Tuck-in Transactions: Straight Paths to Satisfying Outcomes
Tuck-ins haven’t lost their usefulness as a way for up-and-coming companies to broaden their horizons and for legacy businesses to make a dignified exit from the stage. The popularity of tuck-ins rises and falls with general print market conditions. Right now, with many printing and packaging companies in relatively good shape, sale as a going concern is a reasonable strategy for owners of the strongest businesses to pursue. Tuck-ins, on the other hand, remains the best option for firms that may be nearing the end of their operational lives – but still have customers that buyers will find attractive.
We’re thinking primarily of smaller, family-owned businesses that don’t have the resources they need to reinvent themselves by adding new products and services. To further complicate matters, there may be no succession plan in place.
Even so, companies like these frequently have lists of loyal accounts that they’ve cultivated over many years. This ready-made customer base is what appeals to buyers, and a tuck-in is the most efficient way to transfer ownership of it. At New Direction Partners, we recommend structuring the deal as a tuck-in when we’re convinced that it will lead to the most advantageous outcome the owner can expect, given trends in the M&A marketplace and the condition of the business that he or she is trying to sell.
Can’t Be Swallowed Whole
Sellers may need to be reminded that these days, buyers probably won’t be interested in wholesale takeovers unless the objective is to add an entirely new capability or to establish a base in a new geographic location. Hoping to be acquired as a going concern isn’t realistic when the seller’s plant and equipment have fallen behind the times, or when adding manufacturing capacity through acquisition would just exacerbate a problem the buyer already has.
The fact is that even for the most competitive firms, organic growth — the kind that comes from increasing output and expanding sales internally — can be difficult to achieve. A buyer in this position wants to build sales volume and fill excess capacity without expanding the manufacturing footprint or adding to overhead.
This is precisely the solution that sale as a tuck-in makes possible because what the buyer absorbs isn’t the seller’s company in physical form: it’s the seller’s account list and the opportunity for external growth that comes with it. Now the buyer has a fresh set of customer relationships along with an injection of volume to turn idle machine time into productive time. If the buyer can produce the acquired work at lower cost than the seller, profit margins on it will be better as well.
That’s all good news from the acquirer’s perspective, but it’s also important to understand how tuck-ins can be structured to the seller’s advantage.
One of the first questions the seller will ask is, ‘What happens to my equipment?’ Our answer is that it becomes part of the payout to the seller when it is liquidated. Late-model, automated presses are highly desirable in the domestic used-equipment market; older iron can be exported, and even scrapping it fetches a decent dollar. The M&A advisor who helps the seller set up the tuck-in can also assist with liquidating production machinery and other physical assets that the buyer doesn’t want.
Payment in Due Course
The next step in a tuck-in is working out a formula that compensates the seller over a specified period of time, based on what those accounts will produce under new ownership. These are called contingent payments, and they happen in the future, not when the deal is closed. A tuck-in that does not include an up-front payment to the seller will be a cashless transaction (this is one reason we recommend getting maximum liquidation value for equipment).
If it is present, account concentration — individual accounts representing very large percentages of the book of business as a whole — could have an unhelpful effect on the deal from both the seller’s and the buyer’s point of view. For a buyer acquiring a customer that produces a disproportionate share of the seller’s volume, concentration is a business risk and a legitimate reason to avoid prepaying the seller in cash at closing.
Occasionally, we are able to structure tuck-ins to include contracts that require highly concentrated accounts to continue doing business with the new owner for a mutually agreed-to term. This can make concentration less of an issue, but the probability of striking such a deal is low. This is why our advice to sellers in transactions of all kinds is to address account concentration before it becomes an obstacle to potential buyers.
Now the buyer and the seller can get down to the details of how much the buyer will receive in contingent payments and on what timetable the payments will be made. While there are no universal formulas, the payouts typically take place over three to five years based either on a percentage of retained sales, which could mean new sales volume (as opposed to current level of sales) from the acquired accounts; or on a percentage of value added (selling price minus cost of sales).
The percentages range from 3% to 7% of retained sales in most deals of this kind. Some transactions may specify a dollar-amount cap on total payments to the seller during the payout period. Payments may be made annually, semi-annually or quarterly. Quarterly payments usually start at the end of the first full quarter after the deal is closed. Bear in mind that in order to get the best terms, the seller may have to agree to stay on in an executive or a sales role for a transition period specified by the buyer.
As mentioned earlier, buyers want to acquire work that they can produce at a better gross margin than the seller. In due diligence — the phase of the transaction in which every facet of what is being put up for sale is scrutinized — the buyer will price the seller’s book of business as if it were being produced in the buyer’s plant at the buyer’s cost. The greater the potential value of the work, the more negotiating room for a high percentage of payout the seller will have. If, however, the work consists of commodity jobs given away at unrealistically low prices and margins, the seller’s bargaining position will be weaker.
Propitious for Packagers
Digital printing, wide-format output, and web-to-print production yield the kinds of profit that buyers like to see. Margins tend to be strongest in package printing, especially in categories such as high-end folding cartons and premium labels. Because package printers and converters generally are doing well, we see fewer tuck-ins happening in this space than in the commercial segment. That means the demand for packaging tuck-ins exceeds the present supply of opportunities to execute them — good news for packaging company owners who are open to taking this route to a sale.
Although acquiring another company in a tuck-in is inherently less complicated than purchasing it as a going concern, the challenge of bringing a tuck-in to a successful conclusion shouldn’t be underestimated. First comes identifying the target. In some cases, the most desirable candidates may be firms whose owners aren’t thinking about selling in the first place. The task of finding, approaching, and engaging them calls for market knowledge, diplomacy, and tact — an assignment best placed in the hands of qualified M&A advisors.
For owners who are considering their options, professional M&A advisement is the key to choosing an advantageous exit strategy. As we always counsel our clients, there is never a better time than the present to begin preparing the business for sale in whatever type of transaction will deliver the best achievable return. When buyer and seller understand exactly what they can expect the deal to deliver, the answer may well prove to be a tuck-in.
About the Authors
Frank Steenburgh and Thomas Williams are partners in New Direction Partners (NDP), the leading provider of advisory services for printing and packaging firms seeking growth and opportunity through mergers and acquisitions. NDP assists its clients by giving them expert guidance and peace of mind at every stage of the process of buying or selling a printing or packaging company. Services include representing selling shareholders; acquisition searches; valuation; capital formation and financing; and strategic planning. NDP’s partners have participated in more than 300 mergers and acquisitions since 1979. Collectively they possess over 200 years of industry experience with transactions in aggregate exceeding $2 billion. For information, email firstname.lastname@example.org
Frank D. Steenburgh, partner at New Direction Partners, brings over 45 years of industry experience, including the past 30 years in digital and is internationally recognized as an expert in digital printing and publishing. His experience includes corporate officer at Xerox and president of Indigo’s Americas operations. Frank’s value includes a wealth of global industry contacts, a proven track record in development and implementation of business strategies that drive revenue/profit growth and a deep understanding of horizontal and vertical markets. Contact him at (610) 230-0635, ext. 709.