Buyers are looking for companies. Sellers are ready to exit. So how come nothing's moving?

Times are tough for business owners who are ready to sell their companies. Compared with the profitable exits of the mid-to-late 1990s, valuations are lower, credit is tighter, and buyers are more demanding.

Although the buying and selling of small companies is not typically detected by the radar of financial-tracking services, the numbers those services publish are still useful for small-company owners. That's because low-priced mergers and acquisitions are affected by the same market forces and follow the same basic trends as their big-ticket counterparts. And that's been bad news for Inc's community of entrepreneurs.

Consider some numbers. Last year saw a 16.4% drop in the number of transactions completed -- the greatest year-to-year decline in mergers-and-acquisitions deals since 1987, the year of the "Black Monday" stock-market crash. When measured by deal value, as tracked by Mergerstat, the toll looks even worse: total deal value fell from $1.3 trillion in 2000 to just over $700 billion in 2001, a drop of nearly 50%.

Inc's Business for Sale column featured 20 businesses from April 2000 -- the month the dot-com bubble burst, fueling the United States' economic nosedive -- to November 2001. (See " Make Me an Offer ... Please!" below.) Only 10% -- meaning a grand total of 2 -- of those featured businesses were sold: the southeastern seafood distributor and the midwestern outdoor-advertising company. But with nary an offer in sight, owners of 9 of the candidates took their businesses off the market, usually with some plan to better position themselves for a sale at a later point. One owner simply gave up and closed up shop.

For the eight Business for Sale candidates still trying to attract buyers, and for the many entrepreneurs across the nation with exit strategies on their minds, there are lessons to learn from all this. First and foremost, the old rules (that is, those relatively new rules that we came to accept during the 1990s as the way business life was meant to be) no longer apply. What will replace them? Who knows? It's not clear how long it will take the M&A marketplace, at all levels of deal size, to rebound -- and how it will rebound -- even after the overall economy gets a solid footing on the recovery path.

Until then, today's creative chaos will be the norm. So long as buyers expect bargains and sellers expect the high payoffs that until recently were the norm, the negotiation process will remain thorny. The only deals that will get done are those in which the sellers aren't willing to wait for better days. Buyers with cash on hand will dictate the terms of the total package, which will undoubtedly include a lower asking price but maybe also real estate, earnout agreements, seller-employment contracts, and noncompete clauses. Sellers who resist will need to either accept stock deals, which are especially problematic in volatile economies like this one, or help finance the acquisition themselves. All in all, it's a far cry from the conditions that flourished during the mid-to-late 1990s, when entrepreneurs whose companies had strong growth prospects often had multiple suitors courting them and a host of attractive deals to choose among.

The sellers and buyers who thrive in this marketplace are flexible in their strategies and actions, capable of moving quickly, able to find capital (somehow), and above all else, continually adapting to change.

Deer in the Headlights

If there were ever a dream business, it would be Gary Koeppel's coastal California art gallery. The company, which includes craft shops, a restaurant, and a home site, has just about everything going for it: breathtaking views from its location atop the cliffs of Big Sur, a record of profits, and cash flow so robust that it supported $150,000 worth of annual owner's compensation. Plenty of would-be buyers contacted Koeppel after the gallery appeared in Inc's June 2001 column, but nobody made an offer. And the owner, an academic-turned-entrepreneur, knew that he had no choice but to listen to what the market was telling him.

"I never would have known this without the experience of putting the company up for sale and then getting all that feedback," he reports. "People were worried that the cash flow -- although it was very good -- wasn't high enough to justify the very high price of my real estate." It is remarkable that that was the case even in a sure-thing real estate market. Buyers were cautious.

Some people proposed purchasing the gallery, craft shops, and restaurant and leasing the building and land from the owner -- "I could have sold it 20 or 25 times that way," Koeppel says -- but he wasn't interested in becoming a landlord and wanted to cash out all at once. So instead he decided to focus on boosting his revenues and cash flow to levels so high that the disconnect between the business and the real estate would disappear. "I'm doing the same things that a buyer might have done to accelerate growth," Koeppel explains, "including working on a high-quality mail-order catalog and creating a Web site that will attract a big volume of sales."

Listen to the market. If it's telling you that your cash flow is too low or your sales price is too high, you have to either respond or kiss your sale prospects good-bye. It's noteworthy that two of the eight Business for Sale candidates that are still on the block have reduced their asking prices. Only one company, the California dining-yacht service, raised its price, which took chutzpah. The price hike, however, may be justifiable, since the recent addition of a valuable asset (a new boat) may help a buyer get financing.

In this time of dropping valuations many would-be sellers are like deer blinded by headlights: they're paralyzed. Since they aren't willing to lower their expectations, they've taken their companies off the market and hope for better days. But there's little evidence that we'll see a return anytime soon to the valuation levels of the mid-to-late 1990s.

Meanwhile, even in industries in which valuations have remained relatively stable, prices have been dropping. "It's a very tough environment out there," says Mike Sharp, a business broker at IndustryPro, based in Midvale, Utah. "If you've got a company whose cash flow or profits were lower last year than they have been in the past, it's going to command a lower price today, even if its industry multiple stays the same. That's just the reality of the market." Sharp says those owners have two choices: accept today's lower prices or delay their sales for a year or two, until the company's financial results improve. Although that makes sense, it's a strategy that will pay off only if the industry's valuation multiples stay firm over time. And that's a gamble.

Any way you look at it, entrepreneurs with exits on their minds have some tough choices to make. "I tell my clients, 'Go right ahead and set the price. And I'll sell your company at whatever price you want -- even these days -- if you let me set the terms,' " notes John Johnson, a business broker at Bluestem Resources Group Inc., in Tulsa.

"Here's what that means," he adds. "If you're aiming for a price that's unrealistically high for this market, you may find yourself needing to accept a mostly stock deal. Do you want that? Or having to accept a long-term note with plenty of contingencies built in. Do you want that? Or having to sign a five-year employment contract to go work for your buyer. Do you want that? Or do you want to negotiate a nice clean exit that gives you cash for a price you can count on today? And if so, you'd better let me and the market tell you what kind of price tag makes sense."

There are exceptions, of course. Just as they could in the late 1990s, good companies can still command top dollar when their industries are in the throes of aggressive consolidation. Ron Massa, owner of the outdoor-advertising company, knew he was in the right place at the right time. "We're an industry that's experiencing very rapid consolidation. I didn't expect someone from outside the industry to buy my company, but I knew that someone in the business would take a look at my numbers and my location and recognize just how valuable my company was," he says.

Bull's-eye! Massa was first approached by someone who worked in the industry. "He wanted to buy my business himself, but in the end he couldn't get the financing," Massa recalls. "So instead he brought the deal to another company -- which was a third-generation billboard company -- with the proposal that they buy it and install him in management."

That's just what happened. In an all-cash deal, Massa received his full asking price, $1.26 million. Wondering what he's doing with all his free time? "Well, I actually owned a second billboard company, which I held on to," he says. "I've invested some of the money I received in new growth opportunities there. And I guess I'm going to keep building that business until I'm ready to sell it."

Few owners today are as lucky as Massa was. So here's another lesson worth learning for business owners who are enamored of an exit strategy: you'll never carry out a sale until you're prepared to look at your company the way a buyer would -- through a magnifying lens rather than rose-colored glasses -- and then respond accordingly. That's what the owners of the East Coast herbal supplier finally concluded. "There was an enormous amount of initial interest in this company because its revenues were quite healthy and it was profitable. But it was sitting on a lot of debt," explains Mark Romney, a business broker at IndustryPro, "and that scared people off."

The way a buyer looks at a company keeps changing according to whatever else is happening within the economy. Romney's clients learned that the hard way. During the days when the use of heavy leverage to achieve growth was considered a savvy management strategy, they used it to reach nearly $14 million in sales. Until fairly recently, they probably could have sold without a problem. But timing is everything. When the owners finally hung up their For Sale sign, potential buyers viewed the high level of debt as a downright deal killer. "The sellers and I both agreed that there was no point in actively marketing this company until they succeed in bringing down its debt levels," Romney says.

How's this for irony? Across the country, so many would-be sellers have pulled their companies off the market -- either by choice or necessity -- that business brokers and other deal makers are nearly running on empty. "There's a lot of interest from potential buyers. Those lower valuation levels add up to better-priced deals for them, and plenty of people are interested," says Marc Dosik, a business broker in the Columbia, Md., office of VR Business Brokers. "But our inventory levels are very low. Sellers are sitting on their hands. We're down to 40-something listings, when we typically have 80 or more."

News From the Front Lines

What's going to happen next in the business-for-sale marketplace? It's possible that today's imbalance between would-be buyers and sellers could push prices upward again, which would draw more sales prospects back into the market. That's a best-case scenario that may not happen anytime soon.

Another possibility is that when prospective buyers can't get their hands on enough capital to finance deals, their numbers may shrink to approximate today's reduced ranks of would-be sellers. Would enough bargain-hungry corporate buyers show up to compensate for the absence of individual buyers? Probably not, if corporations themselves are kept on tight credit leashes, as they are today. So if the numbers of buyers and sellers decline, the M&A marketplace could remain in a state of chaos for quite a while.

The news from the front lines, at least for now, supports the more pessimistic forecast. Business broker Mike Sharp says, "There's no doubt that in the last 18 months we've seen a much higher number of deals that have failed to happen because financing wasn't available." The software developer, the telecom service, and the distributor of semiprecious stones all lost deals because the buyers couldn't borrow the funds they needed.

"I hate the words tight financing because it makes us seem like Ebenezer Scrooge," says Brett W. Kaplowitz, a senior vice-president at Potomac Valley Bank, based in Gaithersburg, Md. "The way I'd describe the situation is this: We're seeing more cautious financings and more prudent financings. There's more scrutiny going on when it comes to acquisition financing than has been the case in recent years."

Here's how bad things have gotten. "Most of the cash-flow lenders have dropped out," Sharp explains. "The only kind of deals that are easily financed are the ones with plenty of assets to borrow against. And if you do find someone willing to lend against cash flow, you're lucky if you can borrow two and a half times cash flow -- whereas a couple of years ago, you could easily do a 'four and a half times' financing."

In a tight-money environment like this one, it can take a lot of give-and-take to actually close a deal. Sellers may have to agree to a long-term payment plan for part or all of the transaction or lease big-ticket machinery to the buyer.

On their end, buyers need to finance more of the purchase price themselves. That puts people with hefty retirement accounts or severance packages in the driver's seat -- and helps put the kibosh on "handyman specials" that require big infusions of capital in order to clean up problems or pursue growth prospects. How crazy have things become? Business brokers report that a few extraordinarily motivated shoppers have started taking their bankers along with them from day one, just to avoid wasting time exploring deals that they won't be able to finance.

When a weak economy makes acquisitions seem risky, as it increasingly has during the past two years, a vicious cycle takes hold. Buyers wanting to make a lifestyle change or to replace a corporate career may have a hard time getting acquisition capital. Yet from a banker's perspective, that's simply a cautious investment decision. After all, as Kaplowitz explains, "individuals or companies looking to purchase a business in a nonrelated or unfamiliar industry may be turned down by a bank if they can't show management competence or if the existing management is not remaining in place to help train the new owners and ensure a smooth transition."

For sellers, that is the reality as we now know it. Instead of banging your head against the wall, plan ahead to make your company as easy as possible for a future buyer to finance.

"There are two major ways to do this," says Fred Marcusa, a partner in the New York City office of law firm Kaye Scholer. "First and foremost, you've got to have an economically viable business, because nobody is financing ideas or the possibility of a viable business anymore. And then you've got to look for ways to build valuable assets. The obvious ones are inventory, receivables, equipment, real estate. But if you've got a service company, you've got to be more inventive. Try to arrange long-term employment deals with your staffers or sign extended contracts with your customers or key suppliers. You've got to convince both a buyer and a banker that you've got assets." Fail to do that, and you may find your company in the same position as the mid-Atlantic title-insurance brokerage: just plain unsellable.

The risks abound. And the rewards generally aren't what they used to be. Yet business owners can still find a pot of gold at the end of the rainbow. They just have to keep their sights focused on tomorrow (by building a company with strong growth prospects) while remembering yesterday (by ensuring that their record of success is strong and well documented by credible financial statements) and paying attention to today (by proving that they can not only survive but also thrive within the current rough-and-tumble environment).

That's the secret behind the success of the one Business for Sale candidate that sold for more than its asking price -- $1.75 million more, in fact, than its $2.25 million listing in the pages of Inc. For 22 years the southeastern seafood distributor financed its growth with cash flow (the past). The company also had plenty of untapped expansion opportunities (the future) and an owner who, rather than allowing himself to get distracted by efforts to sell the company, kept achieving steady growth despite the weakening economy (the present). And the kicker: in a tough marketplace, the owner threw in the real estate instead of insisting on a leasing arrangement, as he had originally wanted. All that added up to a package that was just too sweet to resist.

Now, that's the way to sell a company.

Jill Andresky Fraser is Inc's finance editor.

Date Featured: April 2000
Annual Sales: $3,000,000
Asking Price: $4,500,000
Inquiries: 6
Result: No longer listed for sale. The broker says: "No offers. Cash flow was strong, but a lot of people worried that the deal was overpriced."

Date Featured: May 2000
Annual Sales: $742,255
Asking Price: $12,000,000
Inquiries: About 12
Result: Still listed for sale. "It's a unique business that isn't for everyone," says the broker.

Date Featured: June 2000
Annual Sales: $66,283
Asking Price: $650,000
Inquiries: Nearly 50
Result: No longer listed for sale. The broker says: "People were intrigued. But the economics of the deal wouldn't make sense, and the seller wouldn't negotiate."

Date Featured: July 2000
Annual Sales: $1,068,094
Asking Price: $1,200,000
Inquiries: About 75
Result: No longer listed for sale. (The owner made a deal with an angel investor instead.) "Since the niche was so specialized and I'd created it, people were afraid that I was the company," says the owner.

Date Featured: August 2000
Annual Sales: $1,113,000
Asking Price: $495,000
Inquiries: About 12
Result: No longer listed for sale. The broker says: "We had serious interest, but the owner got distracted by an arrangement with a friend to solicit offers. None came through."

Date Featured: September 2000
Annual Sales: $4,366,100
Asking Price: $6,250,000
Inquiries: More than 50
Result: No longer listed for sale. The broker says: "We almost had a deal, but financing was impossible to find. Bankers were worried that the inventory could walk out the door."

Date Featured: October 2000
Annual Sales: $13,300,000
Asking Price: $2,250,000
Inquiries: About 75
Result: Sale closed in January 2002 for $4 million. The broker says: "The company kept growing, and we managed to get the real estate included in the deal. The buyer is an Inc reader from Europe who plans to relocate to Florida."

Date Featured: November 2000
Annual Sales: $129,000
Asking Price: $110,000
Inquiries: 18
Result: The owner closed the business. "It was a very small business, and people were afraid that the current owner was the business," says the broker.

Date Featured: December 2000
Annual Sales: $3,111,705
Asking Price: $8,400,000
Inquiries: About 40
Result: Still listed for sale, at $9 million. "We had an accepted, full-asking-price offer from a buyer who came through the Internet, but that evaporated after 9/11," says the broker.

Date Featured: January 2001
Annual Sales: $376,000
Asking Price: $1,260,000
Inquiries: 104
Result: The company sold in August for its full asking price in cash (no stock or terms). The seller says: "We're an industry that's still under rapid consolidation. I knew that it would take someone in the business to recognize just how valuable our company was."

Date Featured: February 2001
Annual Sales: $1,575,000
Asking Price: $5,800,000
Inquiries: 52
Result: Still listed for sale, at $4 million. "We had three offers, including an accepted bid for $4 million, but the buyer couldn't get financing," the broker says.

Date Featured: March 2001
Annual Sales: $14,144,000
Asking Price: $6,000,000
Inquiries: About 15
Result: No longer on the market. The broker says: "The owners signed a letter of intent with a buyer who came to them through a personal contact. That deal dragged on for months but fell apart for lack of financing, and by then the other interest had cooled."

Date Featured: April 2001
Annual Sales: $121,000
Asking Price: $200,000
Inquiries: A few
Result: No longer on the market. The seller is diversifying into high-growth business lines. "The company was too small to attract buyers from outside the region," says the broker.

Date Featured: May 2001
Annual Sales: $400,000
Asking Price: $195,000
Inquiries: 9
Result: Still listed for sale, at a reduced price of $160,000. "We had three decent offers, but the deals dragged," the broker says.

Date Featured: June 2001
Annual Sales: $2,009,313
Asking Price: $500,000 for the gallery, shops, and restaurant; $3 million for the commercial real estate; $8 million for the art collection; and $1 million for the home site
Inquiries: About 35
Result: Still listed for sale. The seller says: "There was a lot of interest, but people felt that the business's cash flow didn't justify the cost of the real estate. So I've now concentrated on a high-growth business plan."

Date Featured: July 2001
Annual Sales: $1,352,000
Asking Price: $1,200,000
Inquiries: 46
Result: Still listed for sale, at $900,000 for a two-thirds stake. The broker says: "Sometimes there's so much interest that sellers become excessively optimistic. One owner decided to hold on to his stake, but his partners are thinking realistically."

Date Featured: August 2001
Annual Sales: $13,735,000
Asking Price: $9,000,000
Inquiries: About 50
Result: No longer listed for sale. "The business was healthy and profitable, but there was so much debt that it scared buyers off," the broker says.

Date Featured: September 2001
Annual Sales: $6,100,000
Asking Price: $4,000,000 to $5,000,000
Inquiries: About 40
Result: Still listed for sale. The broker says, "The article appeared right before 9/11, which sort of dampened any serious interest while also negatively affecting pending orders."

Date Featured: October 2001
Annual Sales: $268,526
Asking Price: $198,000
Inquiries: 1
Result: No longer listed for sale. The broker says, "With the economy already down, then September 11 -- one of the first things people worried about was the travel industry."

Date Featured: November 2001
Annual Sales: $248,000
Asking Price: $140,000
Inquiries: 6
Result: Still listed for sale. "We had an accepted offer on one of the stores for better than half the asking price, but the deal fell through," the broker says.

Note: Annual sales are as reported in Inc's Business for Sale column.

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