Building a Business That Is Ready for an Exit

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Business owners spend most of their time building, operating, and growing their companies. Daily responsibilities naturally take priority over planning for an eventual exit. As a result, many owners postpone exit planning until retirement or a potential sale appears on the horizon. By then, meaningful changes may become difficult to implement.

Every owner will eventually transition away from their business. A sale, succession, retirement, or an unexpected event may determine when that transition occurs. For many owners, the company also represents their largest asset. Creating an exit-ready business should therefore become part of their long-term strategic planning.

Early preparation gives owners time to strengthen the company before a transaction becomes necessary. More importantly, it allows them to make improvements while they still control the timing. The process should begin with understanding the owner’s objectives. Financial needs, desired timing, family considerations, and post-closing involvement may influence the appropriate exit strategy.

Once those objectives become clear, the owner may evaluate whether the company is capable of supporting them. A preliminary business valuation, or Analysis of Value, will establish a baseline and identify potential gaps in value. An Exit Readiness Assessment may provide additional insight into factors affecting marketability. From there, owners may prioritize improvements that strengthen the company and reduce perceived risk.

For example, management may need greater depth before the owner can leave daily operations. Customer concentration may require diversification before buyers become comfortable with revenue stability. Likewise, financial reporting may need improvement to provide buyers with reliable and timely information. Operating procedures may also require documentation to demonstrate that the company can function without the owner. Other value drivers may include recurring revenue, sustainable growth, employee retention, competitive advantages, and scalable operations. Addressing these areas takes time, which makes early preparation particularly valuable.

Along the way, business owners should measure progress and periodically reassess the company’s value. Changes in performance, industry conditions, and buyer demand may also affect the appropriate exit timeline. Creating an exit-ready business does not mean an owner intends to sell immediately. Instead, it creates flexibility and expands the owner’s alternatives when circumstances change.

Just as importantly, many exit-planning initiatives may improve the business before any sale occurs. Stronger management, better reporting, and efficient operations may increase profitability and reduce owner dependence. An experienced M&A advisor will help owners evaluate value, readiness, potential improvements, and transaction alternatives. This process may begin years before the company enters the market.

The best time to prepare for an exit is before an owner needs to. A well-prepared business gives its owner greater control over when, how, and under what circumstances to transition from the business.

2014 M&A Market: What Deal Multiples Reveal About Business Value

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The 2014 M&A market continued to provide favorable conditions for many middle market business owners considering a transaction. Transaction activity remained strong, while reported valuation multiples increased during the second half of the year.

The Alliance of Merger & Acquisition Advisors (“AM&AA”) represents professionals serving the middle market mergers and acquisitions industry. Each year, AM&AA surveys its membership regarding completed transactions and prevailing market conditions. Through its Deal Stats Transaction Survey, AM&AA gathered information about sell-side transactions completed during the second half of 2014. The survey examined transaction volume and multiples of earnings before interest, taxes, depreciation, and amortization (“EBITDA”).

Encouragingly, both average and median EBITDA multiples increased during the survey period. The average multiple increased from 5.52 times EBITDA to 5.64 times EBITDA. Similarly, the median transaction multiple increased from 5.12 times EBITDA to 5.37 times EBITDA. Deal activity also increased, while overall transaction dollar volume remained above historical levels.

The survey reported the following average EBITDA multiples by industry:

  • Construction – 4.87x
  • Manufacturing – 5.68x
  • Wholesale Trade – 6.54x
  • Retail Trade – 6.02x
  • Professional Services – 5.32x

Of note, these industry averages provide useful market observations rather than predetermined valuation benchmarks. Individual companies may transact above or below these multiples based on their specific characteristics. The survey also identified a positive relationship between transaction size and EBITDA multiples. Generally, larger companies attracted higher valuation multiples than smaller companies.

Furthermore, company revenue showed a similar relationship with transaction multiples. These findings reflect the advantages that buyers may associate with greater scale, market position, and organizational depth. More revealingly, AM&AA members identified growth opportunities and buyer synergies as principal reasons for higher EBITDA multiples. Those findings demonstrate why buyers evaluate much more than historical earnings when determining value. A strategic buyer may identify opportunities to expand products, eliminate overlapping costs, or enter new markets through an acquisition. Correspondingly, those opportunities may allow the buyer to justify a higher valuation than another prospective purchaser.

For business owners, the 2014 M&A market reinforces a fundamental principle of preparing for a sale. Strong EBITDA matters, but the quality and future potential of those earnings also influence buyer interest. Owners should focus on sustainable growth, scalable operations, strong management, and defensible competitive advantages. An experienced M&A advisor will then position those attributes effectively within a competitive sale process.

Preparing Your Business for Sale

Strengthening Your Business Before the Sale Process Begins

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The months and years before a sale may significantly influence how buyers evaluate a business. Strong financial performance matters, but buyers also consider risk, transferability, management, and future growth opportunities. Effective pre-sale business preparation addresses these factors before prospective buyers begin evaluating the company.

Strengthen the Financial Foundation

Owners should begin with accurate and timely financial reporting. Balance sheets should accurately reflect receivables, inventory, liabilities, debt, and other accounts. Management should resolve shareholder loans, obsolete inventory, and uncollectible receivables when appropriate.

Before buyer outreach begins, owners should also understand normal working capital requirements and historical capital expenditures. Financial statements should clearly support reported earnings. Owners should also document legitimate normalizing adjustments to develop a representative earnings base.

Reduce Dependence on the Owner

A business that depends heavily on its owner may create additional risk for a buyer. Owners should develop management responsibilities, decision-making authority, and accountability throughout the organization. Key employee retention also deserves attention. Appropriate compensation, incentives, or change-of-control arrangements may help retain employees through a transaction. As responsibilities become distributed, the company becomes less dependent on one individual for continued performance.

Address Operational Risks

Owners should review significant contracts, leases, licenses, intellectual property, and supplier relationships before going to market. Change-of-control provisions or nontransferable agreements may create complications during a transaction. Customer concentration, deferred maintenance, outdated systems, and undocumented processes may also attract buyer scrutiny. An Exit Readiness Assessment can help identify these issues from a prospective buyer’s perspective.

Demonstrate Future Opportunity

Buyers generally evaluate both historical performance and future potential. A credible growth strategy should identify realistic opportunities supported by management capabilities and financial resources. As evidence accumulates, successful initiatives become more compelling than projections alone. Management should track KPIs supporting growth assumptions and prepare reasonable financial projections.

Prepare Before the Marketplace Sets the Narrative

An experienced M&A advisor should begin pre-sale business preparation before the company enters the market. The advisor can work with the owner to identify potential transaction issues and prioritize improvements. An Exit Readiness Assessment may provide the framework for that process. Once marketing begins, buyers will form their own conclusions about the company’s strengths and weaknesses. Preparing early gives the seller an opportunity to address those weaknesses before buyers use them to evaluate risk, value, and transaction terms.

Defining Seller Objectives and Setting Realistic Expectations

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Every seller enters an M&A transaction with certain objectives. Purchase price usually ranks high, but it rarely defines success by itself. Business owners often have financial, professional, and personal priorities tied to a sale. Understanding those priorities should happen before the company enters the market.

Defining seller objectives gives the owner and M&A advisor a clear picture of the desired outcome. It also provides direction for the entire sale process. Some sellers want to maximize cash at closing and retire immediately. Others prioritize employees, retaining company or seller-owned real estate, or remaining involved after closing. The most common seller objectives include:

  • Purchase Price: Achieving an acceptable value for the business.
  • After-Tax Proceeds: Maximizing the amount retained after taxes and transaction expenses.
  • Transaction Structure: Evaluating an asset sale, equity sale, or another appropriate structure.
  • Seller Involvement: Determining whether the owner retires, remains employed, or assists during a transition period.
  • Employees and Family Members: Addressing the future roles of key employees, management, or family members.
  • Company/Seller-Owned Real Estate: Deciding whether to sell, retain, or lease company-owned or seller-owned facilities.
  • Company Legacy: Preserving the company’s name, culture, reputation, or community presence.
  • Closing Certainty: Selecting a qualified buyer capable of financing and completing the transaction.

Identifying these objectives represents only the first step. The seller must also determine whether the marketplace can realistically support them. Here, the M&A advisor plays a critical role. The advisor may compare the seller’s expectations with company value, buyer demand, and likely transaction structures. A preliminary business valuation will establish a reasonable value range before approaching prospective buyers. An Exit Readiness Assessment may also identify obstacles or perceived risks affecting other seller objectives.

With realistic expectations established, the M&A advisor will design a sale process around the seller’s priorities. Buyer selection then involves much more than comparing purchase prices. One buyer may offer the highest price but require significant seller financing. Another may offer more cash, protect employees, and provide greater closing certainty. These differences require tradeoffs. Clearly defined objectives make those decisions easier and help prevent negotiations from losing direction and momentum.

Unexpected issues may still arise during negotiations and due diligence. Therefore, open communication between the seller and M&A advisor should continue throughout the transaction. The advisor must understand which seller objectives are essential and where flexibility exits. This alignment helps the seller navigate challenges, evaluate tradeoffs, and remain focused on the desired outcome.

A successful business sale does not happen by accident or simply produce the highest purchase price. It requires months, sometimes years, of careful planning to achieve a transaction that best satisfies the seller’s financial, professional, and personal objectives.

Using Rules of Thumb as a Business Valuation Starting Point

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Business owners frequently use industry rules of thumb to estimate what their companies might be worth. These formulas offer a quick and convenient reference point. However, business valuation rules of thumb should serve as a starting point rather than a valuation conclusion. Most rules rely on a multiple applied to either revenue or earnings. Earnings measures may include EBITDA, SDE, cash flow, or another industry-specific measure.

Understanding What the Multiple Represents

A rule of thumb reflects observed relationships within a particular industry or market segment. For example, an industry might commonly reference a percentage of annual revenue. Another industry might focus primarily on a multiple of earnings.

At first glance, these formulas appear straightforward. Two companies with identical revenue, however, may have substantially different values. Profitability, growth, customer concentration, management depth, recurring revenue, and competitive position can distinguish one company from another. Company size, geography, capital requirements, and industry conditions may also affect value.

Historical Industry Benchmarks

In the prior year 2010, Business Valuation Resources (BVR) provided revenue-based rules of thumb for several major industry groups. The reported multiples for the period 2008 through 2010 included:

Industry                         2008             2009            2010

Construction                0.39x              0.40x             0.35x

Manufacturing            0.53x               0.61x             0.52x

Transportation            0.69x               0.43x            0.55x

Wholesale Trade         0.46x               0.45x            0.52x

Retail Trade                 0.36x               0.33x            0.34x

Services                         0.56x               0.53x            0.56x

These historical figures illustrate how broad industry benchmarks can change as market conditions change. The variation also reinforces the limitations of relying on a single rule of thumb. Across this period, transaction activity and overall private company valuations were affected by the financial crisis and constrained credit markets. BVR reported fewer private company transactions during 2009 than 2008. Its broader transaction data also showed declining net sales multiples during that period.

However, industry averages cannot account for meaningful differences between individual businesses. Profitability, growth, customer concentration, management depth, and other characteristics may produce substantially different values.

Understand the Transaction Assumptions

Owners must also understand exactly what a particular rule of thumb measures. A multiple does not automatically determine which assets and liabilities transfer to a buyer. Cash, debt, working capital, real estate, and other items depend on the transaction structure. Accordingly, applying a multiple without understanding its underlying assumptions may produce a misleading estimate.

Move Beyond the Rule of Thumb

An experienced valuation professional can analyze the company’s specific financial performance, risks, assets, and market characteristics. An M&A advisor may then evaluate how prospective buyers may view those characteristics during a sale process. Business valuation rules of thumb may provide a useful perspective. However, they cannot replace company-specific analysis or determine what qualified buyers may actually pay.

Rules of thumb provide a reference point. A properly developed valuation provides context, and the marketplace determines the transaction price.

acquisition strategy

Building a Disciplined Acquisition Strategy

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Acquisitions offer companies an opportunity to accelerate growth beyond what organic expansion alone may provide. However, buying another company should begin with a strategic objective rather than the availability of an attractive target. Strategic acquisition planning defines what the buyer wants to accomplish before searching for companies. A clear strategy also provides a framework for evaluating opportunities and avoiding acquisitions that do not support long-term objectives.

Define the Strategic Rationale

Every acquisition should address a specific business objective. A buyer may seek new customers, geographic markets, products, services, employees, technology, or specialized capabilities. Acquiring a competitor may increase market share and provide operating efficiencies. Vertical integration may strengthen control over suppliers, distribution, or other parts of the value chain.

An acquisition may also accelerate a growth initiative that would take years to accomplish organically. For example, entering a new geographic market requires employees, customers, infrastructure, and local relationships, Acquiring an established company may provide those resources immediately. At the strategy stage, management should determine which objectives justify pursuing an acquisition. Without a clear rationale, management risks pursuing opportunities because they appear attractive rather than strategically appropriate.

Establish Acquisition Criteria

After defining the strategy, the buyer should establish specific criteria for potential targets. These criteria may include industry, geography, revenue, profitability, customer profile, management depth, and transaction size. Management should also identify characteristics that would make a target particularly attractive. Recurring revenue, proprietary capabilities, strong customer relationships, or complementary services may support the acquisition strategy.

The buyer should determine acceptable valuation parameters and financing requirements before beginning serious negotiations. Management should also identify potential deal breakers early. Excessive customer concentration, weak management, significant capital requirements, or cultural incompatibility may make certain targets unattractive. Clear criteria keep management focused and provide a consistent basis for comparing opportunities.

Evaluate the Buyer’s Readiness

A successful acquisition requires more than sufficient capital. Management must have enough time and organizational capacity to complete the transaction and integrate the acquired company. The buyer should evaluate its leadership, financing, systems, operations, and existing workload before pursuing a transaction.

Management should also determine how much debt or equity it is willing to use for the acquisition. The existing company must remain healthy while management directs attention toward the transaction. An acquisition that overwhelms leadership may weaken both businesses. Before entering the market, management should identify the internal and external professionals responsible for the acquisition process. This team may include an M&A advisor, attorney, accountant, lender, tax advisor, and other specialists.

Identify and Evaluate Targets

The strongest acquisition opportunities do not always involve companies actively seeking a buyer. An M&A advisor may identify prospective targets through industry research, relationships, proprietary databases, and direct outreach. The search should extend beyond obvious competitors when the acquisition strategy supports a broader buyer perspective. Suppliers, distributors, complementary businesses, and companies in adjacent markets may also represent attractive targets.

Once a target expresses interest, the buyer should evaluate strategic fit before focusing heavily on price. Financial performance, customers, management, operations, competitive position, and growth opportunities all deserve careful analysis. Management should also determine exactly how the target advances the buyer’s original strategic objectives.

Conduct Thorough Due Diligence

Due diligence tests the assumptions supporting the acquisition. The buyer should examine financial, legal, tax, operational, commercial, and organizational matters. Financial due diligence should address earnings quality, working capital, capital expenditures, debt, and other significant financial obligations. Commercial diligence should evaluate customers, competitors, market position, pricing, and future growth opportunities. Operational diligence should examine employees, facilities, technology, processes, suppliers, and management capabilities.

Diligence should also identify integration requirements and any additional investment necessary after closing. As the analysis develops, the buyer should continually compare the opportunity with its original acquisition criteria. Material findings should influence valuation, transaction structure, financing, or the decision to proceed.

Plan the Integration Before Closing

The buyer should begin thinking about integration well before completing the transaction. Management must determine which operations will remain independent and which functions require integration. Accounting, technology, human resources, purchasing, sales, marketing, and reporting systems may require coordination.

The buyer should also identify key employees and customer relationships requiring immediate attention after closing. Cultural differences deserve consideration as well. An acquisition with strong financial logic may still struggle when the organizations operate very differently. Early integration planning helps management establish responsibilities, priorities, and expectations before ownership transfers.

Remain Disciplined

Strategic acquisition planning does not end when the buyer identifies an attractive company. The buyer must evaluate valuation, transaction structure, financing, integration requirements, and expected returns before proceeding. Management should remain willing to stop the process when new information undermines the original investment rationale. Past transaction expenses should not justify completing an acquisition that no longer meets the buyer’s criteria.

An experienced M&A advisor helps maintain discipline throughout the acquisition process. The advisor also coordinates the transaction while management continues operating the existing business. A successful acquisition starts with a clear strategy and maintains that discipline through integration.

M&A Advisor

How an M&A Advisor Guides a Business Sale

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Selling a privately held company requires the owner to make significant decisions while continuing to operate the business. An experienced M&A advisor manages the transaction process and helps the seller make informed decisions at each stage. The M&A advisor responsibilities extend far beyond finding a buyer. They begin with preparation and continue through closing.

Establish Value and Prepare the Business

The advisor should first understand the seller’s financial, professional, and personal objectives. A preliminary valuation establishes a current benchmark and helps set realistic expectations before approaching buyers. An Exit Readiness Assessment should accompany the valuation to identify risks and opportunities to strengthen business value.

At the preparation stage, the advisor also reviews financial performance, normalizing adjustments, working capital, and other transaction considerations. This work helps identify potential issues before prospective buyers begin their evaluation.

Develop the Investment Story

Buyers need more than financial statements to understand an acquisition opportunity. The advisor develops a Confidential Information Memorandum that explains the company, financial performance, operations, and competitive position. The memorandum should also address management, customers, growth opportunities, and other significant value drivers. From this foundation, the advisor positions the company around the characteristics most relevant to prospective buyers.

Identify and Qualify Buyers

The advisor develops a buyer universe based on strategic fit, financial capacity, acquisition history, and investment criteria. Potential buyers may include strategic acquirers, private equity firms, family offices, and qualified individual buyers. The advisor then conducts confidential outreach and evaluates buyer interest. Qualified buyers sign confidentiality agreements before receiving detailed company information. This process protects sensitive information while focusing resources on credible acquisition candidates.

Create and Manage Competition

One of the most significant M&A advisor responsibilities involves creating a competitive marketplace for the seller. The advisor coordinates buyer communications, deadlines, management meetings, and offers. When multiple qualified buyers participate, the seller gains alternatives and greater negotiating leverage. The advisor compares more than purchase price. Transaction structure, consideration, financing, contingencies, and seller involvement also affect an offer.

Negotiate the Transaction

The advisor helps negotiate the Letter of Intent before the seller grants exclusivity. Major economic terms should receive careful attention while competitive leverage remains available. These terms may include working capital, earnouts, seller financing, rollover equity, escrows, and post-closing involvement. The advisor also works closely with legal and tax professionals as negotiations progress.

Manage Due Diligence and Closing

After the LOI, the buyer begins confirmatory due diligence while attorneys negotiate the definitive purchase agreement. The advisor coordinates information requests, buyer questions, financial analysis, and communications among the transaction team. Through the closing process, the advisor helps resolve issues without unnecessarily distracting management from daily operations. Confidentiality also requires continued attention as more employees and outside parties become involved.

Keep the Seller Focused on the Objective

A business sale often takes months and involves difficult negotiations, changing circumstances, and competing priorities. The M&A advisor provides continuity throughout that process while the owner continues operating the company. The advisor’s role is not simply to find a buyer. It is to manage a disciplined process from preparation through closing.

Value Drivers

Strengthening the Value Drivers that Buyers Reward

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Strong earnings provide an essential foundation for business value. However, buyers also evaluate the quality and sustainability of those earnings. They want to understand how the company produces its results and whether those results will continue under new ownership. Buyers also consider the resources required to maintain current performance and support future growth. These business value drivers influence perceived risk, future earnings expectations, and the value buyers place on the company. For sellers, strengthening these characteristics should begin well before the sale process.

Build Sustainable Financial Performance

Buyers generally place greater confidence in earnings that demonstrate consistency, predictability, and opportunities for continued growth. Strong margins, reliable financial reporting, recurring revenue, and disciplined working capital management provide evidence of financial stability. Buyers will also examine historical revenue and profitability trends across multiple periods. Significant fluctuations may require explanations, particularly when recent performance differs materially from historical results.

Growth deserves similar scrutiny. Buyers want to understand what produced historical growth and whether those factors remain sustainable. They may examine pricing, customer additions, geographic expansion, new services, acquisitions, or increased market penetration. From an earnings perspective, sustainable performance carries greater weight than a short-term improvement immediately before a sale.

Reduce Concentrated Business Risk

Customer concentration represents one of the most common risks buyers encounter. Dependence on a few customers exposes future earnings to the loss of individual relationships. The concern becomes greater when those relationships depend primarily on the owner or lack contractual protection. Supplier concentration, employee dependence, and reliance on a single product may create similar concerns.

Geographic concentration may also increase exposure to regional economic conditions or changing customer demand. Diversification across customers, suppliers, products, services, and revenue sources strengthens the company’s financial foundation. Long-term customer relationships and recurring revenue further support predictability. Owners should address concentration through thoughtful growth rather than simply turning away profitable business.

Develop Management Beyond the Owner

A company becomes more transferable when its success does not depend heavily on the owner. Buyers want confidence that employees, customers, and operations will remain stable after the transaction. A capable management team should understand its responsibilities and possess appropriate decision-making authority.

Management should also demonstrate the ability to operate the company without constant involvement from the owner. Documented procedures, reporting systems, performance measurements, and defined responsibilities reinforce that independence. Employee retention also deserves attention, particularly when certain individuals hold critical customer relationships or operational knowledge. As leadership expands, the company becomes less dependent on any single person and more transferable to a new owner.

Strengthen Competitive Advantages

Buyers also evaluate why customers choose the company instead of competitors. A strong competitive position helps support future revenues, margins, customer retention, and growth opportunities. Competitive advantages may include specialized expertise, intellectual property, certifications, technology, geographic position, or established distribution channels.

Other companies may benefit from proprietary processes, strong brands, switching costs, exclusive relationships, or difficult-to-replicate capabilities. Industry-specific business value drivers may include backlog, referral networks, supplier relationships, equipment quality, or specialized operating capabilities. The strongest advantages should produce measurable economic benefits rather than simply differentiate the company. Buyers will evaluate whether those advantages transfer with the business and remain defensible after closing.

Improve Systems and Operating Infrastructure

Buyers also consider whether the company has the infrastructure required to support its current size and future growth. Strong accounting, customer relationship management, operational, and reporting systems provide greater visibility into business performance. Documented processes help employees perform consistently and reduce dependence on institutional knowledge.

Facilities and equipment should also support the company’s operating requirements. Deferred maintenance or outdated equipment may signal significant capital expenditures after closing. Likewise, inadequate systems may require the buyer to invest additional resources immediately after the acquisition. A scalable operating foundation supports growth without requiring disproportionate increases in overhead or management involvement.

Identify Weaknesses Before Buyers Do

Owners should evaluate value drivers before entering the marketplace. A preliminary business valuation establishes the company’s current value and provides a financial benchmark. An Exit Readiness Assessment should accompany the valuation to identify risks and opportunities to strengthen business value. The assessment evaluates the company from the perspective of prospective buyers. It may examine earnings, growth, customer concentration, management, operations, reporting, competitive advantages, and other significant characteristics.

The owner then has a practical roadmap for deciding where to invest time and resources. Some weaknesses require relatively straightforward corrections. Other may require substantial operational or strategic changes.

Give Improvements Time to Produce Results

Buyers place greater confidence in demonstrated improvements than plans presented shortly before a sale. Early preparation gives management time to implement changes and establish a measurable performance history. For example, hiring a senior manager shortly before a sale provides limited evidence of reduced owner dependence. Several years of successful leadership provides a much stronger record.

The same principle applies to customer diversification, new markets, recurring revenue, operational improvements, and growth initiatives. Historical results provide buyers with evidence that improvements have become part of the business. Over a longer horizon, these improvements strengthen the characteristics buyers evaluate when determining risk and value.

Present Those Strengths to the Marketplace

Building a stronger company represents only part of the value equation. The seller must also present those strengths to buyers that understand and value them. An experienced M&A advisor identifies the company’s strongest value drivers and incorporates them into the investment story. The advisor then identifies prospective buyers with strategic or financial reasons to value those characteristics.

A competitive sale process allows different buyers to evaluate the company based on their individual objectives and potential synergies. Increasing sales value starts long before the company enters the market. Strengthening the underlying value drivers gives buyers stronger reasons to compete.

Real Estate

Separating Business Value from Real Estate Value

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Many privately held businesses own the property from which they operate. That ownership creates additional considerations when the owner prepares for a sale. The business and real estate represent separate assets, even when the same owner controls both. Therefore, evaluating real estate and business value requires understanding the economic relationship between the company and its property. The seller must first determine whether the real estate should transfer with the business or remain separately owned.

Determine How the Business Uses the Property

Some properties serve an essential operating purpose. Manufacturing facilities, warehouses, dealerships, and specialized buildings may contain improvements specifically designed for the company’s operations. Other businesses occupy conventional offices, retail locations, or industrial properties that another tenant could readily use.

The property’s role affects the alternatives available to the seller. Where operations depend heavily on the location, a buyer may prefer ownership or long-term control of the property. A more interchangeable facility may provide greater flexibility.

Evaluate the Real Estate Separately

When appropriate, the owner should evaluate the property independently from the operating company. A real estate appraisal considers factors different from those used to value a business. Location, comparable sales, market rents, capitalization rates, zoning, condition, and highest and best use may influence property value. The property’s current use does not necessarily represent its highest and best use.

From a property standpoint, redevelopment or alternative uses may support a different value than continued business occupancy. Environmental conditions, deferred maintenance, or specialized improvements may also affect marketability.

Normalize the Company’s Occupancy Cost

Real estate ownership often affects the company’s reported earnings. An owner may charge the business above-market rent, below-market rent, or no rent. Before evaluating the operating business, the financial statements should reflect a reasonable market occupancy cost. This adjustment helps separate real estate and business value and produces a more representative earnings base. Market rent also becomes particularly relevant when the seller retains the property after closing.

Consider the Transaction Alternatives

The seller generally has several alternatives when the business owns the real estate. The buyer may acquire both the operating company and property as part of the transaction. Alternatively, the seller may retain the property and enter a long-term lease with the buyer. The seller may also sell the property separately to another real estate investor. Depending on the structure, these alternatives may produce significantly different proceeds, income streams, financing requirements, and tax consequences.

Structure the Lease Carefully

When the seller retains the property, the lease becomes an important component of the transaction. Rent should reflect market conditions and the economics assumed in the business valuation. The parties should also negotiate lease term, renewal options, maintenance responsibilities, insurance, taxes, and future rent adjustments. A buyer also needs sufficient occupancy certainty to operate the acquired business. Likewise, lenders may review the lease when evaluating transaction financing.

Evaluate the Business and Property Together

Separating the valuations does not mean evaluating the assets independently from the transaction. The business requires a place to operate, and occupancy costs directly affect its earnings. The real estate also derives economic value from its location, use, tenant, and alternative opportunities.

An experienced M&A advisor will evaluate these relationships before marketing the company. Real estate, valuation, tax, and legal professionals may also provide specialized advice where appropriate. The objective is to understand both assets separately, then structure them together around the seller’s transaction objectives.

Babson College’s 2013 Middle Market/Small Business M&A Survey

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Babson College recently examined the conditions shaping mergers and acquisitions for small and middle market businesses. Professor Kevin J. Mulvaney directed the research with participation from M&A advisors, bankers, and other transaction professionals. The survey evaluated trends affecting buyers, sellers, financing, valuations, and transaction execution.

The 2013 Middle Market M&A Survey described a market that had improved considerably following the recession. However, economic uncertainty continued to influence transaction activity. For business owners considering a sale, several findings stood out.

First, the survey characterized the environment as a seller’s market for quality companies. Strong businesses could attract buyer interest, but preparation remained essential. The same conditions did not apply equally to underperforming companies. Buyers remained selective and placed greater emphasis on sustainable earnings, growth prospects, and business quality.

Deal execution also required patience. The survey reported that transactions commonly required six to nine months from serious negotiations through closing. Some respondents expected timelines to extend another month or two. Buyer due diligence contributed to these longer timelines. Buyers increasingly used experienced teams to examine financial performance, revenue trends, and future growth potential.

Another finding involved seller participation in smaller transaction. As company size decreased, buyers generally demanded greater seller assistance. That assistance could include earnouts, deferred consideration, employment, consulting, or other continuing involvement. At the time, deferred consideration averaged approximately 20 percent of the purchase price in surveyed transactions.

Financing conditions were also improving. The survey identified greater middle market lending availability and a rebound in SBA-guaranteed acquisition financing. Meanwhile, mezzanine debt yields had declined to approximately 12% – 14%. Historical averages had previously ranged from approximately 15% – 20%.

Taken as a whole, the 2013 Middle Market M&A Survey delivered a straightforward message for business owners. Favorable conditions alone did not guarantee a successful transaction. Quality companies still required careful preparation, realistic expectations, and experienced transaction guidance. Sellers also needed the information and responsiveness necessary to withstand increasingly thorough buyer due diligence.

For owners considering a future capital event, the survey supported planning well before entering the market. Preparation allowed sellers to evaluate alternatives and approach potential buyers from a stronger position.

Allston Advisory Group is an experienced boutique M&A advisory firm providing a variety of services to lower middle market companies. See our footer for contact information.

(502) 742-2933
[email protected]
P.O. Box 21266, Louisville, KY 40221

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