Successful Exit 10 + 1

Ten Steps to a successful exit

Before you start

Start Early

Two years before you think you might want to exit, ask your business advisor, accountant and attorney for their recommendations on maximizing the appeal of your business to potential buyers.  There are steps you can take when you first start a small business to defer taxes at the time of same and there are ways to roll gains forward.  These require planning with your tax and legal advisors early in the process.

Do Some Research

Research similar deals in your industry.  Compare your KPIs to companies that recently sold.  Know your strengths and weaknesses compared to other similar deals.

Know the Value

Have a professional provide an opinion of value using several valuation methods.  Ask them which method best suits your business and why.  And know whether your business has cyclicality that may impact the valuation based on time of year or other recurring events that can positively or negatively impact the value on the day of closing.

Know the Market

Ask your advisors whether it is a buyers’ or sellers’ market and why.  Become familiar with the metrics most often used when valuing transactions in your space.  Is it a multiple of sales? EBITDA (which it is in most cases)? Subscribers? Assets? MRR/ARR?

Have a Clear Strategy for Valuing Unique Assets

Most business owners believe they have some asset that differentiates theirs from the crowd.  Be realistic about this.  Tech companies can sell for outrageous EBITDA multiples if they truly have ‘must-have’ intellectual property.  In most cases, unique assets may contribute a slightly higher multiple but they do not drive the overall valuation.

First things first

Customers First

Every buyer wants to acquire a company that is demonstrably customer-centered.  Work with your advisor team to ensure that you have full bandwidth to continue leading your company’s commitment to meeting customer commitments and growing revenue, product offering and other key drivers.  It is our job to insulate you from as much of the deal minutiae as possible.

Don't Take Your Eye Off The Ball

We tell every business owner “Don’t take your eye off the ball”.  Your job is to run the business.  Our job is to run a process.  Inside baseball hint: some buyers are known for their protracted processes that draw the business owner farther and farther down the rabbit trail causing business operations to diminish, decreasing the value of the deal.  Your advisors will help you select the best partner, not just financially, but also in terms of certainty to close on the stated terms, including a realistic, mutually-acceptable closing date.

To Tell or Not to Tell

We tell business owners that unless your deal closes in less than a week, assume your entire team knows about it.  You don’t have to tell employees everything but you do need to tell them something.  Your advisors will help you put the right positive spin on the messaging, even when some employees will not be moving forward with the newco.  A transition is an emotionally-charged event – be prepared to do some hand-holding with a few employees, the ones that find stress in, well, everything.

Clear Lines of Reporting

Designate specific employees to respond to each piece of due diligence and designate delivery dates for each.  Collate due diligence documents in a central location (cloud server, typically) and review them before they are released to your advisors and then to the buyer.  Ask your lead advisor to show how they have indexed your due diligence materials so that the information is easy for the buyer to access.  And your advisors should have a weekly status update with the buyer - this way expectations can be shared by both sides and perceived issues can be effectively resolved.  An email recap with deliverables, dates and responsible parties is a good idea after each weekly meeting.

Deal Fatigue

Deal fatigue happens in most deals.  It seems like the due diligence has no end or that you have responded to specific requests multiple times.  Let your advisors know when you are feeling deal fatigue.  We will take some of the load off you.  And never think “I just want this over with – I will take whatever they will give if we can just close now”. 

Plus One

The most successful acquisitions end up delighting the employees who transition to the newco by building in small rewards after closing.  You may need to negotiate a pool for incentives post-closing in the earliest stages of the process, the LOI or term sheet step, and this will reap enormous benefits post-closing, particularly if you retain a piece of the new entity and get a second bite at the apple.  Post-closing integration planning done before the actual closing is a process that also ensures a smooth transition with minimal loss of traction.  In our experience, most acquirers are well versed in this part of the deal – they don’t leave it up to chance, it is a process.

WAIT!! What about the actual closing?!

If we do the 10+1 well, closing is a natural, organic part of the process.  There are no surprises.  We simply agree on a closing date, spend a week preparing (read: negotiating – everything is a negotiation)  the closing docs, then close.  Find a steady, methodical, calm, experienced professional to lead your process and you will feel much more confident as you experience what will probably be the largest financial transaction of your life.

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Exits Down 75%, IPOs Non-Existent, Secondaries Rising The markets they are a-changing

According to Pitchbook:

 “PE exits in the US dropped from $876.7 billion in 2021 to $295.8 billion in 2022, according to PitchBook's 2022 Annual US PE Breakdown, as investors held onto assets longer to ride out rising inflation, geopolitical turmoil and public market volatility. At the same time, the IPO market almost completely dried up, with public listings accounting for only 2.5% of exit value last year.

 The secondary market—specifically continuation vehicles and GP-led secondaries—offers alternative exit opportunities for GPs hoping to satiate investor demand for liquidity. A GP can retain an asset through a continuation vehicle by moving a trophy asset from one fund to another. In this type of transaction, LPs have the option to liquidate on the secondary market and GPs can retain the asset until the market becomes more favorable for a sale.  Lazard pegged 2022 as the second highest year on record for secondaries issuance and 2023 is setting up to be even bigger.”

 The capital markets are finding ways to continue to fund deals through the double-barrel gutshot of increasing interest rates and higher inflation.

 What does this mean for Main Street (Middle Market) Businesses?

 While deal volume is certainly down from the record levels of 2021, PE firms report a decrease in reserves of only about 10%, meaning there is still about $800B of liquidity in the system.  The question is how much is earmarked for new deals and how much is available for new platform acquisitions and add-ons?

As the graphic above shows, the 2021 vintage year has the greatest remaining bucket of cash followed by 2022.  Funds in these vintage years are still in their deployment phase so most of that capital is available to new acquisitions whole older vintage years will see fewer add-ons with the majority of cash reserved for operations.

While it makes sense to time an exit during a period of low interest rates, low inflation and relative economic stability, there is still plenty of capital available for quality businesses with consistent performance. 

The professionals at Vertical Capital Advisors have experienced many market cycles and can help you realize the maximum value for your business if now is the time consider an exit.

https://files.pitchbook.com/website/files/pdf/2022_Annual_US_PE_Breakdown.pdf

Hear that 7,567% crunching sound?

Has John Paulson smashed his crystal ball on a pile of gold?

Credit Crunch Phase 1

 The first phase of the credit crunch is rates and spreads increasing resulting in higher cost of borrowing.  Liquidity abounds, but at a decidedly higher cost of capital, especially in the credit markets.

 Part 1 of borrowing cost is the relevant index that rates are based on and all of the indices are higher now than a year ago.

 A 7,567% increase – from 0.03 to 2.27

 One year ago, rates were extremely low - as they had been since 2008, with the overnight SOFR at 0.03%.  Today SOFR is 2.27% - a whopping 7,567% increase.  All-in pricing for the most creditworthy borrowers is 2% - 4% higher than a year ago, the result of Fed actions to increase short-term rates and cool the economy, spreads widening with the cost of borrowing for lesser credit borrowers widening significantly over last year’s spreads.  All interest rate indices have increased.

Part 2 of the borrowing cost is the spread the individual borrower is charged over the index and those spreads have widened – increasing by 25bp to 50bp for the most creditworthy borrowers to 200bp or more for lower quality borrowers.  A year ago the most creditworthy borrowers might expect to pay 25bp-75bp over the relevant index with senior non-bank lenders in the 75bp-150bp range and junior lenders in the 150bp-200bp range, meaning there was very little risk premium in the market.  Today the lower range of spreads is 50bp-125bp over the index for strong performing $50M EBITDA middle market companies and 300bp-400bp at the higher end for average performing $10M EBITDA middle market companies. The spreads have increased and risk premiums have returned.

Credit Crunch Phase 2

The second phase of a credit crunch is an increase in covenants, terms and conditions.

 This takes many forms.  Prime among them are higher cash flow to debt ratios and lower debt to equity requirements for new/renewing deals.  Lenders want to see more cash flow cushion in monthly budgets simultaneous to the monthly borrowing cost increasing.  It is a two-fanged viper.    New deals see lower debt to cash flow ratios,  higher debt yield covenants and higher equity requirements with lessened reliance on management roll and greater demand for cash equity.

Lenders want to see more cash flow cushion in monthly budgets simultaneous to the monthly borrowing cost increasing… It is a two-fanged viper!

John Paulson has smashed his crystal ball on a pile of gold…

Credit Crunch Phase 3 

The third phase of the credit crunch is credit drying up.

 We are at the stage where lenders do not yet know if we are heading into a recession-lite, The Great Recession Part Deux (or worse) or a small speed bump.  During The Great Recession liquidity dried up seemingly overnight.  Companies that had working capital lines drew them down fully if they could.  Very quickly lenders started cancelling credit facilities of all types, calling existing loans and not renewing outstanding balances on even performing matured loans.  Hard money lenders, the lenders of last resort, affectionately referred to as vultures in the industry, were the only option for many. 

Credit will become increasingly less available over time until a clear direction for the economy and that is because markets, lenders in particular, hate uncertainty, and...

Uncertainty reigns.  Markets generally abhor VUCA = Volatility Uncertainty Complexity Ambiguity.  But that is exactly where we are today.  Bankers who can sleep at night wake up fearing the morning financial press headlines.  They wilt at the thought of Fed Chair Jerome Powell giving a speech at some college where he might announce MF LRI, many future larger rate increases.  They tremble as they scour the markets for any early warning sign of defaults or regional instability or supply chain disruptions or their shadow unexpectedly appearing on the ground beside them, a fresh batch of Ursula’s poor unfortunate souls. 

 This is where having a really good crystal ball pays off.  John Paulson smashed his on a pile of gold after personally making $4B on the 2008 housing market crash, leaving us all in the same predicament: guessing for now and saying with hindsight in a year “I should have known that was going to happen”.

What do I do today?  Buckle in, build cash supplies and if you are thinking that you want to sell your business in the next few years, act quickly or plan to wait it out.  Vertical Capital Advisors will debut a new valuation tool this month that will enable us to provide anything from a quick snapshot to a comprehensive analysis of your company’s current value.  There is still a record amount of debt and equity capital available but multiples have softened this year so don’t wait too long if you are serious about exploring a possible sale.

The Problem with Bitcoin (and all cryptocurrencies) – The Greater Fool Theory

A Lesson From Jimmy Buffet

The subtitle is just eye-candy to catch readers who, upon seeing Warren Buffett’s name, would click on to the next item of interest.  Warren Buffett’s 2011 shareholder letter is a classic.  You have no doubt heard of it and probably even quoted or misquoted from it.  Page 17 begins Buffett’s musings on gold.  Buffett writes:

“The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future… The major asset in this category is gold”

In banking we called this the Greater Fool Theory.  If a loan became a problem asset, we began the process of managing the borrower out of the bank, hoping that another “hungry” bank/banker would take the problem off our hands.  But the problem with cryptos goes farther than that because, unlike gold, they have no commercial or decorative uses AND, this is huge, you can lose them - forever!

Back to Buffett:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.”

We have all read stories about crypto owners losing their keys or their cold wallets or hackers stealing their quarry – sometimes into the hundreds of millions of dollars.  It would be hard to lose a 68 square foot of gold.  The problem is that you would have to store, protect and insure the gold, meaning you lose value unless the price per ounce continually rises. 

“True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Prophetic, Warren!  In January this year, 11 years after Buffett’s letter, you could buy an ounce of gold for less than the $1,750 per ounce that Mr. B wrote about in 2011. 

So, as a store of value, cryptocurrencies are exactly like gold without the key benefit that Buffett mentions: “You can fondle the cube, but it will not respond.”

But all of those shortcomings of Bitcoin are not the primary problem.

The problem is the price.

The problem with every cryptocurrency is that it is a currency that trades like a stock.  Its value for everyone is set by the single most recent reported transaction.  It is subject to supply and demand, fear and greed – the same motivators of every stock purchase and sale.  Harvey Salkin, my portfolio management prof at Case Western Reserve University, equated stock investors to a psychotic neighbor who, as soon as you step out the front door, starts screaming that he wants to buy your house alternating with shouts of wanting to sell you his house.

Buffett illuminated the shortcomings of gold and, in corollary, I am drawing the same inference for cryptocurrencies:

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobil (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

One share of XOM would have cost you about $90 on the day that Buffett’s shareholder letter was published in 2012.  In the 10 interceding years you would have received about $30 in dividends and still have your original investment.  Gold and cryptos can only sit idle until exchanged for something else.

Cryptocurrencies trade like stocks – their price is set by the last reported transaction – the price for everyone is set by the single most recent reported transaction.  And unlike gold, there is no intrinsic value at all.  Cryptos produce nothing.  Cryptos have no earning capacity.  The only value cryptos have is value that the next person who wants it is willing to pay.  And cryptos have unique risks.

Until and unless cryptocurrencies have an independent intrinsic value separate and apart from the most recent reported transaction, cryptos will fluctuate wildly in value, until the last person with the last Bitcoin loses their key and Bitcoin passes from existence. 

Tina’s Back…

I know you think you understand what you thought I said

Vertical Capital Advisors Blog

March 3, 2021

Actually, TINA never left.  TINA is an acronym for “there is no alternative”.  We blogged about it in August 2016 and although we have had a world of changes since then, the fact remains that there is no alternative to low yields now just as there was no alternative then and, according to Fed Chair Jerome Powell, there will be no alternative for years to come.  The Fed minutes from their September meeting revealed their position to “keep interest rates near zero until 2023”, a far cry from the days of Fed Chair Alan Greenspan who famously said “I know you think you understand what you thought I said but I'm not sure you realize that what you heard is not what I meant” and “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.”

With Congress and the U.S. Treasury adding trillions of dollars to the existing supply and the Fed pumping trillions of dollars into the economy, economists are left scratching their heads about inflation or the lack of inflation more precisely.It seems much of the flow of funds has gone into global stock markets, propelling them to the greatest highs ever with the total market capitalization of the U.S. stock market surging 34.8% to nearly $51 trillion as of December 31, 2020, total U.S. household assets topping $140 trillion and total U.S. household net worth reaching nearly $124 trillion.

This month we will enter the second year of the recovery, a year where the markets typically experience a temporary 10% pullback but end the year 10% higher. 

With the Fed, Treasury and Congress cheerleading expansionary economic policies, at least for the next three years, we are likely to see continued growth in the value of financial assets and real estate assets meaning smooth sailing ahead – unless…

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ABOUT VERTICAL CAPITAL ADVISORS

Vertical Capital Advisors is an Atlanta-area boutique investment banking firm built on creating tangible value for our clients, serving clients in just about every industry.  Our clients are both capital growers and capital allocators.  How can Vertical help your firm maximize value?

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108
678-591-0273