“I’d say that, to be a good deal maker, you have to have 3 basic characteristics – timing, timing, and timing.” – Richard Armitage, Actor
The Importance of Timing the Sale of Your Business
A lot of the mergers and acquisitions (M&A) process, including the team you hire and the buyers you approach to consider buying your company, is entirely within your control. For now, I want to talk about something that is largely outside your control — the window of opportunity to sell into a hot M&A market. In fact, when it comes to hot markets, there are only three things you can control:
- Recognizing when the market is hot;
- Ensuring you don’t need to sell until the market gets hot; and
- Exercising discipline and selling when the market is hot.
As it turns out, that is all the control you will need.
The timing of when you sell your business can make an enormous difference in what you take away from the closing table. For that reason, deciding when to sell is a critical decision, perhaps as significant as any other you are about to make.
During an active M&A market, your deal will close more easily and for higher value, possibly much higher value. If you miss the opportunity to sell during a hot market, you may not get that chance back.
During bad M&A markets, it is exactly the opposite. It is much tougher to close deals even if the price, by all objective measures, represents an incredible opportunity. Furthermore, some companies are attractive acquisition candidates one day and no one wants them the next or, if there are buyers, they are only distressed asset buyers.
Fortunately, identifying a good time to sell is not that hard to do.
Timing When to Sell Your Business Compared to Timing the Stock Market
M&A activity is closely correlated to the business cycle. The business cycle refers to fluctuations in economic activity and is broadly categorized by periods of expansion and periods of contraction (also called recessions). Hot M&A markets show up during periods of economic expansion. Therefore, the first step in M&A timing is to identify when our business cycle is expanding.
During expansions, the unemployment rate is decreasing or is already very low. Meanwhile, corporate sales and personal incomes are rising. Consumers are spending a lot of money, and the stock market is almost always way up during these periods.
During recessions, the opposite is true. Layoffs are up, the stock market is down and people and companies are complaining about making ends meet.
You may be surprised by my earlier statement that timing the sale of your business is not difficult. After all, if you know much about the public stock markets, you know that stock market timing is very challenging. I believe that nearly everyone out there telling you they know what’s going to happen next in the stock market, has no idea.
Disagree? Read A Random Walk Down Wall Street. Or, just take it from the greatest investor of our era, Warren Buffett. The Oracle of Omaha said, “I never have the faintest idea what the stock market is going to do in the next six months, or the next year, or the next two.” There are too many moving parts and so much information and analysis out there to get any true edge. There are exceptions to every rule, but very few to this one.
What makes market timing so difficult is that you need to know which direction the market is heading tomorrow. You are making a prediction about the future. Sure, if you are confident that in the long-term the market is likely to pick up from its current lows (a belief you could reasonably hold, as opposed to what the market is going to do tomorrow or next week), you can buy and hold. You can commit to riding out any further downward movement, although it is challenging emotionally to hold on when things go against you for an extended period of time.
Plus, if you are betting on the market to go up and it’s going down or shifting in neutral, you are not generating a return. Time is a big component in calculating your long term rate of return. In short, a market timing approach to investing is all about predicting the future and that is a very tough game to play.
However, when it comes to M&A market timing you don’t need nearly the same level of precision. And, you don’t need to predict the future. All you need to know is whether or not the economy is solidly in an expansion period now. It does not matter whether the economy is headed up, down or sideways tomorrow.
Notice I did not say you need to know when the expansion is peaking, just that we are somewhere in an expansion. Spotting the peaks and bottoms of the cycles is just as tough as timing the stock market. Forget about that. Spotting peaks and bottoms requires a prediction about what will happen in the future. For your purposes, you only need to know if we are in an expansion period today. This is step 1 of picking the right time to sell your business – simply do it when we clearly in an expansion.
Identifying an Economic Expansion
There are times when economists and financial experts argue about whether the economy is expanding or contracting, although that happens most often during transitional periods. When the economy reverses off a high or low, it is sometimes tough to know exactly where we are at any given time.
During the heart of either an expansion or recession, however, there is typically a general consensus about what is going on because the financial indicators all tell the story. Employment is strongly up or down; the stock market is doing well or poorly; the country’s gross domestic product (GDP) is growing or stalling.
You don’t need to be an expert in the macro economy to get this right. Just listen until you hear a general consensus that the economy is doing great. Read the Wall Street Journal occasionally, watch a little CNBC now and again and keep up with a great financial advisor or two.
Once you are confident we are in a period of expansion (i.e., the general consensus agrees), it is time for step 2 in the process of timing the sale of your company. Turn your eyes to the big players in your industry. If lots of them are buying, sell.
M&A Activity During the Business Cycle
Human emotion and relationships are at the core of business and legal success. We can talk logic and numbers and those things matter. But, if you want to understand what’s really going on and how to gain an edge, look to human nature and emotions. That is absolutely where you need to begin when seeking to understand why the M&A market gets crazy hot during strong periods of economic expansion.
When the business cycle is in expansion mode, large companies progressively step up their acquisition efforts. They do this despite the fact that they have to pay higher and higher purchase prices. Public companies, in particular, start buying anything in sight during boom times. The reason for this is because shareholders demand growth. They want quarter over quarter growth. In fact, they really want growth on growth. “If we grew 15% last year, we need to grow 18% this year!” The growth monster is insatiable. When the good target companies are all scooped up, acquirers start buying marginal ones. Whatever it takes to keep trying for more and more growth. Corporate decision making gets skewed. Obviously, this is all very good for sellers of companies.
Also, public companies often buy other companies using their stock as consideration. When the stock market is booming, companies get more bang for their buck when they buy. So, they buy. Keep this in mind, by the way, if you accept stock as consideration for the sale of your company. What goes up usually must come down, so taking inflated stock as payment carries risk. That’s the subject of a future article.
The M&A integration process also gets messy. During good times, some companies close more M&A deals than they can possibly integrate smoothly. Meanwhile, they are bringing on lots of new people because the core business is doing so well, while at the same time losing valuable long-time employees into the red hot job market. Things get messy and expensive internally.
Eventually, the cycle turns. The M&A window starts to close and price drop. You may be tempted to think that M&A activity would remain robust during down markets as a result of companies with cash recognizing the opportunity to pick up great companies at reasonable values. But, that is not typically the case. To understand why, you should realize that most companies in corporate America, including their Boards of Directors, are reactive. They are human and fall prey to irrational exuberance and fear of missing out during good times; meanwhile, they almost always overestimate how long the bad times will last. They overspend during the good days and clam up during the bad.
During a down cycle, companies preserve their cash and stop doing acquisitions. Some may have spent too liberally during the boom times; others have plenty of cash but still fear running out of it. Either way, Boards instruct their executives to cost costs, lay people off and hold on to cash no matter what.
At the end of the cycle, the economy may slow to a crawl, especially if the contraction meets the textbook definition of a recession – two consecutive quarters of negative GDP growth. Did you catch that? Economists refer to a decline in GDP as negative growth. When GDP decreases, that’s not growth at all, but we are so obsessed with growth that we can’t stomach calling it what it is — a decline. We are truly sick. Profits disappear and cash on balance sheets becomes an anomaly.
Meanwhile, the challenges affecting sellers due to a widespread lack of demand are compounded by the fact that many of their competitors start shopping for an acquirer in order to avoid financial problems if the downturn outlasts their cash. So, more supply comes into the market. If there is one thing you can count on it’s that most companies will buy at the wrong time and sell at the wrong time. Purchase price multiples drop precipitously and M&A activity may grind to a halt. If things get really bad, there may be no buyers in certain industries regardless of price.
Also, you can count on the bankers to clam up and not be lending at all during the downturn. There’s that old joke that a banker is a person who gives you an umbrella when it’s sunny out and asks for it back the moment it starts to rain. We should not blame the bankers, though, as we have no innate right to their money. The truth is, I’d rather lend money during good times and horde it during bad, as well.
Eventually, the economy adjusts and the down market turns. Companies slowly start to hire again and selectively start shopping for good deals in the M&A market. After a little momentum, Boards of Directors, starved for growth, start beating the drum for it. And, the party starts again.
There are many ways to value a business. One common method is to applying a multiple to the company’s revenue or earnings. For example, if similar companies as yours are selling for five times their earnings (net profit), then a valuation of your company based on using a multiple would be calculated by taking your earnings (usually the trailing 12 months of earning) and multiplying by five.
All of this discussion about identifying a hot M&A is meant to help you select the right general time to sell your company. During a hot market, your sale will close more easily and for a much higher price. Higher prices are the result of multiple expansion, which is the term that refers to an environment in which sale multiples are increasing as a result of a lot of M&A transaction activity.
Exhibit 1 below shows average M&A multiples from 2003 to 2015. The multiples are based on EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation and Amortization. EBITDA is a commonly used measurement of the cash a company is generating. The highest U.S. multiple is 11.2 in 2007 before the financial and housing market crash; the lowest multiple is 7.4 in 2009 during the bottom of the Great Recession.
Assuming no change in company performance, that’s a 57% difference if you sold in 2007 compared to hanging on until 2009 (or 2015)! The reality is there was a performance change for the worse in just about every company in the U.S. from 2007 to 2009. So, the lower multiple is almost certainly compounded by lower EBITDA. The result is lower multiples, lower purchase prices, longer and tougher closings and no sale options at all for some sellers.
The Discipline of Timing the M&A Cycle
Selling during a hot market can be a golden ticket. Near the peak of an expansion cycle, buyers are deluded into thinking their growth will never end. They pay outrageous prices and ignore risks. If you sell during an expansion, even if you don’t sell right near a peak, everything about your deal will better than if you sold during a contraction – price, timing, legal terms and conditions. You want a stock sale instead of an asset sale (for the important differences between stock sales and assets sales to you as the seller, read Ways to Structure Company Sales & Purchases. No worries. Buyers will roll over. This tale of irrational exuberance has played itself out over and over and over. There is no reason to expect it to stop anytime soon. Herein lie the seeds of your opportunity.
Be patient and wait for a great M&A market. Remind yourself that this time it is no different. It’s just another example of a typical business cycle. Most importantly, do not try to hold on for maximum price. This goes back to step 1 – just make sure we are in an expansion.
Be content to get an excellent price. If you follow my advice you will do very well. It is actually quite simple to ensure you collect an extra 20%-40% as compared to selling at the wrong time. Note that the high end of the range I just gave – 40% — still isn’t as high as the 57% actual difference we just saw between the market high and lows from 2007 to 2009. That is because I do not want you chasing every single last penny.
It is tempting to hold on and ride the expansion express. Your company’s performance will be increasing at the same time sales multiples are expanding. Every day feels like more money you’ll eventually get when you sell. However, if you aim for perfection and try to time the expansion to maximize every dollar in your pocket, you are prone to miss the turn.
I said earlier that economists and experts generally agree on where we are in a cycle at any given time, just not on where we will be tomorrow. Identifying the top of an expansion period requires a prediction about the future. You cannot expect to get that right. I am not saying that you couldn’t get it right, just that you’d be lucky to do so. Peaks and bottoms are later identified with 20/20 hindsight. When we are in the thick of an expansion, you will not know when it will end. None of us will. If you keep holding on for “just a little more,” you may get hit very hard. Markets often reverse course very quickly. When hot markets reverse, acquirers overreact and many of them stop buying companies altogether.
When a downturn hits, it is common for deals that are in process to close even if the broader markets are getting hit. A deal that is already signed and waiting to close carries contractual obligations and buyers are often committed at that point.
It doesn’t mean buyers don’t walk on signed deals or at least try. Sometimes they will have a contractual right to walk; other times, they may be contractually required to close, but still head for the exits by walking away from a deal and facing with the consequences later. This is most likely to happen when the downturn is fast and furious.
As for deals that are not already under contract, there will be fewer buyers and they will be looking for bargains. The handwriting was on the wall for the company that passed on a $9 million acquisition offer and ended up with nothing. The economy was in overdrive. Turning the corner from 1999 to 2000, the NASDAQ was at ridiculously high levels. By early March, it was absolute insanity. Everyone was buying and investing in anything. I remember one of my colleagues telling me about the cab driver test. He explained, “When every other cab driver in NYC is talking about the stocks they’re buying, get out of the market.” No disrespect to cabbies, but there is wisdom in that test.
None of us knew when things would correct, but most of us knew they would correct. Sure, there were plenty of people telling us “this time, it’s different,” but most of us knew better. It just never is, at least it hasn’t been. In early March, a big correction occurred and the economy immediately started to correct.
We were buying private companies, but remember that the M&A market follows the broader business cycle, which is often reflected in the prices of companies in the public stock market. At that point, we were still looking to acquire the right companies. However, our expectations for what we ought to pay were radically changed from a few months prior. The seller I mentioned was a financial services information provider. It’s ironic, if anyone should have been able to time things a little bit, it should have been a company that sold information about the financial markets.
The Danger of Being Greedy
That seller (and just every other!) should have been shopping itself in 1999. Every deal was closing and prices were incredible. They weren’t even looking then. They started looking right after the March correction. Amazingly, lots of buyers were still in the market at that point. There was so much money and so much “this time it’s different” hype. The $9 million was on the table by the end of May – two full months into the contraction. The M&A market was still hot, which doesn’t usually happen. The M&A market usually follows the business cycle closely.
Even then, the seller did not take the $9 million offer. They wanted to sell, but they wanted to get every last penny. They were probably thinking, too, that they could have gotten much more before the March correction. Perhaps, but that didn’t make holding out now a smart decision. Their decision making was driven by classic seller emotions. They were a strong management team, just without a solid plan, realistic perspective and overcome by emotion.
Later in the year, during a 100-day stretch in 2000, the NASDAQ lost just shy of half of its value. That’s when we showed up. The $9 million offer was long gone. Of course, that didn’t stop the seller from looking to us for a similar offer.
Of course, unreasonable expectations can show up in any market and on either side of the negotiating table – buyer, seller or both. But, in down markets values change rapidly and sellers are very slow to accept the changes.
In this case, the seller’s expectations would have been a bit high for five months earlier, but not wildly. Our expectations were more or less on point. What this all means is that the seller could have sold for roughly eight times as much just five months earlier.
This is an extreme example, compounded by the fact that the market was finally recognizing the limits of the dotcom boom and the impact of over saturation from all the venture capital pumped into the system for the past few years. Only so many new companies can make it. Still, the example serves as a cautionary warning and evidence of the old saying that “pigs get fat, hogs get slaughtered.”
In that type of market/cycle freefall, a seller has to either pull the deal and go back to running the company or reluctantly accept the new reality. I don’t have to tell you that you don’t want to face that lose-lose decision. Instead, plan your approach in advance and be ready for the emotional challenge that comes with maintaining discipline around M&A timing. When the market is going well, your company will be growing along with all the others. You will be tempted to drink the Kool-Aid and listen to those around you talking about how the growth will never stop. It will be tough to sell because you will feel like you are leaving money on the table. And, you are likely going to leave some. But, that’s okay. Don’t focus on what you might miss; focus on what you are going to get. To quote pre-President Donald Trump: “Part of being a winner is knowing when enough is enough.”
Selling your company is exciting, validating and often very lucrative. Playing armchair prophet in an effort to squeeze an extra 10% while risking losing 50% or more, doesn’t make sense. As I said earlier, no one knows where the market is going tomorrow. So, be disciplined, sell when things are good and be satisfied. Remember, the music always stops. Always. Be sure that when it does, you have a lot of shekels in your pocket, not just a “one that got away” story.
If you want to know if it’s a good time to sell your pharmacy, give ColonyRX a call and we will give you our opinion in a no-obligation, completely free discussion.