EP #7: Navigating the Seas of Private Equity M&A: Charting the Course for Financial Finesse and Strategic Exits

Join Russell Cohen and myself, Jeremy Wolf, on a journey to the heart of financial finesse in the fast-paced world of private equity-backed M&A transactions. We pledge to uncover the layers behind pristine financial records that are essential when courting private equity buyers—think of it as financial matchmaking where only the cleanest, GAAP-compliant books win hearts. We'll dissect the significance of the trailing 12-month performance and just why every tick and tock of the quality of earnings report can make or break your EBITDA's credibility. For business owners playing the long game, our dialogue serves as a treasure map to the 'X' marking the sweet spot for your post-transaction salary expectations and company valuation.

Sail with us into the strategic waters of exit strategies, where timing and commitment post-sale are more than just mere details—they're the anchors that can secure future fortunes through rollover equity. Our conversation charts the course every savvy business owner should navigate before setting sail on their M&A voyage. With a seasoned advisory team as your crew and an M&A advisor as your captain, we illustrate how to steer clear of the common storms that besiege sellers. For most, this transaction is not just a business deal but the culmination of a lifetime's work, a pivotal moment that demands expert navigation to ensure their legacy—and financial future—is preserved.

Transcript

Speaker 1: 0:02

Welcome to the South Florida M&A Advisors podcast, your trusted M&A team. Here's your host, Russell Cohen.

Jeremy: 0:14

Hello everyone and welcome back to another episode of the South Florida M&A Advisors podcast of your co-host Jeremy Wolf, joined by your host, russell Cohen. Russell, good to see you again.

Russell: 0:24

All right good morning hey, Jeremy. Good morning.

Jeremy: 0:26

How are you doing? Well, man, it's Friday and ready for a nice relaxing weekend. The wife has taken the sun to Disney. This weekend, it's just me and my daughter. So we're going to do some chilling. We're going to have some fun together.

Russell: 0:37

Have a relaxing weekend. That's good.

Jeremy: 0:39

Yeah, yeah for sure. So we've been going on this journey through the M&A process. We've talked about a lot of different topics and I know today you wanted to focus a little bit more in depth on how to be private equity ready, and I would imagine, from where I sit, that the financial performance of a business is probably an instrumental factor in getting yourself ready for private equity funding. So, with that in mind, how crucial is a company's financial performance when preparing for a private equity backed M&A transaction?

Russell: 1:17

It's extremely crucial. You know you're dealing with professional buyers. They do this for a living. They're buying companies. That's all they do every day of the year. They're looking at companies all day and so they're studying the numbers. And this is your first journey, you know. Especially, you know, when you hire an M&A advisor like myself, I'm doing it on a day to day basis. But the business owner this is their first, first dance in this arena and overwhelming, very overwhelming.

Russell: 1:51

There's not a business owner that is private equity ready. And I say that because the private equity group uses gap accounting, generally accepted accounting principles, and the all these businesses are not gap. They're not using gap principles. There might be close, but their books are not gap prepared. Now, in a business trans, in an M&A transaction, they may not expect you, the private equity group may not expect you to be gap. You know, using those types of principles, but but they're looking at it through the lens of how they're going to run the business. So, as we look at their financials and we think it's great, and then we start unpeeling the onion and we start to realize, as we get a little deeper and we ask more questions, you know we find holes in the books and you know we have. We have to solve that problem. If, obviously, if I'm getting there in early, I can bring in the professionals you know, I could bring in a fractional CFO, I can bring in a higher level accounting firm to plug the holes and start preparing for sale.

Russell: 3:07

But if I'm, you know, if they haven't done it and I'm there ready to bring on the company on the market, then you know we got a lot of work to do to put it in the right light for the private equity group.

Jeremy: 3:21

Yeah, sounds like an intricate process. What key financial metrics and performance indicators do investors typically look for in potential targets when looking for places to invest private equity Right?

Russell: 3:37

so. So they're basically going to be looking. They're gonna look at three years, but the what I'm really commonplace is we're seeing they're really looking at your, your trailing 12 months, the current year. You know, if you could be in business 50 years and if you're on a declining trend then then they're going to look at that, that calendar year, that most recent calendar year in the trailing 12 months, and that's what they're buying and they're trying to figure out. You know, is that trailing 12 months sustainable? Was it quick hockey stick growth or they're catching a slipping knife? So that trailing 12 months is very pivotal and they're gonna they're gonna probably study your financials right up to the closing. 30 days prior to closing, your financials need to be clean. They're going to be making sure that you have the foot on the on the gas pedal all the way through the closing.

Russell: 4:36

So you know these. You know the companies that come in and really order your books. It's called a quality of earnings. The buyers steps aside, the investors steps aside. They're spending 75 to 100,000 for this quality of earnings and they are working on behalf of the buyer.

Russell: 4:55

They're not working for you and they're not trying to kill the deal. They're just trying to make the buyer aware of of where where the potential issues are in the books. They're trying to confirm the EBITDA, the earnings of the company, and a lot of times the business owner owns the property and we got to make sure we have the right rent to the marketplace that could adjust the EBITDA. A lot of times the owners are staying on and they want that same salary, the high-end salary and benefits, which then could negatively affect the EBITDA. So as a M&A advisor, we have to as much as they're worth. Private equity group is not gonna pay $400,000, $500,000 a year for you to run the company Just because it will negatively affect it, would negatively affect the cash flow. So setting expectations with the owner is just as important in the process. So, yeah, go ahead.

Jeremy: 6:08

No, I was gonna say so. I'm trying to think through this in my mind. So the business comes to you, they wanna sell their business or they wanna raise equity, whatever the case may be, obviously you need to do an assessment. That's the first thing you would do is an assessment of the business. How long does that typically take for you to conduct an assessment to determine Cause obviously there's things that need to be done in many cases to the business, like you mentioned, they're not GAP-ready, accounting-wise, you need to bring in professionals. Obviously, before you go out and try to raise private equity, you're gonna wanna get that business as ready as they could possibly be. How long have you seen that process typically take? Is that something that can take six months, 12 months to do for a business, or is it something that can be very quick?

Russell: 6:53

Sometimes the owners are ready. So a lot of times if they really wanna get the true value of the business, we recommend a business appraisal by a certified appraiser. That will give you the value of the business in this point in time. On the flip side, we can give an opinion of value. I'm not a certified appraiser but I can tell you in a roundabout way through an analysis landing spot.

Russell: 7:21

But when we go to market, a lot of times in these M&A transactions we don't have a price. We go to market, we let the marketplace dictate the price. I'll give you a perfect example. I was dealing with a fire production company and we received two offers. One is six million and then another one was nine million. So we did not have a price on the business and it was just one buyer to the other buyer had different values, same EBITDA. We had a $2 million EBITDA. One was willing to pay three and another one was willing to pay four and a quarter. So we don't come to market with a price. And if the owner wants to know kind of the expectations where to land, then that's great for them to know. But we don't come to market with a price.

Jeremy: 8:17

That's very interesting. That's a pretty substantial spread you're talking about. You said six, you got two offers, six million and nine million. I mean you're talking about a huge difference there. So you never come to market, so never do you have a price on the business. That's always kind of let the market dictate that there's no exception, the preferred method is not to come to market the smaller deals.

Russell: 8:42

when we're dealing from five to 10, you can come to market with a price, but you don't have to. You really don't have to. We're trying to do a structured process where we're creating a lot of stir and activity and leverage against each offer and we're trying to get the highest possible price. So if we find a seller who is trying to maximize the price, then that's fine. We'll do a structured process, kind of like an auction process. If we have a seller who is really is more concerned about time and wants and not about price they wanna get a good multiple but time is more important then maybe a price is better because then the buyer knows the target and the seller wants the exit quicker. And that's a good reason why to have a price on the business, so the business can move quicker.

Jeremy: 9:41

Can you share any examples I mean, I know you've done quite a few of these deals over the years of how either a strong or perhaps a weak financial performance by a company you've worked with has ultimately influenced the outcome of the deal?

Russell: 9:57

Oh, no doubt. If you have a hockey stick growth, then the seller is in the driver's seat because they're gonna get a great multiple. You're going to have multiple buyers on the opportunity and the private equity group will be eager to get through the process because it's growing and it's obviously a growing segment. But if you're in a declining trend, like a three-year declining trend, and you're selling it based on the trailing 12 months, you know a whole different set of questions will come out. And if the current year, if the sales are going down, you know that is a concern. So that puts the leverage, the buyer gets the leverage on the deal and you have many hurdles to get through. Because the question is, you know, why are the sales dropping, why are the earnings going down and can the private equity group do something to bring it back to where it was? So downward trends is a whole different animal and it's not a whole other ballgame.

Jeremy: 11:12

You might not be dancing in the multiples of private equity. No, your multiples are going down.

Russell: 11:16

Listen as long as you have the right expectations and you want to be on the other side of ownership, you know then there's still a chance you'll get your deal done. But you know, if you're going to be part of the team you're going to have to be willing to stay on and transfer the business in orderly fashion. That's very, very pivotal in the sale of a larger company.

Jeremy: 11:41

So, on that note, what role does an exit strategy play in the M&A process and how should companies or how do you typically advise companies to work with on developing that exit strategy?

Russell: 11:55

Well, you know we have to set the right expectations. If the owner thinks they're getting out of the business within 30 days to six months, they are probably not going to deal with these type of acquirers, these type of investors. So, as an M&A advisor, the first thing I said to them you've got to commit to a year to two years. Even a year is probably not enough, but you know certain circumstances, you can get away with it. But let's say an average of two years. You have to commit to the investor, private investor, the private equity group, that you're going to be an employee or slash consultant of the new company, which you know business owners are the entrepreneurs. Now, all of a sudden, you know they're still running the company to just don't have the risk associated with it to the same extent that they had prior. So as the M&A advisor, I got to say sorry, you know, I know you're, you want to get out of jail and you want to go off and go on vacation or play golf and start living your retirement life. But you know you got that two year window that you're going to have to, you know, run with the private equity group and be part of their team, and that also goes into deal structure.

Russell: 13:15

A lot of times they're not buying you at 100%. They're going to have you take 10 to 20% roll over equity. So you get something called the second buy of the apple. When they sell, when they sell the business with the other companies they bought, you have the opportunity to be part of that second sale and sometimes, if it's not everyone, if everyone does the job correctly, then that second sale could be bigger than the first. So that's called the second buy of the apple, where, where you, you know you keep your 10 to 20% roll over equity in and when they sell the whole package of all the companies that they bought, then there's a very good chance that you'll get a very nice return. And that's if everything goes as planned, obviously, sure. So yeah, a lot of things.

Jeremy: 14:09

Is that standard practice when you're talking about bringing in private equity, for the owner to stay on for, like you mentioned, up to two years? Or I'd imagine there are scenarios where they're out quick because the for whatever reason the previous owner they want them out, or how does that typically work when dealing with these transactions? I also imagine that there's a threshold, like price you mentioned 5 to 10 million. When you're talking about larger scale transactions, they're probably going to want the previous owner on longer right.

Russell: 14:37

Yeah, yes, I mean so two years. A lot of times we're dealing with business owners during that retirement age. They're selling between 60 and 70. So the itches, you know, to move on and that's why they're trying to be on the other side of ownership. But they are keeping a piece of their sale in the private equity group in the new company and they are expected to stay on for two years.

Russell: 15:01

That's part you know. You have to be part of the team, right? You're now owned by corporate, let's say, and now you're still the CEO, you're still doing everything you're doing. You know less accounting and and you know a lot less responsibility. But you're just. You know you have a professional team behind you to help you grow the business. And and you know that's why they're buying you. They want, they want to grow. You know if you are doing 10 million, they want to see you do 15 to 20 million. So and they're gonna, they're gonna give you the professional you know support, you know the additional capital to jump in and and and try to grow it in the marketplace where you might have hit a wall. And and you've done, you could do what you could only do as a, as an owner operator in the business. Now you have the ability to really take it to the next level if you desire.

Jeremy: 16:00

Anything else you wanted to add before we wrap this one up.

Russell: 16:05

You know, listen, you know this is a very tricky process. It's a very detailed process. It doesn't happen quick. These deals can take six months, plus once you have an LOI. You have many hands in the cookie jar in your deal, many different advisors from accounting legal. You know, just on the, just on the, on the buy side, they have a huge buy side advisory team. It's important that you have your right advisory team, from your attorney to your accountant, your CPA to your M&A advisor to. You know we help. You know we bring in fractional CFOs to help in the quality of earnings. So, yeah, so it is. It's a very tough process. It's an expensive process. Unfortunately, when you start bringing in all these different advisors to get to the, to get to the finish line well worth it, because this is this is your largest chances are. This is your largest asset on your personal balance sheet. So this is vital that we can turn it liquid for you so you can invest the money.

Jeremy: 17:13

Yeah, I mean, you said it earlier, right You're. You're run to the mill, general small business owner, even medium sized business owner, that doesn't have experience with this whole process. So it is incredibly important to have an expert such yourself that has a team of professionals that can go in kind of maximize the value of your business and make sure that you're taking care of moving forward.

Russell: 17:32

So it's a whole different language, yeah, from if you were selling a small business compared to your. When you're doing an M&A transaction, the buyers are speaking a different language and the business owner is kind of taken back because they're trying to understand. You know what does all this mean? And sometimes sellers, you know they they slow down the process because they're trying to grasp the process and and that's why it can't take longer to do a deal, because they, you know they are successful, but they've never done, never, never sold their company before. And so that's why it's vital to have the right team of advisors to you know, do it a straightforward, honest, high integrity and and guide them through this, as I call it a maze of of a, of a, you know, m&a transaction.

Jeremy: 18:26

Yeah, indeed, all right, russell. Always a pleasure. Thanks for the insights. Thank you, yeah, and thanks for everyone for tuning in and we will catch you all next time. Everyone, take care and have a wonderful day.

Speaker 1: 18:42

Thanks for listening to the South Florida M&A advisors podcast. For more information, visit South Florida MAcom or contact 954-646-7651.