At the Main Street level balance sheets rarely come into play, however when we are dealing with M&A transactions balance sheets are important. The following article by one of our M&A professionals Mike Ertle.
THE IMPORTANCE OF A STRONG BALANCE SHEET
Most M&A experts agree that the ultimate transaction value of any profitable, on-going business is largely determined/ influenced by its cash flow, which is most frequently expressed as its adjusted, or normalized, earnings before interest, taxes, depreciation and amortization (EBITDA). If that’s the case, why should we be at all concerned about the strength of the company’s balance sheet?
In point of fact, the role of the company’s balance sheet in the M&A valuation process is not well understood – even by many M&A professionals. Recognizing that in almost all cases the buyer will need to re-engineer the company’s debt in order to finance the acquisition, many M&A advisors spend little time analyzing the seller’s balance sheet.
In reality, the strength of the company’s balance sheet, particularly as it relates to the collateral value of the company’s assets, plays an important role in determining just how much bank debt the business will support, which in turn affects how much cash equity the buyer will have to invest to finance a particular purchase price. Since bank debt typically has a much, much lower return expectation (interest rate) than equity, a company with a strong balance sheet can typically command a much higher purchase price, and still meet the buyer’s expectations for the return on his own equity investment.
It is principally for this reason that manufacturing businesses typically sell for a higher multiple of cash flow than distribution companies, which in turn sell for a higher multiple than service companies.
It’s also important to note that since the company’s financial statements are typically prepared with the goal of minimizing the company’s annual tax liability, its balance sheet typically does not reflect the market value of its assets. Just as the company’s income statement must be analyzed and recast to more accurately reflect its normalized cash flow, the company’s balance sheet must also be analyzed and recast to more accurately reflect its current market value.
If you know of a business owner who’s thinking of selling or buying a business and who might benefit from a free consultation with an experienced M&A advisor, have them contact me, or any of the M&A professionals at www.transworldma.com
Mike Ertel, CBI, M&AMI
Transworld M&A Advisors
813.299.7862 Direct
mertel@transworldma.com