I am often asked the question, “Does it really matter when I sell my company?” My answer is a resounding, “YES!”
How well your company is positioned in the eyes of a buyer matters. How much capital is available in the market to invest in businesses matters.
The right time to sell a business is when two things are true:
- You have built a great business with transferable value and future growth potential.
- The market timing is right for you and your industry.
If these two things are true – sell! You will maximize your return on investment.
Run your business as if you will run it forever, but be prepared to sell it tomorrow by understanding the value of your business and market conditions.
When you decide to sell your business can make a big difference in your return on investment for all your years of hard work building the business. If you have always thought you would sell your company when you are ready to retire, and we end up in an economic contraction then that is bad timing. The optimal time to sell a company is when your business has value that an investor wants and buyers are motivated.
So how do you know the timing is right?
There are internal and external factors that influence a business’ market readiness. The internal factors, as you developed transferable value in your business, are 100% controlled by you.
External factors dictate the amount of capital available, and thus buyer activity in the M&A market. You do not control any of these factors. Buyers are motivated to invest in companies if they believe they can get their required return on investment and this is primarily influenced by economic conditions.
Just like economic cycles there are merger and acquisition cycles. The economy leads, while mergers and acquisitions lags–So goes the economy, so goes M&A.
“There is an absolute correlation between the economy and M&A activity.”
Jimmy Elliot, JP Morgan Chase
When the economy is healthy we see premiums paid for companies and conversely, when the economy contracts, prices for companies retract.
There is what we call the three “Big Cs” that influence buyer behavior:
Cash – The availability of capital drives deals and fiscal policy impacts the availability of cash for investors. For example, The Tax Cut and Jobs Act enacted in 2018 reduced the corporate tax rate to 21 percent which increased cash reserves used for stock buybacks and also merger and acquisition deals. Due to increased free cash flow, valuations soared which meant stock values climbed. Corporate buyers use stock as currency in deals, so the higher the stock the higher the deal value. It is common for a public acquirer to use a stock swap transaction structure and especially when the owner of the business being acquired is staying. Today, strategic and financial buyers have unprecedented levels of capital available for acquisitions.
Credit – Standard monetary policy moves interest rates. If our economy becomes overheated and there is concern for rising inflation the Federal Reserve will raise interest rates to chill the expansion. Conversely, if our economy is sputtering, the Fed will lower interest rates to encourage lending to promote investment and spending which stimulates the economy. Our economy will always be tethered to consumer spending and traditionally when interest rates and the cost of capital are low we have higher velocity of money, which promotes a healthy economy, and therefore, buyers are motivated to invest in businesses.
In the Great Recession we experienced that lowering interest rates had not been an effective policy in stimulating the economy, thus quantitative easing was introduced. This is an unconventional monetary policy in which the central bank buys government bonds and other financial assets in order to inject liquidity into the banking system. Basically they print money out of thin air. This policy was introduced during the 2008 financial crisis when the Federal Reserve and other central banks around the world bought mortgage-backed securities. This policy is utilized to help stimulate the economy when lowering interest rates doesn’t get the job done. Quantitative easing is in play again with central banks around the world in the fight to keep the economy propped up in the face of this pandemic.
Confidence – Confidence in the economy drives investor behavior, as well as the consumer’s and this at times feels like shifting sand. Economic cycles and bubbles have been recorded as far back as the 1637 Dutch Tulip Mania because economies will always expand and retract in a continuous cycle. We have been through the 2001 Internet speculation Dot-com bubble and the 2008 Housing Financial Crisis. Today we now have an impending Debt Bubble and a pandemic thrown in for good measure.
When confidence is high this indicates a seller’s market in the merger and acquisition cycle and premiums are paid for businesses. Conversely, low confidence moves the cycle into a buyer’s market and discounts are given. Movement in cycles is not controlled by investors or sellers, but is the result of dynamics in our economy, the geopolitical landscape, and the health of your industry.
Gauging market timing will always depend on the health of the economy, your industry and specifically your business. Therefore, be sure your business is buyer ready so you can go to market at a moment’s notice when there is capital available and the timing is right.