Sell or Hold- Interview
5/15/2009
M.A.: Should clients "Sell" or "Hold" in this market?
S.W.: I have never had so many people ask me this question. My standard answer is that I don't have a crystal ball, but I will tell you that forward risk is extremely high. High risk generally requires a longer time horizon. In today's high risk environment, "selling" or "holding" is a decision that should be made with both personal and financial considerations in mind. Because it is within the realm of possibility that our current crisis could last for the next five years, if your clients don't have upwards of a five-year time horizon and capital resources to withstand a potential serious downturn then the time to sell may be now, while they still have a choice.
For many, this news goes beyond the economic simulations and forecasting models. It's about reevaluating personal life plans, an assessment that many people have never fully explored because they are too busy operating their businesses.
Key questions they should ask themselves include: "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 a serious downturn?"
M.A.: You are reported to have said strong companies are getting premium prices, even in today's market. Many people just cannot fathom this. Can you elaborate?
S.W.: In most industries these days, if the company sales are flat or growing the business is considered an "outperformer". The amount of available private equity capital is down by roughly 50% year over year. However, the number of "outperformers" are even lower, down by approximately 80%. That means substantially more buyout and recapitalization money is available per outperformer, and as a result, these companies are commanding premium prices. If the target company falls into this category and the Owner does not have the gumption to ride out the continuing downturn, it is probably a prudent decision to sell all or some of the equity in the company now. If the Owner does decide to hang in for the long haul, he/she needs to be sure to have a plan to raise capital so they don't find themselves in a cash crunch. Raising capital in the most effective manner, whether an equity or debt raise, can be a complex issue which will usually require assistance from a seasoned investment banker.
On the other hand if company sales are down, visibility low and the Owner does not have at least five years to ride the wave and the capital resources required to support the downturn, it may be wise to consider an exit or partial exit such as an ESOP (Employee Stock Ownership Program), merger or recapitalization. The idea is not to get caught in a squeeze play like 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."
M.A.: Is cash still "king" right now for those selling a business?
S.W.: Yes, leverage is relatively low. Prior to the banking crisis, on average, sellers were able to borrow 60% - 70% for lower-middle market transactions. Now 40% - 50% is more common. This creates the need to put much more cash into the deal or secure seller financing or mezzanine debt.
If the transaction price were to stay unchanged in this low leverage environment, the return on invested capital ("ROIC") would be significantly lower. In order for the Buyer to achieve an acceptable ROIC the transaction price needs to be reduced. Obviously, Sellers don't favor lowering the price to accommodate the lower leverage. Therefore, many Sellers are supplementing the bank by holding a note at the senior secured rate. If the amount of the note makes up for the lower leverage, then the required ROIC can be achieved while maintaining the higher price.
I've never met a Seller that wanted to hold a note. So, the bottom line is that cash is more valuable when leverage is low. The ultimate benefit to the Buyer will be a lower price with better terms (compared to another buyer bringing less cash into the same deal).
M.A.: What advice do you give clients who decide to hang on to their businesses but need more operating capital?
S.W.: Tell your clients their company is a portfolio of opportunity and analyze the amount of risk/concentration across such issues as customers, markets, products and management. In these extremely challenging times, we are seeing numerous underperforming companies - many for which survival is questionable- merging with another company as a viable solution. The objective is to reduce the overall cost of operations and/or enhance sell side opportunities. If the merger is successful, then the conversion of two unstable operations into one stable business will produce a fruitful outcome for both parties.
Make sure they consistently review their balance sheet. Analyze working capital needs and available credit on a weekly basis. With the substantial lack of availability in the current economic climate, it is imperative to have financing sources lined up just in case there are more bumps in the road ahead. If an equity offering is not in the cards, consider alternative debt vehicles.
Leverage and covenants for conventional commercial loans have been significantly tightened. If your clients find they cannot access enough credit through conventional means then consider receivables financing, factoring and purchase order financing from smaller, nimble financial service companies. Or perhaps they can secure mezzanine funds - which will charge a relatively high interest rate on the unsecured portion of the loan (currently 20% is common) and may take warrants as well. Here is where advisors play a critical role, as interest rates and costs can vary substantially. The key to securing the best deal for your clients lies in your expertise to negotiate and structure the terms.
M.A.: How can advisors be most effective to their clients in today's volatile environment?
S.W.: Clients need more high-touch service than ever before. It is critical to understand their fears and proactively address their concerns.
Surround yourself with a team of "go-to" specialists you can recommend to enhance your client's experience. Try to match them with the best advisor for their personality and business situation.
Don't be afraid to "burst their bubble" if their assumptions are way off. You are an advisor, not their friend. What business owners need now more than ever is someone to talk honestly about their situation and sometimes that means delivering unwelcome news.
When your work is complete, ask them to provide feedback on your performance - a quick electronic survey or a more informal one will give you the information you need to improve your service and shows you care about your client's experience.
M.A.: Thank you.
Scott Waxler is a former winner of the M&A Advisor's "Deal Maker of the Year" award and the Managing Partner of LockeBridge, LLC, an investment banking firm that works with middle-market companies located in Lexington, MA. In our ongoing coverage of today's market conditions we asked Scott his thoughts on the continuing middle-market conundrum: "sell" or "hold."
