If Selling is in Your Future, Move Quickly
July 16, 2012
There are many reasons why middle market owners who wish to sell their companies during the next 10 years should consummate a sale no later than 2014—and preferably sooner. Although most points discussed in this article pertain with equal relevance to all companies regardless of size, the article is primarily directed at middle market companies, which are firms with transaction values between $5 million and $250 million.
I am more optimistic about the prospects for the short and intermediate term (the next 2-3 years) acquisition market than I was last year, when I wrote about what was then the current state of acquisitions. 2012 should be the best time to sell a company because market conditions will likely be strong; they will probably continue to be through 2013 and quite possibly 2014. After that, the market becomes problematical.
However, I am much more negative about the long term than last year. I expect a severe downturn to occur some time before the end of the decade that will have a devastating impact on the U.S., and probably the global acquisition and financial markets. Its impact is likely to be far worse than the so-called “Great Recession” and will be triggered by either a major event or a confluence of events. The impact will probably exceed any business collapse since the Great Depression. The economic conditions it creates are likely to remain for an extended period of time, much longer than those from the Great Recession. These conditions will have a significant damaging impact on the market value of U.S. companies. When it happens, it will start suddenly and unexpectedly, just like in 2008.
The major reason why these significant negative events always occur so unexpectedly is because it is in none of the major financial firms’ self-interest to forecast catastrophic economic or financial market conditions that are on the horizon; it would impact their business severely. And, as we know, the major financial firms think first and foremost of their own self-interest.
Why You Should Sell Promptly
The following are reasons why you should consummate a sale by not later than 2014, and preferably by the end of 2012 or 2013:
- Acquisition pricing is very strong now. I would anticipate it will remain strong through the end of 2013.
- If President Obama is re-elected, it will be necessary for his administration to start significantly reducing the deficit. Hence, more than spending cuts will be necessary, as there are not enough spending cuts to make without harming the very structure and fabric of the U.S., which will necessitate an increase in taxes. These revenue raising measures will primarily be focused on increasing taxes on the wealthy, possibly significantly. One of the taxes almost certain to be increased is the capital gains tax. I expect it to be increased to at least 20%, possibly 25%. If it is increased to 25%, your net after-tax sale proceeds have just been reduced by 10%. This is a sizeable hit.
- Numerous private equity (PE) acquirers have a pressing need to invest capital promptly. Many of these funds received money from their investors in 2008 before the market crashed. That money then sat idle for 2½ years. The PE firms are now under tremendous pressure from their investors to get that money invested. This is driving these firms to invest that money quickly. They are willing to overpay if they have to in order to purchase good companies, rather than risk losing the deal. This has produced some attractive selling opportunities.
- U.S. corporations are flush with cash and have extremely strong balance sheets. This makes strategic acquirers very aggressive in the acquisition market and willing to pay strong multiples.
- The stock market’s performance was extremely good during the first two months of 2012. This has been a contributing factor to an increasing level of optimism and buoyancy in the business community.
- Interest rates are low and should remain low through the foreseeable future. I don’t anticipate the Federal Reserve deviating from its stated policy of keeping interest rates low until 2014. Most Fed governors don’t think it is worth the risk to implement a restrictive monetary policy, as they believe that the premature implementation of a restrictive monetary policy was a major factor causing the depth and length of the Great Depression.
Why a Catastrophic Event is Likely to Occur in the Long-Term
The following are reasons why the U.S. will likely face a catastrophic economic and financial scenario by the end of the decade. This scenario will probably be much longer and worse than any we have endured in our lifetime.
- Europe’s economic and financial problems continue. The European Union (EU) is basically dysfunctional due to its structure—too many countries have to make decisions that then must be sold to their own disparate domestic constituencies. This negates the dramatic action necessary to begin extracting many of these countries, such as Greece, Spain and Portugal, from their disastrous situations. Furthermore, it appears the EU is trying to defer the problem, hoping it will go away or that a painless solution will be discovered. However, that is not going to happen. The European banks also have been weakened, which will impact the global economy since these banks have financial relationships with the world’s major financial institutions.
- The combination of problems the U.S. faces—including its huge budget deficit, the economic stimulus still required to return the economy to a self-sustaining mode, the disparity of income between the “haves” and “have-nots,” and the gridlock between the warring political parties—creates a situation that becomes an almost intractable problem. The U.S. must find a way to bring its deficit under control over the next three years without doing anything precipitous that would push the economy back into a recession. This will be very difficult with our dysfunctional and currently gridlocked political system. If these problems are not solved promptly, the country’s economy and financial markets will be in very precarious shape.
- The emerging markets have driven the world’s economy for more than a decade. However, current problems and others on the horizon will diminish the positive impact of the emerging markets on the global economy. Growth in China has slowed. In addition, the four major banks are all state-owned and have been propping up many failing state-owned companies. In turn, these banks have been supported by the national government. Consequently, the Chinese financial system is not as healthy as it appears to be. The slowdown in China’s growth will have a substantial negative effect on all countries, but especially the resource exporting ones. Brazil will be one of the most affected, as China is its major trading partner. This, coupled with Brazil’s uncompetitive and dying industrial sector, could cause a major slowdown in Brazil. India is now facing its highest unemployment rate since 1983, its lowest growth rate in two years, and an ineffective and corrupt government incapable of solving the country’s fundamental problems. Overall, the emerging markets are not going to be the world’s growth engine they used to be. This could have a major impact on the developed world’s economies.
- There are numerous geopolitical hot spots, particularly in the Middle East, including Iran with its threat of nuclear weapons. This is exacerbated by the potential of an armed conflict between Israel and Iran. There is also a nuclear threat from North Korea, which now has a possibly unstable 27-year-old ruler leading its charge for nuclear weapons.
As you look at the many significant negative possibilities facing the world, it is very unlikely that enough of these problems can be avoided to avert not having a dramatic negative impact on the acquisition and financial markets.
Expert Advice is Crucial for Planning and Timing the Sale
Companies looking to sell should retain an investment banking (IB) firm that can position their company and guide and time its sale. You do not want to do this yourself or use a firm that doesn’t have unique and specialized acquisition market knowledge.
It is essential that you do not miss your chance to realize a premium transaction price during the next 2-3 years. This becomes even more critical when we remember the devastated acquisition market conditions caused by the Great Recession from late-2008 through the third quarter of 2010. You need an IB firm whose fundamental philosophy is to consummate a sale only when their clients have obtained the optimum price, not one that just wants to close a deal quickly at any price. Your advisor should be willing to spend the effort to position and time the sale so it generates the maximum transaction price.
The current period presents a window of opportunity to obtain a premium price. However, if this window is missed, there is a substantial long-term and likely long-lasting risk that the company’s value will be significantly reduced due to events beyond the seller’s control.
It takes an extremely perceptive and sophisticated executive to understand the incredible level of risk lurking over the global economy and correspondingly their company’s value for the remainder of the decade. If these risks come to fruition, it could have a catastrophic effect on the economy and financial markets. The best time to cash out for anyone that expects to sell their company in the next 10 years is by doing so no later than 2014, and preferably by the end of 2012 or 2013.