Punching Out! Bridging the Valuation Gap Between Buyer and Seller

PCB acquisitions in the U.S. are down so far in the first five months of 2017, with only two announced deals (HT Global Circuits’ acquisition of Pho-Tronics in April; American Standard Circuits’ acquisition of Camtech in May); and one anonymous deal that I am aware of that has not been announced. This compares with 11 announced deals in 2016. There are a variety of reasons for the decline, but one reason could certainly be the valuation gap between buyer and seller. In my experience, sellers often estimate a value that is higher than market, either due to higher expectations, or a need to obtain a certain amount for retirement, to pay off debt, or for return-on-investment.

There is an old saying: “You name the price, and I’ll name the terms.” This phrase was probably uttered by traders in ancient Babylon, and it can still be useful today. Some of the main ways of plugging the gap between buyer and seller are earnouts, seller notes, royalties, at- or above-market leases, consulting fees, stay bonuses, carry-over equity, and other methods.

One of the important things to consider are the reasons for the valuation gap. It could be that the business is growing quickly, and the buyer will pay more if the business continues to grow. On the other hand, the gap may be due to the risks involved with the business, such as customer concentration, key-person risk, legal and environmental issues, etc. Another reason for a gap is financing, that is, a buyer may not be able to borrow enough to finance the transaction. In this case, the buyer may ask the seller to hold a promissory note for several years. Often, the main reason for a valuation gap is a difference in value perception between buyer and seller. Depending on the cause for the gap, a variety of solutions may be used to help seal the deal.

Earnouts are often used to bridge the gap. Sellers prefer short earnouts based on sales, with low hurdles. Buyers prefer longer earnouts, based on profits or EBITDA, with rising hurdles. Earnouts based on sales are easier to monitor and less subject to argument, although the parties may even dispute the definition of ‘revenues.’ In a consolidation, in which the seller’s business is going to be moved into the buyer’s facility, the only way to base an earnout may be on future sales to the seller’s customers. The seller must be prepared to trust the buyer’s reporting system, which is made easier if the seller is still involved in the business during the earnout period. A straight royalty on sales is sometimes used, which can be a simple way to track and pay deferred payments.

Buyers typically prefer for earnouts to be based on profit goals, such as net profit, EBITDA, gross profit, etc. The lower the goal is on the Profit and Loss statement, the more difficult it is to monitor, and the more open things are to manipulation and dispute. However, a profit-based earnout is generally acceptable if the seller is going to be involved in the business during the earnout period, and if the buyer agrees to allow the seller to review the books (and to not materially change business practices). If the buyer has a history of good relations with previous sellers, this could help the seller feel more comfortable.

Seller notes are a popular way to bridge a valuation and/or financing gap. Typically, interest rates are higher than bank CDs, so sellers may see it as a way to have some income post-sale, and to defer taxes. If a buyer is also using bank or other debt to finance the deal, the term of the seller note usually must be at least 3−5 years, and often amortization cannot begin for several years. The seller must review the credit worthiness of the buyer, and it increases the complexity of the deal.

There are several income-related ways to bridge the valuation gap, which can be in the form of on-going employment, consulting fees, transition services, stay bonuses, leases that are at-market or above market, continued health insurance or other payments, etc. One problem with these solutions is that the payments are often taxed at personal income rates, which are usually higher than capital gains rates.

Carry-over equity is when the seller continues to hold a share of the business after the sale. This method can be used to ensure that the owner fully assists with the transition. Perhaps the owner believes that the business can grow under new ownership, but the owner does not wish to be involved full-time. Both buyer and seller need to agree on an operating agreement and buy/sell provisions. If the buyer is a public company or ESOP, they may use stock options or stock appreciation rights (SARs) as part of the deal. A privately-owned buyer may use their stock as payment, and this might be acceptable if the seller believes that the combined companies have a good chance to grow.

Many buyers will be open to alternative tax structures to help the seller reduce taxes. Sellers should consult with a tax advisor early in the process to identify various tax strategies. While Cash is King in any transaction, a seller should really be concerned with net proceeds after taxes. The right strategy may allow a seller to accept a lower offer that is all or mostly cash, rather than a higher offer that has more deferred compensation.

Depending on the concerns of the buyer and the needs of the seller, there are a wide variety of ways to bridge the valuation gap. As long as both parties are willing to cooperate, we can usually find a solution.

 

Tom Kastner is the president of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. Securities transactions are conducted through StillPoint Capital, LLC, Tampa, FL member FINRA and SIPC.

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2017

Punching Out! Bridging the Valuation Gap Between Buyer and Seller

06-13-2017

PCB acquisitions in the U.S. are down so far in the first five months of 2017, with only two announced deals (HT Global Circuits’ acquisition of Pho-Tronics in April; American Standard Circuits’ acquisition of Camtech in May); and one anonymous deal that I am aware of that has not been announced. This compares with 11 announced deals in 2016. There are a variety of reasons for the decline, but one reason could certainly be the valuation gap between buyer and seller.

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Punching Out! How to Put a Wrench in the Rumor Mill During the Sale of a Company

05-23-2017

When selling a house, the owner’s agent puts a sign in the front yard, posts info on the Web, and invites buyers over for an open house. When selling a car, we put a sign on the windshield and take out an ad with our phone number on it. However, when selling a business, some owners do not even tell their spouses.

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Punching Out! Selling a Company—Seeing it as a Triumph, Not a Defeat

04-25-2017

Somehow, there is a still a stigma that selling a company is a negative for the owner. Many people think that there must be something wrong, otherwise, they would not be selling. In reality, exiting a business should be looked at as a triumph for the owner, not a defeat.

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Punching Out! 10 Ways to Increase the Value of Your PCB/PCBA Shop

03-22-2017

I have worked with a wide range of companies in the PCB, PCBA, and other tech and electronics sectors. Through the years, I have developed some ideas on how companies can improve their valuation. Some of these ideas are simple and involve little cost, other ideas are more long-term and involve more effort or investment.

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Punching Out! When Should I Call an Investment Banker?

02-20-2017

The quick answer is ASAP. Even if you are not considering the sale of the company for 5−10 years, it is best to be educated and prepared. Give your advisor (or a few advisors) a call to discuss what can be done to get the company ready for a future sale. The worst time to call an i-banker or business broker is when you are forced to sell due to poor performance, health issues, pending bankruptcy, or dispute with a partner or manager.

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Punching Out! Types of Company Buyers in the PCB and EMS Sectors

01-09-2017

Mergers and acquisitions in the U.S. PCB sector have been in the news recently, with at least 12 deals completed over the past year, and several more in the works. In contrast, the EMS sector has been relatively quiet, but that may change now that the presidential election is over.

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2016

War Stories from the Front Lines of Deal-Making

09-16-2016

Here are some war stories from my experience in working on M&A deals in the PCB, EMS, and electronics fields. The names and details have been changed to protect the innocent.

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Timing: When is the Best Time to Sell?

08-18-2016

A few of the top questions we receive relate to the timing of the sale of a business. The first is, "Is now a good time?" The second one is, "How are market conditions?" These are the top FAQs.

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The PCB Sector—What Buyers Look for and Recent Deals

07-14-2016

The past few months have seen a rash of PCB deals in North America, for a variety of reasons.

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What the Heck is Adjusted EBITDA?

06-07-2016

If you are looking to sell or buy a business, you will most likely come across the term ‘adjusted EBITDA.’ Other common terms are adjusted cash flow, owner’s discretionary earnings, earnings after add-backs, etc. What do these terms mean, and why are they important?

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The Additive Process: Tips on How to Buy a Board Shop or Assembly House

05-14-2016

One of the quickest ways to grow a business is to acquire another business. At the same time, acquiring a business can be risky, and a really bad deal may put your original business in jeopardy. Here are some tips on how to make acquisitions.

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Your Baby’s Ugly, Now Get Over it (How to Work with Buyers)

04-14-2016

Here’s a scenario: An owner has gone to market and is starting to get feedback from buyers, and shockingly, not everyone appreciates the hard work and achievements that went into the business. Buyers may not understand the business, or they may be trying to position things for a low offer. In any case, it is important to know how to work with buyers.

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Putting Together the Deal Team

03-21-2016

When preparing to sell, remember the old saying, “He who represents himself has a fool for a client.” While many owners might be tempted to go it alone, in my experience it pays to have a deal team to help prepare a company (and the owner) for a sale

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Punching Out: How to Sell Your PCB/Assembly Shop

02-04-2016

You are thinking of selling your PCB or assembly shop. Perhaps you are contemplating retirement, you have no successors, and the thought of going to the office on Monday is driving you crazy. This column is designed to help your planning efforts. Future columns will go deeper into each subject

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