“Ideal” numbers depend on the buyer

One of the things that makes the M&A marketplace so unpredictable is that buyers don’t all share the same acquisition criteria. Traditionally, there have been two types of M&A buyers: 1) financial, which look for acquisitions that will produce a return on investment, and 2) strategic, which primarily seek business synergies.

 Such broad objectives, as well as industry, size and other factors, influence how buyers evaluate a target company’s numbers. Although certain characteristics have an almost universal appeal — no one is likely to sneeze at 15% annual earnings growth, for example — ideal numbers often are in the eye of the beholder.

 Everyone values earnings

Both financial and strategic buyers typically start by looking at a target’s earnings before interest, taxes, depreciation and amortization (EBITDA). EBITDA measures the operation’s profitability before the factors that probably will change after the merger — such as debt structure, taxes and the amount of fixed assets it takes to generate sales.

 EBITDA also can help buyers compare profitability between acquisitions in the same industry. Caution, however, is warranted because EBITDA isn’t a Generally Accepted Accounting Principle. Buyers must ensure the same assumptions (particularly when it comes to depreciation methods) are used for every company they study.

 Current needs

Ratio analysis provides further general information about a target company’s financial performance trends. It’s up to the buyer to interpret these ratios according to its acquisition needs.

 For example, the current ratio represents a company’s ability to meet its near-term obligations and is calculated by dividing current assets by current liabilities. The general rule of thumb for a current ratio is 2:1, and a ratio lower than 1.1 is usually considered risky.

 A financial buyer might be wary of a low current ratio because it could hamper its ability to realize a short-term return on investment. Strategic buyers may be more forgiving of a lower number if the company has other desirable traits, such as unique products.

Open to interpretation

Another financial ratio that may be open to interpretation is working capital, which represents the company’s ability to carry on business comfortably and expand operations without seeking new financing. Working capital is assessed by subtracting current liabilities from current assets. A positive number is better — unless the buyer is acquiring a distressed company.

Inventory turnover, which shows how long it takes to sell inventory numbers also may be interpreted differently by different types of buyers.  This ratio is calculated by dividing the cost of goods sold by average inventory. Inventory turnover is most useful for manufacturing or distribution companies.

 Desirable numbers depend on the industry and inventory philosophy. A low number means the company chooses to be fully stocked (has a higher investment in inventory and never misses a sale). A high number means a company is thinly stocked (has a low investment, but could miss sales).

 Beyond the numbers

Once financial buyers feel comfortable with the target’s numbers and believe the company offers a more than 10% return on investment, they may be ready to move forward with an acquisition. But strategic buyers typically go a step further and review opportunities for vertical and horizontal integration.

 Vertical integration allows a buyer to reduce supply chain expenses, improve access to key services or materials, and leverage resources. Horizontal integration involves gaining new markets for existing products, cross-selling products to existing customers and expanding distribution networks.

 Today’s landscape

In the current M&A market, strategic buyers far outnumber financial ones. Such an imbalance could mean that what were considered desirable financial ratios only a few years ago, aren’t now.

Business Milestones worth Celebrating

I was reading a blog written by John Warrillow, where he lists what he believes to be the 4 milestones that every business owner should celebrate.

The four are:

1. Your first sale to a stranger

“It’s great to have a supportive network who will buy whatever you hawk, but the first sale you make to a stranger is a glorious moment to remember. It’s the first time someone, unencumbered by “moralsuasion,” sees your advertising/storefront/fan page/brochure/site/keywords and says, “Yes, I’ll have some of that.” It’s the ultimate validation that whatever business idea you dreamed up might actually work.”

2. Your first lease

“I think getting your business out of the house and into a commercial space is one of those important milestones that prove you’re serious about building a company.  You’re committing to a home for your business, showing to potential employees, customers and suppliers that you have a vision for your business that goes beyond just you.”

3. Your first employee

“I’m not against freelancers who run home-based businesses and choose never to hire employees. In fact, many of the freelancers I know take home more money in less time than my business-owner buddies.

But I’m sure you’d agree there is a difference between trying to maximize your personal income and freedom through free agency and trying to build a business that can one day run without you. The latter, of course, needs at least a few employees. And hiring your first is a milestone worth celebrating.”

4. Realizing you can no longer write a check to cover expenses

“ I realized I could no longer think of myself as my company’s banker. This was the moment I finally realized my business was an entity unto itself.”

One glaring oversight to me is any reference to an exit strategy, nothing about selling your business, passing it on to the next generation, creating value in world?

The 4 milestones John mentions are a good start, I wonder if there are anymore that he and I have missed?

-Eric Dunn

Focus Capital Advisors

5 Golf Tips that Go Far

As we look forward to the MBBI Golf outing on July 13th, at Hawk’s View Golf Club, here are some golf Tips from some PGA Pros to help you get that extra 10 yards on your drive and bragging rights in the club house.

By Rick Martino

A good forward pivot can pay off in extra yardage. Most amateurs pivot too slowly on the downswing and lose power through the hitting area. They cut short the follow-through, finishing with the right shoulder still over the right leg (above). Pivot forward from the spine with speed, so your right shoulder ends up over your left foot, pointed at the target and in a powerful position at the finish. ractice holding your finish until the ball lands. (Note: In the middle picture above, I’ve exaggerated my finish position for this drill. As you practice, I recommend you do the same.) Measure the amount of your pivot by the position of your right shoulder in relation to your feet. Right over left means power and distance. A good way to check that you have shifted your weight correctly is to finish in a position that allows you to point your right index finger at the target. If you can do that, it means you’ve turned your body sufficiently and moved your weight over the outside of your left foot. Hands lead clubhead

By Linda Mulherin

Some players lose power by having their hands in the wrong position where it counts most — at impact. Ideally, the hands are ahead of the clubhead when it compresses the ball. For many amateurs, the left wrist breaks down (inset), and the clubhead arrives first, adding loft to the club and producing too much height and too little distance. Focus on the wrist position of your lead hand at impact by swinging into a bag of clothes, an old tire or an impact bag. To hit the ball farther, your wrist must arrive before the clubhead.

Strengthen muscles

By Dr. Gary Wiren

Golf is a game of “through,” not “to.” A lot of us are not strong enough to deliver the clubhead squarely to the back of the ball at maximum speed. In effect, we hit at the ball instead of through it, losing distance in the process. The purpose of the device shown here (a broom is also effective) is to strengthen golf-specific muscles by creating progressive resistance during the swing. If you feel more resistance through the hitting area, that’s a sign you’re hitting through the ball. As your muscles strengthen, your swing speed will increase. The payoff is extra distance.

Power in your back pocket

By Lori VanSickle

To create enough spring release on the downswing, a player must achieve a 45-degree hip turn on the backswing. Most amateurs either have too much lateral movement, which creates sliding, or don’t maximize hip turn, which restricts usage of the hips, thighs and buttocks — larger muscles and tremendous power sources. Try to put your right hip into your right back pocket.

Use a full-length mirror or window to check the position. Your hip will turn back naturally toward the ball on the downswing, producing a powerful move through impact.

Single-handed drill creates speed

By Ken Morton Sr.

From the address position, swing the club back with the dominant hand. The body should turn naturally and the wrist set into a cocking position at the top, the weight of the clubhead resting on the pad of the index finger. Synchronize the hand, arm, upper and lower body on the downswing, the hand falling into position as the body rotates and the weight shifts. Release the club through the hitting area and all the way to the finish. The club should rest back on the index finger at the finish. The drill is the same for the opposite hand, except the club will rest on the thumb at the top of the backswing and again at the finish.

For more details and to register for the MBBI Golf Outing, click here: https://www.mbbi.org/page.php?content=register&eventId=90

How Healthcare Reform May Impact Industry M&A Transactions

This post from the MBBI members of The McLean Group, LLC.:

A recent research paper outlined the trends in health care and discussed which industries will prosper in the near and medium term.  Enrique Brito, a certified financial analyst and senior managing director of The McLean Group, a national middle-market mergers and acquisition firm based in McLean, VA., outlined the new landscape of the U.S. health care system including trends in the industries and which companies expect to show significant growth in the near future. The healthcare industry is divided into services and technology.  Services include hospitals, ambulatory services, and nursing and residential care facilities. The technology sector is defined as companies that provide information technology, pharmaceuticals, biotechnology, and medical devices, says Brito.

 Service revenue and profit growth for U.S. healthcare services from 2000 to 2008 reported average annual growth of 6.8 percent with over $1.7 trillion in revenues in 2008, yet the gross margins, defined as revenues less direct costs related to revenue, were either flat or decreased compared to the revenue growth.  The large healthcare service companies’ market values did remain higher than the broad S&P 500 index of companies.  The trends cited by Brito were cost containment, the future shortage of   primary care physicians, and the growth in alternative medicine.  I found the study’s data of Americans consumption of herbal supplements surprising — $4 billion annually. The cost of malpractice insurance has been another significant trend in the service sector.  Brito mentions that despite the significant increases in premiums, malpractice insurance is not profitable for many insurers.  From 1998 to 2004 insurance companies lost money on malpractice insurance.  Also, high malpractice insurance has encouraged physicians to make changes to their practice including retiring early, limiting their practice, or performing unnecessary tests and other procedures to limit the risk of liability.

The technology sector, Brito mentions, has three main areas of change. Telecom companies are integrating into the healthcare industry. The need for better communication, specialized information technology, and the lack of dominant IT providers is spurring growth and opportunities for providers and investors.  Alternative care delivery is driving IT growth through developments such as consumers’ desire to receiving care consultation by telephone, email, and online. Consumers’ demand for alternative consultation could be a significant growth opportunity for IT providers. Brito mentions that advances in medical device and research sectors will show dramatic advances in the coming years. Medical discoveries in devices expect to quadruple by 2030. Use of electronic medical records has increased to 28 percent in 2006. The use of electronic health records has the potential to improve medical care quality while reducing healthcare costs by as much as $40 billion per year.

 The second portion of the research included Mr. Brito’s analysis of M&A activity and trends for the foreseeable future. M&A trends are result of patent expirations (purchase of biotech companies) and IT inefficiency and inoperability. Patent expirations by pharmaceutical companies are driving companies to look at biotechnology companies to fill their pipeline of new drugs to bring to the market. IT inoperability, as Brito discusses, is due to widespread technology vendors with few standards to follow in this sector. IT standards will become required within the next five years.

Brito reports that venture capital firms seem to have had better success in earning healthy financial returns on investment in the healthcare IT sector compared to biotech, healthcare devices, and healthcare services. The study cites that venture capital firms have had healthcare IT investments returning 25 percent in 2007 and 2008 compared to relatively flat returns or losses in other segments. Investors will be looking for predictable revenue and cash flow streams in the technology firms.  As long as investors are willing to do ample due diligence with investments, especially in the technology segments, returns will be promising in the new healthcare world.

(You can download the complete research paper, “Healthcare M&A: Trends & Outlook,” at www.mcleanllc.com/landingpage/HealthcareLanding/healthcarelanding.htm, or send an email to candrews@mcleanllc.com).

Massive Tax Increases Coming on Sale of Your Business after 2010

This post from the MBBI members of Focus Capital Advisors, Inc.:

Upcoming tax changes make 2010 a very special year to sell a business. For the last several years, we’ve enjoyed a federal long term capital gains rate of 15%. When blended with the current Illinois tax rate the total is 17.55%. If your business sale qualifies for long term capital gains treatment, you get to keep 82.45% of the proceeds. On January 1, when you kiss a loved one and say, “Happy New Year!” the party is really going to be over. The largest tax increases in many years are just around the corner.

Our country has spent more than a trillion dollars to stimulate the economy and bail out troubled financial institutions and automakers. With increasing concern about financing Social Security and Medicare and now, our new health care law; tax increases seem inevitable. In addition, attention is now turning to the unprecedented level of national debt. Some combination of tax increases and spending cuts will be required to reduce this debt to a manageable level. Many of the coming tax increases are already passed into law. The rest are being worked on and will be likely become effective for 2011 and beyond.

Individual components of various tax increase plans are being debated in congress. Increases under consideration could almost double the rate for next year and it’s likely to go even higher in 2012 and 2013. Our most likely scenario will see the 2011 tax burden including a variety of different taxes applicable to capital gains at close to 30%.

Many business owners believe that 2010 is not the best year to sell. The economy is starting to turn around. Wouldn’t it make more sense to wait a year or two until things improve? Understanding the coming tax changes suggests that 2010 may be the best opportunity to sell for years to come. All of the gains in value that you may achieve in the next few years will likely go the government.

The Different Taxes Being Considered

The Bush tax cuts expire on December 31, 2010 and  the federal long term capital gains tax rate will revert to  20% (or a 33% increase) next year and talk continues that the Reagan era tax rate of 28% could come back. Congress continues to explore a Federal Surtax of as much as 5.4% on high income taxpayers to bail out Medicare and Social Security and the health care law tax will add 3.8% on higher income taxpayers beginning no later than 2013. After the fall elections we expect see significant movement on the tax increases including the acceleration of the health care law costs that require more tax revenue. If you wait until this time to market and sell your business, you will be unable to avoid what is looking to be a 50% to 60 % tax increase in 2011 alone.

It is certain that most business sales will put the seller in a high income tax bracket in the year of the sale. It’s also likely that Illinois, like many other states struggling financially, will increase the state tax rates by at least 1% or 33%. In the aggregate, tax on business sales in excess of $500,000 that qualify for long term capital gains treatment may well increase by 89% by 2013 when the Affordable Health Care Act is fully implemented.

A Case Study

Business owners who are thinking about waiting for earnings to rise in a better economic climate would do well to consider how much additional sales volume and bottom line profit is going to be needed to get to the same sale proceeds on an after-tax basis. Consider the following example: Stanford Precision Molding has been a Sub S corporation for more than 10 years and will therefore qualify for long term capital gains tax treatment. Stanford’s earnings for 2009 were down to $4MM. They were $5MM in 2007. Stanford is beginning to see signs that the economy is picking up. The owner, Mel Stanford, who would like to retire, believes that in 2010 or 2011, earnings will be back to 2007 levels.  He plans to wait until EBITDA reaches $5MM and then put the company on the market.

What Mel doesn’t realize is that all of the hard work that he’s planning to do will just result in more taxes with no additional after tax proceeds. The table below illustrates the problem:

Stanford Precision Molding
	2010	No Improvement          New Tax Rates	Sales needed to get back to 2010 after tax gain
Sales	20,000,000	20,000,000	24,000,000
Adjusted EBITDA	4,000,000	4,000,000	4,879,000
Valuation	20,000,000	20,000,000	24,394,000
Federal Capital Gains Tax	15.00%	20.00%	20.00%
Illinois Capital Gains Tax	2.55%	3.20%	3.20%
Federal Surtax	0.00%	5.40%	5.40%
Health Care Tax	0.00%	3.80%	3.80%
Total Tax Rate	17.55%	32.40%	32.40%
After Tax Proceeds	16,490,000	13,520,000	16,490,000

In our example, Mel is better off to avoid betting on future results when he can get nearly the same after-tax result today.

First Post

Greetings! 

OK, so we are up and running (sort of) on the newly established MBBI Blog.  As soon as we get some of the remaining administrative and operational questions resolved, we are looking forward to a very active and robust discussion forum for related MBBI topics.  One of our goals is to use this blog as a potential tool for all MBBI members, their business contacts, customers and associates as well as the business community at large to inquire and discuss any and all topics related to business brokers and intermediary activities.

We’ll keep you ”posted” of futher developments as they continue to evolve.  In the meantime, keep an eye out for potential oppotunities to begin a dialog or respond to any discussion points that are brought up on our blog.

We look forward to hearing from you!

Best Regards,

Brian M. Gawin , MBBI Website Chairman