It remains to be seen if 2022’s unique blend of positive and negative factors will slow down the piping hot mergers and acquisitions (M&A) market that emerged in 2021.
On the positive side for potential sellers, strong economic and profit growth plus record amounts of capital remain potent forces. These factors are likely to drive continued high levels of M&A activity in 2022. Business valuations are at, or near, all-time highs. The market for businesses, like the housing market, is currently a strong sellers’ market.
However, because these valuations are at all-time highs, this could be seen as a negative for potential sellers, if potential buyers are convinced that current prices are not sustainable. Rising raw material costs, and energy and logistics costs, as well as the cost and shortage of qualified labor are pressuring profit margins. Consumer price increases may be temporizing consumer spending. COVID-19 still has the potential to disrupt the economy in unanticipated ways. Finally, the escalation of the Russia-Ukraine conflict is likely to have an undetermined, but likely negative, impact on regional, national, and global economies.
Given this uncertainty, prudent business owners who wish to sell, or otherwise transition the ownership of their businesses over the next 18 months, should focus on a few things no matter what happens in the short term.
Three Suggested Areas of Focus for Sellers in Any Economic Environment
A good thought exercise for any business owner is to ask oneself: who are the likely buyers of my business and why would they want to buy my business? A shrewd prospective seller must empathize with their potential buyers (family members included if they are potential buyers), anticipate their motivations as well as their reservations, and consider how a prospective buyer intends to deploy their business as a strategic asset. This thought exercise should help any business owner identify the areas of their business that are the key drivers of future value and where to focus their energies during the near term.
As a next step, a business owner must consider how their business would look under the microscope of a prospective buyer’s due diligence process. What might they find when they analyze a prospective acquisition’s financial records? One suggestion would be to ask your CPA about a Quality of Earnings (QoE) report. A QoE is a detailed, independent analysis of a company’s revenue and expense streams. QoE differs from an audit and is a better way to identify any potential problems or risk areas before a company enters a sale due diligence process. Finding out problems and risk areas in advance will circumvent efforts by prospective buyers to renegotiate the price lower because of findings during due diligence.
A third area of focus for a prospective business seller is their team of key manager employees. Prospective business buyers would like their new business to be able to function without the involvement of the previous owner. Therefore, a business owner must review the employment contracts of their most essential employees to make sure the key employees will agree to stay with the business through the transition, as well as under new ownership for a negotiated period after the sale. If there are no established mechanisms that incentivize key employees to stick around through a process of ownership transition, now would be a good time to add those provisions.
Two Tips for Prospective Sellers in Today’s Economic Environment
In the current environment, potential buyers are going to be most excited about companies with pricing power, supply chain diversity or the ability to diversify their supply chain, and the ability to source labor from a large pool of prospects.
Buyers are also placing a premium on companies that have meaningful annual recurring revenue (ARR), mimicking the desirable Sales as a Service (SaaS) subscription business model that promises predictable cash flows and higher customer retention.
Suggested Personal Financial Readiness Considerations
For most business owners, transitioning out of ownership is psychologically and intellectually challenging. This is because ownership transition planning requires an entirely different skill set than building a business.
Trusted advisors like attorneys, CPAs and financial advisors must be part of a collaborative cross-disciplinary team that helps business owners plan to transition ownership successfully.
A good quiz for your current advisors would be to ask them the following questions:
- Is the current legal structure in which my business is currently owned the most efficient structure for a sale?
- Is there a risk that I will pay more tax than necessary?
- What has been our strategy for transferring ownership to any of my chosen beneficiaries, and how has this strategy furthered my personal financial planning and estate planning goals?
- Have you helped previous clients plan for their business exit?
If your current advisors shy away, or fail to confidently assert, their advice on these topics or their experience advising selling business owners, they are not the right advisor for you in this critical pre-sale moment. If you sense that any of your current advisors are unable to coordinate their efforts with other key advisors, or that your advisor doesn’t have considerable experience assisting in helping other owners sell their business successfully, it may be time to source a new team.
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