“When is the best time to sell? Has the market reached its peak or will valuations keep rising? Maybe I should hold on and sell after the holidays?”
These are questions our clients grappled with last year. With valuations rising, the concern was potentially selling too early and leaving money on the table. Everyone knew sellers who had sold for too little in 2019 and early 2020, only to regret it when valuations soared in 2021.
In 2022 sellers are faced with the opposite question. Now that the heat has come out of the market sellers are wondering “When will the boom return?” so that they can time the sale of their business with the next upward surge in valuations.
This is no longer the right question to ask. The conditions that led to the buying frenzy for Amazon FBA businesses in the first half of 2021 will not be repeated.
E-commerce has returned to its pre-COVID growth trajectory. Investors are encouraging Aggregators to grow sustainably (i.e. carefully) instead of pursuing growth at all costs. The near-zero central bank interest rate environment is over, and investors will require a higher rate of return.
It’s not all bad news, however. Exit opportunities are still far more abundant than they were two years ago. The majority of the Aggregators will continue acquiring businesses, utilizing the more than $15 billion in capital invested into the space, while strategics and PE will remain too. The Aggregators’ acquisition criteria have narrowed, but strong brands will continue to achieve good exits, and some will achieve outlier valuations. There does not have to be a “frenzy” amongst buyers for there to be a healthy environment.
Right now, the mood is particularly cautious, since there is still significant uncertainty in the capital markets. It should be noted, however, that even during the most cautious period of Q2 2022, deals are still closing. Hahnbeck closed an 8-figure Amazon FBA deal with an aggregator just a few weeks ago. Several aggregators raised new equity rounds (not just debt) during this quarter.
However, from Q3 onwards we expect the market for Amazon FBA businesses to normalize and then continue to operate at a stable level throughout 2022 and 2023. There will be no return to the boom of 2021, but also no “bust”. Acquirers will continue to see value in good Amazon brands and acquisitions will continue at a healthy pace. For sellers, timing an exit according to what is happening in the market will no longer be important, at least for the next few years.
The Right Question
When is the right time to sell? If the answer no longer depends on the market, what does it depend on? Timing the sale appropriately with what is happening in your business is now the most important consideration.
A significant factor in this regard is growth. While everyone appreciates the link between growth and valuation (growing businesses are worth more), the timing implications are not always obvious. Sellers are often tempted to delay the sale of their business while it is growing, so as not to leave too much cash on the table. If treated as a long-term (multi-year) strategy, this has merit. Growing a business to a new threshold level before selling (eg: $10m EBITDA), can make it attractive to new categories of acquirers and warrant a higher multiple.
However, many sellers are tempted to apply this as a short-term strategy, hanging on for “just a few more months” to benefit from additional profits before bringing the business to market. This is risky. It is critical to understand the implications of entering a period of decline (in sales or margins) during due diligence. When this happens, buyers get nervous. Prices that were agreed on the basis of certain growth expectations suddenly appear to be too high. Buyers often use this as a reason to retrade to a lower price, or to delay closing, sometimes for many months, until it becomes clear how long the downturn will last. In some cases buyers (or their investors) simply abort the deal altogether.
Therefore it is important to go to market when the business is expected to show continued growth for at least another six months, to allow enough time for the sale process and due diligence, with some cushion for unexpected delays.
Therefore it is important to go to market when the business is expected to show continued growth for at least another six months, to allow enough time for the sale process and due diligence, with some cushion for unexpected delays. No one can predict the future, but business owners generally have a strong sense of the growth drivers in their business and can develop a reasonable degree of confidence. Continuing to demonstrate growth (or at least not decline) through the due diligence process is crucial in maintaining the seller’s negotiating power and closing the deal at the offer price.
Sellers who time the sale without this cushion, bringing the business to market at the very zenith of its growth, often receive strong offers at LOI stage, only to face issues in due diligence when the business starts to decline. Having solid legal and corporate finance (M&A) teams on the side can help in this situation. Still, even the best negotiators have an uphill battle when sales and profits are declining during due diligence.
Sales growth is not the only important factor to consider. For Amazon brands, margins are critical. While some DTC brands can achieve strong valuations on the back of exploding growth with negative margins, there is no appetite in the market for “pre-profit” Amazon businesses. Acquirers in this sector largely fund their acquisitions with debt and require profits to service these obligations. They all have minimum net margin requirements for their acquisition targets, and they all take the view that as far as margins are concerned, the higher the better.
Note that the aggregators’ minimum net margin requirement has reduced slightly since 2021, when they almost uniformly required 20%+ SDE margins (with rare exceptions). Now the threshold for most is set at 15% and some will look at acquisitions with EBITDA margins as low as 10%, although brands with stronger margins are still favoured.
The trend in margins is important also. The entire sector has experienced margin compression due to inflation in freight costs and other supply inputs, as well as Amazon advertising fees and surcharges. Acquirers understand this. But when the margins of a potential acquisition target are declining, acquirers (not only aggregators) will dissect the accounts in detail to identify the underlying causes. If they are temporary, or sustained but manageable, they will not be terminal to the deal. But where the causes margin of compression are forecast to continue or worsen over time (for example where new competition has caused a price war), the acquirer will not proceed.
Amazon brands with SDE margins below 15% should try, where possible, to increase these before sale. If EBITDA margins are lower than 10% and not expected to increase in the short term, a sale will be very unlikely, regardless of the other business metrics. In these cases management must intervene to address the underlying issues and improve margins before the sale. Brands with stronger – but declining – margins must be able to explain the reasons for the margin compression to give confidence to buyers that they will not worsen over time.
All of this plays into the timing of the sale. If margins are too low, or strong but declining with no end in sight, it is the wrong time to go to market.
A number of other factors can have an impact on an Amazon business and therefore the timing of when to bring it to market. Any problem that can be predicted (naturally some things are out of everyone’s control) should be addressed first, before the sale. Lawsuits, new compliance hurdles and Amazon TOS issues are examples that need to be considered on an individual basis. If any are deemed to create too much risk for the potential buyer, they should be addressed before going to market, where possible.
As the market for Amazon FBA businesses has shifted to a much more stable pattern, it’s no longer sensible for sellers to attempt to time their exit with the “peak” of the market.
Timing is still critical, but the key now is timing the sale optimally in line with what is happening in the business, particularly with regard to growth and margins. Business is cyclical. Viewed over a long timeframe, reductions in sales or margins can be seen as short-term “blips” in a long-term growth story. But bringing a business to market during one of these events is not advisable. Timing your exit at the right time in your business cycle can have an enormous impact on the valuation you achieve and the ability to close the deal.
Hahnbeck is a leading global e-commerce M&A firm with offices in Europe and North America. The insights above are expanded on in detail in a recent report by Hahnbeck on the current state of the market for Amazon FBA businesses. Based on extensive market knowledge, and interviews with more than 25 aggregator firms, the report is a must-read for brand owners considering an exit in 2022 or 2023.