Wheeling and dealing
October 1, 2008
Depending on whom you listen to, the United States has either just entered a recession or is on the precipice of one. Its length and depth, however, is unknown at the present time. The second quarter of 2007 saw the end of some of the highest levels of middle-market deal pricing in 30 years.
Although that window of opportunity has closed, the positive news is that acquisition pricing remains at solid, normal levels.
For an owner or CEO of a middle-market company, defined as one with a transaction price of between $5 million and $250 million, that has an interest in selling their company in the near or intermediate term, there is no reason to be hesitant about proceeding with the sale now.
Generally, acquisition prices do not have to be adjusted downward during a recession.
This article will discuss the following strategic considerations that such owners or CEOs must be aware of and a prudent course for them to follow.
Middle-market companies should be priced based on their expected future earnings and the risk in achieving those earnings from the business foundation given to the buyer.The stock market is known as a predictive indicator, not a historical barometer. A recession is usually priced into the average stock either by the time one starts or shortly after its inception. At that point, the stock market generally begins to rise in anticipation of improved economic conditions. And just as the stock market is a predictive indicator, so too should be deal pricing of middle-market companies.
Buyers solely determine the value of a company based on its expected future earnings and the risk in achieving those earnings from the seller’s business foundation. The buyer’s return on investment will be determined by the company’s profitability from the date of the acquisition forward. Historical earnings have no impact on the buyer’s return. So don’t allow a buyer to intimidate you into accepting the concept that recent historical earnings should determine the deal price during an economic downturn.
Savvy corporate acquirers consider acquisitions an ‘opportunistic' way to grow.When the CEO of a leading international distributor was questioned whether his company would continue their aggressive acquisition program despite the need to effectively integrate prior acquisitions, his response was that acquisitions are an “opportunistic” way to grow.
He said you must take advantage of them when they are available, or you may lose the opportunity forever.
What he meant was that if a buyer has a real interest in acquiring your company, he or she will pursue your deal when they feel they must in order to not lose the opportunity. This type of motivated purchaser will pay a reasonable, but aggressive, premium price at the time you want to sell, even if that is during a recession. Correspondingly, the current condition of the economy should not be a deterrent to making a deal at a premium price.
Never sell until you get a premium price regardless of economic or market conditions.Unless personal needs and considerations overwhelmingly dictate otherwise, never sell until you get a premium price. There should be no deviation from this rule. You only sell your company once. If you meet initial price resistance from acquirers, remain firm in your demands and don’t discount your price. If your adviser knows value and has properly established the premium price, you will eventually obtain it.
Recessions and economic downturns do not have to impact price.Although many acquirers do not reduce their drive during a recession, the majority attempts to use the downturn as an opportunity to prey on poorly advised, weak-spirited sellers by telling them they will only be able to sell if they accept a reduced price.
Unfortunately, many owners accede to these demands. They accept the premise that the acquirer must be protected against an earnings shortfall without demanding that they receive additional value for the increased earnings that will ensue when economic conditions improve.
These owners forget that middle-market deal pricing should be a predictive indicator.
However, this does not have to occur. If you have the will to defend your position and negotiate from strength, you can usually force buyers to pay a premium price regardless of economic conditions.
Even if you are not initially successful in selling your company, there are many corollary benefits from proceeding with the sale promptly.Except for companies in industries with major structural problems, such as home building, or firms with company-specific problems such as a significant weakness in its long-term business fundamentals, there is no reason for a company not to sell during a recession.
However, let’s assume you are not successful in consummating a sale during a recession. There are still numerous benefits from having gone to the market at that time. Once you start the sale process, buyers who are initially contacted will be aware that you are interested in selling your company at a premium price. Even if they reject the purchase, they will now be aware that your company can be acquired. Correspondingly, if their needs change and they later perceive your company as an “opportunistic” way to grow, they will be able to quickly make contact with you.
Many novices believe there is a negative price impact if a company has been for sale for a long time. That’s wrong. When a middle-market company indicates they are willing to sell at a reasonably aggressive, premium price, it is not unusual for many buyers to be skeptical of the seller’s resolve. They believe that if the seller isn’t initially successful, they will lower their price.
Sellers that don’t reduce their price expectations after meeting initial market resistance make acquirers aware that their resolve is unbreakable. Acquirers then realize the only way to buy the company is by paying a premium price.
If you are initially unsuccessful in obtaining a premium price for your company, take it as an opportunity to allow your adviser to strengthen your long-term business fundamentals.As previously defined, the true value of a company is based on its expected future earnings and the risk in achieving those earnings from the business foundation given to an acquirer. The business foundation is basically the long-term business fundamentals of the company. These fundamentals include such things as the strength and protection of its market niche, the scope of its market presence, the breadth and depth of its customer base, the efficiency and cost effectiveness of its production or warehousing operations, the capabilities and depth of its management team and its ability to take advantage of future growth opportunities.
To the extent these fundamentals are strong and position a company for growth and limit its downside risk, the amount an acquirer will pay for any level of earnings should tend to be higher than it would otherwise be. Therefore, if you have retained advisers capable of evaluating your business fundamentals, they can guide you in establishing a program to strengthen them. You can implement this program before reinstituting the active marketing of your company.
This program should eventually increase your earnings while reducing the threats to the volatility of future earnings. This should fortify your ability to sustain an increased transaction price.
Do not accept the prevailing wisdom that a recession means middle-market owners can’t obtain a premium price for their company. It is wrong.
If your personal and corporate objectives dictate that you proceed with the sale of your company now, there is no reason that a recession should deter you from acting.
George Spilka is president of George Spilka and Associates, a Pittsburgh-based merger and acquisition consulting firm that specializes in middle-market, closely held corporations. They have a broad-based service that advises clients through the entire acquisition process. These firms include a diverse group of contractors, distributors and manufacturing companies throughout North America. For more information, write Castle Town Square S., Suite 301, Allison Park, PA 15101. Also call (412) 486-8189, fax (412) 486-3697 or e-mail firstname.lastname@example.org; see www.georgespilka.com on the Internet.