics of the cannabis industry are definitely in your favor. “Cannabis has nowhere to go but up,” says Jalbert. Still, you should do your own research and work with consultants like her company to really understand the opportunities in the space.

As far as business performance timing, you want to make sure that someone “you’ve identified as a good partner has just done something that now makes your merger even more synergistic. For example, they acquire a new big client or they’ve gained a foothold somewhere that they didn’t have six months ago. You have to know what opportunity looks like so that you can seize it when it jumps up,” Jalbert says.

As far as your own timing, always sell when you’re on the up. Says Jalbert, “You’ll know the timing is right when business is going really well and you’re just feeling strong about it. You’ve got that momentum”

What “Buy and Build” Strategies Mean for the Lower-Middle Market

Acquisitions by private equity companies of lower-middle-market businesses has become the main source of value creation for their portfolios. Buy-and-build refers to the buying of a platform company with a well-developed management team and infrastructure, and then using those capabilities to acquire one or more add on companies to build out and grow the platform. According to Boston Consulting Group*, buy-and-build activity has increased from 20% of all PE deals in 2000 to 53% in 2012. The reason for the surge is clear: buy-and-build deals generate an average internal rate of return (IRR) of 31.6% from entry to exit, compared with 23.1% for standalone deals.

PE firms look to buy-and-build strategies due to the traditionally short holding periods of private equity. The typical PE investment thesis requires its portfolio companies be bought and sold fairly quickly, usually within three to five years. PE firms structure their portfolios to invest for their limited partners and then return this investment with value appreciation within a fixed, relatively short time period.

To be successful in this strategy, PE firms work to rapidly increase revenue and profitability of their portfolio companies, in order to structure a quick exit (and high return on investment). The fastest way to drive revenue is through additional “add-on” acquisitions versus traditional organic growth. Hence, the “buy-and-build” strategy is put to work to deliver the needed rapid growth.

So what does this mean for lower-middle-market companies? It means there is allot of capital in the market ready to be put to work in consolidating highly profitable businesses in fragmented industries. According to the Private Equity Growth Capital Council, there are 2,797 private equity firms headquartered in the United States that collectively invest in 17,744 companies. With the baby boomer generation retiring at an increased pace, there will be more businesses available for purchase than ever before. It is reported that 70% of businesses in the lower middle market are projected to change hands in the next ten years. These two market dynamics colliding will likely result in continued high levels of deal flow and valuations.

Therefore, business owners seeking an exit should try to understand PE’s motivations and strategies prior to negotiating a potential transaction. Likewise, owners need to be ready to move and react to opportunities quickly. The financial rewards can be extremely high, but owners need to know what they’re getting into and be thoroughly prepared. There is more to the process than just finding the right buyer, and owners shouldn’t try to go it alone. Seek out a trusted adviser to guide you through the process – without one you’ll be at a significant disadvantage in negotiating and closing your deal.

At Align, we specialize in helping lower middle market businesses navigate the capital market landscape and execute successful transactions. We’ve facilitated hundreds of transactions totaling over $1B in value, so we’ve been where you’re going and can take you there. Going through a transaction without an adviser is like playing poker when you don’t know the rules – only to find that the other players at the table are experts. You’re at an immediate disadvantage. Let us help you level the game and ensure that all walk away from the closing table happy.

*References: Buy and Build Takes Private Equity Value Creation to the Next Level; February 19, 2016; https://www.bcg.com

Yes, You Need a CFO…

Last week I had practically the same conversation with two different startup-founder friends:

“We’re stretched really thin. Do you have any advice on hiring a VP of [X: marketing, people, product, operations, etc]?”

My response …

“You’ll think I’m crazy for saying this, but I think you need a CFO.”

Most startups and small businesses kick the can on hiring a CFO-level resource until they’ve hit major growth mode. Until then, the idea is that a bookkeeper or controller can handle the day-to-day until the company is large enough to be metrics-driven. The problem with this ideology is that the strategic finance – fundraising, strategic planning, budgeting/forecasting, investor relations, and so on – fall on the shoulders of the Founder and/or CEO. Likewise, the Accounting is often not at all connected to the strategy and plan the CEO designs, so tracking, measuring, and reporting success or failure is virtually impossible.

We advise clients that if you’re at a $1MM annual revenue run rate, adding a finance professional to your executive team will probably save you more money than you pay for that resource. And they’ll save you time, as well. Better yet, using a seasoned Fractional CFO service (yes, like ours), will save you even more – you get the seasoned expertise and resource for less than hiring a permanent resource in-house.

An experienced finance executive will:

  • Take the job of managing the accounting and/or bookkeeping staff off of your plate.
  • Ensure your accounting infrastructure is built around your operations and is up-to-date with the latest and greatest GAAP pronouncements. This is especially important if your organization is seeking funding from investors and/or lenders.
  • Build an operational model for you that is cash-flow based, up to date, detailed, and connected back to the GAAP accounting that you need to produce proper reporting on the results of your business. Your board of directors, especially, will require this as they want to be able to quickly assess the health and growth of the business beyond the traditional financial reports (i.e. P&L, Balance Sheet, Cash Flow Statement).
  • Improve your processes all around, and take off of your plate, negotiating with vendors and paying invoices.
  • Build a strategic model (connected back to your operational model & GAAP accounting) that will make investor and lender conversations a lot easier. These stakeholders will fund you faster at better valuations/rates if the financial performance of the company is truly transparent.
  • Help better manage treasury and liquidity. Having a detailed operational plan will help you have access to lines of credit versus having to equity fund-raise too early. This keeps you from being so cash constrained that you’re starving your growth just to run the place.

The above list isn’t all inclusive – there is certainly allot more to be gained. All these things are really, really valuable – they have a tangible cost to the business if left unaddressed. They’ll help you know where your money is really going, where you can save money, and where are the biggest drivers and drains on your cash-flow. Armed with this resource, CEOs can make informed, actionable decisions much more quickly and can take advantage of opportunities and address weaknesses much faster. This is the lighter-fluid that ignites the fire of growth even faster.

And one last thing…the above doesn’t mean you need fancy accounting software or an expensive BI database. Quickbooks and Excel will work just fine and get you the same data. It’s more about having the resource to manage it all for you, leaving you solely focused on continuing to grow the business.

So, where do you find this resource? Well, give us a call…we’ve been where you’re going and can put the above into place for you. Link: Align Finance Services

Why is my technology startup not getting funding from venture investors?

We get allot of requests from early stage startups for help with their business plans, pitch decks, and seed/angel funding. While we at Align have a pretty high batting average getting our clients the funding they need, not everyone gets funding.

 Even when fully prepared, 95% of angel venture investors pitched by startups will decline to commit an investment.

That seems really daunting, we know. But, it’s a numbers game. It means there are 5% of angel or seed investors that will be willing to invest. So, what do those investors want to see to get funding? That’s the million dollar (literally) question!

Can You Do It and How Will You Do It?

Every startup that pitches an investor has the “best” idea. It’s “disruptive” and “never been done before” among many other over-used descriptions. They don’t care. They just want to know the basics: who, what, where, when, and how. The most important being the HOW. They want to know WHAT you are developing (product or service or both), WHO your leadership is, WHERE is your target market and customer, HOW will you execute, and WHEN will they realize a return?  Oh, and they also want to know exactly how you are going to use the money they give you.

It’s a Partnership

Yes, you need the capital. But you also need to make sure you’re pitching to and partnering with the right investor for the stage you are in. If you are idea or early-stage, don’t waste your time going to late-stage investors or funds. Do your research and ensure your pool of target investors lines up with your current life cycle stage, your industry, and that they have resources and expertise to bring to your organization beyond just the capital. And if that seems daunting to try and research on your own, no worries, we can help you with that.

Overall Investment

We encounter many founders that have watched too many episodes of Shark Tank and Silicon Valley – and they don’t realistically evaluate the valuation of their company. Early-stage founders and investors are extremely sensitive to valuation as it significantly impacts returns for all involved.  And founders’ ego tend to not want to give up too much of their “ownership.” Valuation is based on value. What value have you created? Be able to outline in detail your value – based on market traction, momentum, IP, operating trends so far, financial metrics, etc.

Team

Early stage investors are backing the idea and the management team. They’re betting that the management team can execute. Leadership ability, technical aptitude, prior experience, salesmanship, ambition/passion, ability to be coached, and many other attributes are things that investors will evaluate in the management team. They look for A-players. If you don’t have them, get them before you start pitching. Or, at the very least, have them committed to join pending the funding (if budget is your issue). The management team is where most deals fall apart. Investors that don’t feel confident in and excited to work with the team, they won’t invest. No matter how good the idea is.

Market & Customer

Who is your customer? It is amazing how many startups can’t answer this question succinctly. (If you can’t, call us. We can help you). Clear definition of product/service-market fit is critical. Investors want to know who will consume your good or service, and how will you get the product/service in front of them to grow volume? Pricing and distribution are components of this strategy as well – make sure you know what you are selling, for how much, and how you’re going to sell it. This is paramount because it determines the trajectory of the hockey-stick. Investors are looking for the hockey-stick – when will the market adopt the product/service and when will revenue take off?

Infrastructure

Lastly, you need to articulate how you’re going to support this growing company. First, start off with explaining how your’re going to use the investment. People, IT, marketing, advertising, etc, etc. By line item – where will the funds go? Then illustrate how you will scale the infrastructure of the business in parallel with growth. They want to see the cash burn to break-even and beyond. HR, Finance, Technology (development and support), operations, customer service, and all other applicable support areas need to be defined. Here’s a free tip: try to make as much of those costs variable and in line with revenue as possible. Fixed costs = cash burn. Then you’ll be raising money again really quickly.

Summary

So, if your business plan, pitch deck, financial plan, etc all contain the above key items, you’re likelihood of receiving investment subscriptions is much higher. Nothing’s guaranteed, but you’re far more prepared than others who don’t put the time into those details before they start the roadshows. And again, if you need help, just call us. We’ve done LOTS and LOTS of pitch decks and facilitated many, many management presentations, so we know where you’re going and what you need.