What to do When the Chairlift Ride Turns Into a Rollercoaster Ride?
Tyler Lang outlines some tips and tricks for how to get a deal done for a business that has experienced an anomaly in its top and bottom line due to a one time events like Covid.
10 Proven Tips to Selling a Business That Has Been Impacted by Covid
We have the pleasure of speaking to dozens of companies every month that are considering selling now, or in the next few years. While some businesses have managed to remain stable (or even thrive) during Covid, others have taken a hit to their top and/or bottom line. Some businesses currently feeling the pain have operated for decades without major issues, only to catch Covid and give owners the surprise of their career. Unfortunately, for many owners this has happened just when they were planning to retire or exit their businesses.
So now what? Do you wait until the Covid hangover has worked its way through and you have a couple of years of positive trending numbers, then go out and start a sale process? Or do you sell now for less than you expected because valuation multiples are being applied to lower than normal revenue/profit numbers?
The Answer: with some creative structuring, you can sell NOW and not leave anything on the table. Here are some tactics we have used in arranging sale transactions for clients during Covid (or after any challenging period in a Company’s trajectory):
Get a really good handle on your financial metrics. To employ the strategies outlined here, you need to arm yourself with data. Gather detailed monthly financial information (P&L and balance sheet) going back 3 full fiscal years, as well as for any months since your last fiscal year end. It can be painful for some businesses to pull this together, but it will pay off in spades in the long run. This data will allow you to calculate the TTM, YTD and Run-Rate figures (see below) that will be critical in convincing a buyer that you are back on track. Also pull together monthly revenue-by-client and revenue-by-product/service going back the same 3 years. Do it now, there is no getting around this—purchasers will just ask for it later, and then you’ll be scrambling to pull it together and risk looking disorganized or unsophisticated. All data should be in Excel format to be of maximum use for everyone involved.
Pull a realistic, detailed, budget/forecast. For the next full 2 years minimum (again, monthly, in Excel). Go with your “most likely” scenario and avoid wasting time doing “best-case” and “worst-case” modelling. If you produce your budget in Excel, purchasers will typically do their own best-case/worst-case scenario analysis to “stress test” your baseline budget. Build forecasts pivoting off of your actual historical data, particularly revenue-by-service, revenue-by-client. Forecast increases in that revenue/profit based on things you have visibility on (new accounts signed up, new products being launched, reductions in overhead, etc.).
Avoid forecasting by putting an arbitrary % increase on last year’s numbers. Google “bottom-up forecasting” for info on how to build a budget properly. Even if your budgeted revenue, cost, and profit figures are flat for the next few years, having this budget available is necessary to engage in a productive dialogue with prospective purchasers. You need something for everyone to focus the discussion around. If you don’t have Excel budgeting/modelling skills, ask your accountant, hire a consultant, or even better, work with an M&A advisor who will do this (and much more) as part of their engagement scope.
“TTM”, “YTD”, and “Run Rate” numbers are your friend. Trailing 12-month or “TTM” financials look back at the last 12 consecutive months of financial performance. It allows purchasers to look at the current flow of business and spot any trends (positive or negative) that would not otherwise be visible by looking at last year’s fiscal year-end numbers alone. To illustrate this, let’s say you had a weaker than usual fiscal year ending December 31st, 2021, with total revenues of $10M (when your revenues are usually at the $12M level historically).
Then let’s assume you have had a strong recovery year-to-date “YTD” in the first 8 months of 2022 (say you already reached $8M of revenue in the first 8 months YTD). Calculating the TTM revenue/profit figures from September 1st, 2021 to August 31, 2022 should most certainly provide real support that the business is recovering nicely, tracking to exceed last years depressed $10M revenue. Similarly, if your revenues/profit are fairly stable from month-to-month, with little variation due to seasonality etc., you should also calculate your “Run Rate” metrics to show where your numbers will likely end off at for the current full year.
In the above example, to calculate your run rate revenue or profit, take the monthly average for your first 8 months YTD (so $1M average revenue per month), and multiply that by a full 12 months to get your run rate revenue (which in this case is $1M x 12, or $12M). As you can see, the TTM and the Run Rate figures point to a recovery in revenue to prior $12M levels, giving you some ammunition to negotiate a deal without taking a haircut due to the weaker 2021 performance anomaly.
Make sure your “blip” in performance was truly an anomaly. It’s critical to get buy-in from purchasers that your drop in revenue/profit is already on the mend (using the TTM and Run Rate data above). It’s equally important to provide support that the performance drop was a “one-time” affair and is not likely to happen again in the next 3–5-year time horizon. If you own a gym franchise or a restaurant chain that was shut down due to Covid, it’s going to be pretty hard to avoid similar shutdowns in the future (unfortunately, its inevitable).
On the other hand, many strong, predictable businesses (particularly those that were deemed “essential” during the pandemic) were arbitrarily and unnecessarily shut down for a period of time because the government had no idea what we were dealing with yet. Next time around, (god forbid) there will be much clearer protocols already established, and we would expect masking and testing to kick in much quicker, with shorter quarantine periods from the beginning.
If your business is constantly varying up and down from year-to-year over an extended period of time, regardless of a pandemic or other seemingly “one-time” events, then it’s much more difficult to focus on TTM, YTD, Run Rate etc. You are likely going to have your business valued on a multiple of trailing 24, 36, or even 48-month revenue/profit average, and hope to bake in some upside profit sharing if you beat plan in the years after closing the sale transaction.
What if the numbers just don’t support a recovery? If after analysing your YTD, TTM, and Run Rate numbers you just can’t evidence a recovery, but still need to get a deal done now, you are unfortunately going to be leaving a lot on the table. You could still negotiate a deal to sell based on a multiple of your now lower revenue/profit numbers, but that could be very hard for you to stomach (additionally, some buyers may sit on the sidelines before engaging to make sure you don’t sink even further).
If this sounds like your situation, be very careful not to paint a rosy picture of a big recovery and structure a deal around that, as it’s only going to come back and bite you later. We see this all the time at WDC, and refer to that approach as “fun with numbers”. Most sophisticated buyers can see right through that anyways. So, your only options are 1) wait longer to see if your numbers rebound, or 2) do a less attractive deal now, at a lower valuation, and push to bake in some upside for exceeding your numbers in the years after closing.
The recipe to get a deal locked down NOW without waiting a few years. So, you have your historical numbers and a budget together, and your business is in recovery mode (or at least stabilized, and not tanking). Lets talk structuring. Lets use our example above (2020 revenue $12M, 2021 revenue $10M, 2022 “Run Rate” revenue tracking for $12M), and assume a 25% EBITDA (earnings before interest, taxes, depreciation, amortization).
Let’s also assume that this industry has a 5x EBITDA valuation multiple. If we sold in 2020, on a 5x multiple, we would have expected the $3M of EBITDA would yield a $15M purchase price. The same business sold in 2021, with the lower $2.5M EBITDA at that same 5x multiple, would yield a $12.5M purchase price, with $2.5M notionally being left on the table. Even if you average the EBITDA from 2020 and 2021 (that’s referred to as your “TTM 24-month EBITDA”), using the same multiple, you only get a purchase price of $13.75M (still not great, considering you could have sold for the full $15M just a year prior).
So, what’s the best way to have your cake and eat it too? In comes the earn-out. If you are highly comfortable that you will be back at the $12M revenue/$3M EBITDA level by year-end, and can continue that “baseline EBITDA” level ($3M) for at least 2-3 years post-closing, then an M&A advisor would typically push to lock in a deal at the full $15M purchase price, ask for anywhere from 50% to 75% payable at closing, and then have the remaining 25-50% paid out in equal payments over the next 2-3 years post-closing.
The purchasers would typically look for a “pro-rata” reduction in your annual payments for any shortfalls in EBITDA in those next 2-3 years, so it’s not an “all or nothing” approach. For example, if you miss EBITDA by 20% in one of those years, your payment in that year would also be reduced by 20%. We typically include a “catch-up” provision, allowing you to recoup any reduced payments along the way in subsequent years where you exceed that baseline EBITDA.
Don’t plan on hitting the beach in 12 months after closing. If you want to maximize your valuation and total payout after having a downturn in your business, you cannot expect to exit the business after one year. You should expect to stick around and be active in the business for the entire earnout period. Trying to push for a shorter exit window tends to spook purchasers.
Leaving 25-50% on the table and sticking around for 2-3 years sends a strong message and creates alignment with the purchaser (it also makes deals close faster from my experience). Besides, if you want those earn-out payments to materialize in each of the next 2-3 years, shouldn’t you be closely involved to make sure the business stays healthy? For sticking around and growing the business, you should be able to negotiate some sharing of any EBITDA generated that exceeds your baseline EBITDA hurdle during your 2-3 year earn-out period.
We have seen this range anywhere from a 5% up to a 50% share of that incremental EBITDA, and in some cases have seen that incremental upside bonus payout actually exceed the total 2-3 year baseline earn-out payment.
Get an Audit done if possible (or at least Review Engagement). The pace of due diligence and the speed to closing far faster when clients have an audit available for purchaser review. A full Audit may cost a small to mid-sized business $10-20K per year audited (and you should have at least two full years audited), or less for a Review Engagement, which is also acceptable to may purchasers.
The cost is entirely dependent on the size and complexity of the business (Audits can range from $25K to $100K+ per year for larger, more complex private companies). Regardless, Audits speed the time to closing and provide high levels of confidence on the part of the Purchaser, allowing you to focus on other more important items, like integration planning.
Get a full “package” together in advance. Before you start speaking to any prospective purchasers, get your house in order. We already spoke of the importance of having your numbers ready, which is only one half of the story. The other half is the story: what you do, who you do it for, what’s your secret sauce, avenues of growth, some commentary on the competitive landscape, team background etc. etc.
Typical “business plan” type stuff but put it in a nice 10-20 page PowerPoint slide “deck”. Any private equity or strategic buyer is going to need to communicate your story up the chain internally to get approval or buy-in, so make sure they have the right content. Don’t get caught flat-footed when a purchaser comes along—we often see companies get all hot and heavy with a purchaser, only to get asked for a financial budget and a “deck”, after which they disappear for weeks or months trying to pull this together, only to have the purchaser fade into the sunset or turn focus to another acquisition.
If you don’t have the bandwidth or creative flair, hire someone. Or engage an M&A Advisor to put the whole thing together for you as part of their engagement scope.
Hire an M&A Advisor. If this article has been helpful and informative, then you should probably hire an M&A Advisor's to sell your company. There are so many more strategies that can be employed based on decades of transaction experience, all to protect you and maximize your economics.
The majority of the cost of working with an Advisor should be paid only at a successful closing of your transaction in order to create alignment. Various research studies (including a study of nearly 4,500 private M&A transactions over a 30-year period) have shown that that companies who work with an M&A Advisor garner a 5%-25%+ higher purchaser price than those who go it on their own. That’s a pretty big return on investment. (see article here: Does Hiring M&A Advisers Matter for Private Sellers? )
I honestly could have continued writing numbers 11 through 200 in this article, as I have seen all of this play out literally hundreds of times. There are completely separate articles we have in the works that apply to technology/SaaS companies, and others that focus in on the valuation multiple hysteria. In all cases, an experienced M&A advisor’s biggest value is helping you avoid the same stupid mistakes that companies make over and over again when selling, and believe me, I’ve seen them all.