A buyer's market for businesses

In a recent issue of Inc. Magazine, the signs of the economic downturn are quite clear. The values of the top private companies in the United States are down significantly. Business values, multiples of private companies' earnings (defined by earnings before interest, taxes, and depreciation, or EBITDA), have dropped 20 percent or more compared to last year.

Uncertainty in predicting future cash flow and huge decreases in revenue are some of the reasons for the drop in values. The national credit freeze hasn't helped either, especially for high-growth companies. The lack of funds available for credit purposes has created uncertainty for companies that were on solid financial ground as recently as six months ago. The poor credit conditions are hampering working capital needs of many top-quality companies.

Many sellers seem to be open to negotiate relatively low cash on a sale and are open to extended earn-out terms. Earn-out terms allow buyers to pay for performance on future sales, earnings, or other factors dependent on conditions in the future. Also, buyers are cautious for two reasons: 1) financing availability is a challenge, and 2) many sellers with solid companies are waiting for conditions to improve rather than dealing with bargain hunters.

If you are thinking of going to market now or within the next 12 to 36 months, what should you be doing now? If the economic recovery is slow or lethargic, then consider a plan that will put you in the top 25 percent of your industry to attract a premium buyer. As a general rule, there will be more sellers then buyers within the foreseeable future. If the recovery is slow and sporadic, buyers will be more selective and consider much more due diligence with their purchases to pick the top of class.

What does this mean? a) Buyers are looking for predictable revenue streams and steady cash flow as compared to the past five years. b) Also, they are looking for industry leaders and possible IP (intellectual property) that can be sold or licensed in multiple industries. c) Buyers are interested in a shorter time frame to show significant sales and earnings growth. They are less patient with longer term financial projections.

If the recovery is V-shaped, then sellers just need to bide their time and wait for the pent-up demand for buyers to go shopping. The V-shaped recovery is unlikely based on the slow bank lending policies and regulations that seem to be hampering even aggressive bankers who want a jump on their lending competitors in this environment.

Well-managed companies should consider each of the fore-mentioned scenarios to optimize their value when going to market. What industries will flourish as the economy recovers? Inc. magazine pointed to the staffing industry to see early growth in the recovery due to the expected demand for labor. In addition, banks and finance companies historically have enjoyed skyrocketing values early into the recovery as well.

Scott T. Wait is a managing director of The McLean Group LLC, a merger and acquisitions firm. Contact him at 825-7637 or swait@mcleanllc.