Heading into 2019 we are at a bit of a crossroads. With 36 consecutive quarters of economic growth in the rear view mirror, most experts believe we are in the last throes of a bull market[1]. The M&A market has reflected the health of the economy- it’s been a seller’s market with valuation multiples largely high across the board. With that in mind, is now the time for family businesses to consider a sale? The bottom line is likely that you should either go to market now, or be prepared to wait 4-6 years. How does one decide?
This is often the decision of a lifetime for most entrepreneurs. In fact, we’ve seen countless owners struggle for years trying to make a “go to market” decision, only to falter at the finish line. To help firm up the decision process three variables need to align for a great M&A transaction: the economy needs to be ready, the company needs to be ready, and the owner needs to be ready.
Assessing Company Readiness
Company readiness is what most folks think of when they think “exit planning.” Just how well is the company positioned for a buyer? We typically think of company readiness in terms of core business fundamentals, as well as the harder to determine intangibles. Strong fundamentals imply steady growth, healthy gross margins, increasing earnings, a well constructed balance sheet, etc. The intangibles are often hard to sort out but critically important- especially when you consider that in the vast majority of transactions intangible value – or goodwill- vastly exceeds the value of tangible assets. Intangibles might include the customer base or book of business, the strength of an assembled workforce, the process and procedure that makes a company hum, or even a consistent base of recurring revenue. Taken together, strong core fundamentals and associated intangibles implies that a company is well positioned for a sale.
Owner Readiness
A company itself may be well positioned to sell, but that certainly doesn’t mean that the ownership group is ready. Studies show that 80%[2] of private company owner’s net worth is often locked up in a privately held company, meaning that the sale of that company is often critical to funding retirement goals. For this reason, it’s critically important that entrepreneurs have worked with their financial planner to model their retirement based on transaction proceeds. Equally important is having a current business valuation performed. The best financial planners with the most intricate models fail every time if the largest assumption in the model – the business value- is incorrect. Armed with a financial plan and a fresh valuation, owners should be in a position to answer “Am I financially in a position to exit now, or do I have some work left to do to grow value?”
One more point on owner readiness: not all decisions are financial ones. Most entrepreneurs have dedicated much of their adult life to their company – often working 50 to 60 hour weeks towards building a successful family business. That company has become part of their identity and walking away isn’t easy. We’ve seen countless deals where owners have serious misgivings about how they are going to spend their time after closing. A flush bank account and endless rounds of golf seem perfect in those rough months where making payroll is hit or miss. But weeks out from closing, the realization that you don’t even really like golf that much starts to take some of the shine off of the dream! Having a personal plan for post-closing life and coming to peace with a new, non-business owner identity may well be the most overlooked (yet one of the most important) aspects of assessing deal readiness.
Timeline and the Economy
Let’s assume that owner has worked their financial plan, they’ve looked in the mirror, and they’ve determined themselves “Ready to exit.” Great. And the company? If they haven’t been working hard towards positioning for a sale there very well could be some fixing to do – a pretty common scenario.
This brings us to the economy and that “now or in 4-6 years” notion. Deal timelines can vary greatly from one to the next, but on average most transactions take 9 to 12 months. What we have seen in past downturns is that when the economy turns, the deal market evaporates. That’s not to say the solid companies cannot go to market in a down economy – but the private capital markets are not kind. Interest rates increase, lending standards tighten, private equity evaporates… all leading to longer deal timelines and often lower valuation multiples. Bottom line: with our current “late cycle” economy the clock is ticking. We certainly don’t know exactly when a downturn is coming – but we do know it’s coming.
The 9 to 12 month deal timeline implies that waiting much longer to start in on the process is tempting fate. The key question to ask is “Do I wanted to take advantage of this seller’s market? Or am I comfortable waiting another 4-5 years to get back to the same type of deal environment?” Adding complexity to this decision is the risk inherent in managing a company through such a downturn.
What’s the almost-ready owner to do? We’d suggesting working with a professional to really dial in how well the company is positioned. If fixes can be conducted on the fly it’s time to hit the market. If there are minor problems it may still be worth it to go to market and take advantage of the current deal environment. On the other hand, a company that still has some “heavy lifting” left to do is likely better off waiting until the next cycle (but digging in to aggressively build value in the interim)!
Takeaways
Bottom line, these decisions are complex in any market. They are even more nuanced as we hit the tail end of an economic expansion. Family business and entrepreneurs should assess their personal and company readiness in the context of our late economic cycle. If both the company and entrepreneur are reasonably well positioned for a transaction, it may be time to make a serious run at getting a deal done.
[1] https://www.bea.gov/data/gdp/gross-domestic-product#gdp (Consolidated here for easier consumption: http://www.multpl.com/us-real-gdp-growth-rate/table/by-quarter)
[2] Several sources for this statistic. The Exit Planning Institute publishes various studies that generally coalesce around this value. See: http://exit-planning-institute.org/state-of-owner-readiness/
