15 Oct Today’s Business Sale Climate
Undeterred by the weak economy, a surplus of buyers remains ready, willing and able to purchase businesses of every size, and contrary to the ever-present scuttlebutt about banks not willing to lend, they are, in fact, making loans, including loans for purchase/sale of businesses. After all, that’s what commercial banks do. They must make loans to earn a profit.
The federal government, via Small Business Administration loan guarantees, makes it easier for bankers to say yes. Interest rates are very low, which lowers the cost of debt financing and raises the purchase price that can be amortized. Banks just need sensible deals, just as they always have. A sensible deal is one that cash flows with a reasonable cushion (the exact amount hinging on risk factors such as volatility of earnings) and also has a meaningful secondary source of repayment, i.e., collateral or a good personal guarantee.
Equity contributed by the buyer will reduce the amount that must be borrowed and thereby improve the cash flow, i.e., “bankability” of the deal. And when the sum of the equity contributed and debt that can be borrowed falls short of the purchase price, the only way to make it up is seller financing. Most deals include some seller financing. That’s just the way it is. Yes, and the bank will want the seller note and payments subordinated to the bank.
“Banks get a lot of flak as being unfriendly to business, unjustifiably in many cases, in my view,” says Brit Callahan, a private business owner. True, banks are not set up to take much risk. They earn a slim profit on each loan, and one bad loan can wipe out profit earned on hundreds. “Many people get confused between equity investors and commercial lending institutions,” Britt adds. “Equity investors are ‘partners’ of the owner as they are in the same position, as holders of equity. It’s referred to as risk capital because they take larger degrees of risk. They only get what’s left over after the liabilities and cost of the same have been paid. As compensation for their more risky position, they have the chance to earn returns far in excess of their lenders.”
Cash Flow Is King
“It’s extremely difficult to sell a business that is not making a profit,” says Duff Weddle, dealmaker with Acquisition Advisors. “Buyers just aren’t very imaginative. They assume what the business is doing now (and in the recent past) is what the business will do in the future. So if your business is performing well, this works in your favor. Storm clouds may even be on the horizon, but you will likely be able to get a deal done based on current (recent) cash flow. But if your business is not profitable, it’s almost impossible to sell the potential,” Frieden continues. “Try and you’ll almost certainly waste time and energy, unless you’re willing to give it away.”
And so the rich get richer. Those with profitable companies today can sell for a bit of a premium. This is because buyers of all types — individual, industry and private equity — are “out there” in great quantity; they just want profitable firms. Those earning profits today have the opportunity to sell for nice valuations as a multiple of cash flow. Owners of unprofitable businesses are stuck until they succeed in establishing a track record of profit.
Buyer Types and Selling Prices
“Much is written about business purchase prices and multiples,” says David L. Perkins, Jr., also of Acquisition Advisors, “but it’s not that darn complex and it doesn’t fluctuate all too much over time.“ Businesses with less than $500,000 in annual earnings almost exclusively sell to individual buyers at multiples of EBITDA in the 2.5 to 4.5 range, depending on risk factors and rate of growth. Private-equity groups and corporate buyers (primarily peers and competitors) will begin to enter the picture as possible buyers as annual EBITDA exceeds $500,000 but don’t become real players until annual profits exceed $1,000,000. Purchase prices (for all the non-cash assets and the assumption of working liabilities of a business) are in the 4x to 5x range. Higher growth rates can command higher multiples, as can synergies with the buyer. When annual EBITDA exceeds $3 million, the industry, i.e., corporate and private-equity buyers, come out in full force. These are the deals that have been bid up of late because of the supply-demand imbalance. Multiples of 6x are now pretty common, and growth and synergies can raise prices further. Look at it this way: It’s a reward for being able to operate profitably during a very weak economy.
It’s a fine time to sell a business. Nothing is holding you back except, well, the performance of your business. Many businesses, of course, are struggling because of the moribund economy. Unfortunately, business salability and sale price are a function of current and near-term profit performance. There’s just no getting around it. If your business is performing well and you really want to do something different, it’s a fine time to exit. And you can expect to be rewarded for your business operating profitably during these difficult economic times.