Selling a privately-held business is one of the most important decisions any distributor, rep or manufacturer will ever make. It's an emotional decision that touches on family dynamics, your business' profitability and reputation in the market.
But to make the most from all of the hard work you, your family and your employees have put into the business, it also depends on exquisite timing. Fortunately, late 2011 and 2012 will be a good time to sell a family business. A brief description of the history of recent deal pricing will put things into perspective. During 2006 and the first half of 2007, the greatest market bubble in middle-market deal pricing in more than 50 years occurred. As I mentioned in an article written during that period, any middle-market executive that had plans to sell their company within the next 20 years should have sold then because those pricing levels will probably not be seen again in our lifetime. But during the second half of 2007 and first half of 2008, deal pricing reverted to normal levels. As the business downturn started in the third quarter of 2008 and we fell into the recession, deal pricing collapsed. In fact, 2009 was the first year the world economy contracted since the 1930s. Fortunately, although economic and market conditions were awful, they never deteriorated to the levels realized during the Great Depression. However, middle-market deals (defined as transactions with values between $5 million and $250 million) were few and far between during this era. Those deals that were completed were usually done at deeply discounted prices. This pricing level continued until the start of the third quarter of 2010, but at that time deal activity and pricing started to improve.
Current deal pricing
As we begin 2011, deal pricing is making strides to return to normal levels and middle-market deal activity, which is not necessarily comparable to large deal activity, has greatly improved. However, many acquirers still believe they can “steal companies,” primarily due to the depressed earnings most companies realized during the recent recession. Many sellers are susceptible to accepting these discount prices, as the scars created by the recession make them concerned they won't be able to sell their companies. However, by the latter part of 2011, I expect middle-market deal pricing to increase to above normal levels.
During 2010, many acquirers used the depressed earnings realized by a seller during the two-year period ending June 30, 2010 as justification for a substandard offer. Middle-market executives must understand that their company is a long-term asset with a sale price that should not be impacted by short-term transient considerations. Furthermore, any serious acquirer does not anticipate earnings returning to 2009 and 2010 levels in the foreseeable future, or they would not be interested in buying companies. Middle-market executives must remember that the true and most significant determinant of a transaction price is a company's expected future earnings before interest, taxes, depreciation and amortization (EBITDA), and the risk in achieving that EBITDA from the business foundation given an acquirer. This is an acquirer's major consideration in determining a seller's value. If they mention any other factors during a negotiation, they are merely using them for negotiating leverage to justify an unwarranted discount price. Consequently, don't consider your earnings during the two-year period ended June 30, 2010 as a factor in establishing a transaction price. They simply are not a consideration, and you should demand they be treated accordingly.
Expected deal pricing in late-2011 and 2012
The optimum time to sell a company should be the latter part of 2011 or 2012 because of several factors:
A positive business climate's impact on your future earnings
Most companies' earnings began to show some strength during the second half of 2010. Earnings should continue to grow in 2011 and increase at an even higher rate during 2012. Furthermore, 2013 should be a very good earnings year, supported by a healthy economy. These earnings levels make it possible to realize a premium price.
During 2011 and 2012, the capital-gains tax will remain at a reduced level of 15 percent compared to the prior rate of 20 percent. It's unlikely the 15-percent rate will be extended beyond Dec. 31, 2012. This 5-percent tax savings on the realized gain is a significant consideration when determining the timing of a sale.
Cheap money is a by-product of the excessive credit provided by the Federal Reserve and should contribute to strong acquisition prices during this period, while still enabling the acquirer to have a solid return on invested capital. As 2011 begins, the majority of banks are loosening the credit spigots. By the latter part of 2011, I anticipate the availability of credit to be at normal levels.
Market demand for acquisitions
Around the end of 2010, acquirers began to aggressively pursue deals. These factors combine to mandate that owners interested in selling their companies within the next seven years should seriously consider selling them during the latter part of 2011 or 2012.
Deal pricing in 2014 and later
Beginning in 2014, the intermediate and long-term economic outlook gets pretty murky. It's not inconceivable the economy could stay strong during 2014 and 2015, but several factors are firing off warning signals that trouble could be on the horizon, which could affect these and/or possibly later years. It's possible the following factors could negatively impact middle-market deal pricing and activity, in a big way:
The condition of the credit markets, especially in Europe, could be an intermediate to long-term financial problem.
Major issues are impacting the Chinese economy and banking system, including the Chinese Central Bank increasing the “benchmark” lending rate and the reserve requirements for the commercial banks to reduce an increasing inflation rate. Potentially, these could have a negative impact on the Chinese economy. And as the Chinese economy is one of the most dynamic and important economies in the world, a negative impact on it will likely have global consequences.
The political and economic instability in the world at this time could provide the basis to produce an event that would have wide-ranging repercussions.
There are many global “hot spots” that could erupt at any time. The impact of any of these events could produce fear and tremendous instability in the financial markets.
I am not saying intermediate and long-term economic and market conditions will definitely be bad. However, I am advising clients that I strongly prefer to consummate the sale of their company in the latter half of 2011 or 2012 due to the substantial risk facing the economy and acquisition market in 2014 and subsequent years. The risk factor is too great to delay a sale until 2014 in light of all the positive reasons why a sale should take place before Dec. 31, 2012.
Obtaining a Premium Price
For a middle-market seller to obtain a premium-priced deal with terms that fully insulate them from post-closing liability, they must find an investment banker/acquisition consultant (IB) that has certain capabilities and characteristics. A seller should be looking for the following things in their investment banker:
An investment banker that realizes — and actually relishes — that a sale is not a win-win situation. In reality, it's much closer to a win-lose situation. This type of IB recognizes that negotiations are a psychological war between disparate interests with conflicting goals. The seller wants the maximum attainable premium price, while the much larger, sophisticated acquirer expects a discounted price, as they normally get their own way in middle-market acquisitions. There is no way these diametrically opposite interests can't result in a psychological battle where the better prepared, more determined party will prevail.
An investment banker with compassion and concern for their clients that understands most acquirers will try to steal a seller's company. The right IB for you will be steadfast and resolute, concerned only with protecting and maximizing your realistic interests. If an acquirer won't optimize your interests, the right IB will not consummate a deal under lesser terms.
An IB that has the aggressiveness, determination, toughness and force of personality combined with the market and financial knowledge to force their will on large corporate acquirers or sophisticated private-equity firms. If those traits are not present in the investment banker, you won't get a premium price.
An investment banker that has executive and business skills that transcend the financial skills that any IB should have. The IB needs to fully understand your company, its strengths, market niche and potential. They also must have the ability to present and articulate these facts clearly and persuasively to an acquirer. To prevail, your investment banker must understand your company better than the acquirer and understand your industry at least as well. This knowledge when combined with the personality traits and attitude previously described will intimidate an acquirer, convince them they can't steal your company, and that they can only buy it at a realistic premium price. There is no other way to win the psychological war of negotiations.
An IB that has the patience and confidence to wait, if necessary, to obtain a premium-priced, all-cash deal. In certain situations, they must be willing to allow the power of their knowledge and personality traits to have the time necessary to wear down the acquirer to agree to the deal and terms essential to maximize your interests. This is the only type of deal you want.
Summary. Although the 18-month period ending June 30, 2007 was the most lucrative time to sell a middle-market company in more than 50 years, the latter part of 2011 and 2012 should present a great opportunity to sell a middle-market company at a premium price. This is true for all of the economic, tax, financial and market reasons defined in this article.
If you are to realize the premium price you deserve, your investment banker must have the commitment to protect and maximize your interests and the determination, toughness and strength of will to force an acquirer to price your company on its expected future EBITDA and the quality of its business foundation. If, and only if, they have these traits and abilities will you be able to obtain the premium price that should be available to middle-market sellers during the latter part of 2011 and 2012.
The author is president of George Spilka and Associates, a national investment banking firm based in Allison Park, Pa. that specializes in middle-market, closely-held corporations. You can contact him by telephone at (412) 486-8189; by e-mail at [email protected]; or at his website: www.georgespilka.com.