KUHN CAPITAL Saturday, February 24, 2018
Dispatches from the front

The Ultimate Sale Part I: Is This the Right Time?

Welcome to the first of six columns on the Ultimate Sale -- the sale of your business. In this column we’ll examine whether you should now consider “monetizing” what is probably your largest single asset.

Forthcoming columns will address how to prepare your company, assemble an effective M&A deal team, enter the market, select the most promising buyer, and close the deal. That covers a lot of ground so think of these columns as your handy sellside pocket guide.

Successfully selling a business is different from successfully building one. But the good news is that, while the process has its own quirks and shoptalk, much of it yields to common sense. Fortunately for you, you’ve already got common sense. You used it to create your current business.

To know if now’s the time, we’ll start by reviewing your attitudes and circumstances. Then we’ll look at the state of the M&A marketplace in general.

You, You, You
So are you ready? Answer the following questions to find out:
• To reach the next stage of growth you need resources that exceed your current capacity. Say you’ve got a world-beating product but nobody knows about it. Speed is important. Want to hook up with the marketing resources of a bigger, recognizable brand?
• Would selling your company generate enough to fund an attractive lifestyle? For that matter, have you thought about what an attractive lifestyle is?
• Are you bringing less energy and joie de vivre to the job than you did 10 years ago?
• Are there technological or industry developments that threaten your business model? For instance, is cloud computing hanging over your packaged software applications business? Is consolidation creating competitors with scale advantages that are squeezing your margins?
• Said more generally, will it be substantially harder for your company to put on a second act as impressive as its first one?
• Do you have better or more diversified uses in mind for the capital locked up in your business?
• Are you done proving something? That is, can you point to what you’ve accomplished with pride and feel that future company challenges are mostly mundane?
• Is it clear that your children won’t eventually take over the business?
• Have you received unsolicited bids to purchase your business?
• Would your company’s products or services fill a valuable gap in a competitor’s line-up?

Of course, this isn’t a list of all relevant questions. But whatever they are, they all have to do with crossroads. If you answered yes to one or more of the most common ones above, the situation augers well for considering a transaction.

Of course, there are also situations that argue against selling. Among the most common are:
• Have sales been continuously declining for reasons you understand and can fix? If so, hold off selling the business till you can prove you’ve recovered. (On the other hand, if you don’t know how to fix the problem or it will be expensive to do so, you may be better served by going into the buyers’ market now. Just be aware that only a subset of all possible buyers is willing to “catch a falling knife”, and they’re more likely to administer you a haircut in the process.)
• Are you running a young company and have yet to establish a solid upward sales and/or profit trend? Ideally, you’d sell after that curve has inflected into “takeoff” mode but before the rate of change has begun to decline.
• Have you established clearly ramping sales but, not surprisingly, your SG&A expenses are much higher than normal, depressing EBITDA? In other words, have you yet to get your money back on high marketing and administrative expenditures made in anticipation of increased sales? While there are exceptions (like with Internet-based companies where the economies of scale are so evident that buyers value market share above all else), for more down-to-earth businesses, you may find it prudent to sell after EBITDA has demonstrated at least the beginnings of recovery.

The Current and Maybe Future M&A Environment
Now we’ll check out the health of the M&A market. We want to know if today’s transaction volumes and prices are conducive to the prompt and full-valued sale of your business.

Keep in mind that what follows is about general trends only. To determine more precisely what your company might be worth today, talk to a competent investment banker. That is, unless you need to produce a value for estate planning or intra-family transaction purposes. In that case, hire an appraiser or valuation expert. Their values are different from the market-based values produced by M&A advisors.

The appetite of acquirers generally tracks positive GNP growth. Interestingly, though, M&A activity typically lags GNP recoveries. That’s probably because many prospective sellside targets fighting their way out of a downturn are stressed and therefore look risky to outsiders. Who knows how they’ll turn out? In the event, buyers don’t feel confident enough to offer strong values or sometimes any value. As for sellers, they’re typically preoccupied with regaining lost ground and/or decide to wait for a stronger valuation.

So where are we in the M&A cycle now? Considering GNP is only up about 6% from its recession nadir in mid-2009, M&A action has been surprisingly strong.

Let’s look at deals worth $500 million or less, what we’ll call “mid-market” deals. They’re more likely to be relevant to your situation than, say, Skype’s sale to Microsoft for $8.5 billion. In 2010, the total value of US mid-market deals was $225 billion, nearly as high as 2006.

2010 also beat all prior years through 2006 on the number of deals closed, 5,000. In sum, 2010’s M&A performance across US industry has been rather remarkable. Average transaction values haven’t been what they were before 2008, but they’re close.

Note well, though, that the first quarter of 2011 saw a material decline in both deals done and total value. It’s not yet clear what caused this, perhaps a rush at the end of 2010 to beat anticipated capital gains tax increases, or perhaps a growing fear that the recovery is stuttering.

At any rate, three industries in particular enjoyed strong 2010 M&A showings -- financial services, information technology and healthcare. About 1,700 financial services industry transactions occurred last year, a steady year-over-year increase since 2006 when about 630 deals closed. The aggregate yearly value of these deals in 2010 was $65 billion, way up over 2009’s miserable $28 billion.

For IT, both dealcount and total deal value took a major hit in 2009, but with 588 closes in 2010, the industry recovered to a value level of $31 billion, about where it was in mid-2007.

Like IT, healthcare transactions were punished in 2009 but 2010 saw far more value changing hands at $28 billion, up nearly 60%, with dealcounts rising 35% to 468.

If you’re in one of these three industries, your prospects for a successful sale remain good. Of course, other sectors aren’t off-limits: a profitable and growing, or at least stable, company in any industry will attract buyers.

Strangers Bearing Gifts
With the decline in US asset values, a rising number of transactions are occurring between domestic sellers and foreign buyers. Should the dollar continue its slide, this trend will pick up more speed. The sorts of US companies that overseas buyer like are those with proprietary intellectual property and/or access to rich domestic markets. However, because of the higher fixed costs of closing deals between companies in different countries, size matters. Such deals start to become uneconomic when they’re worth less than about $15 million. If you’re running a business with revenues below this figure, beware the broker who promises access to “thousands of overseas buyers” or miscellaneous Kuwaiti sheiks, especially if the broker asks for big fees upfront. Meanwhile, if you generate sales of more than $15 million and you have the characteristics mentioned above, foreign buyers can be players.

Asset bubbles are both the seller’s friend and nemesis. They occur when the value of a certain asset class rises fast and far above long-term historical comparisons. They are in fact filed with the heady gas of speculative M&A and public stock buying. For a glimpse into two candidate bubbles now abuilding, check out the values placed on social networking companies and – nearly the opposite sort of business – natural resource companies.

Bubbles are your friend when you sell out of them, but your nemesis when you buy or stay in them. That’s when they suddenly pop. Another problem with bubbles is that they take a long time to revisit where they grew up, sometime never. If your business is operating in bubble territory, think closely about an exit.

What’s Next?
So much for the current picture. Since selling a company can take about six months, what will the world be like then? Will the creeping recovery have picked up steam, eventually followed by rising animal spirits among buyers?

As in the section above, you’re the boss. Ask yourself:
• Do still-falling home prices, rising energy costs, debt-fueled government spending, a cheapening dollar and chronic high unemployment predict an improving or worsening environment for your company? Are you vulnerable to declines in consumer spending?
• Does the current bull market in equities predict good times down the road? Does it do so frequently or rarely? What do inflating commodity prices mean, especially for metals, fuel and agricultural products?
• Will taxes on the ”rich” – notably capital gains and state taxes -- go up or down in the future? If you happen to be what the politicians are calling “rich”, should you therefore get out before your butler greets a taxman at the door?
• Are you a baby boomer entrepreneur who missed the chance to sell at a high EBITDA multiple back in 2007 or before? If so, are you now determined to catch the next wave at its peak? Do you feel lucky?

When considering M&A market activity as a factor in deciding whether or not to sell, you may find it helpful to look at the choice as a trade-off between what most pundits forecast will be a mincing recovery in the years ahead versus what other people think is the prospect of a double dip and rising taxes. If your position is that the chances of either thing happening are about equal, is the downside deeper than the upside is high? If so, is that a call to action?

Finally, as you mull over whether to sell, know that some who have gone through the process say they never worked harder in their life. You’re running and selling a business at the same time. That requires commitment and the acquisition of new knowledge. Wise entrepreneurs get help from Sherpas who have trod this path before, experienced investment bankers. Even then it can be a demanding hike. Yet it is often exhilarating and holds out the promise of paying you handsomely for your years of effort and entrepreneurial inspiration.

Next up: our checklist of pre-sale steps that can not only enhance your company’s “curb appeal” quickly but add genuine value.

Ryan Kuhn

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