Sourcify founder Nathan Resnick invites business broker Nate Lind from Website Closers on this week’s episode of eCommerce on Tap!
As a broker with experience and insights into M&A (Mergers and Acquisitions) in 2023, Nate answers some of the most common questions in the mind of entrepreneurs along with crucial advice and tips for business owners, whether they’re looking to sell now or down the line.
Starting with a current and immediate concern stemming from present economic circumstances, Nate addresses the question about recessions and whether M&A activity is halted during them.
Are Mergers and Acquisitions Recession Proof?
The relationship between economic recessions and M&A is a complex one, with varying degrees of impact depending on the circumstances. Contrary to popular belief, recessions do not always hinder M&A activity. In some cases, they can even promote it.
With examples of cases explained below, you’ll get an understanding of how and why recessions may not affect M&A, allowing you to explore the potential benefits of M&A activity during economic downturns.
1. Opportunity for Bargain Deals
One of the primary reasons why M&A activity is not necessarily deterred by a recession is that it presents an opportunity for bargain deals. When companies are struggling financially, they may be more open to selling their assets or merging with another company to stay afloat. This can create a buyer’s market, with many businesses looking to acquire assets at a discounted price.
For example, during the 2008 financial crisis, many distressed companies were forced to sell their assets to larger corporations looking to expand their operations. These companies were able to acquire valuable assets at a fraction of their pre-crisis value, giving them a competitive advantage once the economy began to recover.
2. Strategic Consolidation
Another reason why recessions may not affect M&A activity is that they can provide an opportunity for strategic consolidation.
During a recession, many companies may be struggling to stay afloat, but others may be thriving in the new economic environment. In such cases, it may make sense for successful companies to acquire struggling ones to consolidate their market position.
For instance, a large corporation may acquire a smaller, struggling competitor to eliminate competition and gain access to its technology, expertise, or customer base. This consolidation can enable companies to become more efficient and competitive by streamlining operations and reducing overhead costs.
3. Access to Capital
A third reason why recessions may not necessarily affect M&A activity is that companies may have access to more capital during an economic downturn. Although banks may tighten their lending requirements during a recession, there may be other sources of capital available to companies looking to make acquisitions.
For example, private equity firms may be willing to invest in companies that are struggling during a recession, providing the necessary funding for M&A activity.
4. Industry Disruption
Finally, recessions can disrupt entire industries, creating opportunities for M&A activity. When an industry is facing a downturn, companies may be more willing to engage in M&A activity to gain access to new markets, diversify their operations, or develop new technologies.
For example, during the COVID-19 pandemic, many companies in the travel and hospitality industries struggled to stay afloat due to travel restrictions and decreased demand.
However, some companies were able to adapt to the new reality and find new opportunities in the market. This led to M&A activity, with larger companies acquiring struggling competitors to expand their operations and gain access to new markets.
While it may seem counterintuitive, recessions do not always affect M&A activity. In cases like the ones cited above, economic downturns can create a buyer’s market, promote strategic consolidation, provide access to capital, and disrupt industries, all of which can drive M&A activity.
Therefore, companies should be prepared to seize opportunities during a recession and engage in M&A activity if it makes strategic sense.
M&A Earnouts:
Post-acquisition compensation packages are a significant part of the M&A process. In case you’re thinking of selling your business, you need to be aware of the various post-acquisition compensation methods to make a decision.
The most commonly known method of post-acquisition compensation is called an earnout, and many business owners wonder if it is guaranteed.
To clarify, there are different ways an earnout or post-acquisition compensation package can be offered. These include:
1- Equity
2- Seller Financing
3- Revenue shares/earnouts
The most secure post-acquisition compensation method is seller financing. With seller financing, a promissory note is given to the seller similar to real estate transactions, and the buyer makes payments over 3-10 years. The interest rate on these notes is typically lower than other financing options and offers a steady income stream.
The second-best option is equity, where the seller retains a portion of the equity after the transaction.
The final option is an earnout, where the business usually has to continue performing at its current level, and the payment is contingent on the performance of the company.
However, it’s crucial to listen to Nate when he clarifies, “None of these are guaranteed. The only thing that’s guaranteed is the cash at closing.”
Nate also gives advice to business owners facing burnout after seeing significant growth for a few years and then struggling to keep up with revenue growth.
His suggestion: look at the situation and see if you are overcapitalized or if the revenue growth has slowed. Based on this assessment along with a financial and growth analysis, business owners can then look at their options and make informed decisions about what to do next.
“The best time to sell is when you don’t need to, when things are easy.”
What are the Biggest Factors that Kill an eCommerce Business Deal?
eCommerce businesses are highly attractive to buyers, but several factors can lead to a deal’s collapse. Here are some of the most significant factors:
1. Declining Profitability:
If your eCommerce business is declining and as Nate says, “In a tailspin, it will be difficult to sell. The buyer’s thinking, ‘Wait a second! If the person who founded this can’t turn this thing around, how could I?’”
The biggest factor that can kill a deal is a decline in profitability. It is crucial to show stable and reliable growth patterns in your financial records. This is especially important for businesses that experienced a boom in 2019-2020 but the demand spike dropped after 2022, resulting in an evident post-COVID decline in profitability.
2. Inexperienced Deal Attorneys:
Just like in real estate, attorneys play a critical role in the eCommerce M&A process. Inexperienced deal attorneys can cause deals to fall apart. It is vital to work with experienced attorneys who can draft the appropriate documents to assign assets and close the deal.
Not knowing who to reach or how to approach potential buyers and the processes involved in drafting, legitimizing and closing the deal can jeopardize even the easiest opportunities. Nate says entrepreneurs need to vet the brokers they work with carefully. The better your broker, the more money you’ll make.
3. Unlikable Personality:
Your personality can have a significant impact on the sale of your eCommerce business. If you are disagreeable or unlikable, it will be challenging to sell your company. Buyers want to work with founders they like and can trust.
4. Poor Financials:
The financials of your eCommerce business are the foundation of the sale process. Transparency is crucial, and the more visibly accurate and clear your income statement and balance sheet are, the more credible and trustworthy you appear to buyers. If your financials are poor, it can lead to a lack of trust and a deal’s collapse.
Golden Handcuffs in eCommerce M&A: How They Work
As a business broker, Nate sheds light on another important question in business owners’ minds about how much of their presence would be required post-acquisition.
Golden handcuffs, as they’re referred to, in eCommerce mergers and acquisition is an agreement between the acquirer and the founder to keep the founder present in the company for a certain period after the acquisition. The goal is to ensure a smooth transition and maintain the business’s success post-acquisition.
For the acquirer, the importance of having the founder stay on can fluctuate depending on various factors such as the eCommerce company size, etc. or others that indicate the degree of reliance of operations on the founder.
If the business is over $10 million and the buyer is a private equity firm without an operational staff, the founder’s presence is critical. The founder will need to stay on for at least a year to ensure a smooth transition and maintain the business’s success.
Similarly, if the founder is critical to other operations such as marketing, management, operations, etc., a longer transition period would be required.
How to shorten your Golden Handcuff duration?
The answer is delegation and outsourcing. Moreover, it is essential to delegate and outsource tasks in your business before you start the acquisition process. And it’s not something you can do in a month or two. You’ll need to show your buyers the business is reliably autonomous.
If you are an owner-operator and handling the ins and outs of the business every day, you will need to delegate and teach the buyer to maintain the business’s success.
And since buyers look for reliability, you can’t rely on immediate hires to take up your responsibilities and satisfy the stability and growth requirements of the buyer.
Takeaway
Much is hindered by economic recessions, but not M&A which is why growth-promising businesses are always in demand.
Timing a business exit is perhaps the most important step to consider once you decide to sell. After the decision, it’s a completely different challenge to prepare yourself for a merger or acquisition. A lot can affect the way a deal goes in today’s market.
However, it is essential to keep in mind the critical factors that can kill an eCommerce business deal, such as declining profitability, poor financials, and inexperienced business brokers.
About Website Closers
Website Closers is a business brokerage firm that specializes in selling eCommerce businesses. Helping business owners identify the value of their online businesses and find the right buyers, Website Closers operates on a performance-only basis.
This means that until the transaction closes and the client receives a wire, they don’t charge anything. There are no upfront costs or monthly fees.
Due to this, brokers like Nate will offer free consultations but only accept listings that they believe will attract the right audience. The initial consultation can involve going over things like business valuation, and discussing the trading range with prospective sellers and buyers.
After the mutual interview, if both parties agree, the business gets listed, and Nate markets it. He vets all the buyers and creates the offering memorandum, which outlines the key details of the business.
If everything goes well, brokers at Website Closers can draft up LOIs and generate bidding action, particularly for businesses that do well.
They’ll help pick the best buyer and work together with business owners to ensure that the transaction is completed successfully. Website Closers also helps clients through due diligence and provides suggestions and resources for tax strategies and maximizing the amount of cash in their pocket.
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