Month: October 2019

If you’re the owner of a small to midsize business, now is a great time to consider selling your business.

Simple: valuations are high — historically so.

…but that’s not likely to last much longer, so if you are considering a full or partial sale of your business within the next few years, it’s likely in your best interest to act now.

What makes now a great time to sell?

There Are Two Factors Increasing Valuations Right Now…

1. There is a large amount of cash that needs to be invested.
2. Interest rates are low.

What This Means For Selling Your Business

Simple: if you sell your business now, it’s likely you’ll make more money than you would’ve in the past (or even in the future — the market isn’t going to stay strong forever).

Why Is There So Much Cash Available to Buy Businesses?

The current bull market has been ongoing since the global financial crisis bottomed out in March of 2009. That’s an incredibly long period of growth — the longest in history. On average, a bull market lasts 4.5 years. We’re at year 10, and it’s still going.

This sustained period of growth across many of the markets has resulted in strong performance for many types of investments. Many people have chosen to lock in their gains on those investments by selling while they are high (#1 rule to investing: buy low, sell high) and now they have cash they need to reinvest.

The Buyers Who Want to Acquire Your Business

Stock Investors – The stock market, as measured by the S&P 500, is up more than 300% (at the time of this article) since its low in March 2009. Investors have profited off of this run, and many are looking to make an additional acquisition.

Business Buyers – Groups such as family offices, private equity firms, and other individual operators buy, operate, and sell businesses. Those who have bought companies over the past decade (or more) have seen many of them experience strong growth in revenue and profits. This means many buyers bought a company, watched it grow, and then had a chance to sell it at a much higher value.

Other Businesses – Other companies that operate in your industry (or a different industry) are often called “strategic buyers” and are frequent purchasers of SMBs for a variety of reasons.

These businesses have experienced strong growth, and are now sitting on a bunch of cash that they want to invest to help grow their business.

Sometimes, this is in new equipment, real estate buildouts, or hiring additional employees. Yet, many companies find it extremely valuable to acquire other, smaller companies that allow them to realize synergies within their current business, expand into new areas, or improve their position in the market.

Why Does This Cash NEED to Be Invested?

For individual buyers, the only real risk of not immediately investing gains back into the market is inflation. Money that sits idle can’t earn a return, meaning that it stagnates over time.

For other strategic buyers, though, investing that cash is required in order to achieve growth.

For Other Businesses (“Strategics”) – Reinvesting in their business is critical for future growth. When markets are strong, some business owners may start by making improvements to their business, followed by making some additional hires and expanding the office. But with a decade-strong bull market, many are still sitting on cash even after making those investments.

Many large businesses continually measure their return on capital and report this back to stakeholders to demonstrate how well the leaders are running the company. If they are letting large amounts of money sit idle, they are missing out on opportunities and doing a disservice to the company which could lead to them losing their jobs in the future.

The leaders of these companies need to reinvest that capital in order to show a strong return on capital, and when these parties have large amounts of cash, they are more likely to “pay up” for another business — like yours!

For Private Equity Funds – Simply stated, private equity funds are a group of individuals who raise money from outside investors so they can operate their “fund.” The principals of the private equity fund then invest in other businesses on behalf of the outside investors in order to generate that return.

If the principals are letting the money sit in cash (and not invest it in businesses) they will never reach the returns that they need to achieve for their investors. If they don’t achieve the targeted return, they may not be able to raise their next fund and they could then potentially be out of a job. Therefore, they NEED to invest the cash that they have.

Likewise, many private equity firms have experienced strong returns on the businesses they’ve invested into. That means they not only have more money that they’d like to reinvest back into the market, but they also have a proven track record of success — which means they’re likely to raise more money from investors in the future, which they want to use to acquire more resources (such as businesses that run parallel to their interests).

So, when owners consider “who can I sell my business to,” the groups above are two candidates that should be on your radar.

How Are Valuations Being Driven Up?

Having all this cash available drives up valuations because there are more people potentially competing for the same business.

When M&A Advisors, like Your Legacy Partners, work with clients (owners selling a business) our goal is to get you the highest price for your business. We do that by helping you improve key areas of the business, preparing quality marketing materials and then creating competition for your firm by bringing as many qualified buyers to the table as possible.

The more competition, the more people will be competing to buy your company — and the more they’ll be willing to spend to acquire it. We’re seeing this play out in today’s market, making this a great time to sell your business.

Why Are Interests Rates So Low Right Now?

There are a variety of factors that impact interest rates, including supply and demand for credit, inflation, as well as the government via the Federal Reserve (the “Fed”). Because there are plenty of academic articles and opinions on the individual reasons, we won’t discuss those in detail here.

With that said, rates are currently low — which is good news if you’re selling your business.

How Does All of That Increase Valuation?

Lower Discount Rates Used in Business Valuation

As Your Legacy Partners often talks about, the Income Approach, and particularly the Discounted Cash Flow (“DCF”) method, is often the best way to value a business because it takes into consideration the unique attributes of each company instead of simply relying on a generic multiple formula. We won’t go into deep detail about this method here.

After calculating future free cash flows for a business, the valuation expert calculates a “discount rate” to apply to those future cash flows and terminal value to arrive at today’s value. The current interest rate is a key factor in calculating that rate, so lower interest rates directly lead to a lower discount rate.

If you divide any number (In this case future value of cash flows) by 2 different numbers (discount rates) the lower discount rate will result in a higher valuation for the business.

Lower Interest Rates Entice More Borrowing to Finance a Purchase

When you sell your business, each buyer will need to determine how they are going to pay for that acquisition. There are a variety of tools and structures that can be used to acquire a business that we won’t discuss here, but a very basic list includes cash or debt.

When interest rates are high, that makes it more expensive to use debt (resulting in a higher cost of capital) and many buyers may choose to use cash, stock or other means to make the purchase. But when interest rates are low, this entices a buyer to use more debt, since it is cheap, which would allow them to buy a larger business or pay more for the same business.

There are a variety of factors to consider when deciding to sell your business and determining what value you may receive for it when you do sell. But two factors that can have a major influence on that valuation are the amount of cash that buyers have to invest and the current level of interest rates. In the current environment both of these factors are strongly in the seller’s favor, but it certainly won’t last that way forever.

So if you are the owner of an SMB, it may be well-worth your time to sell your business now — or to at least consider starting the selling process.

If you have questions or would like to discuss getting started selling your business, we would be happy to schedule a no-obligation call to decide if the time is right for you! Contact us today.