Sell or Hold? Strategizing in a Turbulent Market

4/03/2008

Reprinted from Mass High Tech

 

Inside Finance Strategies

 

During this Volatile Economy how do you, the business owner, diversify/preserve Your investment in Your business?

By Scott Waxler
Managing Partner, Lockebridge, LLC

If your like most business owners who operate in the Lower-Middle Market (i.e. enterprise value between $5M – $50M), a substantial, if not most, of your net worth is invested in your business. Most well respected wealth managers are now touting: "Preservation of Wealth” and “Diversification of Investments" as the theme of the day. During this Volatile Economy how do you, the business owner, diversify/preserve your investment in your business so that you are not risking the majority of your net worth? For those owners who wish to take some of the chips off the table there are plenty of options such as ESOPs, mergers, laddered equity offerings and recapitalizations.

Preserving Your Equity

After 25 years of blood, sweat and tears many small business owners are watching the equity value in their business wither away. For businesses which are still growing, most owners are scrambling to preserve the current entity value. Their main focus is cost-side restructuring and increasing market share through aggressive discounting. But what happens when you have wrung out most of the costs and the prices are barely covering the overhead? In these tough times savvy owners are able to stand apart from the pack by executing alternative solutions. Such solutions include acquiring or merging with synergistic companies and selling a stake of the business in order to diversify and preserve the years of hard work that went into building the business. The last CEO I spoke with about the above issue stated the following: “I agree with the diversification strategy but I hear about owners which have attempted to sell all or part of their business only to receive lowball valuations and/or a lack of bids or no bids at all.”

Premium Prices for Attractive Companies

Regarding the above comment, strong companies are always in demand and command a premium price.For companies which are facing difficult times, merging with another company, also facing serious challenges, can result in preserving equity value while creating substantial cost saving synergies. Owners of companies which are flat or growing should know that they are in the minority and are considered outperformers. The fact of the matter is that the reduction in the number of attractive companies has far exceeded the reduction in investment capital. While the amount of U.S. Buyout Fundraising through Q2 2008 has been reduced by approximately 16%, on an annualized basis (refer to chart) the percentage of middle-market companies which are flat or growing or have strong growth opportunities have shrunk by an estimated 70% over 2007 levels1. This supply and demand imbalance translates into premium offers for the outperformers.

As a firm which focuses on representing outperformers, LockeBridge is receiving more inquiries from private equity groups (“PEG) than ever before. Although capital raising is always a challenge, currently the biggest challenge for the PEG is finding good companies in which to invest, as opposed to raising capital. They simply cannot find companies with strong historical performance and/or growth opportunities. As such, these companies are attracting multiple bids and premium values.

Seems that every week I get a call or two from a business owner asking me about market conditions and the impact on valuations vis-à-vis an equity offering or outright sale. As Warren Buffet stated, “I have no insight regarding the direction of the economy over the next year or two.” I tell the business owner “we are operating in an extremely high risk environment which may very well continue to be challenging over the next five years. As a potential Seller, if you don’t have upwards of a five year time horizon and capital resources to withstand a potential serious downturn in your business then the time to sell is now, while you still have a choice.” As a buyer, there are certainly plenty of bargains for those that have the appropriate time horizon, capital resources and sweat equity to outlast the current economic havoc.

Look Inside Yourself

For many, if not most people, the most valuable insight into the question “Should I Sell of Should I Hold” does not lie in economic simulations and forecasting models. For most of us we need to look inwardly, beyond the numbers, to asses our personal life plan. An assessment which many people have never taken the time for deep and deliberate contemplation.

As a business owner who has started several businesses and outlasted numerous downturns, at each economic down cycle I have, on several occasions, asked myself questions such as: Am I at a time in my life where risk reduction is favored over high potential earnings? What will be the impact on my life and that of my family’s if the next several years do not pan out? Do I have enough endurance, drive and support to work the long hours required to withstand as serious downturn ?

The Bottom Line

In most industries, these days, if the company sales are flat or growing the business is considered an outperformer. Although the amount of private equity money is down this year, the percentage of outperforming businesses is down much more. Therefore there is substantially more buyout and recapitalization money available per “outperformer”. This results in premium prices being paid for such “outperformers”. If your company is indeed an outperformer and you don’t have the gumption to ride out a potential downturn, it is probably a prudent decision to sell all or some of the equity in the company now. If you in it for the long run, the business owner should have a plan in place to raise capital if he finds himself in a cash squeeze. Raising capital in the most effective manner, whether it be an equity or debt raise, usually requires the services of a seasoned investment banker.

On the other hand, if your company sales are down and visibility is low and if you don’t have at least five years to ride out a potential serious downturn as well as the capital resources required to support such a downturn, it may be a prudent idea to consider an exit or partial exit such as an ESOP, merge or recapitalization. The idea is not to get caught in a squeeze play such as reported by Cerberus Capital Management, the owner of Chrysler. As Robert Nardelli, CEO of Chrysler, put it “Looks like things have gotten so bad so fast that protecting principal is the cause of the day at Cerberus”. Too many owners have worked too long to risk losing all of their equity over the next year or two. After many good growth years, most owners still have substantial equity value in their business. Which strategy to pursue may be complex, requiring significant analysis and external consultation.