Despite being in the midst of a U.S. recession and at the end of the highest level of middle market deal pricing that I’ve seen during my 30-year career as an investment banker, there is positive news for owners and CEOs seeking to sell their middle market companies (those with a transaction price of between $5–$250 million).
In a previous feature, I recommended that any owner or CEO with an interest in selling during the next 10 years should avail themselves of the “bubble pricing” that was prevalent. Although that “window of opportunity” has closed, the acquisition pricing remains at solid, normalized levels. Downward price adjustments are not necessary now or in the foreseeable future. For companies looking to sell in the near or intermediate-term, there is no reason to be hesitant about proceeding with the sale now.
There are, however, strategic considerations that owners or CEOs must be aware of and prudent courses to follow during the current economic conditions.
1. Regardless of conditions, middle market companies should be priced based on their expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer.
Savvy corporate acquirers consider acquisitions an opportunistic way to grow. They realize they must take advantage of an opportunity when it is available or risk losing it.
2. Never sell until you get a premium price—again, regardless of economic or market conditions. Experience shows that recessions and economic downturns do not have to impact middle market deal pricing.
Even if you are not initially successful in selling your company due to economic or market conditions, there are many corollary benefits from proceeding with the sale promptly.
If you are initially unsuccessful in obtaining a premium price for your company during a recession, don’t overreact and accept a substandard offer. Instead, suspend the sale process and take advantage of the additional time as the opportunity to allow your advisor (an investment banker or acquisition consultant) to guide you in strengthening your long-term business fundamentals. Note that 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. An acquirer solely determines 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. Therefore, don’t allow an acquirer to intimidate you into accepting the concept that recent historical earnings should determine the deal price during an economic downturn.
Opportunistic Growth
A CEO of a leading international distributor was asked whether his company would continue its aggressive acquisition program despite the need to effectively integrate prior acquisitions. His answer was that acquisition opportunities must be taken advantage of when they are available, or the opportunity may be lost forever. And his answer should be noted by potential sellers, to whom the implication is that, if acquirers have a real interest in acquiring your company, they will pursue the deal when they feel they must in order to not lose the opportunity. This type of motivated acquirer will pay a reasonable but aggressive premium price at the time you want to sell, even if that is during a recession.
Acquirers do not reduce their acquisitive drive during a recession, and, in fact, many will use the downturn as leverage to gain the terms to their benefit. Unfortunately, most selling owners concede to the demands of these acquirers, and accept the premise that the acquirer must be protected against an earnings shortfall during the downturn without demanding that they receive additional value for the increased earnings that will ensue when economic conditions improve—forgetting that middle market deal pricing should be a predictive indicator.
Experience, again, indicates, that this leveraging strategy will falter with a hard stand by the seller. During the downturn of 2001–02, for example, I did not discount the price of any selling client and managed to consummate three deals at strong prices. During the 18-month period of the significant recession of 1991–92, I consummated six deals at premium prices and for 100% cash. The key is defending your position as a seller and negotiating from a strength.
Bottom line: Unless personal needs and considerations overwhelmingly dictate otherwise, never sell until a premium price is offered. There should be no deviation from this rule in otherwise difficult economic conditions. You only sell your company once; if there is initial price resistance from acquirers, sit tight. If your advisor knows value and has properly established the premium price, you will eventually obtain your price.
Patience and Progression
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 proceed to the market during a recession. And, if you are not successful in consummating a sale during the recession, there are still numerous benefits from having gone to the market at that time. Once you start the sale process, the acquirers that are initially contacted will be aware that you are interested in selling your company at a premium price. Even if they reject the acquisition, 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 an extended period of time. This, however, is not the case. When a middle market company indicates it is willing to sell at a reasonably aggressive, premium price, it is not unusual for many acquirers to be skeptical of the seller’s resolve and ability to accomplish that. They believe that if the seller isn’t initially successful, it will lower its pricing expectations. Sellers that don’t reduce their price expectations after meeting initial market resistance make it known that their resolve is unbreakable. They 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 during a recession, take it as an opportunity to allow your advisor to strengthen your long-term business fundamentals. As previously stated, 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 an acquirer. The business foundation is basically the long-term business fundamentals of the company, and 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 and/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 multiple an acquirer will pay for any level of earnings should tend to be higher than it would otherwise be. Once fundamentals are evaluated, they’ll guide you in establishing a program to strengthen them. You can then implement this program before reinstituting the active marketing of your company and eventually increase earnings while reducing the threats to and volatility of future earnings—fortifying your ability to sustain an increased transaction price.
Summary
Do not accept the prevailing wisdom that a recession means a selling middle market owner can’t obtain a premium price for its company. It is wrong. Experience shows us that recessions do not negatively impact middle market deal pricing when transactions are handled by a sophisticated advisor. If your personal and corporate objectives dictate that you proceed with the sale of your company regardless of economic conditions, there is no reason to veering from that goal.
George Spilka is president of George Spilka and Associates, a national investment banking firm specializing in middle market, closely held corporations. E-mail: [email protected]; 1-412-486-8189; fax: 1-412-486-3697 www.georgespilka.com
