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Privately-held company owners contemplating a corporate transaction – such as sale of the company or selling part equity to co-investors supporting further growth – should begin the process now.  Market conditions are very seller-favorable.

• Debt financing availability and terms restrictiveness is a key pillar and leading indicator of M&A market strength. Debt is widely available (record $107 billion raised by new private debt funds in 2017) [i]. Terms favor borrowers, and though rising, interest rates remain historically low.
• Private equity (PE) capital available is at a record level of $1.09 trillion.[ii]  About $200 billion is for venture capital investments, but the vast majority will be invested in established companies’ M&A deals.
• Family offices, which invest personal capital and typically uncounted in the PE number, are growing rapidly in number, influence and commitment to investing in private companies
• American corporations’ cash and investment holdings is extraordinarily high, over $2 trillion among non-financial or real estate S&P 500 companies, and the 2017 Tax Act will further increase it. Some will find its way to M&A.[iii]
• Disclosed value of 2017 foreign purchases of middle market[iv] companies exceeded $20 billion for the second consecutive year, while the number of deals reached the highest level since 2011[v]
• Prices for good companies have been driven upward continuously, and S&P expects that trend to hold in 2018
• The global economy is performing exceedingly well, thus businesses going to market are more likely to show growth, increasing their value

If the historic pattern holds, the next  seller’s market cycle is likely to be around 2024-2028.[vi]

It will be hard for a foreseeable future private company seller’s market cycle to top this one, because the collective aging of business owners wanting to sell may begin flooding the market over the coming years.  60% of U.S. private companies’ owners are 54+ years of age.

Making Acquisitions

Since it is a seller’s market, companies wanting to acquire or merge should be aware that since valuations are at a premium, acquisition targets or the equity of a merger partner won’t come inexpensively.  However, since capital is readily available at low interest rates and favorable financing terms, there is some offset to a higher price.  As interest rates creep up, as they are doing, capital to support acquisitions or mergers will become progressively more expensive, and eventually tamp down activity and valuations.

Divesting Part Interest

For some, achieving liquidity through a sale and exiting the business need not be a binary choice; a growth goal and a goal of getting liquidity now don’t have to be mutually exclusive.  So, for instance, owners could potentially reduce their family’s wealth concentration risk by harvesting part of their wealth now…and maintain control of the day-to-day operation while they and their team continue to grow the business over the next several years using the resource of private equity investors with relevant industry experience.

Incentives can be created to reward the management team or even family members working in the business.  After perhaps five years, all owners would collaboratively sell the business, but now the original owners’ share would be of a bigger, more valuable company.  So, in a sense, the original owners would get to sell the company twice.

Supporting Conditions to Various Owners’ Objectives

When It’s Appropriate for Owners of Established Private Company to	Fundamental Conditions Apart from The State of the M&A and Capital Markets
Sell the Company	When owners’ seek maximum liquidity for all their years of investing in and building the company When owners’ age makes it unlikely that they will continue working in the company for several more years When ready to embark upon “The Next Chapter” – whatever that may be, e.g. “retirement” (however defined!), starting another company, becoming an investor and mentor to younger entrepreneurs, extensive travel, more family time, etc. Many acquirers want the seller to retain some relationship to the company for a few years after the sale, so the transition may be over time
Seek Outside Investors for Minority or Majority Ownership of the Company	When owners want to reduce their family’s wealth concentration risk by divesting part ownership, but continue to actively manage the company for growth When the company is professionally-managed by an ambitious, competent management team focused on growth, though may have some management gaps to fill When the company’s growth goal will be better supported by additional capital and experienced Board-level managerial resources, and the owners appreciate hearing outside perspectives and new ideas When owners envision collaboratively with investors divesting remaining ownership of what should become a larger company in 4-7 years (the average private equity investor hold time is 5 years) – effecting a 2nd sale event, maybe larger than the first
Acquire Other Company or Companies	Since growth by acquisitions is risky and difficult, it is best to do this in conjunction with experienced, serial acquirers such as private equity or strategic investors if the company has not already successfully acquired and integrated another company When the company is very strong managerially and financially, and has a clear, well-planned goal that an acquisition may achieve Is it a good time to grow by making acquisitions?  If consistent with your company’s growth strategy, perhaps, but market conditions alone should be a tertiary factor, subservient to factors within the company, the available targets and the dynamics of the industry.
Run the company passively, with no deliberate, i.e. funded, growth initiatives or plan for divestment of ownership	Never, unless the plan is to milk the remaining earnings potential of the company over a period of time before a probable shut-down (a harvest strategy).  However, is that really the best strategy for profit maximization?  Probably not. It is difficult to manage a harvest strategy – it’s not the easy path it appears to be.  It is easier to destroy value through neglect than it is to effectively maximize profits. Industries and their competitors are ever-changing.  Standing still is only a temporary option.  Grow or Go.

Preparing for Great Exits

Do you know how to prepare for a great exit?  Depending upon owners’ needs and goals and factors specific to the company, it may take some time.

Owners contemplating a transaction within the foreseeable future should begin the process now.  It may make a profound difference in how much the company sells for, how much tax on the sale must be paid, and thus how much sellers keep free and clear after the sale.  Specifically:

1. It’s a seller’s market now, which may last into next year, possibly but less likely, even 2020
2. Some advanced tax strategies take time to “season”
3. Initial Transferability Assessment may reveal that the company has much to do to prepare

Preparing to Catch the Next Wave

Alternately, owners who want to wait until years 2024-2028 to catch the next anticipated seller’s market cycle should undergo a Transferability Assessment now.  With proper planning, risk management and diligent execution, many private companies can perhaps double their value within a few years.

There are many reasons to put a plan in place now if the intent is not to sell for several years.

• Build transferable value – Requires an actively managed, deliberate process over time
• React to market conditions – Evaluate whether it’s realistic to continue the company’s growth rate in a changing market.  Has the strategic planning been done to project market dynamics over the next five years?  How much consolidation activity is there in the industry?  It becomes increasingly difficult to compete against fewer but larger companies.
• Lack of liquidity – Do you or your spouse want to convert some of your business assets to liquid wealth? Personal asset wealth concentration in your business creates needless risk.  Even venerable accounting firm Arthur Anderson’s senior management and employees thought that they were building retirement wealth, until the firm suddenly closed and they lost all.
• Succession planning – What happens to your business, family wealth and employees’ security if you get hit by a bus?  Is there a plan for that?

Company owners who wait until they suddenly decide “it’s time” may destroy their wealth by procrastination.  The average age of a US private company seller is around fifty-two.  Most owners past seventy with no transfer planning in place never become sellers.

It is common for owners to want to stay in the driver’s seat when the market’s good, and bail when it turns.  The problem is that their company is likely to be less valuable and harder to sell.

Timing for Great Exits

The best time to sell requires four things to line up – think of it like a slot machine.  When they’re in perfect alignment, company owners win big, anything less than that is a matter of degrees off the optimum.

What is “to win?” It is achieving the owners’ stated objective, which is typically optimal price and terms of the sale.

To align all four takes advance planning, and perhaps some luck.  Ideally, one would be optimally positioned in the first three factors to be at least somewhat inoculated against the cylicality and vagaries of the fourth.

1. Owners’ personal timing (Controllable).
   1. Pro-active, not reactive to adversity (“dastardly Ds”…declining markets, debt overload, dissenting owners, divorce, disability, death).
   2. Estate and financial planning preparation, i.e. your personal wealth and tax considerations. Some advanced tax planning strategies take time to season.
   3. Emotional readiness and preparation for “The Next Chapter”
   4. It’s important to remember that most smaller-to-mid-sized company sales require that the seller have some sort of a continued relationship with the business for 2-3 years – exiting is not likely to be an abrupt event after handing over the keys.

2. The business being prepared and ready (Controllable). This is not simplistic like cleaning up and painting before selling a house.  It’s about addressing the major drivers of value and the sub-elements that add or subtract to them; in other words the “architecture” of the intangible assets (which averages 72% of business value).
   1. At a high level, addressing drivers and risk factors builds acquisition attractiveness by increasing earnings and reducing risk that those earnings will not continue at the current level or grow,.

3. Favorable industry dynamics. (Partly Controllable). The first question a financial investor will ask “is this the right industry to invest in?”  If it is not, then does the company have a way to extract value beyond the cost of capital needed to acquire or invest in them?  If the industry itself is unattractive, it is likely that companies are consolidating to build market power so that they can fight more effectively for diminishing business.  There may be opportunity to be acquired by a corporate strategic investor consolidating smaller companies, but doing so would be very time-sensitive.

4. And fourth, the sellers’ market cycle being favorable (Uncontrollable). It’s hard to time this exactly, but there are definitely established patterns and factors to watch for.
   1. The US private company transfer market has run in roughly 10 year cycles, starting with a 3 year buyers’ market beginning in 1980, 1990, 2000, 2010 that then turned to a seller’s market for roughly five years, ending approximately on the 8s. After that is an uncertain, wobbly market for two years.[vii]
   2. The M&A market is influenced by the macro-economy. Unemployment is at a 17-year low, corporate profits are high, and the pace of global growth has accelerated.  The Stock Market Bull Run turned nine years old on March 9, 2018, the second longest recorded up-market.  However, volatility, inflation and interest rates have increased, which suggests the likelihood of diminishing growth.
   3. Right now the market for sellers is robust, and the new tax bill is adding stimulus on top of it. Financial insiders have been expecting the end of this strong M&A market for two years, but wrongly thus far.  Prices are high, partly because there’s so much money chasing deals, and it keeps coming.  However, a prominent M&A research firm, PitchBook, reports “Several signs suggest that the cycle may be ready to turn, including elevated pricing and relatively high levels of debt usage.” [viii]
   4. If the pattern holds, this year will mark the apex, before an uncertain, wobbly market in 2019 and 2020, followed by a turnover to a buyer’s market again.[ix]
   5. However, there are four “wild card” factors that didn’t previously exist, so the pattern may differ:

1. Institutional investors’ interest in making private equity investments is at an all-time high, which has led to more money raised by private equity funds to buy and invest in companies than ever. Since this money must be invested, the private equity investors compete fiercely to find good companies.  Then, add in the family offices now competing for those same investments.  This factor supports a case that prices will remain firm – a seller’s market.

2. Ever increasing federal debt and the interest on it was forecast by some economists to pull down the U.S. economy starting in the early 20’s. That was before the new 2017 Tax Act, which the non-partisan Congressional Budget Office (CBO) forecasts to “boost economic output and increase budget deficits, on net.”[x]  However, economists don’t have a model to precisely forecast this new approach of adding stimulus to an already-highly stimulated economy, so nobody really knows how accurate CBO’s estimate of the Act increasing the Federal Deficit by $1.9 trillion 2018-2028 will be.  We do know that the debt and interest payments continue to climb though, which will push up interest rates unfavorably for business investment and growth, thus ultimately reducing values.

3. Baby Boomers may decide to sell en masse. The owners of ~60 percent of the 15 million privately-held businesses (200,000 between $10 million and a billion revenue) in the U.S. were born before 1964, making them all 54+.  Currently, 10,000 Baby Boomers—born between 1946 and 1964—per day turn 65 and face the reality of considering retirement. This will happen through 2029.  The math suggests that over the coming eight years, we might see about 450,000 small business owners looking to make an exit each year.

There simply are not enough buyers nor cash available to capitalize the transitions, despite so much money available for private equity investments. Many Baby Boomers can’t afford to maintain their lifestyles without their annual salaries, so they aren’t retiring at 65, [xi] but that can change suddenly.  If so, it could precipitate a shift to an extreme buyer’s market.

4. Shortage of Skilled Labor. Some occupations are facing a critical shortage of labor trained to meet the future needs.  For instance, 89% of manufacturers say that they have trouble finding the skilled workers they need, and the problem is likely to worsen in a few years, as 68% of the current manufacturing workforce is projected to retire in 5 years.[xii]  A cap on available labor is prompting investment in automation technologies like robotics, but it may also devalue many businesses by limiting their growth potential, thus encouraging a shift to a buyer’s market.

The first two major factors, preparing the owner and business, establish readiness and are in the owners’ control.  Regardless of whether a company owner may want to go to market, getting a handle on those first two factors is crucial for being able to take advantage of a sudden, opportunistic sale, too.  Not being prepared and ready if a potential acquirer calls is a tip-off to them that they have immediate advantage – they do.

However, awaiting such a call is akin to finding money on the sidewalk – nice if it happens, but completely unpredictable.  Contracting an investment bank instead is the pro-active approach.

If those first two major factors aren’t being actively managed, and if the company is not represented by a deal professional that manages the process, it’s guaranteed that a hypothetical buyer would get a much better deal than the owner.

Timing for Established Companies Taking Outside Investment

The saying “a rising tide lifts all boats” applies.  When the market is strong everyone seeking capital benefits to some degree.

The question of optimal timing is differentiated by whether the investor is contemplating a minority or majority ownership position.  By far, most private equity investment into established companies is for a majority ownership position, but more and more firms will consider a minority stake under select circumstances.

Minority Stake

Investors bet on growth potential.  Companies which have shown growth over the past few years, and are well positioned for future growth, will attract capital regardless of market conditions.  While the M&A market conditions described previously certainly apply, they are less directly influential.

The optimal timing is more determined by the capital access needs of the business to support its growth plans than the strength of the M&A market.  Since the less proven the business proposition (risk), entrepreneurs’ best timing for raising money is after achieving a significant de-risking milestone, e.g. a successful new product introduction.

Private equity investors and family offices will only accept a minority stake when there is an exceptionally strong management team, the investment proposition is de-risked, and there is strong potential for significant and rapid growth potential.  Typically these companies will generate a minimum of $10 million annual revenue, be growing very quickly, but need capital to continue that growth rate.  These so-called “growth equity” investments may overlap with venture capital in the transition zone from early stage to established company.

Majority Stake

Market timing is as influential as for a buyout transaction, but there is one very important distinction: where the business fits in the owners’ investment cycle.  Is the business 30 years old and the owners of a normal retirement age, or is it 5 years young and the owners at a life stage in which they are likely to continue working for several years?  For apparent reasons, the former is more attractive to investors as a buyout transaction, not shared ownership, unless there is a strong management team that would qualify for private equity sponsorship to buy into the company (see article: Important Information About Management Buy-Outs (MBOs).

In summary, M&A market timing is influential for owners to obtain optimal price and terms, but less so than the other three factors: owner readiness (prepared, not reactive), business preparedness, and industry attractiveness.  Regardless, the market is ripe now.

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Mid-Market Securities, LLC is a boutique investment banking broker-dealer that provides smaller to mid-sized companies the international access, insights, processes and professionalism larger companies command. 

Generally, we provide strategic and financial solutions to smaller-to-mid-sized companies to support their growth goals, address challenges to the business and/or facilitate their owners’ personal financial goal of achieving liquidity.

Our services help business owners who are motivated to build or harvest part or all their wealth tied up in the business – and want proven methods for doing so in the most market-competitive, tax-advantaged manner possible.  Part of our role is to help them understand what options best support their needs, and what the company qualifies for.  Then we provide the insight and implementation to support the desired outcome. 

McGavock Dickinson (Dick) Bransford is a Managing Director in San Francisco with Mid-Market Securities, headquartered at 11 East 44th Street, 19th Floor, New York, New York 10017. Member FINRA/SIPC.  He can be contacted at (415) 294-0002 or mdb @ mid-marketsecurities.com.

Disclaimer: This article provides general information, and is not intended to constitute, and should not be construed as, legal, tax, accounting or business advice, nor does it constitute an offer to sell or to purchase securities. Rather, it is summary compilation of timely issues confronting your industry and as such does not purport to be a full recitation of the matters presented.  Prior to acting upon any information set forth in this article or related to this article, you should consult independent counsel and/or more detail contained in the Source Information. The article reflects the opinion of the writer and does not necessarily reflect the opinions of Mid-Market Securities, LLC, or its affiliates.  IRS Circular 230 Disclosure: In order to comply with requirements imposed by the Internal Revenue Service, we inform you that any U.S. tax discussion contained in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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Quote in introductory box by Robyn Engleson, Sapphire Financial, provider of capital to private equity investors, from Axial article

i] Prequin, Q1 2018 Quarterly Update, Private Equity and Venture Capital

ii] Ibid

iii] S&P Global Intelligence, as reported in Middle-Market Trends Report

iv] The “Middle Market” refers to the 200,000 U.S. companies with annual revenue of $10 million to $1 billion, a standard used by the National Center for the Middle Market at Ohio State, S&P, and the Alliance of Merger & Acquisition Advisors

v] Ibid

vi] Slee, Robert; Private Capital Markets, Second Edition, 2015 chronicles the historic pattern. Forward projection based on it.

vii] Ibid

viii] PitchBook M&A Report Q1, 2018

ix] Ibid

x] Congressional Budget Office publication, April 20, 2018 https://www.cbo.gov/publication/53787 Selected Excerpts: “CBO projects that the act’s effects on the U.S economy over the 2018-2018 period will include higher levels of investment, employment and Gross Domestic Product (GDP).”  “One result of the Act will dampen those positive effects on potential output: it will increase federal deficits and therefore increase federal borrowing and interest rates, crowding out some private investment.”  “…raised projected debt service costs by roughly $600 billion…The act therefore increases the total projected deficit over the 2018-2028 period by about $1.9 trillion.”  “CBO’s estimates of the economic and budgetary effects of the 2017 tax act are subject to a good deal of uncertainty.”

xi] How Baby Boomers’ retirement will impact small businesses, PitchBook blog guest article

xii] http://www.sme.org/smehome.aspx