M&A activity continues to increase in the agribusiness sector and the industry continues to evolve due to interest from investors and the trend to consolidate in an increasingly competitive environment.
Regardless of the deal size or type of buyer, a successful sale transaction will require significant preparation and a team of experts guiding you through each stage.
The following insights into pre-transaction preparation through the due diligence stage can help sellers prepare for a successful agribusiness transaction.
M&A in Agribusiness Overview
As investors look to diversify their exposure to market conditions, agribusiness enterprises become increasingly attractive due to long-term stability in land values, beneficial tax treatment, and diversification of crop types in production agriculture.
Agribusiness operators are generally well versed in growing and processing, adapting farm practices to environmental conditions, and understanding commodity pricing. Selling the business, however, requires an entirely different skill set, as the necessary financial planning and analysis can be complex.
Pre-Transaction Preparation
Preparing for a transaction should begin well in advance of the buyer’s diligence process. While the preparation timeline may vary, a common pattern in successful sales transactions is sellers preparing for a possible exit one to two years before the go-to-market process. Larger and more complex deals require a longer preparation cycle.
Key areas to evaluate include:
- Financial and operational reporting
- IT
- Tax structuring
- Enterprise value
Assess Quality of Financial and Operational Reporting
A buyer will perform a comprehensive buy-side diligence process. One of the key reports they look for to help assess the viability of a business or group of assets is a company’s financial statements, which will have enhanced credibility when accompanied by an audit report prepared by an independent CPA.
Companies will often only have their financial statements audited if their current ownership group or bank requires annual audited financial statements. When a company’s lenders or owners haven’t historically required audited financial statements, it’s not uncommon for them to have their financial statements reviewed by an independent CPA.
Less comprehensive in scope, reviewed financial statements don’t provide the same level of assurance as audited financial statements, but can be useful when no audited financial statement is available. Buyers will often perform expanded due diligence in the event of lacking or limited assurance.
If a company never engaged an independent CPA to perform an audit or review its financial statements, proactive sellers should begin gathering their first audited financial statements a couple years in advance of a transaction, knowing that most buyer’s will request as much as part of their due diligence process.
In cases where a sale is imminent and there’s not enough time to engage a CPA to audit the financial statements, another option is for management teams to obtain a sell-side quality of earnings report. This may provide insight to investors on the viability of sales, collectability of account receivable, margins, and the overall measure of current and future profitability.
Sellers should prepare for investors to ask for reports to support all facets of the balance sheet and income statement including:
- Working capital
- Operating cash flow
- Customer relationships
- Asset valuation
- Inventory existence
- Accrued liabilities
- Contingencies
- Margins by revenue stream
- Historical productions records
A combination of historical audited financial statements coupled with strong internal reporting of current and projected operations is paramount to a successful diligence process and should be assessed well in advance of engaging a buyer or investor.
Assess the IT Environment
Consider your current technology setup and how it could affect your ability to represent your business operations and projections to an outside buyer. Many farmers will opt for simple bookkeeping software, despite agribusiness operations often demanding more sophisticated technology.
A farm facing a business transition could benefit from a more scalable financial management system that can run reports and analyses in a quicker, more efficient manner as well as integrate inventory and fixed asset tracking.
If your business is vertically integrated from growing to processing to marketing, or you have disaggregated operations in various regions, your enterprise resource planning (ERP) system should allow for reporting by division as well as consolidating business operations. Depending on the size of your workforce, your IT environment should allow for adequate segregation of duties for user access and security from outside attacks.
Agribusiness companies will often use an ERP system just to get the job done, meaning that they can assess historical results and have backups and firewalls to prevent a major loss from business operations, but lack the capabilities to project future operations. In these instances, there are analytics tools that can be added to an existing ERP or accounting system to facilitate projections and budgets that buyers will want to analyze during the diligence phase.
Buyers are increasingly interested in the quality of ERP capabilities and system security and may shy away from transactions that require significant IT upgrades post-transaction. Assessing your technology constraints and addressing them well before the stage of a buyer’s due diligence is also critical.
Tax Considerations
Owners often overlook tax planning opportunities available prior to engaging with a buyer and tax structuring can have significant implications to the current owners as well as the buyer. Whether business assets are personally owned or owned through an operating entity such as an LLC, S corporation, or C corporation, will impact the ultimate taxation of sales proceeds to the seller.
Taxes can become increasingly complicated in situations where the seller remains involved post-sale, either through a management agreement or through a continued ownership stake in a portion of the business.
Sellers are generally interested in reducing tax exposure and state and federal taxes due on the proceeds of the sale. Conversely, buyers will be interested in achieving the most advantageous tax position that may include a step-up in tax basis of the newly acquired assets or business and reducing property tax and other state and local taxes.
Tax planning becomes increasingly important when the sellers’ ownership structure comprises multiple family members from different generations, which is often the case in farming operations.
Understanding the possible tax outcomes of a sale and performing a thorough assessment of the tax structuring opportunities available using the help of agribusiness tax experts will put the seller in a better negotiating position and allow for time to adjust to the buyers’ needs.
Know Your Value
Selling a business founded and grown over multiple generations with years of work put into cultivating crops or fine-tuning processing capabilities will inevitably be an emotional decision—which becomes apparent when trying to assess the value of the business. The intrinsic value of a farming business to the seller often doesn’t represent the economic value to a buyer. To bridge this gap, sellers should perform an assessment of the enterprise value of the business to understand what the market perception will be before deciding to go to market.
Determining fair market value of a business or set of assets can become increasingly complicated as the scale of the business increases with disaggregated business operations or multiple crop types. Depending on the size and type of business operations, a seller can get a reasonable assessment of fair market value using independent business valuation experts.
Land or equipment appraisers will suffice if the sale consists of orchard operations with limited processing. However, in a vertically integrated farming operation, sellers should consider engaging business valuation experts or investment bankers who can perform in-depth analyses on future cash flows, financial ratios, and earnings before interest, taxes, depreciation, and amortization (EBITDA) multiples to determine a starting selling price.
In addition to knowing the value of the business, it's important for sellers to understand the market opportunity and potential buyers. The pool of buyers of an agribusiness operation will either be other similar agribusiness operators looking for a strategic acquisition to fuel growth, or private equity or institutional investors looking to provide strong returns to their limited partners.
Strong relationships with advisors such as CPAs, attorneys, or bankers that specialize in agribusiness can be crucial when identifying market opportunities and matching the right buyer with the right seller.
Knowing the value of the business and market opportunity using an independent perspective will help the sellers overcome bias when determining the selling price and is a critical step in a successful transaction.
Due Diligence
Once the seller has completed the pre-transaction steps and has engaged with a buyer, the next step in the sale life cycle is the buy-side due diligence phase. During this time, the buyer and their representatives will perform an in-depth analysis of the assets and business operations.
Depending on the complexity of the business and the preparation by the seller, this process can take weeks or months to complete. As previously mentioned, buyers will ask for historical financial statements as well as supporting documentation and analysis of all aspects of those financial statements.
If not performed during the sell-side diligence, the buy-side due diligence process may include the buyer performing a quality of earnings assessment. This analysis often focuses on determining if adjustments need to be made for the financial statements to be in accordance with GAAP.
Additional adjustments could include adjusting GAAP earnings to reflect EBITDA, removing significant nonroutine transactions, or normalizing business operations due to recent changes in cost structure and related party transactions that don’t reflect arm’s length terms and conditions.
The buyer will also spend time understanding customer and vendor relationships, assessing possible contingencies, terms of contracts and agreements, remaining life of assets, value of real estate, the competency of management, and anything else that concerns the buyer about the terms of the deal.
This process, which will likely feel invasive, requires a significant time commitment from the seller’s entire team including operations, finance, legal, human resources, and sales and marketing. Successful due diligence requires patience and collaboration between the seller and buyer.
We’re Here to Help
For guidance on any stage of an agribusiness transaction, please contact your Moss Adams professional.