Business values are getting a boost from low interest rates
Today’s near-record low interest rates have acted to boost business values much in the same way low mortgage rates have helped to restore residential real estate values. If a business owner were to consider that low interest rates are being held down by aggressive Federal Reserve Bank action, one could envision that rates will likely rise in coming months and years, leading to lower earnings, higher borrowing rates and eventually lower business values.
Despite almost daily newspaper headlines and television reports about how bad the economy is in Michigan, and now Detroit’s municipal bankruptcy, the state’s economy is doing fairly well. Comerica Bank’s Michigan Economic Activity Index is 74 percent above its low point during the Great Recession. The U.S. economy continues to grow at a projected 2 percent rate for 2013, and the S&P 500 stock index hit an all-time high in July. These may not be the heydays of 2004 to 2007, but it is a pretty good time for many businesses.
For privately held business owners, the question of when to transition their business to the next generation of family, the management team or to a third party, is often a complex and emotionally charged issue. Most business owners will be faced with this decision only once during their career, and yet this one decision can have profound effects on the future wealth of the business owner, future generations of the family, the company employees and the business itself. The “right” answer to this decision varies from business to business but often lies in a mix of internal business issues, external market forces and the personal desires of ownership.
Private business owners who have a personal desire to transition their business in the near term might ask whether now is a good time to sell their business. While each business must consider its own performance and readiness, external market conditions, such as interest rates and income tax rates, can have a tremendous effect on the ultimate value a business owner receives from a sale transaction.
At the end of 2012, the U.S. tax rate for long-term capital gains rose from 15 percent to 20 percent. Many business owners rushed to complete transactions before the tax increase took effect. While that opportunity has passed, tax rates remain at historically low rates. Given the mounting national debt, social program costs and aging population, there will be increasing pressure to raise rates before too long.
All of this recent economic stability, availability of low-cost money and a relative absence of troubling world issues have brought out the buyers for small and mid-sized businesses. Numerous private equity and corporate acquirers are reporting virtual bidding wars that are causing a spike in the prices commanded by sellers of profitable, quality businesses.
Why is that? Many financial and strategic acquirers were unable to grow via acquisition during the recession and took that time to stockpile cash, de-leverage their balance sheets and trim costs. As the economy and their business have recovered, they are well positioned to grow — in part through acquisitions. Add to that a rebound in business lending from increasingly aggressive commercial banks and you can understand the increase in business values.
However, national transaction statistics show only modest increases in the number completed in the lower middle market. Most buyers attribute this to a lack of available business sellers. What better time to be a seller than when there are many buyers anxious to buy?
To be certain, a business owner must consider a wide and varied range of factors when deciding the right time to exit a business. Those factors are highly personal and unique to each business, industry and owner. Many investment professionals advise investors against trying to sell a stock at the peak of the market or buy at the absolute bottom of a cycle. Similar advice applies for owners of privately held businesses — finding the perfect time may never occur. But, it sure does help to enter the market when times are good. Such times don’t last forever.
John Kerschen is the managing director of The Charter Group in Grand Rapids.