During 2006 and the first half of 2007, the greatest market bubble in middle-market deal pricing in 50 years occurred; those pricing levels will probably not be seen again in our lifetime. During the second half of 2007 and the first half of 2008, deal pricing reverted to normal levels. However, as the business downturn started in the third quarter of 2008 and led to the Great Recession (my terminology for the period from the fourth quarter of 2008 to the start of the third quarter of 2009), deal pricing collapsed.
In fact, 2009 was the first year the world economy contracted since the 1930s. While economic and market conditions were awful, they fortunately never deteriorated to the levels realized during the Great Depression. However, middle-market deals (transactions with values between $5 million and $250 million) were few; those deals that were completed were usually at deeply discounted prices. This pricing level continued until the start of the third quarter of 2010. At that time, deal activity and pricing started to improve.
Current Deal Pricing
In early 2011, deal pricing began making strides to return to normal levels, and middle-market 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 Great Recession. Many sellers are susceptible to accepting these discount prices, since the scars created by the Great Recession make them concerned they won’t be able to sell their companies. However, by the latter part of 2011, middle-market deal pricing is expected to increase to above normal levels.
During 2011, as many acquirers use the depressed earnings realized by sellers during the two-year period ending June 30, 2010, as justification for a substandard offer, it is imperative for middle-market executives to understand that their company is a long-term asset whose sale price 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 currently 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 EBITDA/earnings (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. Any other factors they cite are merely used for negotiating leverage to justify an unwarranted discount price. Consequently, you should not entertain any discussions regarding your company’s 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 that they be treated accordingly.
Short-Term Deal Pricing
Due to a number of factors, the optimum time to sell a company should be the latter part of 2011 or 2012. 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. In addition, 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%, compared to the prior rate of 20%. It is unlikely that the 15% rate will be extended beyond 2012. This 5% tax savings on the realized gain is a significant consideration when determining the timing of a sale.
Cheap money, which is a byproduct of the excessive credit provided by the Federal Reserve, 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, the availability of credit should return to normal levels.
In addition, acquirers began to aggressively pursue deals around the end of 2010. These factors mandate that an owner interested in selling his company within the next seven years should seriously consider selling it during the latter part of 2011 or 2012.
2014 and Beyond
Beginning in 2014, the intermediate and long-term economic outlook gets pretty murky. It is not inconceivable that the economy could stay strong during 2014 and 2015. However, a number of factors provide warning signals that trouble could be on the horizon that might potentially affect these and/or possibly later years. These factors could negatively impact middle-market deal pricing and activity, possibly significantly. For example, the condition of the credit markets, especially in Europe, could be an intermediate to long-term financial problem.
In addition, 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 in an attempt to reduce an increasing inflation rate. These factors could potentially have a negative impact on the Chinese economy. Since the Chinese economy is one of the most dynamic and important economies in the world, any negative impact 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. Many global “hot spots” 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 that 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 risks 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 the end of 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, it is imperative they find an investment banker/acquisition consultant (IB) that has certain capabilities and characteristics. Sellers should look for a number of traits in their investment banker.
The IB should realize-and actually relish-the fact that a sale is not a win-win situation. In reality, it is actually 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-who normally gets their way in middle-market acquisitions-expects a discounted price. These diametrically opposite interests are almost guaranteed to result in a psychological battle where the better prepared, more determined party will prevail.
The IB should have compassion and concern for their clients and realize that most acquirers will try to steal a seller’s company. The right IB 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.
In addition, IBs should have the aggressiveness, determination, toughness, and 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 can be assured that a premium price will not be yours.
The IB should have executive and business skills that transcend financial skills 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. If they are to prevail, the investment banker has to understand your company better than the acquirer and understand your industry at least as well. This knowledge base will intimidate an acquirer and convince them that they must buy your company at a realistic premium price.
Finally, IBs should have 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 and get them to agree to the deal and terms that are essential to the maximization of your interests.
The 18-month period ending June 30, 2007, was the most lucrative time to sell a middle-market company in the past 50 years. However, due to a number of economic, tax, financial and market reasons, the latter part of 2011 and 2012 should present a great opportunity to sell a middle-market company at a premium price. If you are to realize the premium price you deserve, your IB must have the commitment to protect and maximize your interests, as well as 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.For more information, contact George Spilka and Associates at 4284 Route 8, Suite 301, Allison Park, PA 15101; phone (412) 486-8189; fax (412) 486-3697; e-mail firstname.lastname@example.org; or visit www.georgespilka.com.