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By Julie Garella
One of the comments I hear most often from business owners is, “I want to sell my company.” “But,” they add, “I just need a little more time to (get my bottom line where I want it, cement that new big deal, launch in a new market, recruit a new sales leader, or you name it).”
While I am all for maximizing your sales price with robust earnings, key personnel, and solid contracts, it also is important to understand the effect that external market factors have in the sale of a company. Those external factors include variables such as market multiples, interest rate cycles, and availability of capital for buyers and investors to fund deals, as well as relative certainty on the economic and political fronts.
Let’s take a closer look at the role each of these factors plays in determining whether or not the time is right to sell.
Market Multiples
Companies tend to trade at prices based upon multiples of EBITDA (earnings before interest, taxes, depreciation or amortization). After the bottom fell out of the market in 2000, the average company sold between three and five times its earnings. That means that a company with $2 million of EBITDA would have fetched a $6 million to $10 million sales price.
In today’s market, companies are getting four to seven times EBITDA on average. This means the same company, without growing its bottom line, would now be worth $8 million to $14 million on the market.
What happens if the seller hangs on because she thinks she can grow earnings to $3 million of EBITDA? She risks market multiples returning to the three to five times range, a development that would drop the sales price to 2000 levels.
Why are multiples higher today?
Availability of Capital
A large number of funds raised capital in 1999 and 2000, at the top of the cycle. When the bubble burst, these funds were left with the capital and no place to put it to work. The year 2001 came and so did the events of Sept. 11, 2001, which basically paralyzed the markets.
Investors in the private equity and venture funds have put pressure on the fund managers to put cash to work. When the supply of available deals is smaller than the amount of capital available, multiples rise, and so do prices.
What other factors contribute to being able to get a deal funded?
Interest Rate Cycles
One of the easiest ways to understand the effect of interest rates on a deal is to consider what happens to housing prices when interest rates go down. People refinance, they move into larger homes, and/or they acquire second homes or investment properties.
The same holds true in business. When rates are low, it is easier to use banks’ money to finance a transaction, and companies are more comfortable expanding.
This is what is happening in the market right now. Low interest rates are giving companies the opportunity to grow strategically through acquisition, without straining their balance sheets with a heavy debt load.
Of course, there are other issues to consider.
Timing
Remember the previous example? Think about how long it takes to increase your bottom line by 30 percent. If you have $20 million in sales and a 10-percent earnings margin, you have $2 million of EBITDA. If, in today’s market, you can sell your company for six times earnings, that’s $12 million.
If you take two to three years to increase your bottom line by 30 percent, say to $2.6 million, but you can only get four times your earnings, then you will receive $10.4 million in a sale, even though your company is earning more.
While that may not seem fair, that’s the impact market dynamics have on a company’s valuation.
External Events
The markets hate uncertainty. No matter which side of the political camp you were on during the U.S. elections last November, a decision was made, taking domestic political uncertainty out of the equation for a while.
Yet, on the other side, although no one likes to think of it, lurks the threat of a terrorist attack. As business owners, we remember the effects of Sept. 11.
Lastly, nothing is certain except change.
Markets have cycles, and no one has a crystal ball to see how long they will last or when they will end. Understanding what the drivers are that make a market ripe to buy or sell your company is one of the crucial keys to maximizing your return.
JULIE GARELLA is the managing partner of McColl Garella LLC (www.mccollgarella.com), a Charlotte, NC, investment banking firm providing strategic advice to women-owned and women-led companies in the areas of merger, acquisition, and raising private capital. She can be reached at jgarella@mccollgarella.com
(This article is reprinted from the Winter 2005 edition of Enterprising Women magazine. Copyright 2005 Enterprising Women Inc. Reproduction in whole or part is prohibited, except by express permission of the publisher.)
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