Multi-Unit Franchisee Magazine Issue II, 2011 | Page 92

exitstrategies
By Dean Zuccarello

M&a activity: 201 Outlook
1
avoid obstacles as the climate slowly improves

M

any restaurant operators
and dealmakers are hoping
for a return to the pre-2008
environment, when multiples were robust, liquidity was flowing,
equity was prolific, and debt capital was
plentiful.
We have seen a respectable improvement in restaurant company performance,
capital availability, and M&A activity in the
past six months, and we expect a recovery
in deal transactions. We have seen some
market players revert to what we’ll refer to
as the “new normal,” in which buyers and
sellers recalibrate valuation expectations and
deal structures to reach the closing table.
This caution has arisen from t he difficult
economy, and may be a factor for some
time. However, we sense that the M&A
market is recovering in lockstep with the
general economy and expect 2011 and beyond to be increasingly healthy and active
in terms of the deal environment.
While the selling process has never been
easy with middle market transactions, owners and entrepreneurs must be especially
strategic, educated, and prepared when
going to market in today’s still somewhat
uncertain environment. Obstacles to successful deal completion in 2011 include:
• Political risk and costs. While we
may have seen the worst from Washington
and state governments in terms of more
regulation, uncertain tax legislation, and
mandates on new government initiatives
(e.g., healthcare), reversing government
programs in a divided political environment is at best difficult and uncertain. In
short, sellers must be prepared to address
the costs associated with these programs
and defend their impact on future expenses
and cash flow. Buyers generally assume the
worst and project higher costs in evaluating acquisition opportunities.
• Credit and lending markets. The
credit markets tightened dramatically in
2008–2010, while underperforming loans
spiked and chief credit officers at financial
institutions experienced days that will long
remain in their memories. While financing
activity is returning and lenders recognize
they’re in the business of providing credit,

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Multi-unit Franchisee Is s ue II, 2011

the process is slow, tedious, and littered
with landmines. Equity requirements are
higher and have not reverted to pre-2008
levels, and borrowers must be prepared to
address any deviation in company financial
performance. Borrowers cannot expect
lenders to ignore uneven financial results
and should have a backup plan when applying for credit. In most cases, borrow-

We sense
that the M&a
market is
recovering in
lockstep with
the general
economy and
expect 2011
and beyond to
be increasingly
healthy and
active in terms
of the deal
environment.
ers and buyers should engage multiple
lenders to underwrite transactions, even
at the risk of paying higher up-front fees
to avoid a change in advance rate, pricing,
or credit structure.
• Operating results. Valuation integrity is based on the seller’s ability to drive
positive company results during what is
typically a protracted deal process, and
sellers must focus on maintaining positive operating trends throughout. With

transactions taking longer to close, operators must keep their eye on managing
costs, growing sales, and ensuring that
the company’s performance is sustainable.
While the natural instinct for an entrepreneurial seller or middle market CEO is to
micromanage the deal process, sellers are
advised to focus on company operating
performance and allow transaction professionals to navigate the often-changing
dynamics of the deal process. The most
difficult assignment for any M&A professional is to maintain deal pricing in a
declining operating environment.
• Plan and over-communicate. Sellers
and borrowers sometimes delay negative
news until later in the process. This strategy
might work in a robust deal environment,
where buyers look for reasons to make a
transaction happen. In challenging times
the reverse occurs, and negative developments often result in deals falling apart
over a perceived lack of trust between
buyer and seller, without even a chance to
attempt to renegotiate. If bad news surfaces, disclose and manage the situation
proactively. Burying or hiding questionable information will not suffice today.
Plan the transaction process, anticipate
negative developments, and manage the
communication and disclosure. Remember, in almost every case, the information
will come out eventually.
• Understand the realities of buyer
psychology. Buyers in today’s marketplace are more opportunistic than at any
time in recent memory. Well-capitalized
buyers often are convinced that sellers
have to sell and will attempt to re-trade,
restructure, and renegotiate based on any
unforeseen or expected development. If
margins contract, sales drop temporarily,
or the underlying brand or concept has
a tough comparison or weak promotion,
be prepared for the demand of a price adjustment. Buyers will use any tool to take
advantage of a short-term correction. Be
prepared, know your limits, and have a
backup plan in place. Many deals need to
die before they eventually close.
• Most sellers don’t have to sell. Most
value buyers remain unconvinced of this