Business owners are constantly faced with decisions to make. Not only are they responsible for the success of the business but also the well-being of employees, family members, and stakeholders. Outside of all of the day to day decisions, there is one decision that business owners do not even realize that they are making. Every day a business owner makes a decision on whether to keep, grow, or sell their business. Now this decision is many times not apparent because most of the time it is not a conscious decision. When you boil it down, every decision you make shapes the decision of keep, grow, or sell. This is why it is important to sit back every once and awhile and assess where you sit on this spectrum as a business owner.
This article will focus on why now is an important time to focus on the sell part of the spectrum. Every business owner that I work with has some type of plan for the future. It may be a 3 year plan, a 5 year plan, or a 10 year plan. The timing is irrelevant and what is important is that every business owner has a longer term plan. For those owners that have retirement, business sale, or even simply a scale back of hours this will be particularly important. This is one of those times where a number of events are coming together to make this an ideal time to put your succession into place now.
Reason #1 – High Valuations Make an Exit Attractive
Business valuations are like real estate in that it really does not matter until you are ready to sell. The interesting thing is that while business owners have a majority of their net worth tied up in the business, only 2% of them actually know the value of their business. While most business owners are very aware of revenue, costs, and profits this is not necessarily an indication of the value of their business. As we sit in one of the longest economic expansions of all time, this valuation becomes even more crucial for those that are looking to exit in the next several years. Here is an example of why valuation matters. First of all, we have a chart that shows how valuation metrics are at an all-time high.
While every business is different this gives an idea of what private equity is paying 12.3x EBITDA on average vs 10.4x EBITDA back in the first quarter of 2016. There are a number of different reasons for why multiples change including the economy, interest rates, availability of credit, etc. One can argue that the economy is slightly better today than it was in 2016, interest rates are about the same, and credit availability is better.
Let’s take a look at a few different scenarios that demonstrate what would happen if valuations simply went back to where they were in 2016 and what it would mean for the value of your business. Again this does not even include the effect of a recession which would hurt both EBITDA and the multiple you could receive in a sale. This demonstrates that you would have to grow EBITDA by 7% a year for the next 3 to be better off than where you are today.
Reason #2 – Low Interest Rates
Interest rates are currently very low on a historical perspective and expected to go lower as the Federal Reserve begins to cut rates. Low Interest rates are important because it provides potential buyers a lower hurdle for their investment and thus they will be willing to pay more for your business. Very few economists and financial strategists have been correct about the direction of interest rates over the past several years. Most have expected interest rates to move higher and normalize as the economy has continued to rebound from the 2008 financial crisis. This has not happened and now there are many parts of the world that have negative interest rates. While future direction is a coin flip at best, the one thing we do know is that interest rates are historically low and that should be enough reason to use it to your advantage.
Reason #3 – IPO market is strong
There are a number of companies that have come to market this year and some of them in very high profile fashion such as Uber, Lyft, Beyond Meat, Slack, Pinterest, and WeWork. In fact, we have seen the most companies with negative earnings come public in the last year since 1999. While there are a number of reasons for a company to list on an exchange the most important at this time is how that money is used to fund the business. Similar to the private valuation we discussed earlier, the higher the stock price a company can receive in an IPO the more capital that company will have to invest in the business. It is no coincidence that we have so many companies coming public at the same time. While the party may last awhile longer, it is a good cue for private business owners to realize there is a party and you should enjoy it before the inevitable hangover.
Reason #4 – Mergers and Acquisitions are strong
Similar to the amount of companies that are going public there are also a high number of mergers and acquisitions at this time. While every year will provide mergers and acquisitions the important thing to look at are the number and size of each transaction. The below chart shows this by year and while there is still several months to go in 2019 we are tracking above average. One thing that is interesting is that both size and value tends to peak before an economic downturn.
Reason #5 – Near Top of The Economic Cycle
Economists and financial strategists spend countless hours trying to predict the economic cycle. In many cases, the signs of a slowdown or a pickup in the economy do not become obvious until after the fact. However, there are certain attributes that are evident right now that can lead you to believe that things cannot get much better. While economic cycles do not end of old age, we are currently in one of the longest economic expansions of all time. Additionally, we have unemployment rate that is well below the previous 3 cycle lows and very low on a historical perspective at 3.63%. Given that this is not where I want to make predictions about where the economy is going it does put in perspective where it could be in the next several years because at some point we will see a contraction.
Reason #6 – The 2018 Tax Law Has Provided Big Tax Benefits
For years real estate investors have grown wealthy from benefits in the tax code that provide for deferral of capital gains. One particular area is a 1031 exchange in which a real estate investor could trade one income producing property for another and not pay any taxable gain. This has allowed real estate investors to buy and sell properties with increasing value and income with no tax effect. In the 2018 tax law there was a provision that extended this benefit to other areas of capital gains into what are called Opportunity Zones. If an investor takes the capital gains and invests in either a business or real estate in a Qualified Opportunity Zone they will get a tax deferral for up to 10 years, a reduction in the tax owed up to 15%, and no capital gains on any investment gains within the Opportunity Zone. For the first time ever, someone can sell their business and use the proceeds to invest in an Opportunity Zone and receive tax advantage similar to or even better than a 1031 exchange. While there is little use in speculating on the political future of this tax advantage it is in place now and ads more incentive to act.
While there is never a perfect time to sell a business there are plenty of reasons why now is a great time to consider it. Even if the ultimate decision is not to sell the business, taking the steps to understand your current business value and what options are available is prudent.