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The Impact of the Financial Crisis on Middle Market Acquisitions

George Spilka

The U.S. is in the midst of its greatest financial crisis since the Great Depression. Congress approved a $700 billion bailout package for the financial industry on October 3, 2008—an infusion of capital that is the most massive governmental intervention in the financial markets in U.S. history. After the initial rescue package was denied, the second version passed relatively quickly, as the consequences of not doing so were too dire. Had Congress not approved the package, there would have been a complete freezing of the credit markets.

Congress’s delay in passing a rescue package caused an intensification of the anxiety and fear gripping the financial markets. This significantly contributed to the overwhelming crisis of confidence that now impacts the U.S. financial markets and has spread to all global financial markets. Subsequent aggressive and prudent measures instituted by the Federal Reserve and U.S. Treasury (i.e.  the direct lending by the Federal Reserve to industrial companies) and the reduction of the Fed funds and discount rates, among other actions, did not immediately stem the panic devastating the markets. However, the former will eventually loosen up the commercial paper and general credit markets for numerous reasons, and the latter will have a positive impact on overall economic activity. And more actions are likely. The world's central banks and most national governments now seem to be making the right moves, while operating in a tremendously complex, unique and opaque environment. These moves will eventually bring stability to the world financial markets.

However, we are definitely not facing a financial Armageddon. The market should hit bottom in the very near-term, and, at that point, the return to normalcy will begin. And normalcy should arrive much before most people expect. Despite what you have witnessed, there is no reason to panic.

What brought the country to the brink?

Very simply, the reckless residential mortgage lending that began in 2004 combined with the use of modern technology to design exotic financial derivatives, which were little understood by many and had consequences that almost no one could forecast. The massive use and distribution of these derivative products was almost completely funded by debt.

What hasn’t happened in the financial crisis?

The impact has been limited to the financial industry, which has been devastated by the losses sustained in the residential mortgage lending market and the losses related to credit default swaps and other derivative products. The crisis reached one peak on September 17 when financial institutions became concerned about extending credit anywhere; thereby nearly causing a meltdown of the U.S. financial structure. The Federal Reserve and Treasury stepped-in and proposed the bailout package. This brought renewed life to the credit markets. However, while this scenario evolved, U.S. industrial companies (both manufacturers and distributors) had their strongest balance sheets since the 1970s. There has been no massive borrowing by America’s industrial companies during this period, nor has there been any meaningful disruption in the manufacturing and distribution segments of the U.S. economy. The immediate impact has been limited to the financial markets, and this is where the impact will be contained.

As I survey the landscape, although the economic figures indicate the country is in a recession or an economic downturn (define it as you like), the profits of U.S. industrial companies remain strong. The results for public companies indicate that, although profitability is moderating, it remains at historically high levels. In my opinion, the intermediate and long-term impact of the financial crisis on the economy is going to be negligible, if any. I believe that by the second half of 2009, the U.S. will be coming out of the economic downturn. One major concern regarding future economic performance is the amount of guarantees that have been made by the Federal Reserve and Treasury. These could possibly lead to a significant worsening of the Federal deficit. If it does, it will exacerbate U.S. dependence on on the global community. In this scenario, without foreign governments increasing their already large purchases of U.S. debt instruments, we will likely have a significant increase in the inflation rate and a further weakening of an already weak dollar. However, I still believe the financial crisis will have limited impact on the intermediate and long-term economy.

Owners and executives of middle market companies, such market defined as companies with a transaction price between $5-$250 million, will now continue to get their ceaseless level of calls from brokers, intermediaries and low-grade investment bankers. However, their storyline will now be either upfront or as a deal progresses, something similar to “you better sell at a discount price before the carnage gets worse," or “you should be thankful to receive this price due to current financial conditions.” There is no justification, though, for those type of statements.

Most acquirers will tell you the devastation in the financial markets means you will have to accept a substantially discounted price. You will be told that pricing will be “dirt cheap” into the foreseeable future and might even deteriorate further. Don’t pay any attention.

The Impact of the Financial Crisis on the Sale of Middle Market Companies

  1. Short-term impact  (up to 1 year): There will be a period of three (possibly even six) months where there is some turmoil in the acquisition market. Conceivably, there could be a degree of transaction pricing weakness through the end of the second quarter of 2009, but I doubt it.
  2. Intermediate-term impact (1-3 years): There should not be any impact on transaction pricing, unless the impact on the Federal deficit of the guarantees made by the Federal Reserve and the Treasury have a greater impact than expected. Therefore, deal pricing to be similar to the first half of 2008, which was reasonably solid.
  3. Long-term impact (3 plus years): None. Many things will affect pricing, none of which will be the current financial crisis.

Based on my economic outlook, I don’t feel the financial crisis should have any significant impact on potential sellers of middle market companies.

The Recommended Course of Action

Don’t change the overall strategy regarding the sale of your company. If selling satisfies your personal and business objectives, you should proceed with the process. You might delay contacting potential acquirers until after the first quarter of 2009, but that will not be necessary in most cases. Furthermore, don’t modify your expected transaction price at this time.

For companies not yet in the market or ones at the very start of the sale process, whose fundamentals and business foundation are somewhat deficient, they might want to delay the sale while they strengthen and reposition the company. However, where there is no need to strengthen the company’s fundamentals or foundation, there is no reason why approaching acquirers should be delayed past the start of 2009.

Don’t be intimidated by acquirer’s “doomsday scenarios.” The financial crisis has not changed anything in the industrial sector of the U.S. economy. Most companies remain very profitable, and the intermediate and long-term business outlook remains good. Therefore, there should be no transaction price concessions. If patience is necessary, it will provide you a bountiful reward.

These are times when you truly need a strong-willed, determined, knowledgeable investment banker that understands the causation of the financial crisis and how it is likely to play out. They will provide you the proper guidance in how to proceed in these exciting, yet turbulent, times. If you have this strength and expertise on your team, you will get a premium price. Don’t let acquirers intimidate you, and don’t accept less than you deserve.

George Spilka is president of George Spilka and Associates, a national acquisition consulting firm specializing in middle market, closely held corporations. E-mail:; 1-412-486-8189; Fax: 1-412-486-3697

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