M&A and the Economy Part ll: Six Considerations Affecting Sellers’ Timing

There are numerous economic indicators that are pointing towards recession or stagflation. As discussed in our previous Wire article titled M&A and the Economy Part 1: Americans are Getting Poorer, price increases driven by rampant inflation and the energy sector crisis (gas, natural gas, diesel fuel supply demand imbalances) are hurting the American public, and business owners, in a multitude of ways.

This is concerning for business owners that have been considering selling their company. Data indicates that a majority elect to sell their company due to personal reasons beyond the scope of the economy, specific market conditions, or business performance. The number one reason cited for selling one’s business is retirement (or age), which poses a key question: “How does the current economic environment affect the timing in my decision to proceed in selling my company?” This is by no means a simple question with a simple answer. There are various considerations to be made when answering this question. Let’s consider a few…

Age

The age of the owner plays a significant role in whether to decide to defer a sale process or proceed on, despite a recession. Empirical data indicates that the older the owner, the more likely they are to go ahead and attempt to sell.

Previous Recessionary Performance

The owner should look to how the business performed in previous economic downturns. If it was resilient, then consider how conditions may be different this time. Has your industry changed, such that stability and strength going through a recession is more than likely difficult? Can you sustain or even grow revenues in a brief or prolonged recession? How about holding the line on Gross Profit and EBITDA margins? Predicting the duration of a recession is nearly impossible. Therefore, keep this in mind when you sell your company: buyers will be focused on a history of Revenue and EBITDA growth and ideally sustainable Revenue growth over the next several years. Your projections will be heavily scrutinized. During what time period will that picture of growth best be represented? 2019-2021 historically and 2022-2026 projected? If you wait to sell, it may be harder (or take a long time) before you can represent an attractive picture of historical and projected financial performance. This may lead to deal terms that consist of greater contingency payments tied to the projections you release. Timing the launch of a sale process, which is often tricky, is a factor that should be taken into account with great deliberation.

Consistently Revisiting Strategy

Only by consistently revisiting your business strategy can you best prepare a business to weather an economic recession. Companies that can withstand cyclicality of earnings are more attractive to acquirers. Here, I am reminded of a briefing I shared many years ago on outpatient surgery centers. TLC Vision Centers, a premium LASIK provider saw revenues grow from $58MM in 1998 to $201MM in 2000. This was in parallel with industry procedures exploding at a 61% compound annual growth rate from 1996-2000. The strategy of TLC Vision (a first mover into the market) was to establish itself at a premium price point. It sustained that strategy even as discounters entered the market from 2001-2004. TLC’s fortunes changed soon thereafter as its procedures per center fell 75% from 2000-2003.  Management was slow to react. In 2004, they revised their strategy, pricing, and branding to better compete with discount centers. Too little too late. Revenues declined. An increase in marketing expenses to support its new value-priced centers put pressure on EBITDA margins. All the while, management had discovered that its performance was significantly tied to consumer confidence. Fast forward to the great recession in 2008-2009. Poor strategy and execution had led the company into bankruptcy in December 2009. The moral of this story is that strategy needs to be constantly revisited to ensure adaptability, not only to competitive pressures, but to withstand all seasons of the economy. Bringing this back to M&A, if an owner masters strategy, then they should be more confident in considering an exit despite recession.

EBITDA Levels & Industry Attractiveness

Typically, businesses with $2MM EBITDA or more garner greater interest from financial buyers (private equity, family offices, etc.) than businesses with less than $2MM. If your business has surpassed $2MM EBITDA and sustained or grew from those levels, and if your business operates in an industry that generates solid demand from strategic and financial buyers already (indicated by having received unsolicited approaches in the form of phone calls and letters over the past 24 months), then demand may be sustained in a recession from prospective acquirers.

Adaptable Overhead Structure Driven by Operational Excellence

Several years ago, I shared another briefing on the drastically different outcomes that 2 competitors had in home healthcare services: Lincare and American Homepatient. Both became serial acquirers in the late 1990s. Both grew top line dramatically from 1997-2009. However, when Medicare reimbursements were slashed by the federal government, Lincare was able to quickly adapt by cutting approximately $130MM in overhead, while exiting lower margined businesses. Unfortunately, American Homepatient’s revenues dropped from $387MM in 1997 to $243MM in 2009. The difference in performance between these two companies came down to operational excellence versus operational sluggishness. Lincare had a much stronger focus on operational excellence than American Homepatient. As a result, by 2009, Lincare had nearly quadrupled in size, while American Homepatient’s revenues declined, forcing the company into bankruptcy. The lesson to apply is that external shocks, like recessions, are navigated better when management has a relentless focus on operational excellence.

These factors detailed above are all areas that an owner and management can influence outcomes. This type of preparedness will point to how strong a company will be going through a recession. The stronger it is, the better your odds are to conduct a sale and still reach a favorable outcome. There are still other considerations, however, which are distinctly different than evaluating the strength of the company’s ability to weather a recession.

Due Diligence Preparedness

One of the greatest miscalculations an owner makes in selling their company is believing that the strength of their company’s market position, financial performance, and team will carry them to an extraordinary outcome in deal structuring. There is often one road bump underestimated – buyer due diligence. The owner is going to receive a barrage of 200-350 questions covering topics such as: financials, taxes, legal, IP, IT, commercial, real property, insurance, environmental, human resources, and more within a period of 8-12 weeks’ time. How well the company holds up under this intense due diligence scrutiny will determine the final deal structure, and even whether a deal is done at all. In a recessionary period, due diligence will be even more stressful and influential, due to the heightened intensity for the business to perform under headwinds. Preparing for due diligence prior to pre-marketing the business is a wise decision.

In conclusion, selling your business in a recession should be considered a viable option.  However, thinking through readiness under such conditions requires careful consideration.

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