When middle market business owners place their privately held companies for sale, they soon discover the market is the final determiner of value, not appraisers, CPAs, or even their own opinions. The market can delight or disappoint depending on an owner’s expectations. Disappointment inevitably arises when the highest offers received fall below the owner’s preconceived notion of value.
What should an owner do when the market confronts elevated valuation expectations? Should they:
- Sell at the lower value?
- Hold the business to capture the ongoing benefits and/or hope for a higher value in the future?
- Hire a different investment banker/M&A advisor?
- Pursue other options?
Infusing Rationality into Emotionally Charged Decisions
The selling decision is emotionally challenging for owners in the best of circumstances, but it is even harder when offers fall short of expectations. That’s why owners and their advisors should intentionally separate from the emotional disappointment and dispassionately analyze the situation before walking away from market-driven offers. Let’s look at 6 different questions that can help clear the fog.
1. Does the offered price accurately reflect the opinion of the market?
The process of selling a middle market company is complicated. It involves identifying and confidentially approaching the right potential acquirers; effectively presenting the business and all of its attributes to the selected acquisition candidates; soliciting offers in a controlled setting; and much more. The universe of potential buyers for any given private company is finite. It may not be necessary to approach every single potential buyer to get a good reading on value. However, a bona fide market will always include enough capable buyers to reflect real demand for the business. When sufficient numbers of buyers compete for acquisition rights, business value rises to the appropriate level.
If the selling process presented the business to an adequate number of potential buyers and the materials accurately presented the business attributes, one can assume the market has given its ruling on value through the received offers. If so, business owners need to adjust their valuation expectations to align with market realities. The selling decision can now be based on a new and more accurate valuation paradigm.
However, if the selling process was inadequate in the sense that not enough buyers were given the opportunity to invest or the business story was inaccurately presented, the owners may desire to reapproach the market on a larger scale by relying on the services of a qualified investment banking firm or M&A broker. Private companies are bought and sold in the private capital marketplace, which is not like a bizarre or other traditional location where things are traded. Instead, professional M&A firms make the market for private businesses and manage the process to completion. The private capital marketplace is difficult for owners to navigate without professional guidance.
Caution! If the business has been adequately presented to a sufficient number of potential acquirers, including the very best buyers, but the owner rejects all offers, there is a chance those buyers will be hard to reengage in the future. It can be costly for buyers to enter acquisition competitions. When owners demonstrate they are not reliable transaction counterparts by holding unsupportable valuation expectations, most quality buyers will permanently lose interest. By driving away good buyers, market demand decreases, which ultimately diminishes value.
2. If the established market value is reliable but lower than owners require, do the owners have the necessary time, energy, resources, and risk tolerance to build value to the higher level?
To illustrate, assume the following:
- An owner receives an offer for $20 million, but requires $25 million to sell – a $5 million increase from today’s market value;
- Current company sales are at roughly $23.5 million;
- The compound annual growth rate of sales has been 3% for the previous 5 years;
- EBITDA margins for the past 5 years have averaged 17%.
- To achieve the $5 million valuation uplift, sustainable EBITDA must increase by $1 million, and sales must rise to $29.4 million, a revenue increase of roughly $5.9 million.
- Sales would need to increase by more than 25% from current levels to achieve the owner’s valuation requirement assuming the market remains same as when the offer was received.
When owners identify how buyers establish value and what actions they need to take to increase value, it’s time for serious introspection before walking away from existing offers. Are the owners willing to make the necessary sacrifices to reach the higher valuation plateau? Do they have the time, energy, and treasure to devote to new growth initiatives? Are they willing to risk that the invested time, energy, and treasure will deliver the extra amount knowing that things beyond their control can affect outcomes? If the answers to the above questions are yes, it makes sense for the owner to hold the business and grow it. If the effort necessary to build value causes owners to recoil, maybe the offer is not so bad.
Caution! If owners choose to reject existing offers preferring to hold the business, but make no provision to purposely grow the business, the outcome may be disappointing down the road. If owners choose to hold the business expecting economic changes, tax law changes, political changes, or other factors beyond their control to influence value, it is called “hope”, and hope is not a strategy.
3. For the sake of all who are touched by the business outside of the ownership group (i.e., management, employees, customers, suppliers, communities, etc.), would the business be better in the hands of a new regime willing to take it to the so-called “Next Level?”
Solomon, purportedly the wisest man who ever lived, wrote: “There is a time for everything, and a season for every activity under the heavens: a time to be born and a time to die, a time to plant and a time to uproot, a time to kill and a time to heal, a time to tear down and a time to build, a time to weep and a time to laugh…”
That certainly applies to the season of business ownership. There is a time to take entrepreneurial risks, and a time to eliminate risks. There is a time to build a business and a time to sell a business. How can an owner know when it is time to sell? The time may be near when passion for the business has waned, but its burdens are chronically heavy; when the appetite to infuse personal funds to support growth has diminished, and the notion of additional business risks causes sleeplessness. When business growth has stalled, corporate value stopped increasing, visions for new growth initiatives come and go without action, it may be time to sell.
Caution! Owners subliminally know when they are ready to sell, but very often they hang on for too long and unintentionally damage the business. Management teams eager to drive growth can become frustrated by ownership’s unwillingness to invest in the business. Sometimes they leave. Customers may ask for creative ways to address challenges, but the ownership’s risk-averse austerity opens formerly strong business relationships to competition. There is a time for everything under the sun, and owners need to remain attentive to their season of life. If they are coasting and not vigorously driving growth, it may be time for new ownership to take over for the sake of others.
4. Will the quality of the owner’s life be enhanced or potentially diminished by the decision to hold the business?
A good friend in the M&A industry, Walt Lipsky, shared a story about an owner who rejected a $17 million offer for his business in 2007. In 2009, during the heart of the great recession, the owner asked Walt to help him sell the business for whatever he could get. The business sold for $10 million. Walt asked the owner to explain what changed between 2007 and 2009.
The owner said that he bought the business from his parents when his dad was 65. His mom and dad immediately leaned into retirement. They traveled, golfed, fished, spent time with grandkids, and enjoyed life to its fullest. His Dad’s health declined when he was 82 and he passed away at 83. His mom passed away when she was 84. From retirement to death, his parents had less than 20 years.
The son reasoned that if he followed a similar life pattern, he should live to 83. In 2007, the son was 65-years-old. Two years after rejecting the first offer, he realized he had been fighting all kinds of business challenges even though he had lost his zeal for the business. Two of his remaining 18 years had been wasted running a business he no longer loved. He wanted to retire with his wife the way his parents had. He finally appreciated his remaining retirement years were more valuable than any dollar figure he could get from the business.
Caution! The measure of a person’s life never consists of stuff. We cannot take a single belonging to the hereafter. Our stuff remains here after we are gone. Job said, “Naked I came into the world, and naked I shall return.” Therefore, don’t let aspirations for a few more dollars cut in on the priorities that really matter in life.
5. Given an owner’s age, actuarial tables, and other factors, what are the chances an owner could experience a disabling illness or worse during the extended ownership period?
Involuntary transactions occur when owners lose the right to choose how business ownership is transferred. Such transactions are typically associated with unfortunate events like disabilities, death, disputes, debt, and other issues that cleverly begin with the letter D. In most cases, involuntary business transfers are distress sales that produce inferior outcomes.
Before owners walk away from a market-driven offer, they should carefully consider what would happen to the business and everyone it touches if mortality touches them.
Caution! Proactively choose to transfer business ownership while you can. When choices are taken away due to unfortunate events, outcomes are always worse for those left behind.
6. Are there other non-emotional arguments owners should consider before walking away from market-based offers?
Perhaps the most important thing for owners to recognize is that the business is an asset. It’s not your baby. It’s not your mistress. It’s not an extension of who you are. When owners become extremely emotionally attached to their businesses, they tend to lose the ability to think rationally. Therefore, when considering a business sale, recognize the business for what it really is, a wealth creating asset. Then make prudent choices as you would on any other asset like stocks, bonds, real estate, precious metals, car collections, etc.
For example, most professional wealth managers recommend reasonable portfolio diversification (i.e., don’t keep all your eggs in one basket). Yet, for many owners, the business represents the lion’s share of their entire net worth. Private company business risks can wipe away significant wealth in an instant. The simple stroke of a politician’s pen can change the entire landscape on taxes. A simple rate increase by the Fed can increase a buyer’s borrowing costs, and diminish private business value. Private businesses are high-risk endeavors, and owners should take reasonable risk mitigating measures when appropriate.
Caution! Excessive concentrations of high-risk assets in a person’s portfolio may not be suitable or prudent as one ages. Lost wealth at an older age may not be recoverable.
No business owner wants to receive offers lower than expected when selling. Even so, the market ultimately determines value. When faced with disappointing market realities, an owner can sell the business at the offered value; hold the business and hope for better results in the future; or create a more robust marketing effort to assure the business has been adequately presented to the universe of potential buyers. Before walking away from market-driven offers, however, owners should intentionally examine rational considerations for accepting the offer. Better and wiser decisions tend to come from non-emotional analysis.
William “Bill” Loftis is Managing Partner and co-founder of Blue River. Mr. Loftis developed a passion for M&A as a transaction principal, and has assisted buy and sell-side clients through the M&A process in multiple industries. He earned a B.A. in Business Administration from Alma College and a Master of Science in Finance from Colorado State University. Bill’s full bio is available here.
About Blue River
Blue River has been representing middle market business owners and professional acquirers through the merger and acquisition process for nearly two decades. We understand transaction values from the theoretical and practical levels like few others. Since transactions depend on funding, we blend traditional appraisal methods with advanced modeling used by banks and professional investors to support our opinions. Our findings are supported by internal and external industry transaction databases, original research, and experience.
If you plan to sell all or a portion of your company in the near term or over the next 5 to 10 years, transaction value will likely be among the most important decision variables. The sooner you understand how key internal and external drivers affect value, the more time you will have to strategically influence outcomes. Contact us to schedule an appointment with one of our Certified Valuation Analysts.