As this article is being written during the third week of March, there are many reasons why middle market owners wanting to sell their companies during the next 10 years should consummate a sale no later than 2014, preferably sooner. Although most points discussed in this article pertain with equal relevance to all companies regardless of size, the article is primarily directed at middle market companies, which are firms with transaction values between $5 and $250 million.
I am more optimistic about the prospects for the short- and intermediate-term (the next 2-3 years) acquisition market than I was last year, when I syndicated an article on the then current state of acquisitions. 2012 should be the best time to sell a company because of the likelihood that market conditions will be strong. They will probably continue that way through 2013 and quite possibly 2014. After that, the market becomes problematical. However, I am much more negative about the longterm than I was last year.
Sometime before the end of this decade there is a strong possibility that a catastrophic downturn will occur and have a devastating impact on the U.S., and probably the global, acquisition and financial markets. Its impact will be far worse than the Great Recession and will be triggered by either a major event or a confluence of events. The impact will far exceed any business collapse since the Great Depression. The economic conditions it creates will remain for an extended period of time, much longer than from the Great Recession. It will have a devastating effect on the market value of U.S. companies. When it happens it will start suddenly and unexpectedly, just like in 2008. The public will express shock and amazement as they did then. No one saw that coming either.
The major reason why these significant negative events always occur so unexpectedly is because it is in none of the major financial firm's self-interest to forecast catastrophic economic or financial market conditions that are on the horizon. It would severely impact their business. And, as we all know, the major financial firms think first and foremost of their self-interest.
Why you should sell promptly
The following are certain reasons why you should consummate a sale by not later than 2014, and preferably by the end of 2012 or 2013:
- Acquisition pricing is very strong now. I would anticipate it will remain this way through the end of 2013.
- It is likely there will be a second Obama Administration. In order for them to start significantly reducing the deficit, it will require more than spending cuts, as there are not enough spending cuts to make without harming the very structure and fabric of the U.S. Correspondingly, it will necessitate an increase in taxes. These revenue raising measures will primarily be focused on increasing the taxes on the wealthy, possibly significantly. One of the taxes almost certain to be increased is the capital gains tax. I expect it to be increased to at least 20%, if not 25%. If it is increased to 25%, your net after-tax sale proceeds have just been reduced by 10%. This is a sizeable hit.
- Numerous private equity (PE) acquirers have a pressing need to invest capital promptly. Many of these funds received money from their investors in 2008 before the market crashed. That money basically sat idle for 2 and a half years. The PE firms are now under tremendous pressure from their investors to get that money invested. This is driving these firms to invest that money quickly. For certain good companies they are willing to overpay if they have to, rather than risk losing the deal. This has produced some attractive selling opportunities.
- U.S. corporations are flush with cash and have extremely strong balance sheets. This makes strategic acquirers very aggressive in the acquisition market and willing to pay strong multiples.
- The stock market performance during the first 2 months of 2012 has been extremely good. This has been a contributing factor to an increasing level of optimism and buoyancy in the business community.
- The interest rates are low and should remain low through the foreseeable future. I don't anticipate the Federal Reserve deviating from its stated policy of keeping interest rates low until 2014. The majority of the Fed Governors don't feel it is worth the risk to implement a restrictive monetary policy, as they believe that the premature implementation of a restrictive monetary policy was a major factor causing the depth and length of the Great Depression.
Why a catastrophic event is likely to occur in the longterm
The following are certain reasons why the U.S. is likely to be faced with a catastrophic economic and financial scenario by the end of the decade. I expect this scenario to last for a long-time and be much longer and worse than any we have endured in our lifetime.
- Although the European economy and financial mess has not been in the news as much during the past few weeks, the problem is far from receding. The European Union (EU) is basically dysfunctional in this situation due to its structure. There are too many countries that have to make decisions that then must be sold to their own disparate domestic constituencies. This negates the dramatic action necessary to begin extracting many of these countries, such as, Greece, Spain and Portugal from their disastrous situations. Furthermore, it appears the EU is trying to defer the problem basically hoping it will go away or they will discover a painless solution to it. However, that is not going to happen. The European banks are also in a very weakened condition. This will impact the world economy, as these banks have financial relationships with the world's major financial institutions.
- The combination of problems the U. S. faces including its huge budget deficit, the economic stimulus still required to get the economy back in a self-sustaining mode, the disparity of income between the "haves" and "have-nots" and the gridlock between the warring political parties creates a situation that becomes an almost intractable problem. The U.S. must find a way to bring its deficit under control over the next 3 years without doing anything precipitous that would push the economy back into a recession. This will be very difficult with our dysfunctional political system that is gridlocked. If these problems are not solved promptly, the country's economy and financial markets will be in very precarious shape.
- The emerging markets have driven the world's economy for more than a decade. However, current problems and others on the horizon will diminish the positive impact of the emerging markets on the global economy. The growth in China has slowed. In addition, the four major banks are all state-owned. They have been propping-up many failing state-owned companies. In turn, these banks have been supported by the national government. Correspondingly the Chinese financial system is not as healthy as it appears to be. The slowdown in China's growth will have a substantial negative effect on all countries, but especially the resource exporting ones. Brazil will be one of the most affected, as China is its major trading partner. This coupled with Brazil's uncompetitive and dying industrial sector could cause a major slowdown in Brazil. India is now facing its highest unemployment rate since 1983, its lowest growth rate in two years and an ineffective and corrupt government incapable of solving the country's fundamental problems. Overall, the emerging markets are not going to be the world's growth engine they used to be. This could have a major impact on the developed world's economies.
- There are numerous geopolitical hot spots. The major ones are in the Middle East, including Iran with its threat of nuclear weapons. This is exacerbated by the potential of an armed conflict between Israel and Iran. There is also the nuclear threat in North Korea that now has a 27 year old, possibly unstable leader leading its charge for nuclear weapons.
As you look at the many significant negative things facing the world, it is very unlikely that enough of these problems can be avoided to avert not having a dramatic negative impact on the acquisition and financial markets.
The necessity for expert advice on planning and timing the sale during this risky period
You should retain an investment banking (IB) firm that can position your company and guide and time its sale. You do not want to do this yourself or use a firm that doesn't have unique and specialized acquisition market knowledge.
It is essential that you do not miss the "window of opportunity" that you have to realize a premium transaction price during the next 2 or possibly 3 years. This becomes even more critical, when we remember the devastated acquisition market conditions caused by the Great Recession from late-2008 through the third quarter of 2010. You need an IB firm, whose fundamental philosophy is to consummate a sale only when their clients have obtained the optimum price, not one that just wants to close a deal quickly at any price. Your advisor should be willing to spend the time to position and time the sale, so that it generates the maximum transaction price.
The current period presents a window of opportunity to obtain a premium price. However if this window is missed, there is a substantial long-term and likely long-lasting risk that the company's value will be significantly reduced due to events beyond the seller's control.
It takes an extremely perceptive and sophisticated executive to understand the incredible level of risk lurking over the global economy and correspondingly their company's value for the remainder of the decade. If these risks come to fruition, it could have a catastrophic effect on the economy and financial markets. The best time to cash-out for anyone that expects to sell their company in the next 10 years is by doing so no later than 2014, and preferably by the end of 2012 or 2013.
About the Author: George Spilka is president of George Spilka and Associates, a national investment banking firm based in Pittsburgh that specializes in middle market, closely-held corporations. It has a broad-based service that advises clients through the entire acquisition process. Its client base has included a diverse group of distribution, manufacturing, construction and service companies. Spilka has been advising middle market companies in the sale of their firms since 1978. For more information go to www.georgespilka.com; call 412-486-8189; fax 412-486-3697 or email at email@example.com