“TIMING THE MARKET” is something that every investment counselor advises against for your personal finances, and it’s no different when selling your business. In fact, any prudent mergers and acquisitions advisor would recommend against trying to time the market. The reason is simple: The only thing you be can sure about in any economy is what is going on right now. Global events are beyond our control; a cataclysmic disaster or natural disaster can set the economy reeling. And that’s to say nothing of the unpredictability of accidents at your business location or family emergencies.
Now, with some macro economic indicators predicting a tightening of the economy as soon as 2017, timing the market for the sale of your business may be a matter of simply acting now.
Invariably, the reason business owners wait to sell their business is because they want to grow it to get a higher value. Fair enough, but let’s take a scenario where the market takes a bit of a downturn and see how that would wipe out any incremental growth that you were able to achieve.
According to DealIQ, which reports on M&A activity in different markets, the multiple of earnings that has been used to purchase LBM businesses in 2014 and through the second quarter of 2015 ranged from 6.4x to 7.1x EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Strategic buyers (like other LBM dealers) tend to pay more than purely financial buyers.
What happens to that multiple in a downturn? It drops, obviously. If the economy tightens even a little bit, that multiple might move to 6x, 5x, or even lower. What are the implications?
Let’s say that your business has not yet reached its peak potential in terms of sales growth and earnings and you want to hang on to grow it for a couple more years. If your business is worth a 7x multiple of EBITDA today in this strong LBM market, and that multiple drops to 5x, you would need to increase your EBITDA by a whopping 40% just to get back to a dollar valuation equal to the 7x multiple being used in today’s market. Think of what effort it would take to improve your earnings by 40% today based on increased sales (even in a good economy), and you can understand the magnitude of the effort that would be required to fight your way back to a 7x from a 5x.
If the economy tightens, and you didn’t want to sell at a 5x or lower, you would have to wait out a multi-year business cycle to see valuations return to what they are today.
Obviously, you want to sell your business when it is doing well and the industry sector is healthy. Just as an unprofitable business has little value in a good economy, a company with historically strong earnings will not achieve its highest value if it is sold when the economy is on the decline or in the tank. Right now, in early 2016, the economic conditions are ideal for sellers to achieve high values, and they will remain so throughout this year, barring unexpected events. That said, selling today at a 7x multiple, even when you suspect you could achieve a higher value, would likely be a great move in retrospect if the economy were to constrict next year.
As for setting a realistic price for your company, obtain a valuation range from your M&A advisor. Knowing that range is a critical step to determining a realistic price for your business, but it represents an average and not necessarily what you’ll end up getting. The actual price is determined by such additional features as the quality of earnings; your management team; market position and competitive landscape; product mix and services; your customer concentration, and asset quality. We will cover that topic in a forthcoming column.