How, and by whom, valuations are established.
After a string of rough years and falling values for private companies, here's some good news: Now just might be the best time to sell a business that we've seen in quite some time.
Why? Jay C. Jester, marketing director of Audax Group, a Boston-based private equity and mezzanine firm, explains that many private equity companies and venture capital firms raised money for investment funds with capital-deployment time limits several years ago, and now the clock is ticking ever closer to midnight. "There's a ton of private equity with a fuse on it," Jester says. "You've got pent-up supply and pent-up demand coming together. There's activity in just about any sector you can think of." Of course, some sectors are hotter than others. Right now, telecommunications equipment and semiconductor companies are starting to fetch good prices again as those industries bounce back after having been down for years. For obvious reasons, companies involved with various aspects of security are hot -- home security systems, devices that control access to buildings, retinal identification. Many companies dominate various niches of the medical instrument sector, and as the population continues to age they'll command premium prices.
During the past several years, as the market stagnated, buyers eased their demands that acquisition candidates have at least $20 million in annual revenue -- in part because fewer companies qualified. More and more buyers are now willing to consider $10 million or even $5 million. Andrew Cagnetta, CEO of Transworld Business Brokers in Fort Lauderdale, Fla., reports that in the past five years individual buyers from around the world have started to check out businesses advertised by his firm on the Internet. They arrange to come here, and if they like what they see, they apply for a visa on that first trip, buy the business, and move here. Cagnetta cites Venezuela, Colombia, Canada, and Great Britain as some of the most common homelands of these new immigrants. In addition, says Phil Steckler, a principal with business brokerage Country Business in Brattleboro, Vt., a tight job market means that lots of downsized-out-of-a-job executives are looking for businesses to buy and run. Given the way private equity firms and their funds have multiplied, however, the odds are much better than they were five years ago that a buyer will be a company rather than an individual.
Even if you're not interested in selling your business right now, it's a good idea to put your company through a valuation process regularly (see "Judgment Day," page 69). You can even do a self-valuation; that's what Kelly Flatley and Brendan Synnott, owners of Bear Naked Granola, do quarterly (see "Maximizing a Company's Value," below). They would eventually like to sell a majority stake in their business, but because they're in no hurry, they can afford to wait for the perfect fit and the right price. Meanwhile they can hone their strategic plan and continue to grow.
"There's a ton of private equity with a fuse on it. You've got pent-up supply and pent-up demand coming together."
Right now, service seems to be the hottest sector. If you turn to the "Trends by Industry Group" charts on page 78, you'll see that multiples for service businesses jumped in 2003 -- meaning sellers at service businesses got a higher price per, say, net income or cash flow than they had in recent years. An example from Stanley Feldman, chairman of independent valuation firm Axiom Valuation Solutions and associate professor of finance at Bentley College in Waltham, Mass., shows how some service businesses are making the most of the improving economy. Medical practices, Feldman says, might sell for a lower multiple than dental practices (our data shows the opposite, see page 81). The difference, he says, is that dentists have the greater ability to go after discretionary spending by encouraging, say, whitening, straightening, or cleanings four times a year. Doctors are much more dependent on insurance and on the political pressure to keep health care costs down. "They're trying to pay doctors less and less money," says Cagnetta of Transworld Business Brokers. "So as doctors are bringing in less and less money, people aren't buying doctor practices the way they used to."
Retail and wholesale businesses also saw healthy increases in multiples last year. In particular, several business brokers and private equity executives report that food distribution is hot -- especially small ethnic and natural food distributors, which are being snatched up by larger companies as their fare continues to grow in popularity.
By contrast, manufacturing has drifted, with multiples of earnings neither rising nor falling much. But buyers are paying much less for book value. "There's tremendous discomfort with domestic manufacturing because of outsourcing overseas," says Bill Landman, chief investment officer at CMS, a Philadelphia investment firm. "A lot of people that used to concentrate on domestic manufacturers are trying to buy them for less." Buyers don't want to pay a lot for costly production facilities in the U.S. When they do make a purchase, there's a good chance they'll move the plants overseas.
Current owners of manufacturing concerns are doing the same. "Companies that can move quickly and adopt new market economics will receive higher multiples," says Linn A. Crader, president of Crader & Associates, a mergers and acquisitions boutique in Lake Oswego, Oreg. "And companies who don't move or stay with the old economic ways of doing business will decrease in value." This may well mean outsourcing production to someplace like China. It could mean "componentizing" -- having other, most likely foreign, manufacturers make your components, assembling the components at your own offshore facility, and selling the completed product here at a price below what it would have cost to manufacture it here. Companies with annual sales of as low as $20 million now need to consider these measures, says Crader. And this doesn't apply just to manufacturing. If services are your thing -- processing health or benefits records, for example -- you can batch them here, send them to India overnight, and have them back in the morning at 20% of the cost of doing it all here.
