When is the right time to consider a merger or acquisition? 2023 was a challenging year for many tech-enabled services businesses as many end customers deferred projects or reduced technology-related spending. This doesn't mean it's a bad time to buy or sell, and in this episode we're helping business owners determine if this is the right time.
2023 was a challenging year for many tech-enabled services businesses as many end customers deferred projects or reduced technology-related spending.
This stressed revenue growth and gross margins, reducing EBITDA for many tech-service firms.
It’s tough to run a business through these times, it's easy for founders to become exhausted dealing with less while trying to run the firm as best as possible. If you founded a business in the early 2000s, you’ve been at it a long time and it may be time to cash out or at least remove some chips from the table.
With reduced profit and growth, many founders may defer selling their business as lower profits could lead to lower enterprise values.
We’d like to put a framework in place that helps business owners determine if this is the right time to buy.
Cash at close vs. Structure:
Selling in vs selling out
Current market conditions
Business performance now:
Understanding your current investments and commitments.
Understand the risks of running the business
Work with an advisor
Mike Harvath 00:02
Hello and welcome to this week Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington Minnesota. Revenue Rocket is the world's premier, M&A advisor and growth strategy advisor for tech enabled services companies. Today, my partner Ryan Burnett's with me, what are we talking about today? Right.
Ryan Barnett 00:26
Hey, Mike, thanks for hopping on here today and appreciate some insights here. And the discussion we're about to have. One of the questions that we get most often is, whilst in a mergers and acquisition world in which we're oftentimes reaching out to someone, on behalf of a buyer, a potential seller is a little taken aback, they don't quite understand why they're reaching out or why we're reaching out or, more importantly, they that way, it's one point, it'd be great to sell my business, but I never thought it was gonna be today. And so the question that we hear a lot is, should I sell or consider selling my firm today? Or should I wait? And if you're pulling money out of the business, and you've got a lifestyle that you're used to, and things are going well, it may be really something to consider of, do I continue to harbor this harbor side cash? Or do I look to grow with a partner who might acquire my firm, and I just wanted what we wanted to walk through a couple of these things, you know, 2023, was really hard for a lot of technology as tech savvy, tech enabled services business. And when you looked at the macro environment, and many customers deferred spending, or they reduced technology renaming spending, in a lot of companies in our market came out a little bruised. And so that, that you saw some distressed revenue growth, you saw some distressed margins, and, and reducing EBITDA on for some of these firms, and is a person who's in this business. It's quite difficult to run a business, especially, let's say you founded your firm in 2005. And you've been running it for 20 years. And you're finally getting to the point where, Oh, should I should I be still doing this? Should I still be dealing with a day to day headaches? And you just been at it for a long time? So why that's this discussion, want to start here today and put a framework in place that helps you discuss or think about, know, should I sell my business today? Or should I wait? Mike, any anything to get us going?
Mike Harvath 02:45
Yeah, you know, I have a lot of thoughts on this topic. Obviously, we've talked to a lot of potential clients and sellers and others about, you know, is now the time or not. And I think in many ways, you know, this is a real personal decision. You know, to frame it up, you know, one way to think about it, and I encourage a lot of people to also realize this is with the big caveat that if you run your business well, let's say you run it in a top quartile of profit performance. And, you know, you're kind of off into the right meaning you're growing year over year revenue and profitability. You know, if that, if that trajectory would continue, your business will always be worth more later than it is today. However, that's just one consideration. You know, I think there's a lot of things that, you know, business owners need to contemplate, one might be, you know, where am I in my career journey? Right? Am I early in my journey? Or am I later in my journey? You know, do I want to do something else, right, there may be a reason and emphasis for selling your business, you want to focus on other things. We certainly had a lot of people tell us, they want to do other things or sort of be interested in other areas, someone opened restaurants I want to open we've highlighted this one a bunch of times, you know, one of our clients sold their business and opened a Taekwondo studio, another one, you know, wanted to hike, you know, mountains, you know, the 14 foot 1000 foot peaks or more than when the height goes in the world and someone to, you know, open a restaurant or whatever. And so a lot of it has to do with your personal journey, and timing. You know, kind of where you are in your career. We talk a lot about selling in selling out, you know, do you want to recapitalize the business, take some chips off the table, so to speak, and then continue on the journey with a new capital partner so you can do more and grow more through acquisition as an example. A lot of it has to do with your personal motivation as to whether Now's the right time or not, you know, beyond that, I think there's your number, right, there's this price in your head. Most sellers have a number that, hey, if I could sell my business for this number, then I would entertain it. So that I could go do something else. And you have to make sure the business condition will support evaluation around that number. And also for further understand, you know, and we've done podcasts on this in the past, they encourage you to go back and listen to them on how much you'll take out of a transaction, after taxes and fees. You know, so make sure that your numbers aligned to sort of that post taxes and fees structure. If now's the time, you know, and I guess I'd also Park and think for consideration, you know, most deals in our industry are based on a multiple of EBITDA. And the way to think about that is if you didn't grow the business, whatever that multiple is, whether it's 678, times trailing 12, month EBITA. That's the amount of profit you're going to get in the transaction, pre tax and fees. And essentially, a number that says they're paying it forward for that number of years of operations without the risk of running the business. And certainly, you hear from a lot of sellers, well, I could just run the business for another six, seven or eight years and, you know, get the same money and all this, which is totally true. But they also have to contemplate the business cycles and risk associated with running the business for that period of time. And for the opportunity cost of them working in the business versus doing something else they might want to do. So, hopefully, that's planted a few seeds for you Ryan.
Ryan Barnett 06:54
Yeah, I think it's a great start, it's one of those of you use a bit of a gamble. Scenario, in one way, when you're running your own business 100% of the risk is on you. And you're kind of on the table all the time. If you look at a acquisition, it gives you an opportunity to take a few chips off the table. And I think one of the things you've got to consider is that typically a tech services founder and operator, and this is your biggest investment. This is where your your likelihood your retirement is coming from in either running or selling this business and, and when you when all of it's in your risk, it's very, it can be daunting to to continually deal with the minutiae of the day to day and deal with the running of the business and, and have every bit of a headache and and the corresponding joys that come with running a business. So there's that risk is something that I think is is huge. If we start to think about a company, again, framing this in the valley of 2023, in which we did see a few p&l cells that were not looking as great as 2022. So you saw some depressed revenue, and some depressed profits. And a lot of sellers look at and say, well, this just isn't my time, because I've had a bad year. Mike, I'd like to get your thoughts on perhaps. What are what are some ways in that? A CEO may think about that differently. Maybe perhaps, introduce the concept around deal structure or our concept around selling in versus selling out?
Mike Harvath 08:44
Yeah, that's a great question, Ryan. And I think, you know, certainly there is a cyclical nature to most small businesses in how they perform. And I think if you look and if you've been in business for any length of time, you'll see that oftentimes there is a sort of some lumpiness to your revenue and profit growth. It certainly could have to do with macro factor, like in some ways, you know, a lot of folks saw macroeconomic headwinds early in 2023. Because the whole world was sort of expecting a recession later in the year that never really showed up. And a lot of companies and customers of our clients were pulling back, not investing, trying to keep some dry powder for the impending doom of a potential recession that never materialized. And once they realized that it didn't materialize, that created some pent up demand, and I think we're probably seeing now as we look at, you know, early 2024, because certainly, in the market today, there's a lot of demand and a lot of things going on. But there are business cycles where that's introduced internally just based on you operate and what your investment cycle is typically in your own business, or whether that's due to macro economic factors or both. And having an understanding of what those are is important. More to do with sort of what's coming sort of forecasting, I think, why is that is important. But it may also have some impact on when you might think you might want to exit. Now, timing in the market, whether it be in the stock market, or in selling your business is probably a bad idea, it's hard to try to predict when the best time to do a deal is looking into the future. As I often say, you know, the only thing I know about predicting some very specific outcome in the future is that I'm likely to be wrong, because the odds of you being wrong are much higher than the odds of you being right. And so I think when you think about the business and think about value in the business, you know, there's a, there's sort of some I don't want to call it sort of a, some thinking that the only way you value a business is based on trailing 12 month, EBITDA. That is not the case. And that's not evaluation, it's just sort of a stake in the ground about what your value might be. The way you actually evaluate the businesses on a variety of different methodologies over a much longer historical period, you know, up to five years, as well as taking into account the value of those future cash flows, kind of discounted back to today for risk. So a comprehensive valuation really looks at your business over a broad period of years. And, as a result, can, in many ways, neuter a bad year, or in some cases, tamp down a good year in the cycle, in an effort to come to real value or valuation. So, you know, the short answer is I wouldn't be so short sighted, I wouldn't recommend that you'd be so short sighted to say, hey, we had a bad year 23, sometimes a bad time to do a deal, not necessarily the case, you have to look at sort of a much longer term view of normally what will be historical view but also a future view. And was that forecast come into play? Because I think most IT services firms today are experiencing a rising tide environment, and are now looking at a pretty good 24. And I think in no small part, that's a servicing some of the pent up demand that probably came from 23. But the takeaway here is that they'll always be business cycles, macro economic cycles, things that investment cycle as you do in the business. And you have to understand that the value of that business is looked at on a much a multi year basis back and forward. And it will take out some of those bad years when you think about true value.
Ryan Barnett 13:17
The other thing I'd add here like is that there could be a case in which looking at a structure of a deal for the lowest future years. And I'll give some examples that you may have a perhaps a lower cash offer, in but the total consideration, oftentimes what we call enterprise value might actually be higher, based on a commitment to the future, if you're willing to set sign up for that future. So you may see something like an aggressive earnout that allows you to not only reap what you get today with some cash flows, but you can have a successful earn out assuming is built correctly, based on those future years that you feel more confident about. The same can go with the seller notes in which you can help a buyer from the business theory side some economic downturns, but still creating an investment vehicle that will get you market rates on a an on note for a period of one typically one to three, three ish years that allow the buyer to act and allows you to have a more guaranteed payment. And then the third option consideration is that if everyone is going through the same time and we think everyone might be going higher later, looking for in equity investments in the continuing operation of the combined entity might be a great option for trying to hit a number that you could commit to in the future, and be able to reap the rewards of having a combined company together. I think a lot of this requires you having the concept of selling in, which means that you'd be working with the ongoing firm, perhaps you're running a division, perhaps you're running a certain initiative, perhaps putting your skill set to the area that's needed most. But if you're able to sell in and look at something together, you can not only de risk in times, like today, which can be more difficult to produce cash, you could also have a better opportunity for a larger market in the future.
Mike Harvath 15:45
Yeah, I would add, Ryan, that, you know, this is an important point that, you know, earn off actually paid out at a pretty high, high percentage, I think many sellers go, Oh, I'm gonna avoid it or not, because I don't control my destiny, and I could get not get it and blah, blah. And while some of that is true, the statistics actually don't bear that out, it was several studies that say, you know, earnouts, get paid out at or above index value at least 86% of the time, which means that you have a high probability of having that be a creative to your purchase price. And it generally favors the sellers versus the buyers. Even though many people go into an urn out thinking it's much more of a buyer risk mitigation strategy. In fact, it is a seller's sort of value optimization strategy, when the when the earnouts are structured properly, I'll just add that are certainly a bad structure that could that a much lower likelihood of getting turnout, but that's part of why I use it advisors to make sure that the structure is proper, and that you have a higher, much higher probability of achieving that outcome.
Ryan Barnett 17:10
Now, that makes sense. To switch gears a little bit, Mike, you know, 2023, you know, is that a bad year? Or is it something bigger going on here? And B, to B, what do you do see for valuation? Trends, if a lot of people might look at 20 to 23, and go, this is just not the year per deal? If the deal flow overall was a little bit down, and I agree, thinking, Oh, maybe this is not my time. So now it's 2023 something or something bigger? And B, what do you see for valuation trends?
Mike Harvath 17:45
Well, I think, you know, in 2023, looking back, I think it wasn't indicative of something bigger. It was indicative of sort of anticipation around a recession. And there was a lot of a lot of people were jittery when those banks started failing, due to the increased interest rates early in the year, you know, late 20, tune into 2013, at least through the spring of 23. That created quite a bit of jitter. And I think because of the increased interest rates, there was some, you know, I put a lot of leverage buyers on the sidelines. But fascinatingly enough, we did not see downward pressure. In tech enabled services, businesses valuations, we thought some leveling, certainly, if we look historically, probably over the last 10 years or so we've sort of seen a slow increase an increment up in valuations, year over year, we saw it level out in 23. But we certainly didn't see them go down. We saw some downward pressure in SAAS, we saw some downward pressure and other parts of the market, but protect enabled services, we didn't really see that. And now we saw demand, you know, picking back up dramatically, sort of in the middle, a fourth quarter of 23 and going into 24. You know, it's quite hot now, as it relates to demand, and I suspect that demand will continue this year, particularly as interest rates start to ease, you know, either in the spring or in the second half of 24. I think, certainly the that that, that pent up demand for client work is going to prop up the P&L's and potentially the balance sheets of many companies, technical services companies, and you know, that will in its own right, create more friction free dialogue around people acquiring businesses that are in a rising tide environment. And then I think in the second half of this year, they'll get further into because of reduced interest rates, it just brings in more buyers who are using leverage as a vehicle. And, you know, all that may add up to a slight that that trend of a slightly increasing multiple, but you should know that you know, where to you shouldn't get in your head that you should be sticking around because multiples are going up. So we're just gonna wait a few years, that's gonna happen. It, it may not right, I think that there's a much broader concern longer term in the market, as it relates to, you know, government debt and what the impact will be on inflation and, you know, in our current environments around the macro economic condition, meaning that it may, it may make less sense to wait years or into the future to do a transaction than right now. I think 24 is going to be a great year to consider doing a deal. If you're looking to you know, as I said before, it's hard to time the market. But, you know, reading the tea leaves sitting here in January 2024, it certainly looks like it's going to be a good year. You know, if you're in a position to entertain a deal, it's probably not a bad time.
Ryan Barnett 21:17
That's I think that's a great point. And, and part of this does, you would you'd mentioned it goes back to what your current investment commitments may be. If you built a business, you may have certain financial commitments you're working through. And so taking a moment, I'd say before selling any business, it's critical to look at what are the tax implications of a deal. There are things today that a tax professional can help you out with everything from corporate structure to financial planning to, if you're in Canada contain your wills and trusts set up correctly, that are critical towards making an investment more successful, if you're going to have a large sum, sum of money coming your way. The other part is understanding your number and understanding what your firm is worth. It's critical for you to, as Michael mentioned earlier, get a a valuation on your business. And we're certainly happy to help help with that, just to understand is that that number going to be what I need. And then also looking at in the larger and macro trends and investment options. A lot of questions we have is, is there enough financial products out there outside of your investment within your business, that can be leveraged to help you obtain the wealth that you need to go forward with your kind of the rest of your life will like be able to find consistent returns. And in overall there's there's a lot of financial instruments, and they're there to help you really be successful. With a a chunk of money coming your way. Today. Good. We've covered a lot here today, Mike, I read throughout this whole process. There's there's advisors kind of needed throughout, from the evaluation to helping you come up with a process to make sure that if you do sell your firm, it's got the most and best buyers available to even advisors helping you tune up profits and sales to help you the list better if you may, like what else did other people consider if this process and where can advisors help?
Mike Harvath 23:43
Sounds good question, Ryan. So, you know, we think that if you're going to contemplate an exit, it may be worth spending some time, you know, being introspective on the business, to see how can you optimize the business, one for self sufficiency, which means as a leader in the business, you're kind of working yourself out of a job if your plan is to leave. And that can involve a lot of things that may involve changing your staffing, sort of ratios and kinds of skills that you have on your team. transitioning your role from more working in the business to working on the business and being in a position to be more of a leader around, you know, helping your team achieve their career goals and aligned to the overall goals of the corporation and and being much more about a navigator if you will, versus the person at the helm of the business and steering the boat or navigating where the voters going is important. And, and I think you know, getting outside counsel as Ryan mentioned, you know, getting your estate plan in order and Being able to understand, you know, what, what is important to you and understanding what's next are pretty critical. If you're contemplating a transaction, I think, you know, certainly talked to a lot of business owners who transacted deal because it presented itself but they didn't contemplate beyond the payment, what was in it for them, like what they really wanted to do with their life beyond their business. And I think spending time thinking about that, both in the short term and in the long term. And understanding what's going to make you happy is really important understand, because you have to be a little bit careful what you wish for, because you might actually get it. And once you do, you want to be prepared to transition into whatever's next, whether that's selling in and guiding the firm to the next level of growth and profitability with a capital partner, whether that's selling out and focusing on sort of some other, you know, enterprise, or maybe it's just focusing on you and your family and, and spending time together, you know, in the years you have left, regardless of when that is, could be retiring, what some people would define as early or are moving into a different, different focus in your life, whether that be sort of hobby, or philanthropy or travel or whatever it might be. But, you know, contemplating those things ahead of time will help you shape up, you know, why, you know, like, not only the business for the optimal outcome, but sort of your head for the optimal outcome, which will help you be successful yet.
Ryan Barnett 26:46
Yeah, and that really helps on my quest to wrap this up, and maybe ask a question that, well, contrary to what we had been talking about, but are there scenarios or what scenarios might be out there where a business owner really shouldn't sell today, at least today?
Mike Harvath 27:06
Well, I think if you're losing money, you shouldn't contemplate selling. I think if you're running a breakeven business that may or may be more aligned to what some would call a lifestyle business, it may not be the best time for you to exit either. I think you have to run a going concern that can get transitioned to new owners, whether you're staying on with the business or not. In order to do that, the business has to be growing, it has to be profitable. It has to be ideally in a top quartile, both growth and profit, but certainly in profit. And it has to be run well, you have to have good processes and controls and systems in place. So that the business can continue to scale. If the business is kind of all revolves around you, or a limited set of owners working in the business every day, unless you're going to do what's called a recapitalisation where you roll equity and bigger entity and you focus on moving forward with that business, it would not be the right time to sell, if you're going to sell out, you really have had to already kind of work your way out of a job and have a transition plan that's been executed or is in place, so that you can begin to exit that business in an orderly fashion post transaction, and know that your customers and employees and teams will be well taken care of. So you know, certainly if the numbers don't support a transaction, we would recommend or your even your head isn't in the right place, we'd recommend that you think about those things, make sure the business is optimized, and make sure you're ready, whether that is to sell in or sell out before you would contemplate a deal.
Ryan Barnett 29:08
And that's very helpful. We've covered a lot here today. To summarize they, I heard a bit about making sure that you have your number in your mind that really helps decide this is something now or in the future. If you're are considering and we had a nominal you this year, considered deal structures or something that may get you a number that the future value may have better than your perhaps historical values. I heard that valuation trends are similar, not necessarily down but relatively flat. And to expand on that I think we've seen oftentimes we have a range of adjusted EBITDA and numbers and right at this moment they may be falling slightly on the smaller end of the range, but the ranges are still holding up. Well, I heard that running a business today it's your largest investment, but also your largest area for risk. And a capital partner that brings cash to the table can help de risk your your biggest investment that you've got. And I can help you get your commitments for the future, more aligned to something that is less risky than than running a business on or present yourself. And lastly, heard, it's great to work with an advisor that can help you get a valuation done, help get your tax planning done, or even help tune up both profit and growth in preparation for a potential sale. Maybe not this year, but maybe next year, and we're ready to rock it out. We're happy to help evaluate your business and help where you can if it's appropriate to do so. Micah, anything else?
Mike Harvath 30:57
With that I say we try ribbon on it for this week's Shoot the Moon podcast. Thanks for tuning in and make it a great week.