So how should I describethe current environment for selling a business?
I could just stop now andsimply say that it is not the ideal time to sell a business. That would be anaccurate 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 withinsomnia, and economic history is my passion. Combine those, and I’ve come tothe conclusion through many late-night hours that we currently face a set ofpolitical and economic hurdles that are unprecedented in our country’s history.
Much of what makes a goodmarket for selling a business depends very simply on the strength of theeconomy. Business valuations are tied to multiples of the recent cash flow ofthe 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 itwas just three years ago? Of course not. Sure, the business is the same onethat it was three years ago. It is just not as profitable because the economyis in a recession because sales are down.
However, if you believedthat the country was coming out of the recession, you might even see yourselfpaying a higher multiple of earnings than the current profitability couldcommand in the marketplace. Unfortunately, not many of us think we are comingout of the recession. Just about everybody that runs a small or medium-sizedbusiness thinks we are going to see a flat economy for years to come.
Yes, the stock market isup. But it has been responding to higher reported earnings of public companies.Earnings are growing at high percentages the last couple of quarters, and themarket is following suit. But if you were to look behind the profitability ofthese corporations, generally you will see that the profitability increases aretied almost exclusively to cost cutting and increases in efficiency. Costs have been cut to the bone. Peoplehave been laid off.
This just might havesomething to do with the almost 10 percent unemployment rate. And what happenswhen the growth that the market seems to think is coming doesn’t materialize?
Credit availability isalso an important driver of strong merger and acquisition multiples. Despite amonetary 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-timelows, but the multiple of earnings on which a bank will lend money to a buyerof a business is half of what it was three years ago.
Why is that? Well, manypeople think it is due to banker greed. After all, the banks can borrow allthey want at 0 percent and invest it in Treasury bonds at 2 percent. But, in myopinion, it’s not greed that’s creating today’s economic climate. It’suncertainty.
If you were a banker, wouldyou lend money to a buyer of a company that is counting on economic recovery topay back his loan? I wouldn’t. You would pretty much loan just enough money sothat you could get repaid if the economy just continued to lumber along as itis now.
Equity availability isalso an important determinant of the strength of the mergers and acquisitionsmarket. The country is awash in equity. Unfortunately, most of that money is inmoney market accounts or short-term debt. Why? Because the equity holders don’tbelieve our economy is out of the woods yet.
Private equity, which inthe past has competed with strategic buyers to drive up purchase multiples, isstill largely on the sidelines. The equity managers and owners are busy nursingtheir acquisitions made in 2006 through 2008 back to health and trying tofigure out how to get sufficient returns on their equity dollars investing incompanies with flat projections for the foreseeable future and low levels ofcredit availability.
Why all the uncertainty?Have you listened to the president lately? Let’s face it; the president — anypresident — has little to do with the economy. He does get blamed,however.
What he can do though isgive 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 believethat distributing enough stimulus money to make sure public employees don’t getlaid off will return the country to prosperity. I really believe that he existsin 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 tothe businessman is net after-tax cash flow. It is the only thing that willdrive new hires and increased business investment. Net after-tax cash flow isjust another name for profit.
Now, we face one of thelargest tax increases in American history as Congress is set to let the Bushtax cuts expire. I believe that this will have a devastating effect on theeconomy. Also, I was particularly struck by President Obama’s remarks withregard to the capital gains rate increase. He has stated that he is fully awarethat 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, youmust pay more, despite any damage to the economy.
So after thinking a bitmore about it I have to tell you, ‘No. It is not the ideal time to sell yourcompany.’ But maybe you should consider selling while you still can. If thestate of affairs in Washington continues after the November election, you maynot be able to sell for years to come.
It may well take until2012 before our economic ship can be righted and the economy is permitted toregain its strength. Free-market capitalism will always restore economic growth— assuming we still have it in 2012.
Michael E. Gibbons isfounder of Brown Gibbons Lang & Co., and serves as senior managing directorand a principal. Reach him at [email protected]or through the firm’s Web site, www.bglco.com.
