Resource Management

SPECIAL SECTION/RESOURCE MANAGEMENT: Recession-Proof the Sale of Your Company

October 1, 2008
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As this article is being written (May 2008), the U.S. has either just entered a recession or is on the precipice of one, and the length and depth of the current financial crisis is unknown. In addition, 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 avail themselves of the bubble pricing that had been prevalent for two years. Although that particular window of opportunity has closed, the positive news is that acquisition pricing remains at solid, normalized levels. I have not made any downward price adjustments on the deals that I am handling, nor do I anticipate making any in the future.

For an owner or CEO of a middle-market company (defined as one with a transaction price of $5 million to $250 million) who has an interest in selling their company in the near or intermediate-term, there is no reason to be hesitant about proceeding with the sale now. Acquisition prices do not have to be adjusted downward during a recession. Following are some strategic considerations that owners or CEOs should be aware of in the current economic climate.

1. Regardless of economic conditions, middle-market companies should be priced based on their expected future earnings and the acquirer’s potential risk in achieving those earnings based on the business foundation.<
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 deal pricing of middle-market companies. An acquirer solely determines the value of a company based on its expected future earnings and the risk in achieving those earnings based on 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.

2. Savvy corporate acquirers consider acquisitions an opportunistic way to grow.
When the CEO of a leading international distributor was questioned about whether his company would continue its aggressive acquisition program despite the need to effectively integrate prior acquisitions, his response was that acquisitions are an “opportunistic” way to grow. He said, “You must take advantage of them when they are available, or you may lose the opportunity forever.” His comments are 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.

3. 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. Never deviate 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.

4. Based on experience, recessions and economic downturns do not have to impact middle-market deal pricing.
Although many acquirers do not reduce their acquisitive drive during a recession, the vast majority 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 accede 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.

My experience has been that this does not have to occur. During the downturn of 2001-2002, I did not discount the price of any 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 were for 100% cash. If you have the will to defend your position and negotiate from strength, you can usually force an acquirer to pay a premium price regardless of economic conditions.

5. Even if you are not initially successful in selling your company, you can achieve 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 its long-term business fundamentals, there is no reason for a company not to proceed to the market during a recession. If the sale of your company is handled by an expert and sophisticated advisor, you should be able to successfully sell your company at a premium price during a recession.

However, let’s assume you are not successful in consummating a sale during the recession. You will still see numerous benefits from having gone to the market at that time. Once you start the sale process, the acquirers that are initially contacted will be aware that you are interested in selling your company at a premium price. Even if they reject the acquisition, they are now aware that your company can be acquired. Correspondingly, if their needs change and they later perceive 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 is not unusual for many acquirers to be skeptical of the seller’s resolve. 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. Acquirers then realize that the only way to buy the company is to pay a premium price.

6. 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 acquirer’s risk in achieving those earnings based on the company’s business foundation. The business foundation includes such things as the strength and protection of a company’s 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, its ability to take advantage of future growth opportunities, and so on.

To the extent that these fundamentals are strong, position a company for growth, and limit its downside risk, the multiple an acquirer will pay for any level of earnings tends to be higher than it would be for a company with a weak business foundation. Therefore, if you have retained an advisor capable of evaluating your business fundamentals, they can guide you in establishing a program to strengthen them, if necessary.

You can implement this improvement program before reinstituting the active marketing of your company. Improvements should eventually increase your earnings while reducing the threats to and volatility of future earnings, which, in turn, should fortify your ability to sustain an increased transaction price.

No Need to Wait

Do not accept the prevailing wisdom that a recession means a middle-market owner can’t obtain a premium price when selling their company. It is wrong. In my experience, recessions do not negatively impact middle-market deal pricing when transactions are handled by a sophisticated advisor. 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 they 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 (or the threat of one) should deter you from proceeding.

For more information, contact George Spilka and Associates, Suite 301, 4284 Route 8, Allison Park, PA 15101; (412) 486-8189; fax (412) 486-3697; e-mail spilka@nauticom.net; or visit www.georgespilka.com.

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