While the U.S. economy may or may not be in a full-blown recession right now, there's no doubt that the record prices distributors were getting for their businesses in the past few years is now a thing of the past.
The second quarter of 2007 saw the end of the highest level of middle-market deal pricing that I have seen during my 30-year career as an investment banker. An article that I wrote in December 2006 recommended that any owner or CEO with an interest in selling during the next 10 years should take advantage of the “bubble pricing” that was prevalent for two years. Although that window of opportunity has closed, acquisition pricing remains at solid, normalized levels. To illustrate that point, I have not made any downward price adjustments on the deals that I am handling, nor do I anticipate making any in the future.
Owners or CEOs of middle-market companies (defined as companies with a sale price of between $5 million and $250 million) interested in selling their companies in the near or intermediate term should not hesitate about proceeding with the sale now. My experience has been that acquisition prices do not have to be adjusted downward during a recession. This article will discuss the following strategic considerations that owners or CEOs must be aware of and a prudent course for them to follow.
Regardless of economic 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's available or risk losing it.
Never sell your company until you get a premium price, regardless of economic or market conditions.
Recessions and economic down-turns do not have to affect middle-market deal pricing.
Even if you aren't initially successful in selling your company due to negative economic or market conditions, you gain 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 an opportunity to allow your investment banker or acquisition consultant to guide you in strengthening your long-term business fundamentals.
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. 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. Just as the stock market is a predictive indicator, so too should be deal pricing of middle-market companies. An acquirer determines the value of a company solely 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.
Savvy corporate acquirers see acquisitions as opportunities 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 if you don't take advantage of acquisitions when they are available, you may lose the opportunity forever. This CEO's comments were right on the money. If an acquirer has a real interest in acquiring your company, they will pursue your 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. Correspondingly, the current condition of the economy should not be a deterrent to consummating 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 advisor knows value and has properly established the premium price, you will eventually obtain it.
Recessions and economic downturns do not have to affect middle-market deal pricing. Although many acquirers do not reduce their acquisitive drive during a recession, the vast majority of acquirers attempt 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 during a downturn if they accept a reduced price. Unfortunately, most selling owners give in to the demands of these acquirers. They 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. These owners forget that middle-market deal pricing should be a predictive indicator.
During the downturn of 2001-2002, I did not discount the price of any company for a selling client and managed to consummate three deals at strong prices. Furthermore, during the 18-month period of the significant recession of 1991-1992, I consummated six deals, all of which were premium-priced and for 100 percent cash. If you have the will to defend your position and to negotiate from strength, you can usually force an acquirer 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 their long-term business fundamentals, there is no reason for a company not to proceed to the market during a recession. If an expert advisor handles the sale of your company, you should be able to successfully sell your company at a premium price during a recession.
However, even if you are not successful in consummating a sale during the recession, numerous benefits still exist from going to the market at that time. Once you start the sale process, the acquirers 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 the purchase of 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. In my opinion, nothing is further from the truth. When a middle-market company indicates they are willing to sell at a reasonably aggressive premium price, it's 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, they will lower their pricing expectations. Sellers that don't reduce their price expectations after meeting initial market resistance make acquirers aware 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 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 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 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. Therefore, if you have retained an advisor who can evaluate 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 and volatility of future earnings. This should fortify your ability to sustain an increased transaction price.
Summary. Do not accept the prevailing wisdom that a recession means middle-market owners can't obtain premium prices for their companies. From my experience, recessions do not negatively impact middle-market deal pricing when transactions are handled by sophisticated advisors. Savvy corporate acquirers consider acquisitions an opportunistic way to grow. They realize they have to pay a premium price when a company wants to sell or risk losing the deal. Consequently, 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 working toward that goal.
The author is president of George Spilka and Associates, Allison Park, Pa. The firm specializes in mergers and acquisitions. The author's Web address is www.georgespilka.com. Reach him at (412) 486-8189 or by e-mail at [email protected].