With plenty of available capital and record valuations, is this the right time to sell your company?
SAN FRANCISCO, Calif. (PRWEB) July 02, 2018
Today, there is a flood of money searching for investments in middle market businesses—from private equity funds, corporate buyers, wealthy families, banks and other lenders. Private equity investors alone have amassed over $1 trillion that they need to invest in the next few years. Because more money is chasing a limited number of good companies, valuations are high and continue to increase. With plenty of available capital and record valuations, is this the right time to sell your company?
Most owners of closely-held businesses plan to leave eventually. The important question is when. If you are thinking about selling some or all of your company, it is important to answer these three critical questions:
- Is the market ready?
- Is the business ready?
- Is the owner ready?
Let’s look at each of these questions in more depth.
Is the market ready?
In simple terms, the value of your company is based your operating cash flow (EBITDA) and the EBITDA multiple that investors are willing to pay. We are all aware that the US stock market has been very strong in the past eight years. The Dow, S+P 500 and the NASDAQ are all at near record levels. Valuations of private companies track the public markets so private company valuations are also near record highs. Many factors affect the specific valuation your company can obtain—size, profitability, growth rate, risk factors—but you are unlikely to see higher EBITDA multiples than those prevailing today.
Why? There is a huge amount of money in the hands of private equity investors. The global private equity industry raised over $450 billion in 2017, a new record. They are sitting on over $1 trillion that they haven’t invested yet. That’s great for the PE firms, but they must put all that money to work to generate profits for their investors. Strategic buyers are also becoming more aggressive because corporate balance sheets are flush with cash, and cuts in corporate tax rates make them even more willing to invest. Many wealthy family offices and even pension funds are starting to purchase operating companies. And, at today’s low interest rates investors can borrow 70% of the purchase price or more.
But EBITDA multiples are only part of the valuation equation. The profit growth of your business is equally important. In the US economy today, corporate profits are at record levels. Since the depths of the 2007-08 recession the US economy has grown consistently for 100 months, more than nine years. Only the tech boom of the 1990s (120 months) and the 1960s boom (106 months) lasted longer. Many economists are telling us that US growth will be strong in the first half of 2018, slowing in the 2nd half and flattening or declining in 2019.
If your revenue and profits have grown by riding the rising tide of this long, sustained expansion, the tide may be about to peak and ebb. No one can time the market exactly, but earnings growth is likely to slow in the next year or two, interest rates are likely to increase, and valuation multiples are unlikely to rise beyond current levels.
So—the market is probably as ready as it is ever going to be. If you are planning to sell eventually, now is the right time, but only if you and your business are ready.
Is your business ready?
To realize the highest sale price, your business needs good profit margins and strong sustainable profit growth. But, investors will examine your business very carefully—especially at today’s high valuation multiples—to identify every flaw and risk that make future profit growth less likely.
Business owners should ask what they can do today to increase profits, cash flow and growth in the next 12-24 months, during this peak market. Most business owners have a “To Do” list of projects to improve the performance of their business that they intend to launch when they have the time and money to do so. Now is a good time to take out that list and rank each project on four criteria—how much would profit and cash flow improve; how long until the improvements show up in your financial results; how much would the project cost and what are the risks of delay or failure? In this environment, it makes sense to commit to low cost, low risk projects that will produce results quickly. Potential investors will appreciate the profit potential of your longer-term projects but will pay for those that show up on your bottom line today.
Investors buy future profits and cash flows. They are interested in past performance as an indicator of future performance, but will probably build their own financial forecast for your business. They will use this forecast to calculate the value they will offer you in their indication of interest or letter of intent. Then, they will immediately start looking for all the risks that make that forecast unrealistic, ratcheting down the price they are willing to pay.
Think of the due diligence process like the inspection report that you order before you buy a house. All the problems identified in the inspection report become negotiating points—the buyer will ask you to reduce the selling price by the cost to repair them or they will walk away from the deal.
When you sell your company, you should expect the buyer to examine your business in microscopic detail. They will try to identify every risk and flaw that threatens your future profits then use those risks to negotiate a lower purchase price. The list of risk factors is virtually limitless, because a lengthy list gives the buyer more power to negotiate a better deal. Common red flags that show up in the due diligence process are:
- weak profitability, flat or declining revenue or profit growth trends
- lack of a strong management team who can run the company without you
- too much of your revenue depends on a few customers
- no contracts with your key employees, customers and suppliers
- poor documentation of your key IT systems and business processes
- worn out or obsolete capital equipment and inventory
- aging and uncollectable receivables
- threatened or unresolved legal disputes
- unpaid taxes or other legal compliance issues
Before you start the sales process, study your business objectively to identify all the risk factors that potential buyers will use to discount their purchase price. After completing this “sell-side due diligence” review, you can rank and prioritize the “fix” projects just as you ranked your profit improvement projects, above. Important ranking criteria are how long each fix will take, how much will it cost and what are the risks of delay or failure.
If you believe that the market is ready and your business is ready, you should ask yourself, “Am I ready?”
Is the owner ready?
Most owners of valuable middle-market businesses are completely absorbed by fixing current problems and driving growth. They rarely take the time nor have the opportunity to step back and ask the big questions—why am I doing this? What do I want to accomplish? What will be the purpose and meaning of my work life? What is most important to me—the maximum selling price I can realize? The jobs and income of all the employees and customers who helped me build this company? My impact on the lives of my people and our community? The continuity of the business and the legacy of our family name on the front door?
It is important to think carefully about what you want because your personal goals will affect your sales strategy. For example, if you are trying to maximize your sales price, you probably want to sell to a competitor or another strategic buyer from your industry. However, strategic buyers are likely to consolidate operations, reduce headcount and replace your business name with their own. Conversely, if you sell to your management team and other employees, you have the greatest chance of preserving jobs, your business’s role in the community and your family legacy. But, most employees don’t have a lot of money and other assets, so you may have to accept a lower selling price, finance part of the sale and wait for your money.
It is also important to think about how you want to live your life and accomplish your other meaningful objectives after you leave your business. How much money do you really need to support your desired lifestyle? Do you intend to keep working or will you depend on income from your investments? How will you provide for your children and their education? Do you want to contribute to your church, your college or other organizations that fund causes that are important to you?
These aspects of your personal readiness will lead you into deep discussions with your accountant, attorney and financial planner or wealth manager and other advisors. There are many tax-advantaged ways to ensure that the proceeds from your sale will meet your personal and family objectives. It is important that you have these strategies and vehicles in place before you receive a Letter of Intent from a potential buyer. It is never too early to build a team of trusted advisors and start these exit planning conversations.
There may never be a better time to sell your company. The valuations of private companies are at or near their all-time highs. Your earnings and cash flow growth may not continue to grow at the current rate for the next 12-24 months if the economy slows. You should look at your business objectively as a buyer would see it to determine which projects you want to undertake this year. And, you should prepare an exit plan to fund your desired life style and other personal goals after the sale.
David Roberts is the Managing Director of the Colorado office of the Newport Board Group.
David.Roberts@newportboardgroup.com - (303) 697-2030