The Best Time To Sell A Distribution Company Is Near
To start, a brief description of the history of recent deal pricing is necessary to put things in perspective: During 2006 and the first half of 2007, the greatest market bubble in middle market deal pricing in more than 50 years occurred. As this author mentioned in an article written during that period, any middle market executive that had plans to sell his or her company within the next 20 years should have sold then.
However, those pricing levels will probably not be seen again in this lifetime. During the second half of 2007 and first half of 2008, deal pricing reverted to normal levels. As the business downturn started in the third quarter of 2008, which led to the Great Recession, (terminology for the period encompassing 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.
Although economic and market conditions were awful, they never deteriorated to the levels realized during the Great Depression. However, middle market deals, (defined as transactions with values between $5 million and $250 million) were few. Those 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
As 2011 begins, deal pricing is making strides to return to normal levels and middle market deal activity, which is not necessarily comparable to large 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, as 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 a seller 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. Any serious acquirer does not anticipate earnings returning to 2009 and 2010 levels in the foreseeable future, or they would not be interested in buying companies.
Middle market executives must remember that the 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, which they cite, are merely used for negotiating leverage to justify an unwarranted discount price.
Consequently, business owners should not entertain any discussions regarding earnings during the two-year period ending June 30, 10 as a factor in establishing a transaction price. They simply are not a consideration, and sellers should demand they be treated accordingly.
Expected Deal Pricing in Late-2011 and 2012
The optimum time to sell a company should be the latter part of 2011 or 2012. This is due to a number of factors:
1. 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. Furthermore, 2013 should be a very good earnings year, supported by a healthy economy. These earnings levels make it possible to realize a premium price.
2. During 2011 and 2012, the capital gains tax will remain at a reduced level of 15 percent compared to the prior rate of 20 percent. It is unlikely the 15 percent rate will be extended beyond Dec. 31, 2012. This 5 percent tax savings on the realized gain is a significant consideration when determining the timing of a sale.
3. The cheap money, which is a by-product 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.
4. As 2011 begins, the majority of banks are loosening the credit spigots. By the latter part of 2011, the availability of credit is anticipated to be at normal levels.
5. Around the end of 2010, acquirers began to aggressively pursue deals.
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.
Possible Deal Pricing Factors in 2014 and Later
Beginning in 2014, the intermediate and long-term economic outlook gets pretty murky. It is not inconceivable the economy could stay strong during 2014 and 2015; however, a number of factors give off warning signals that trouble could be on the horizon, which could affect these and/or possibly later years. These factors could negatively impact middle market deal pricing and activity, possibly significantly. Some of these concerns, which could have a major negative impact on the world economy, are:
1. The condition of the credit markets, especially in Europe, could be an intermediate to long-term financial problem.
2. 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. Potentially, these could have a negative impact on the Chinese economy. And as the Chinese economy is one of the most dynamic and important economies in the world, a negative impact on it will likely have global consequences.
3. 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.
4. There are many global "hot spots" that could erupt at any time. The impact of any of these events could produce fear and tremendous instability in the financial markets.
This is not to say that intermediate and long-term economic and market conditions will definitely be bad. However, it is advised that sellers consummate the sale of their companies in the latter half of 2011 or 2012 due to the substantial risk 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.
How to Obtain A Premium Price
For a middle market seller to obtain a premium-priced deal with terms that fully insulates them from post-closing liability, it is imperative they find an investment banker/acquisition consultant (IB) that has certain capabilities and character-istics. A seller should be looking for the following things in their investment banker:
1. An investment banker that realizes, and actually relishes, 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 that have conflicting goals. The seller wants the maximum attainable premium price, while the much larger, sophisticated acquirer expects a discounted price, as they normally get their own way in middle market acquisitions. There is no way these diametrically opposite interests can't result in a psychological battle where the better prepared, more determined party will prevail.
2. An investment banker with compassion and concern for his or her clients that understands most acquirers will try to steal a seller's company. The right IB will be steadfast and resolute, concerned only with protecting and maximizing realistic interests. If an acquirer won't optimize these interests, the right IB will not consummate a deal under lesser terms.
3. An IB that has the aggressiveness, determination, toughness and force of personality combined with the market and financial knowledge to force his or her will on large corporate acquirers or sophisticated private equity firms. If those traits are not present in the investment banker, it can be assured that a premium price will not be had.
4. An investment banker that has the executive and business skills, transcending the financial skills that any IB should have, to fully-understand a seller's company, its strengths, market niche and potential. An IB also must have the ability to present and articulate these facts clearly and persuasively to an acquirer. The investment banker has to understand the seller's company better than the acquirer and understand the jan/san industry at least as well, if they are to prevail. This knowledge when combined with the personality traits and attitude previously described will intimidate an acquirer and convince him or her that they can't "steal" the company; rather he or she can only buy it at a realistic premium price. There is no other way to win the psychological war of negotiations.
5. An IB that has the patience and confidence to wait, if necessary, to obtain a premium-priced, all-cash deal. In certain situations, an IB must be willing to allow the power of his or her knowledge and personality traits to have the time necessary to wear down the acquirer to agree to the deal and terms that are essential to the maximization of your interests. This is the only type of deal sellers want.
Although the 18-month period ending June 30, 2007 was the most lucrative time to sell a middle market company in more than 50 years, the latter part of 2011 and 2012 should present a great opportunity to sell a middle market company at a premium price. This is true for the myriad economic, tax, financial and market reasons defined in this article.
If jan/san distributors are to realize premium prices, their investment bankers must have the commitment to protect and maximize sellers' interests and the determination, toughness and strength of will to force acquirers to price their companies on their expected future EBITDA and the quality of its business foundations. If, and only if, they have these traits and abilities will distributors be able to obtain the premium prices that should be available to middle market sellers during the latter part of 2011 and 2012.
George Spilka is president of George Spilka and Associates, a national investment banking firm based in Pittsburgh that specializes in middle market, closely-held corporations. They have a broad-based service that advises clients through the entire acquisition process, and also in preparing a company for sale. Their client base has included a diverse group of distribution, manufacturing, construction and service companies. They have been advising middle market companies in the sale of their firms since 1978. For more information, visit www.georgespilka.com. Spilka can be reached at 412-486-8189 or at firstname.lastname@example.org.
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