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M&A Advisor Tip

Reps and warranties insurance

When selling your business, typically you’re going to “represent and warrant” certain things about the business (e.g., you’ve provided accurate info, no known legal issues pending). If something turns out to be not wholly accurate, the buyer can come back to you for a certain percentage of the purchase price.

In smaller deals, the seller can simply agree to a guarantee. But as transactions get larger, buyers may ask sellers to put that money in escrow. That money is then tied up for typically 12 to 18 months.

As an alternative to escrow, the deal can include reps and warranties insurance. Seller don’t have to hold that money in escrow, and they shed the risk of covering a reps and warranty claim.

Reps and warranty insurance can expedite the sale process and even drive down your legal fees. (Negotiations are easier with insurance in place.) To learn more about creative deal structures and how key negotiation points can impact your proceeds, give us a call. All conversations confidential.

Market Pulse Survey - Q4 2021

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M&A Feature Article

This year, we based the deal on a hot tub company, using real numbers from a real business. We were specifically looking to present a company that had experienced a “covid-bump” with a surge in sales since the pandemic.Things like hot tubs, pools, outdoor furniture, grills, and outdoor lighting all experienced boosts in demand during the pandemic. Since people weren’t traveling or eating out as much, many were investing in their homes and backyards instead.The question then, was how would buyers value a business that had experienced such a bump? Would they throw out 2020 numbers as an anomaly, or would they factor the increased sales into their offer?Our sample hot tub company had seen their EBITDA (earnings before interest taxes depreciation and amortization) nearly double from 2019 to 2021, jumping from roughly $3.3 million to $6 million.But the growth in earnings wasn’t exclusively due to the pandemic. The company had also made a strategic shift from manufacturing hot tubs for private label, to marketing their own brand. They now had their own branded hot tubs for sale, direct to the consumer, on their website. So, it wasn’t clear how much of their growth was due to a shift in their business model and how much was from the pandemic.Offer #1: As the offers were revealed, the lowest one came in at $23 million. This PE firm based their offer on 2019 numbers, the last base year not affected by COVID-19, calculating at a 7.0 multiple ($3.3 million EBITDA x 7). Their offer structure provided significant cash at close with a $5 million earnout.Offers #2 and #3: Two more offers came in around $30 million. These buyers looked at the trailing twelve months EBITDA of around $6 million and put a 5.0 multiple on the business. The deal structures in these offers were roughly split between 60% equity and 40% debt. Both contained earnouts of around $10 million and proposed the sellers would rollover 20%–40% equity into the new company.Offer #4: The highest offer came in at $39 million. This firm “bought in” to the hot tub company’s projected sales figures and built their offer on unproved potential. They believed there would be continued momentum in sales, driven in part by FOMO (fear of missing out). As in, I see my neighbor got a hot tub, and now I want one too.They also liked the direct to consumer model and saw opportunity for ongoing parts and maintenance sales as the hot tubs aged. This PE firm had experience in ecommerce and manufacturing, so it fit their niche, too.But the $39 million offer came with a couple caveats. Of the deal, $12 million was structured as an earn out. That means the seller only realizes those dollars if future benchmarks are hit. The other caveat is the sellers had to roll over $6 million in equityComparatively, that still puts them well above the $22 million offer, but slightly below $30 million. Then again, the $30 million offers also included earnouts and rollovers.Each of these offers came in from proven, successful private equity firms. One offer came in more than 75% higher, but they all presented different deal structures.That’s the marketplace right now. There are groups out there that have to put money to work. They’re willing to jump to bigger numbers, especially when they feel they have a secret sauce they can bring to your business – or you have a strength they can build on.Private equity raised over $900 billion in 2021 alone and spent a record $1 trillion last year for the first time. They’re stacking businesses together, leveraging the synergies, and delivering 18% to 22% rate of returns to their investors.That’s why the lower middle market is so hot right now. Private equity has money to spend. And as long as their investment model keeps working and outperforming other asset classes, they’ll continue to have dollars and deadlines – and drive.

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