By Dennis Roberts
Based on population demographics, it is reasonably estimated that Baby Boomers own approximately 67% of middle market businesses and will sell or otherwise dispose of (as opposed to abandoning) approximately 83% of them2 as they retire or die in the coming years. Assuming that most of these businesses will be disposed of when their owners reach age 65, more than 671,000 middle market businesses worth an estimated $2.47 trillion will be disposed of between 2011 and 2029 by Baby Boomers alone (or an average 35,000 middle market businesses a year). Exactly when this wave arrives will be determined not simply by Boomers' ages but also by the economy, interest rates and other factors. There is no question, however, that the selling wave should begin shortly and steadily rise over the next 10-12 years, peak during the 2020s and taper off during the following 10-12 years. The other drivers previously mentioned--shortened business life cycles, one-world cross border M&A deals, and private equity capital seeking middle market business investments--likely will continue to influence middle market M&A throughout this period and beyond.
This article discusses the requisite training and licensing requirements needed to help NACVA members establish the specialized practice knowledge for middle market M&A work, either exclusively or as an adjunct to their own practices.
Broker vs. financial professional
The best CVAs/AVAs have people skills that rival those of any other business professional anywhere. As with business valuation in the past, most CVAs/AVAs seriously entering the M&A intermediary or investment banking world tend to be professionals with a number of years’ experience and the resulting wisdom and maturity necessary for this sophisticated work. In fact, few professions depend more heavily on people skills than M&A advisory.
On the professional side, M&A investment banking takes a second seat to no other financial services industry activities. It requires knowledge of, among other things, accounting and finance, contract law, taxation, negotiation techniques, banking and the capital markets, deal structuring, and fundamental competitive analysis. In other words, this is highly sophisticated and technical work, and few professions besides valuation provide as comprehensive a preparation for it.
Finally, middle market M&A transactions involve large sums of money and the ethical and objective professional standards maintained by most NACVA’s members are ideally suited to guiding clients through what is likely to be the largest transaction of their lives. There have been too many cases where national business brokerage firms were sued for allegedly selling hyperbole, unjustifiable promises and dubious valuations in return for high retainer fees while, in fact, closing very few client transactions. The competency and high ethical standards of a NACVA certified member provide a welcome counter given past abuses and, in my opinion, will provide a strong competitive advantage.
- The initial phase: Execution of an engagement letter or financial services agreement; preliminary valuation of his clients' businesses in the M&A marketplace; buyer/investor and industry research; and offering memorandum preparation. Typically about 30 to 45 days.
- The marketing phase: Buyer and investor contact; securing non-disclosure documents; and securing preliminary expressions buyer/investor interest. Typically about 60 days but can be much longer.
- The negotiating phase: Extensive deal structuring and negotiations, typically with several buyers. Typically 30 to 60 days.
- The preliminary conclusion phase: Negotiating phase concludes with a fully negotiated letter of intent (LOI) and then proceeds to buyer/investor confirmatory due diligence.
- The final phase: The definitive agreement development phase. Normally about 60 to 75 days and typically with some renegotiation of original LOI deal terms.
As noted above, a command of the basic financial sciences is required as a foundation for entering the M&A advisory world: all CVAs/AVAs inherently share this basic training, and have demonstrated this through certification. The most important distinction between business valuation and M&A valuation is one of perspective and measurement, given the contrast between Fair Market Value – an abstract concept – and Investment Value, the real world of deals.
Before entering the M&A advisory world, one should first consider acquiring training in M&A conventions (standard financial frames of reference regarding how things are done, how they are measured); M&A protocol (a frame of reference regarding the typical order of things, when they are done), and financial negotiations. M&A negotiating requires work well beyond simply winging it. Typically, very basic formal training will take approximately 40 hours and is currently offered by the Middle Market Investment Banking Association (MMIBA).
Starting and running an M&A practice
Credibility: These transactions involve large sums of money and while the CVA/AVA credential brings a great deal of credibility, it probably will not be enough. Credibility largely derives from having represented transactions successfully. Investment bankers and intermediaries typically maintain prominently displayed Web site libraries of Tombstones reflecting completed transactions they have represented. Credibility, the largest barrier to entry, presents a chicken-and-egg dilemma to would-be practitioners. But this is not an insurmountable obstacle: the best way to leap the hurdle is to affiliate or partner, at least initially, with a well-regarded boutique investment bank or to hire someone with the requisite skill set and the Tombstones to prove it.
Staffing and research: M&A intermediaries’ backrooms serve critical functions in support of buyer and industry research necessary to represent a transaction. They also prepare the offering memoranda that provide buyers or investors detailed client overviews and pitch books to land new business. (These also must reflect reasonably deep knowledge of the potential clients’ industries). Unless you choose to affiliate with an existing boutique intermediary, count on having, even in the smallest practice, one support professional and several databases. Expect to pay from $45,000 to $85,000 a year for the support professional and at least $15,000 annually for the minimal databases and research tools.
Marketing: To some degree, a CPA or Valuation firm could expect to receive some baseline of M&A engagements from among its own clients, assuming the requisite credibility and its clients’ awareness of its M&A practice. Unless M&A activity is offered as a clearly distinct client service, this rarely will generate sufficient business to develop a serious M&A practice so additional marketing is crucial. Much business-to-business marketing attempts to entice businesses to make impulse purchases of attractive products or services, items they didn’t know they needed. Because M&A services are only bought when required, an entirely different marketing approach is necessary. The secret: stay in front of the potential market for long periods of time while trusting that when M&A services are needed the client will associate the firm’s name with providing them. This typically is achieved by publishing newsletters regularly, holding seminars, networking actively and, if possible, developing M&A specialty industry practices. All of this is most easily achieved by affiliation with an existing M&A firm.
Setting up a BD is more complicated and requires that a firm member obtain a securities principal license, but with the aid of a consultant and perhaps $10,000 in consulting fees and $5,000 of minimum capital (assuming M&A is the only function of the BD), it is well within the reach of any CVA/AVA who decides to proceed. The BD will require an annual independent audit and the filing of quarterly (FOCUS) reports with FINRA. FINRA takes BDs seriously and subjects them to heavy scrutiny. During the first year, the extent of oversight may seem annoying and will be time consuming but manageable. Many of those who have committed to going the BD route also have considered that it provides a significant competitive advantage not only to their M&A practice but, perhaps, to their valuation practice as well. As in the cases of training and credibility, the issue of the BD also can be easily dealt with by simply affiliating with an existent BD. At least some boutique investment banks see this as a great way to affiliate with skilled professionals and to promote deal flow for both the professional and the bank. It is simply a matter of obtaining and associating one’s license with those banks that will consider this approach and are themselves licensed broker dealers.
As a final note, CVAs/AVAs considering this kind of work should of course be aware of issues concerning accepting contingent fees from attest and audit clients and also should review their local state regulatory laws and CPAs should also check with their State Board of Accountancy for prohibitions, if any, concerning this kind of work.
(See Table Two)Assuming the Sale of 83% of these Businesses Number of businesses 1,000's%Aggregate Revenues ($1,000's)Number of businesses (1,000's)Estimated Revenue of Businesses ($1,000’s)Number of businesses (1,000's)Estimated Value of Businesses sold ($1,000’s)Lower Middle MarketBusinesses with revenues between $1 million and $50 million1,16797.7%$5,358,282,278790$3,627,557,102656$1,505,436,197Mid Middle MarketBusinesses with revenues between $50 million and $250 million252.1%$2,425,940,19317$1,642,361,51114$1,681,580,027Upper Middle MarketBusinesses with revenues between $250 million and$500 million30.2%$1,006,886,2172$681,661,9692$282,889,717Total Middle MarketTotal:1,195100%$8,791,108,688809$5,951,580,582671$2,469,905
1 See Table Two: Assuming an approximate age range for the controlling owners of middle market businesses to be between 35 and 69, then Boomers, born between 1946 and 1964, based on census data would own approximately 67.7 percent of middle market businesses as defined for this article.
2 This 83 percent sale of business estimate was taken from a PriceWaterhouse study.
3 As a practical matter, most boutique middle market M&A intermediaries spend the bulk of their time on the sales side of transactions although most will also do engagements (perhaps 20 percent of their total) representing buyers. In addition, institutional capital raises, especially from Private Equity Groups seeking to recapitalize the ownership of middle market businesses, is a substantial part of M&A practice for most.
4 There are ongoing developments on M&A licensing requirements and practitioners should seek the guidance of qualified counsel before proceeding with registration. Additional information can be found in the Securities Act at Section 3(a)(4)(A) and in the Guide to Broker Dealer Registration. Of particular note is the recent adoption by FINRA of the Series 79 license which is the first such license granted exclusively for M&A professionals and in certain cases valuation professionals.