Sep 10th, 2013 by Achim Neumann, President
“The overall economic outlook is unexceptional, but Main Street is more confident about the future than it has been in years” concludes a recent Wall Street Journal Article [WSJ August 29, 2013]. These findings are supported by a WSJ/Vistage survey as well as a Wells Fargo/Gallup poll, which indicate that a majority of business owners expect revenue and profitability growth in the coming months.
“Indeed” says Achim Neumann, President, A Neumann & Associates, New Jersey. “We have seen a significant upswing in many companies’ cash flows and profit numbers in the recent 6 months. However, we are not certain yet how this will translate into an immediate stronger deal flow.”
Typically, business owners who are not truly in retirement age tend to stay longer in the business when things are good, and tend to express a desire to sell when profit margins are slim. Although this approach might be logical to the business owner, it is in conflict with the buyer’s objectives most notably, that no buyer wants to acquire a business on the down trend. Further, as most business acquisitions are financed, a down trending business is much more difficult to acquire due to the reluctance of banks to finance such a purchase.
Another factor is the expectation on the sell side that the most recent “better numbers” will translate into a significant higher asking price. “This is indeed not the case,” says Gary Herviou, Managing Director, Central NJ, “as investors usually view a broader time span in determining average profitability, and more importantly, in assessing the interest payment coverage.”
This last item is of particular importance: a seller who expects to sell his business based on a six month history of better cash flow, compared to a year ago, will have a significant challenge on hand, as the (relative) increased asking price will translate into higher financing costs, resulting in a considerably lower interest coverage for investors – ignoring for a minute, that the continued growth rate is anything but assured in the coming years.
This is particularly true as the economy is only now very slowly recovering from the recession. Given the significant lower cash flows in the past three years, few investors will rush to purchase a business that is highly priced – with little “security margin. This is truly the case, as many businesses still operate below pre-recession levels.
To quote the recent WSJ article: While small-business confidence is at its highest in years, it is still well under prerecession levels. “Let’s not get too excited,” said NFIB chief economist Bill Dunkelberg, who added that its own confidence index “is still well below the average reading” over the past 35 years.
Ironically, it’s exactly these aggressive sellers who had pleaded “mercy” in the past three years by referring to the “cash flow average” of their “good years”, whereas now the “bad times “ are forgotten and only the most recent six month cash flow appears to count.
Ultimately, only an independent Fair Market Valuation will resolve this dilemma, as such assessment will clearly identify both the strong and weak spots in a company’s performance. Typically, very little time and expense is involved to establish such a key value by way of a national appraisal firm that reviews thousands of transactions for the past three years.
“Last year alone, we conducted over 150 business appraisals, “ says Neumann, “and it’s surprising that there are not more business owners who want to take a hard look at the real value of their operations by way of such inexpensive and fast means.”
As a matter of fact, overpricing will only result in generating a lot of buyer interviews for the seller with no resulting deal. Ultimately, worse yet, it will expose the business to too many investors that will never follow through with a sale and that could conceivably compromise confidentiality.
All in all, buyers and investors of small businesses will operate with a healthy prudent security margin – an approach a motivated seller should always keep in mind.
A Neumann & Associates, LLC is a professional merger & acquisition and business brokerage firm with 30 years of experience in New Jersey, New York, Pennsylvania, Delaware and Maryland that assists business owners and buyers with the business transfer process in a completely confidential manner. The company is affiliated with BBN, with 450 offices and access to a national network of qualified buyers and sellers. For more information, please contact A Neumann & Associates at 732-872-6777