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ComplianceMay 07, 2021

Prepared sellers garner the best valuations

Today’s M&A market is white hot, and the data certainly bears that out. U.S. private equity deal making appears to be as strong as ever despite the pandemic, with deal values topping $200 billion in Q1 2021, according to Pitchbook Data. Additionally, private equity firms have plenty of capital available for new deal opportunities. US private equity fundraising rebounded substantially in the first quarter of 2021.

What’s more, company valuations are soaring. Private equity firms paid an average 13.2 times a company’s annual EBITDA for US-leveraged buyouts in 2020 — an all-time high, according to financial data provider Refinitiv.

These numbers make one thing clear. Private equity firms are aggressively looking for acquisition targets and are willing to pay high prices for high-quality companies. This is all good news for owners who are thinking about selling their businesses. Companies that showed they were resilient during the COVID pandemic will be all the more attractive, and private equity firms are eager to scoop them up.

Be ‘sale ready’ before opportunity knocks

That said, the competition for great target companies is fierce among private equity firms. It’s extremely important for owners who wish to sell to have their companies ready for sale before a private equity firm comes knocking.

Pre-sale planning is the best way to achieve a successful sale. Selling at the best price is not as easy as it appears. In fact, according to a study conducted by the Journal of Private Equity, on average a private equity firm reviews 80 potential investments before they make a single purchase. The odds that your company gets picked are slim to begin with. Companies that aren’t prepared for a sale will have less chance of being bought and will certainly lose out on the best price if they aren’t prepared to sell.

“Private equity firms have a lot of money they are looking to deploy. Now can be a great time to sell if your company is ready. Conversely, if a company is in disarray, it may not gain much interest or the best price, which can be disappointing to owners who expect to sell high and have worked hard for this liquidity event,” says Elina Balagula, Esq., Transactional Business Consultant at CT Corporation.

Are you prepared for a sale?

Be sure your business has

  • set clear objectives
  • hired and secured an experienced management team
  • a recurring and increasing revenue base
  • at least two years of double-digit revenue and earnings growth
  • recruited a recognized audit firm to audit for the last two years
  • a trusted investment banker and attorney
  • an advisor to perform sell-side due diligence
  • documented and ensured that assets, IP, and trademarks are protected
  • improved internal financial reporting process and systems
  • its tax-house in order

Wolters Kluwer’s CT Corporation supports businesses with a broad range of compliance requirements and issues that often come into play when private equity firms are buying a company. What follows is information about what private equity firms look for before moving forward with an acquisition. The bottom line is sellers who have gotten their house in order will fare far better when it is time to sell.

“We are often asked to research sellers for private equity firms, among other things. We spend a considerable amount of time checking on things that could potentially be problems. For example, we do lien searches, we look at where companies are located to make sure they are in good standing, and if there are any open litigation or bankruptcy proceedings. Many companies have taken advantage of the loans available because money is cheap to borrow. Have they over borrowed, are they responsible for paying it back? These are some of the things private equity firms are looking into,” says Michael Malkowski, an Account & Relationship Management Executive with CT.

The importance of quality financial statements

One of the keys to creating credibility with buyers is preparing high-quality financial statements and business documents that a buyer can rely on long after the seller has left the business. Financial statements should provide accurate information that will help potential buyers make decisions going forward. The more information that’s on paper, the easier it is for a potential buyer to get comfortable with a company. It lowers the risk for the buyer because it shows that there are clearly established processes and protocols in place.

When potential buyers look at the financials of a company, they want to see accounting records, financial statements, systems and controls, taxes, working capital expenditures, sales reports, analysis of debts, budgets, and forecasts. Having a well-documented paper trail of non-recurring expense items is a must as is establishing a monthly reporting package that highlights key top and bottom-line metrics.

Lastly, making sure the company has been tax compliant with returns filed on both the state and federal level in a timely fashion is critical. Although seemingly obvious, outstanding tax issues will delay negotiations.

Being in good standing is critical

Other documents that will create a level of comfort with buyers include insurance documentation, employment agreements, and intellectual property documents such as copyrights and patents. Sellers will want to be sure they have current/active business licenses and permits, no liens related to past legal judgments or taxes owed, and are in good standing with lending agreements.

Frequently working with private equity firms’ advisors, CT sees firsthand how easy it is for companies to be unprepared should a buyer show interest. Being in good standing — meaning the seller has complied with all their legal and regulatory obligations, not just financial obligations—is another critical component to being an attractive seller. “Companies have to produce good standing certificates in the states where they do business. Companies fall out of good standing all the time. Sometimes, it’s by accident and other times there are reasons, but nonetheless the company will not be of great interest to a private equity buyer if it isn’t in good standing,” says Malkowski, who explains that there are various parts to being in good standing, including not owing taxes, having all licenses up to date, registering businesses lawfully, being free of litigation, among other things. “It’s shocking to see how many companies fall out of good standing and don’t realize it. There are serious implications for letting things lapse. You can actually lose the authority to do business,” he says.

Other factors that buyers will look for that aren’t obvious include past operational challenges like product recalls that may not have been appropriately remediated, poor record keeping and governance regarding corporate records, disparate internal policies across siloed departments, and cybersecurity threats as a result of outdated software.

Sellers need to be ready for all areas of scrutiny. “It’s like cleaning your house before you go to sell it. You are more likely to get a better offer if your house is cleaned and staged. You don’t want potential buyers looking in the closet and finding a big mess to clean up. That will turn them off to the sale,” says Malkowski. “It’s the same concept with a business.”

Learn more

Working with the right trusted partner can help you feel confident that you’re doing everything possible to help your company succeed. To learn more about how CT can help your deal go smoothly and navigate your compliance needs, contact your CT Service Representative or call (866) 692-1202.

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