The market for Mergers and Acquisitions for quality private companies below $500 million in enterprise value is very strong and should continue through 2012. Supply (availability of capital) and demand (quality companies ready to sell part or all of their equity) is out of balance today with much more supply than demand. For many industries, valuations are back to pre-recession levels for strong companies with a solid management team and good growth story. However, the window of opportunity to invest for the $330 BN of private equity funds closed on in 2007 begins to shut in 2013. Click here to read more…
Owners frequently say they are receptive to taking some chips off the table but indicate their reluctance because of this question:
“Where can I invest my sale proceeds that can give me a higher return than investing in my business?”
This is a very fair question BUT it is not the right question.
What Motivates YOU to SELL?
For a “founder”, the underlying issue may be giving up “control” which is an emotional issue not a financial one. An attorney friend recently shared with me a story about a client in the Building Supply industry who was pursued by multiple buyers to sell in 2006. He was offered $350 million for his company but elected not to sell because he was confident others would offer more. Today he is still around but just struggling to survive digging into his pockets to honor his personal guarantees securing his company debt.
Many would immediately respond that the reason the owner “walked” was “Greed”. I disagree. A recent study (Noam Wasserman and Timothy Butler – The Motivation Matrix) of 2,000 business founders were given 13 motivational traits to rank in order from the most to least important. The TOP two motivations driving founders are AUTONOMY (cannot work for others – control) and POWER & INFLUENCE (likes to be the Boss). Unfortunately, these founders rarely build large companies because they refuse to hire top-level employees where the owner must relinquish his power and control over their pet areas. By contrast, according to Wasserman, those entrepreneurs that place FINANCIAL GAIN near the top of the list ended up with an equity stake 52% more valuable on average than those who ranked AUTONOMY/POWER & INFLUENCE first (“Rich vs King Dilemma”).
INVESTING in your Business
This may be the BEST option but you must analyze it objectively. What is the real return of investing in your business versus the risk associated with it? To evaluate this let’s look at five market influencers –
- Interest Rates
Interest Rates: The Federal Reserve Chairman did NOT announce last week the third round of “Quantitative Easing” (another term for printing money) to keep interest rates low to create a positive environment to support the economic recovery but he did not rule out the possibility in the future if the EURO Zone deteriorates further. It previously announced that it intends to end this policy by 2014 allowing rates to be determined by market forces versus government intervention. WHAT happens then? (Hint: It is hard for rates to go below zero)
If rates do rise, how will it affect your value?
- Borrowing costs for your company, customers and potential acquirers will go up. This reduces your cash flow and makes it more difficult for buyers to pay as much and meet their return expectations (this frequently results in a lower valuation).
- It has a negative impact on GDP since more resources will go to service debt versus being invested in growth. It also will increase the need of Government to collect more revenues (pressure to raise taxes) and it can put a damper on economic growth. This tends to make business owners hesitant to hire additional employees and expand in uncertain economic times. (i.e. current woes in the EURO Zone)
Inflation: Currently it is not a factor, global economies are struggling on how to prevent a double dip recession (many believe Europe is already in a recession) and reverse the effects of “deflation”. However, the sovereign debt crises of the US will have to be addressed. It is estimated to reach approximately $16 Trillion in 2012. This debt burden coupled with the coming huge expenditures to support the aging US population will definitely put upward pressure on inflation in 2014 and beyond (SEE Chart below).
Globalization: You use to compete with the firm across town. Today you compete with firms from Asia, India, South Africa, and all over the globe. You cannot ignore international opportunities and threats in the future and be prepared to act. Is the health of the U.S.’s key trading partners important to you? YES! Collectively the EURO Zone is our largest partner and if they are in a severe recession they cannot (or will not) buy as many products and services from U.S. companies.
Technology: It has changed every industry and the way we live our lives. It is facilitating change at a speed never seen before. Ten years ago did you foresee corporate names like Eastman Kodak, Blockbuster, and Borders Books disappearing? We had not heard of household names like: “Nook” or “Kindle”, iPad, and “Cloud Computing”. If you are not familiar with “Moore’s Law” then follow the link. As a business owner you must keep pace with technology advances because your competitors will.
Demographics: The chart below says it all. The U.S. like most of the industrialized countries in the world have a Sub-Replacement Fertility Rate (less than 2.1 births for every female in the population) and this has been occurring every year but 2 years since 1976. On January 1, 2011, Baby Boomers began turning 65 at the rate of 12,000+ per day and will continue to so through 2030. This will double the percent of the population reaching retirement age and receiving entitlement benefits such Medicare, Social Security, etc. while the percentage of those between 25 and 65 of age (wage earning years) are declining by approximately the same percentage. There is no reserve fund set aside to pay for this so the government will have to borrow to meet these obligations.
Effect on Your Company: What will higher interest rates, inflation, globalization and technology have on the value of your business and Middle Market M&A activity? For starters the first two will increase the cost of borrowing for your company and acquirers desiring to buy your company. How will the more stringent lending practices and higher rates affect consumers and their ability and willingness to borrow to buy your products or services? If these cause a slowdown in your company’s growth and the confidence of buyers about where your business will be in the future, it can translate into a lower value.
If you are convinced that your business is recession resilient AND you still have the fire in your gut – then use this opportunity to expand by creating additional products/services, distribution channels and/or acquisition of competitors or other synergistic targets to strengthen your position for when the economy recovers.
The facts are:
- Only approximately one-third of family owned businesses will successfully pass to the second generation, 12% to the third and 3% to the fourth according to the Small Business Administration statistics.
- Some experts’ estimate as high as 70% of those failing to transfer will liquidate because of insolvency or the owner ceases operations and sells the assets!
- The remaining businesses are sold to third parties.
Regardless of what you decide to do, explore other options that can protect your family and employees to provide for an orderly succession but will not necessarily maximize your purchase price because it is a non-competitive process. None of us mortals can beat father time but we can plan for an orderly transition of the business.
Non-market (non-competitive process) types of exits are:
- ESOP (Employee Stock Ownership Plan)
- Transition to Family
- Management Buyout
- Liquidation (most likely)
Is FINANCIAL GAIN a key Motivation for YOU?
For those owners where wealth creation is a high priority and you would like to:
- De-risk your personal financial picture (i.e. remove yourself from personal guarantees of company debt)
- Not have to invest in new facilities and technology to keep up with global competitors
- Hedge your bets or retire by capturing some or all of the value you have created
- Maximize your purchase price in this “seller’s market” window
If you answered YES to the above desires and are psychologicaly prepared to separate from your company, you should take the following steps ASAP:
- HIRE the best professionals possible who are expert in succession planning to assist in creating an EXIT PLAN (this will be more than one person but you should have a team leader coordinating the efforts).
- Develop a plan to prepare for a sale of part or all of your company as soon as practicable (2012 if possible)
Your planning will need to include both YOUR personal objectives and those to prepare and execute a Sale of the business. Your planning will include multiple disciplines;
- Succession Planning
- Accounting & Legal
- Wealth Management and Planning
- Strategic Planning
- M&A Market knowledge
- Transaction Execution Expertise (MUST create competitive tension)
The lead adviser (coordinator) should have a complete picture and be experienced in the planning and process. The M&A MARKETPLACE by CHC can assist with referrals if desired.
WHAT Should I to DO WITH MY SALE Proceeds?
We finally get to the Title subject! Hopefully you have followed the above advice and have selected an expert in wealth management to help in creating your plan. Most good money managers will tell you, their job is not to match the growth in value (or take the RISK) you did in building your company, their objective is to preserve what you worked so hard to build. Your decision is:
“Do you want the responsibility of managing your sale proceeds OR do you HIRE a professional to do it for you?”
Robert Balentine, CEO of Balentine, LLC a respected wealth management firm, recently gave an excellent presentation to a group of Vistage CEO’s outlining in a simple chart the reasons business owners, who are use to controlling their world, have a hard time turning what they worked a career building over to a third party.
There is huge “Uncertainty” about the global economy, especially the EURO zone (the U.S.’s largest trading partner) and the possibility of its woes putting the U.S. back into recession. The options for investing are limitless and confusing with huge pitfalls for the inexperienced. No longer can you Buy and Hold (“on”) in the age of 24/7 trading hours and computer trades where trading algorithms can cause a 700 point drop in the DOW in minutes when certain triggers are hit.
Potential OPTIONS for INVESTING the PROCEEDS
Remember, the goal of a professional wealth manager is NOT to make you a fortune, it is to preserve the one YOU made! Warren Buffet did not become the most successful investor on the globe by taking wild risks – he did it by avoiding them!
Note: Buffet’s gains in positive periods were slightly below the S&P 500 (93.9%) BUT outperformed them in down periods by limiting his loss to only 37.8% of the S&P 500. The result were annualized returns of 15.9%, 2.24 X the 7.1% return for the index!
Below are the raw returns compiled by the U.S. Treasury Department since 1928 through 2011 for Stocks, T-Bills (3 month maturity) and T-Bonds (10 year maturity) the average annual compound return for each category was 9.35%, 3.66% and 5.20% respectively. Below is a summary of the returns for the periods following the two worst depression/recessions in U.S. history.
U.S. Stock, T-Bill & T-Bond Market Performance
|5 Years||10 Years||20 Years||Average Compound Annual Return (1929-2011)|
|Post Great Depression (1932)|
|Post Arab Oil Embargo (1974)|
Stocks outperformed their historic average return after both of these down periods. It is interesting to note that after a prolonged period of “deflation” (Great Depression) stocks performed roughly the same as the “inflationary” period following the Arab Oil Embargo (except for 10 year period post 1932).
Alternative Investment Options:
The Investment Management field is one of the fastest growing business areas and investing today is more complicated than ever. In an attempt to show how professionals in this arena can make a difference, the author has selected a portfolio strategy that he found during his research that was created in the early 1980’s to provide the investor long term market returns without the volatility. Please see the disclaimer at the end of the blog about the opinions and statistics of others. The following approach was useful to see how one manager has attempted to create the perfect “Permanent Portfolio”. Though allocation among four asset classes this strategy attempts to provide protection as the economy shifts between cycles of prosperity, inflation, deflation and recession. The four classes are:
- 1. 25% Stocks – Total Stock Market Index Fund (TSM)
- 2. 25% Cash – Treasury Short Term Bonds (1 – 2 years)
- 3. 25% Treasury Long Term Bonds (20+ years)
- 4. 25% Gold Bullion
Going back 40 years (1972) using this methodology the creators (Harry Browne, deceased, Terry Coxon and John Chandler) claim an average return over that period of 9.7%. This is roughly the same performance of “stocks” compiled by the US Treasury over the same period BUT what stands out is the “Permanent Portfolio” only shows losses in two years and greatly reduced year to year fluctuations. Two of the creator’s of the above “Permanent Portfolio” strategy started a mutual fund called The Permanent Portfolio Fund (Ticker: PRPFX) in 1981 that demonstrate the fund’s success at limiting the magnitude of losses in down markets. (Example: in 2008 the fund claims a positive 1.9% return when stocks lost approximately 40% of their value)
Please forgive this long-winded explanation to try and address what may not be your real concern – giving up control, of your company and investment decisions. If wealth creation is a key motivator then hopefully some of this is helpful.
Author: Huxley Nixon has been involved in M&A (mergers and acquisitions) for 35 years as a buyer, seller and intermediary. He is founder of the M&A MARKETPLACE by CHC (www.mamarketplace.com) where the buyer pays all success fees and the process is only 120 days. For owners of private companies considering a sale of part or all of their company – it provides a very quick, confidential and competitive alternative to current options less transparent and more disruptive for the owner.
DISCLAIMER: Opinions and conclusions in this post are solely those of the author unless otherwise indicated. This article is for general information purposes and is not intended to be and should not be taken as advice on any particular matter nor is it intended to be a solicitation regarding any securities transaction and or investment relationship. For those desiring additional information please visit our website www.mamarketplace.com.