External factors boost acquisition valuations to high level
The value an owner gets when selling a business can depend on a lot of factors beyond his or her control.
Sure, there are significant steps an owner can and should take to maximize value. But sometimes — just when retirement looms, perhaps — external factors can slash significant dollars from a business valuation. That might seem unfair.
But then there are the times when external factors boost valuations. Times like now.
Political climate, economic trends, available capital and interest levels in a market segment all can drive company value down — or up. The good news right now is a perfect storm of positive factors is boosting merger and acquisition sales valuations to one of the highest levels in recent history.
Gordon Bell, founder of Fort Wayne-based The Midland Group, is the national Exit Planning Institute Exit Planner of the Year. He leads seminars across the country and also partners with my firm. Bell lists seven factors that impact the value of a business and help answer the question, “How do you know when to sell your company?”
How strong is the economy?
Is the market hot?
Is your industry in favor?
What kind of capital gains tax treatment do you foresee?
What is the availability and cost of debt and equity financing?
Is your company ready to sell?
Are you ready to sell?
You see the seller controls only the last two factors. The first five are market conditions and are exactly the factors now pushing acquisition multiples 20 to 40 percent higher than just a few years ago. Where typical prices might have been five times earnings, right now, prices are closer to seven times earnings.
Let’s look at those five external factors.
Capital gains tax treatment (Factor No. 4) is on a lot of minds right now. Since the election, more sellers are approaching me thinking about going to market next year because they believe taxes are going to be more favorable and because markets are good.
At the same time, financing (Factor No. 5) is having a positive impact. Capital is available, banks want to lend money and interest rates still are very good.
“And not only banks,” Bell said, “but you have all these wonderful strategic companies that have been stockpiling cash since the recession because there wasn’t any place to put it. And then you have the equity groups. For many years, they couldn’t invest money because there was nothing good to invest in.”
With ready cash, they’re willing to invest a higher percentage of equity, and when coupled with the combination of external market conditions, this can result in higher valuations.
Next, consider the economy (Factor No. 1). A booming economy would let companies grow internally, but the current slower growth, along with favorable financing, encourages businesses to grow by acquiring other businesses — again, boosting valuations.
Finally, Midwest industries are very much in favor now (Factor No. 3). Other countries and states outside the Midwest are realizing the value in the Midwest’s manufacturing infrastructure. Companies are acquiring and polishing up “Rust Belt” businesses to put into use buildings and equipment that were underutilized and undervalued coming out of the recession. Our region is being recognized as having essential resources and hard assets.
“We have the highest concentration of factories in America,” Bell said of Michigan, Ohio and Indiana. “These three states are going to do very well. Look at the I-69/I-80 intersection, and there’s going to be a tremendous increase in the flow of traffic.”
Finally, that rising industrial tide is lifting the value of other regional businesses, too. In other words, the market is hot (Factor No. 2). Bell calls it a “trifecta” of pent-up transaction demand after the recession; talk of tax law changes; and a political climate that favors financial institutions that can support transactions and extend a hot market.
Which naturally prompts the question, “How do I know what my business is worth?”
That’s an entirely different topic, but a short answer is that traditional business valuations are just a start. Best methods combine a valuation with market testing that looks at current prices and deal structures as well as banking and investor activity in a particular industry. That testing helps account for those five external factors. When those factors were negative, around 2009 for instance, prices were 70 to 80 percent of valuations. Now, because those factors are positive, sales are coming in much higher than valuations — those two to three extra points in the market multiples.
It would appear the market conditions are strong now, and they likely will not remain this way forever. If you’re considering sale or transfer of stock, now is the time.
Randy Rua is the owner of two West Michigan mergers and acquisitions firms, Rua Associates and NuVescor. He can be reached at firstname.lastname@example.org