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Buying or Selling?

 Buying or Selling? Either Way, Be Strategic

There comes a time in the life of many middle market businesses when owners must decide either to start a new chapter or close the book.

When looking to sell, companies must position themselves attractively, calculate their market value accurately, and identify potential buyers. Those wishing to acquire must perform the due diligence to identify the candidate with the best combination of market savvy, management style, and financing terms.

Comerica Bank’s network of middle market-focused merger and acquisition advisory firms builds long-term relationships with clients to help them efficiently navigate the complexities of selling or buying a business. 

The decision to acquire another company may be driven by the need to increase market share, expand the product lineup, gain customers, or acquire technology. Business owners may choose to sell if there is no clear succession plan, if they want to cash in a career-long investment, or if they decide to heed the call to pack it in and teach or volunteer.

Selling the Future
When considering selling a company, owners must first determine if it is attractive to potential buyers.

“You need to have a growth story because any investor is really buying the future of a business,” says Philippe Faraut, a managing director at Intrepid Investment Bankers LLC in Los Angeles. “Companies that are ready to go to market must be in growth mode. You want to be able to show a couple of years of positive trends and be able to explain how and where your company is growing. It really comes down to storytelling.

“Appropriate margins for your particular industry and a healthy financing environment are also critical.”

Faraut says California is a hotbed of middle market growth. “California has a very healthy, growing middle market and has become the center of the country for consumer brands in the food and beverage, beauty, and apparel spaces,” Faraut says. “When we sell a California-based business, we go around the country and international.” 

Determining a company’s realistic market valuation is a vital step in successfully consummating a sale. For most industries, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is the most widely accepted valuation metric.

“There’s a lot of activity in today’s mergers and acquisitions market, and valuation levels have become fairly attractive for sellers,” says Jeremy Falendysz, director at Amherst Partners in Birmingham, Mich. “It’s conceivable that a company could be valued up to one EBITDA multiple higher, or more under certain circumstances, today relative to a less robust market.

“You can either sell in this market or continue to grow the business, but if multiples come down, you have to do a lot more growing to achieve the same outcome as you could in an elevated valuation market.”

Culture and Chemistry
Advisors can help sellers identify potential buyers by accessing industry databases and leveraging relationships with private equity funds. The right deal doesn’t necessarily mean the highest price.

“One offer might have the highest value, but a lower offer might be more attractive. Maybe the transaction structuring is better or maybe there’s more cash up front,” Falendysz says. “We also look at potential buyers from a culture and chemistry perspective. If the seller is going to hold an interest in the business after the transaction, picking the right partner is very important.”

Selling a company typically does not require large up-front funding because the investment bank that manages the transaction gets paid when the company sells.
Middle market companies wanting to merge with or acquire other businesses must not only secure funding through a bank or private equity firm, but they must also articulate an acquisition strategy that examines target companies for, among other things:

  • financial results
  • management strengths and weaknesses
  • business culture
  • marketing and product strategies
  • history and reputation
  • trademarks and patents, and
  • any collective bargaining agreements that may be in place.

By clearly defining the criteria of potential transaction targets, companies can enhance the probability of a successful transaction by focusing only on those firms that represent a good fit. 

Whether buying or selling, companies must have realistic expectations and be willing to give and take. “If you’re a seller, you obviously want to structure your agreement as favorably as possible. But once you send it to the other side, they’ll respond with a deal that’s favorable to the buyer,” Falendysz says. “A good approach is to craft an agreement that creates very early on in the process an understanding that all parties are negotiating in good faith and truly working toward an agreeable solution.”

To learn more about Comerica Bank’s network of middle market-focused M&A advisory firms, contact William Murdock at 313-222-5594 or wbmurdock@comerica.com.

Comerica Bank Member FDIC.

This material has been distributed for general educational/informational purposes only, and should not be considered as accounting, tax or legal advice or recommendations by Comerica Bank, its affiliates or subsidiaries.

R & D

 When It Comes to Research and Development, Quality Trumps Investment

While R&D is critical to a company’s success, few middle market companies can afford to spend lavishly on “white lab coat” basic research or incremental product improvements. The good news? They don’t have to.

“There is no correlation between how much you spend on R&D and your financial performance over the long term,” says Barry Jaruzelski, senior partner at Strategy&. “You can’t buy your way to the top.  When it comes to innovation, how you spend is much more important than how much you spend.”

Budgeting for R&D
Investment in research and development among the top 1,000 global R&D spenders reached an all-time high of $638 billion in 2013 — up 5.8 percent from 2012, according to the Global Innovation 1000 study conducted by global strategy consulting firm Strategy&, part of the PwC network of firms.

“Even in the recent recession, when revenues were down more than 10 percent for the Innovation 1000 companies, research and development only slipped by about 3 percent,” Jaruzelski says. “They realize that R&D is the future and that recessions are always shorter than the average product development cycle time.”

As companies plan R&D budgets, Jaruzelski says three factors are essential: 1) Possess deep insight into the needs of their products’ end user; 2) Align innovation strategy with overall business strategy and company culture; and 3) Make effective use of the latest digital tools.

“The first and most universal requirement is to develop deep end-user insight — not just from the direct customer,” Jaruzelski says. “For many companies, the customer is not the end user of the product — it may be a wholesaler or another intermediary.”

As an example, Jaruzelski notes that power tool maker DeWalt regularly sends its engineers and marketers to job sites so they can observe how their products are being used. “Forcing the engineering and product management talent to interact with the end user develops a superior result and surfaces unanticipated ideas for new products,” he says.

Key Strategies
Jaruzelski’s research indicates that most companies adopt one of three prominent innovation strategies: Need Seekers directly observe how customers use their products to identify unarticulated needs; Market Readers take a more cautious approach, focusing largely on creating value through incremental change, and then being a “fast follower,” or quick to market with changes; and Technology Drivers leverage their R&D investment to drive breakthrough innovation, often seeking to address how customers can use new technology.

“There’s no such thing as a one-size-fits-all innovation strategy,” Jaruzelski says. “What matters is having real clarity on what role innovation is going to play in your business strategy. It has to be very tightly aligned. If your business is a market reader/fast follower, which is lower risk, you don’t want to be the first one to stick your nose out. “You’re not going to follow a technology driver strategy because that involves taking bigger risks.”

The third requirement that middle market businesses can take to drive innovation is to embrace digital tools that provide market insight. The first wave of digital enablers such as computer-aided design, milestone tracking, and customer relationship management has been widely adopted. Companies are now turning to tools like crowdsourcing, which connects remote teams to facilitate idea generation; augmented reality, drawing on Google Glass technology; and software that collects real-time data from products such as copy machines and jet engines. 

“Research and development are critical to the long-term success of middle market businesses, and the fact that companies are small doesn’t mean they can’t be very impactful. If that weren’t true, startups would never happen,” Jaruzelski says. “Tesla created a world-class luxury electric vehicle on an R&D budget of $300 million a year. That’s a lot of money, but in the auto industry that’s nothing.

“It proves the point that if you have the right customer insight, talent, and process approach, even modest budgets — by the standard of the competitive set — can turn out winners. For the middle market business, it means approaching it in the right way and understanding your customer can still lead to world-class success.”

Links for More Information:

Comerica Bank Member FDIC.

This material has been distributed for general educational/informational purposes only, and should not be considered as accounting, tax or legal advice or recommendations by Comerica Bank, its affiliates or subsidiaries.

Genuinely Green

 Making Environmental Claims? Make Sure You Can Back Them Up

Kermit the Frog once lamented his station in life by singing, “It’s Not Easy Being Green.” A growing number of businesses that attempt to gain favor with customers by marketing their products as environmentally friendly might sing the same song.

A recent study published by TerraChoice, a unit of Underwriters Laboratory, found that the number of products claiming to be green increased by 73 percent in a single year. However, the study showed, more than 95 percent are still guilty of “greenwashing.”

“Greenwashing is the act of misleading consumers regarding the environmental practices of a company or the environmental benefits of a product or service,” says Scott Beckerman, Comerica Bank’s senior vice president and director of Corporate Sustainability. “Most commonly, greenwashing is overstating an environmental claim. “Sometimes the statements are plain false, but most of the time they are simply misleading.”

In their haste to stake the environmental high ground, middle market companies must take care to avoid committing what TerraChoice calls the Seven Sins of Greenwashing: the hidden trade-off, no proof, vagueness, irrelevance, the lesser of two evils, fibbing, and false third-party endorsements.  

Have the Goods
“What we see most commonly is the sin of no proof – making a claim with nothing to back it up,” Beckerman says. “You tell customers that buying your product is the easiest way to save the planet. How? Can you prove it?

“Another is the sin of vagueness. Arsenic and uranium are both all-natural, but I wouldn’t want to sprinkle them on my corn flakes. By saying a product is all-natural, it’s so vague that it’s meaningless. But to an uninformed consumer, they feel good about buying an all-natural product. While the claim may be true, there may be no real environmental benefit.”

For example, a company’s reputation can suffer if it overstates, however innocently, the progress it’s made in creating a more eco-friendly product. This is especially true as consumer watchdogs and online customer reviews play a more potent role in reporting companies’ behavior.

“A lot of people are evaluating these statements and will come down hard on businesses if they believe that they have overstated a claim,” Beckerman says. “With the power of social media, a company’s reputation can be very quickly and severely impacted, and that hurts the bottom line.”

Know the Law
Companies that misstate environmental claims can also run afoul of the federal government. Since the Federal Trade Commission finalized its Green Guides in October 2012, the FTC has brought 19 enforcement actions related to environmental marketing claims. These Green Guides dictate what companies must prove before they can make claims about products being “recyclable,” “ozone safe,” or even “refillable.”

According to FTC spokesman Mitchell Katz, on the first violation of a Green Guide, an order is typically issued prohibiting the defendants from engaging in the allegedly deceptive conduct; on violation of an order, fines of up to $16,000 per day per violation can be levied.

Beckerman says the simplest way to avoid being accused of greenwashing is to be deliberate and accurate in the way claims are made in advertising, merchandising, or even in internal company documents.

“You want to test any communication against the principles of clarity and transparency,” he says. “As you look at a claim, evaluate whether or not someone could charge you with one of these greenwashing sins and make sure you’re not over-emphasizing a particular attribute.”  
Third-Party Certification
For companies to be protected even more effectively, Beckerman recommends getting a recognized third party to evaluate and certify their products or processes. These groups range from the Forest Stewardship Council that sets standards for paper and other forest products to the U.S. Green Building Council’s Leadership in Energy & Environmental Design (LEED) program that recognizes best-in-class building strategies and practices. Your banker can put you in touch with Comerica’s Sustainability office, which can help identify the appropriate organizations that certify products and services.

“Sustainability is a journey, and eco-attributes are increasingly important differentiators in the marketplace,” Beckerman says. “Being accurate and transparent in your claims of where your products are along that journey will help keep you out of trouble. That transparency and honesty will resonate with your customers.”

More information is available at the following resources:

Comerica Bank Member FDIC.

This material has been distributed for general educational/informational purposes only, and should not be considered as accounting, tax or legal advice or recommendations by Comerica Bank, its affiliates or subsidiaries.