I could just stop now and simply say that it is not the ideal time to sell a business. That would be an accurate enough statement, but this would not provide the reasons why it is notan ideal time. So let’s set the scene better: I have a bit of a problem with insomnia, and economic history is my passion. Combine those, and I’ve come to the conclusion through many late-night hours that we currently face a set of political and economic hurdles that are unprecedented in our country’s history.
Much of what makes a good market for selling a business depends very simply on the strength of the economy. Business valuations are tied to multiples of the recent cash flow of the business. Just as important is the expectation of growth of that economy.The greater the expectation of growth is, the higher the multiples being paid. It’s pretty simple when you think about it.
As a buyer of a business, are you going to pay as much now for a business that is not as profitable as it was just three years ago? Of course not. Sure, the business is the same one that it was three years ago. It is just not as profitable because the economy is in a recession because sales are down.
However, if you believed that the country was coming out of the recession, you might even see yourself paying a higher multiple of earnings than the current profitability could command in the marketplace. Unfortunately, not many of us think we are coming out of the recession. Just about everybody that runs a small or medium-sized business thinks we are going to see a flat economy for years to come.
Yes, the stock market is up. But it has been responding to higher reported earnings of public companies. Earnings are growing at high percentages the last couple of quarters, and the market is following suit. But if you were to look behind the profitability of these corporations, generally you will see that the profitability increases are tied almost exclusively to cost cutting and increases in efficiency. Costs have been cut to the bone. People have been laid off.
This just might have something to do with the almost 10 percent unemployment rate. And what happens when the growth that the market seems to think is coming doesn’t materialize?
Credit availability is also an important driver of strong merger and acquisition multiples. Despite a monetary policy that has been printing money as fast as the presses will run, credit remains extremely tight. Yes, interest rates are at or near all-time lows, but the multiple of earnings on which a bank will lend money to a buyer of a business is half of what it was three years ago.
Why is that? Well, many people think it is due to banker greed. After all, the banks can borrow all they want at 0 percent and invest it in Treasury bonds at 2 percent. But, in my opinion, it’s not greed that’s creating today’s economic climate. It’s uncertainty.
If you were a banker, would you lend money to a buyer of a company that is counting on economic recovery to pay back his loan? I wouldn’t. You would pretty much loan just enough money so that you could get repaid if the economy just continued to lumber along as itis now.
Equity availability is also an important determinant of the strength of the mergers and acquisitions market. The country is awash in equity. Unfortunately, most of that money is in money market accounts or short-term debt. Why? Because the equity holders don’t believe our economy is out of the woods yet.
Private equity, which in the past has competed with strategic buyers to drive up purchase multiples, is still largely on the sidelines. The equity managers and owners are busy nursing their acquisitions made in 2006 through 2008 back to health and trying to figure out how to get sufficient returns on their equity dollars investing in companies with flat projections for the foreseeable future and low levels of credit availability.
Why all the uncertainty? Have you listened to the president lately? Let’s face it; the president — any president — has little to do with the economy. He does get blamed, however.
What he can do though is give the people who hire people a little confidence that the future will be better. In my opinion, President Obama doesn’t do that. I think he really does believe that distributing enough stimulus money to make sure public employees don’t get laid off will return the country to prosperity. I really believe that he exists in a parallel universe where ideology always trumps economic principles.
From my perspective, though, President Obama has not grasped the fact that the only thing that matters to the businessman is net after-tax cash flow. It is the only thing that will drive new hires and increased business investment. Net after-tax cash flow is just another name for profit.
Now, we face one of the largest tax increases in American history as Congress is set to let the Bush tax cuts expire. I believe that this will have a devastating effect on the economy. Also, I was particularly struck by President Obama’s remarks with regard to the capital gains rate increase. He has stated that he is fully aware that the tax increase will have the effect of lowering overall government tax receipts.To me, that means that if you are a member of the top tax bracket group, you must pay more, despite any damage to the economy.
So after thinking a bit more about it I have to tell you, ‘No. It is not the ideal time to sell your company.’ But maybe you should consider selling while you still can. If the state of affairs in Washington continues after the November election, you may not be able to sell for years to come.
It may well take until 2012 before our economic ship can be righted and the economy is permitted to regain its strength. Free-market capitalism will always restore economic growth— assuming we still have it in 2012.
Michael E. Gibbons is founder of Brown Gibbons Lang & Co., and serves as senior managing director and a principal. Reach him at [email protected]or through the firm’s Web site,www.bglco.com.
