Time Running Out for 2010 Business Sellers

Business owners were supposed to rush for the exits in 2010 to avoid the increase in capital gains tax rates that will happen 4 months (122 days) from now.  There’s been a little bit of a flurry of activity but many business owners have decided to hang on and seek to rebuild their businesses following one of the worst recessions we’ve ever experienced.  This owner reluctance to sell now makes economic and financial sense for a company that suffered a big drop in sales over the last few years as long as there actually will be a substantial recovery in the economy and as long as the business will recover as well.  Let’s hope both of those things happen. 

Unfortunately, for some owners it hasn’t worked out as they had planned and some companies have had to close their doors and liquidate.  Bad things do occasionally happen to good people and good companies.  Exacerbating the problem for many owners of really good companies has been the behavior of the banks.  I’ve heard many stories from owners lately about how the bank walked in and changed loan covenants, cut their credit line, or eliminated it entirely, even if they were in compliance with their loan terms.  Bank debt may be a cheap source of capital, but you get what you pay for, and many owners got a big surprise as bankers pulled away working capital just when the companies needed it. 

Successful owners have been creative, and done whatever was necessary to get through this prolonged period of low sales – deep staff cuts and mortgaging personal assets have been necessary for many to preserve their business to fight another day.  For these owners with greatly reduced earnings who’d like to sell today and say goodbye to their friendly bankers, they’d probably take a big hit in company value that would far exceed the tax savings they’d realize by selling in 2010, so they’re going to wait and sell in a future year. But suppose you’re the owner of Rip Van Winkle Enterprises, LLC and you’ve just awakened today to learn your sales and earnings are up, flat or only down 5-10% compared to prior years, and you’ve also turned on the news and learned that the Bush tax cuts are scheduled to expire in 122 days, so if nothing else happens your capital gains tax on selling your business will be 33% higher if you sell on January 1, 2011 compared to selling on December 31, 2010. 

You have a different decision in front of you.  Maybe you’d like to sell now and save on your taxes associated with the sale.  Can you still get a deal done in 122 days?  The answer is Yes, but just barely.  You have almost no time left to procrastinate, and your choice of buyers is limited.  With a buyer in hand and a letter of intent negotiated, signed, sealed and delivered, due diligence and negotiating definitive documents to close a transaction takes 60-90 days, or longer if there are hiccups (there almost always are).  Thus there is essentially no time for a methodical marketing process such as we routinely execute for our clients. 

Instead we’d need a “go quick” process that has a chance of closing before the end of the year.  Fortunately, there are some buyers who can accommodate such a process.  These are the professional business buyers at private equity groups, family offices, Small Business Investment Companies (SBICs) and some industry consolidators.  With a compelling story about Rip Van Winkle Enterprises we can target a few such buyers with a snapshot of the business and bring a few to the table.  With so little time to get a deal done, we’d need to limit the market to the precious few who have all the capital needed to close a transaction without delay.  We can do this for you if you’ve got the right kind of company, because we specialize in knowing who wants to buy what and why they want to buy it.   What’s the right kind of company?

1.   Any size company that could be an add-on acquisition for a successful portfolio company of a private equity group, family office, SBIC or industry consolidator.  Something with good products or services that would fit well with the buyer’s current investments.
2.   A company with a chance to become a portfolio company – minimum $5 million revenue or $500,000 EBITDA (earnings before interest, taxes, depreciation, amortization), the bigger, the better.  Management team in place, and growth opportunities are important, but it’s not necessary that the company be exceptional or in the latest high tech industry.  Perfectly boring industries are just fine as long as the company knows what it’s doing and where it’s going. We’re going to go fast now, so you’ll have to trust us to do a good job of targeting.  We can do this because we’ve been working in this market every day for many years and we have the knowledge and tools to allow us to be systematic in our approach to identifying and contacting good buyer prospects in a matter of days.  It will still take a few weeks to get to the point of providing you with a term sheet that would outline price and terms of a transaction.   

Bottom line:  Yes, you can still get your company sold or re-capitalized in 2010 before taxes on business sales increase.  No, you can’t get it done if you wait much longer.  If you wait another 30 days, then maybe, if all the stars align, you can still get your deal done this year.  But if the buyer or you want to take time off at Thanksgiving or 2 weeks at Christmas, forget about it.  If the owner of Rip Van Winkle Enterprises, LLC waits much longer he’ll learn the motto for 2010 business sellers: “If you snooze, you lose!” 

Who Are The Buyers Who Will Close Deals in 2010? 

They’re the ones with the money, of course.  To get a deal done in 2010 we need to concentrate on buyers who have all the cash they need to close.  We need to avoid “unfunded sponsors” who raise money on a deal by deal basis.  We need to look askance at “pledge funds” where the equity investors are standing by to put up their equity capital when the sponsor says it’s time to close (some might say no to your deal and we’d lose time trying to fill the gap).  We need to be careful if the buyer has all the equity in a fund that can be drawn on at closing but still must borrow a large share of the purchase price (40-60% borrowed is typical), because the lender may not lend the money at the last minute or may throw in conditions you or the buyer will find unacceptable.  We feel more confident if the buyer says they’ll use all equity dollars from their fund, and will consider refinancing later.  We feel most confident with a one-stop-shop that provides all levels of the capital structure from existing funds, i.e., they provide both equity and the acquisition loan from their own funds.  Owners who don’t do transactions every day don’t know who is who and sometimes end up in an exclusive arrangement with a would-be buyer that can’t really get a deal done when you want it done. That could be costly if you’re trying to cut your tax bill by selling in 2010.  It’s pretty simple, really – just follow the money and sell to the entities that have plenty of it.  Can you figure this out for yourself?…sure, if you want to do the research and take all the time necessary to figure out who’s who.  You don’t need to do that, of course, you can simply call and ask me to bring you a buyer with money who can close in 2010.  I’m available toll free at 800-240-4609. 

What Will Buyers Pay For My Company in 2010? 

Honestly, I don’t know exactly what they’ll pay for your business but I have a good idea of the ballpark for most transactions.  First let’s clear away some of the underbrush.  There are 2 worlds of business sales.  One is the small “Main Street” business world.  These sell as a multiple of “Seller’s Discretionary Earnings” a figure that represents EBITDA + owner’s compensation.  The multiple is pretty low, but the owner keeps the accounts receivable.  The other world is the middle market world where businesses sell as a multiple of EBITDA or free cash flow (EBITDA-capital expenditures), but the buyer acquires the accounts receivable, and sometimes a small amount of operating cash.  In both worlds we are talking about “enterprise value” as being the business value if it were free of debt and excess cash.  In other words, the proceeds of the sale must be used to retire the debt on the business, much like you’d use the proceeds of a house sale to pay off a mortgage.  This means all the debt: term debt, line of credit and capital leases must be paid off from the proceeds of a sale, and enterprise value is the debt-free value of the business.  It’s just like your house value.  If it’s worth $500,000 but you want the buyer to assume your $300,000 mortgage, the buyer will pay you $200,000 for the house, or he can pay you $500,000 value and you can pay off the mortgage and still net the same $200,000.  Sorry to belabor the point, but owners of some pretty big businesses sometimes figure that they should get the enterprise value for their business AND the buyer should assume the debt too.  Nice deal if you can get it, but don’t count on it since this would mean the buyer would be willing to overpay by the amount of the debt.  One more thing – if the business owns real estate enterprise value does not include real estate.  That value is determined separately.  Enough said.  Now we know what enterprise value is conceptually.  What does the market tell us it should be numerically? For lower middle market businesses with enterprise values under $50 million you can count on most companies having enterprise values in the range of 3-6x EBITDA, probably 90% of all companies of this size will fall in this range.  The majority will fall in the range of 4-5x EBITDA.  Very few exceptional situations will produce sales prices of 7x or more times EBITDA, and relatively few will have values less than 3x EBITDA.  [For Main Street businesses where the owner keeps the accounts receivable, most are going to come in the range of 2-4x Seller’s Discretionary Earnings.  A small percentage will get less than 2x (as low as 1x), and another small percentage will get more than 4x.]  To start getting enterprise values around 7x EBITDA or more in the middle market the companies need to be larger – enterprise values of $100 million or higher. Just so you know I’m not pulling these numbers out of the air, here are a couple of statistics from GF Data Resources’ most recent survey of private equity group transactions for the second quarter of 2010: All transactions $10-$250 million Enterprise Value: average 5.6 x EBITDA (an increase from the average 5.2 x EBITDA in the prior 2 quarters) Small Transactions $10-25 million Enterprise Value: average 4.8 x EBITDALarge Transactions $100-$250 million Enterprise Value: average just under 7x EBITDA These are averages, some get more and some get less, but the ranges I’ve given above will fit most of our clients’ companies most of the time.  Since most of our clients don’t have over $500 million enterprise value (OK, I admit it, none of them do), it doesn’t do us any good to look at the S&P or Capital IQ or Thompson/ACG stats for these companies.  GF Data Resources is more on target for us.  I’m not saying it’s impossible for one of our clients to get a high multiple.  I’ve had one client get a 12.5x EBITDA multiple.  But I am saying that’s a rare event, and most enterprise values will fall in the typical ranges I’ve given above.  That’s where I would expect any 2010 deal to close. 

Management Buyouts When Managers Have No Money 

We often hear that the owner would like to sell to his loyal management team, but the problem is the managers have no money, or hardly any money.  So a deal can’t be done for the managers and we need a third party buyer, right?  WRONG!  We have a willing seller.  We have competent management.  We have a willing buyer (the managers).  They just have no money.  What do we need?  We need a partner for the managers who will bring the money needed to buy the company.  This can be done for most quality middle market companies.  If we hurry we could even get it done in 2010.  You’ve got to be willing to sell at a market price and terms (see above), and you might need to keep an equity slice of the business, say 10 percent.  So if you want to sell to your managers, don’t send them off on an impossible mission to find the money they need.  That’s not what they do for a living.  I know where to get the money and their best partner, so call me instead at 800-240-4609 and I’ll help you to really get a deal done that will be a win-win for everyone. 

Referrals 

Thank you to all of the attorneys, accountants, financial planners, bankers, business owners and others who have referred clients to us.  We greatly appreciate the trust and confidence you have placed in us.  If you would like to refer a business owner to us for value consultation, business purchase, business sale, management buyout, management buy-in, or re-capitalization, please be assured that all of our services are totally confidential. 

Call me today at 800-240-4609. 

Best Regards, 
K. Perry Campbell, Ph.D.,
CM&AA Chair, AM&AA Market Research Committee
Alliance of Merger & Acquisition Advisors
2009 Member of the Year

Principal & Managing Director
ACT Consultants, Inc.
110 Columbia Street
Vancouver, WA 98660USA
Phone: (360) 696-9450Toll Free: (800) 240-4609Cell: 360-904-9048
Fx: (503) 296-2452
pcampbell@actconsultants.com http://www.actconsultants.com 

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