George Spilka & Associates

As this article is being written, the US has either just entered a recession or is on the precipice of one, however its length and depth is unknown at the present time. Furthermore, the second quarter of 2007 saw the end of the highest level of middle market deal pricing that I have seen during my 30 year career as an investment banker. An article that I wrote in December, 2006, recommended that any owner or CEO with an interest in selling during the next 10 years should avail themselves of the “bubble pricing” that was prevalent for 2 years. Although that “window of opportunity” has closed, the positive news is that acquisition pricing remains at solid, normalized levels. To illustrate that point, I have not made any downward price adjustments on the deals that I am handling, nor do I anticipate making any in the future.

For an owner or CEO of a middle market company, defined as one with a transaction price of between $5-$250 million, that has an interest in selling their company in the near or intermediate-term, there is no reason to be hesitant about proceeding with the sale now. My experience has been that acquisition prices do not have to be adjusted downward during a recession.

This article will discuss the following strategic considerations that such owners or CEOs must be aware of and a prudent course for them to follow:

1.	Regardless of economic conditions, middle market companies should be priced based on their expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer.

2.	Savvy corporate acquirers consider acquisitions an “opportunistic” way to grow. They realize they must take advantage of an opportunity when it is available, or risk losing it.

3.	Never sell until you get a premium price, regardless of economic or market conditions.

4.	From my experience, recessions and economic downturns do not have to impact middle market deal pricing.

5.	Even if you are not initially successful in selling your company due to negative economic or market conditions, there are many corollary benefits from proceeding with the sale promptly.

If you are initially unsuccessful in obtaining a premium price for your company during a recession, don’t overreact and accept a substandard offer. Instead, suspend the sale process and take advantage of the additional time as the opportunity to allow your investment banker/acquisition consultant (hereinafter referred to as “advisor”) to guide you in strengthening your long-term business fundamentals.

Middle market companies should be priced based on their expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer.

The stock market is known as a predictive indicator not a historical barometer. A recession is usually priced into the average stock either by the time one starts or shortly after its inception. At that point, the stock market generally begins to rise in anticipation of improved economic conditions. And just as the stock market is a predictive indicator, so too should be deal pricing of middle market companies. An acquirer solely determines the value of a company based on its expected future earnings and the risk in achieving those earnings from the seller’s business foundation. The buyer’s return on investment will be determined by the company’s profitability from the date of the acquisition forward. Historical earnings have no impact on the buyer’s return. Therefore, don’t allow an acquirer to intimidate you into accepting the concept that recent historical earnings should determine the deal price during an economic downturn.

Savvy corporate acquirers consider acquisitions an “opportunistic” way to grow.
When the CEO of a leading international distributor was questioned whether his company would continue their aggressive acquisition program despite the need to effectively integrate prior acquisitions, his response was that acquisitions are an “opportunistic” way to grow. He said, you must take advantage of them when they are available, or you may lose the opportunity forever. His comments are “right on the money”. What they mean to you is that if an acquirer has a real interest in acquiring your company, they will pursue your deal when they feel they must in order to not lose the opportunity. This type of motivated acquirer will pay a reasonable, but aggressive, premium price at the time you want to sell, even if that is during a recession. Correspondingly, the current condition of the economy should not be a deterrent to consummating a deal at a premium price.

Never sell until you get a premium price regardless of economic or market conditions.
Unless personal needs and considerations overwhelmingly dictate otherwise, never sell until you get a premium price. There should be no deviation from this rule. You only sell your Company once. If you meet initial price resistance from acquirers, remain firm in your demands and don’t discount your price. If your advisor knows value and has properly established the premium price, you will eventually obtain it.

From my experience, recessions and economic downturns do not have to impact middle market deal pricing.
Although many acquirers do not reduce their acquisitive drive during a recession, the vast majority attempt to use the downturn as an opportunity to prey on poorly advised, weak-spirited sellers by telling them they will only be able to sell during a downturn if they accept a reduced price. Unfortunately, most selling owners accede to the demands of these acquirers. They accept the premise that the acquirer must be protected against an earnings shortfall during the downturn without demanding that they receive additional value for the increased earnings that will ensue when economic conditions improve. These owners forget that middle market deal pricing should be a predictive indicator. However, my experience has been that this does not have to occur. During the downturn of 2001-2002, I did not discount the price of any selling client and managed to consummate three deals at strong prices. Furthermore, during the 18 month period of the significant recession of 1991-1992, I consummated six deals, all of which were premium-priced and were for 100% cash. If you have the will to defend your position and negotiate from strength, you can usually force an acquirer to pay a premium price regardless of economic conditions.

Even if you are not initially successful in selling your company, there are many corollary benefits from proceeding with the sale promptly.
Except for companies in industries with major structural problems, such as home building, or firms with company–specific problems such as a significant weakness in its long-term business fundamentals, there is no reason for a company not to proceed to the market during a recession. If the sale of your Company is handled by an expert, sophisticated advisor, you should be able to successfully sell your company at a premium price during a recession.

However, let’s assume you are not successful in consummating a sale during the recession, there are still numerous benefits from having gone to the market at that time. Once you start the sale process, the acquirers that are initially contacted will be aware that you are interested in selling your company at a premium price. Even if they reject the acquisition, they will now be aware that your company can be acquired. Correspondingly, if their needs change and they later perceive your company as an “opportunistic” way to grow, they will be able to quickly make contact with you.

Many novices believe there is a negative price impact, if a company has been for sale for a long time. In my opinion, nothing is further from the truth. When a middle market company indicates they are willing to sell at a reasonably aggressive, premium price; it is not unusual for many acquirers to be skeptical of the seller’s resolve and ability to accomplish that. They believe that if the seller isn’t initially successful, they will lower their pricing expectations. Sellers that don’t reduce their price expectations after meeting initial market resistance, make acquirers aware that their resolve is unbreakable. They then realize the only way to buy the company is by paying a premium price.

If you are initially unsuccessful in obtaining a premium price for your company during a recession, take it as an opportunity to allow your advisor to strengthen your long-term business fundamentals.
As previously defined, the true value of a company is based on its expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer. The business foundation is basically the long-term business fundamentals of the company. These fundamentals include such things as the strength and protection of its market niche, the scope of its market presence, the breadth and depth of its customer base, the efficiency and cost effectiveness of its production and/or warehousing operations, the capabilities and depth of its management team, and its ability to take advantage of future growth opportunities, etc. To the extent these fundamentals are strong and position a company for growth and limit its downside risk, the multiple an acquirer will pay for any level of earnings should tend to be higher than it would otherwise be. Therefore, if you have retained an advisor capable of evaluating your business fundamentals, they can guide you in establishing a program to strengthen them. You can implement this program before reinstituting the active marketing of your company. This program should eventually increase your earnings while reducing the threats to and volatility of future earnings. This should fortify your ability to sustain an increased transaction price.

Summary
Do not accept the prevailing wisdom that a recession means a selling middle market owner can’t obtain a premium price for their company. It is wrong. From my experience, recessions do not negatively impact middle market deal pricing, when transactions are handled by a sophisticated advisor. Savvy corporate acquirers consider acquisitions an opportunistic way to grow. They realize they have to pay a premium price when a company wants to sell or risk losing the deal. Consequently, if your personal and corporate objectives dictate that you proceed with the sale of your company now, there is no reason that a recession should deter you from proceeding towards that goal.