It’s safe to say that many business owners have considered selling their business at one point or another. Regardless of what factors provoke these thoughts of selling, it is imperative that owners carefully consider timing in order to maximize value. How do business owners determine whether or not it is the right time to cash out?
This may come as a surprise to many business owners but right now is a great time to consider selling. In fact, if you are an entrepreneur with a well-run business, you should have no shortage of buyers.
A common valuation method is to use a multiple of Earnings Before Interest Tax Depreciation and Amortization (EBITDA). Valuation multiples have hit their highest point in Q1 of 2016 at 12.2 times EBITDA.
The table below illustrates this upward trend which has occurred as a result of a combination of the current state of the North American economy and a large volume of capital chasing fewer deals.
There is a battle between Corporate Buyers and Financial Buyers.
Corporate buyers are defined as companies who acquire other businesses for the purpose of gaining a strategic advantage. This may include product or geographic diversification, or gaining economies of scale.
Unlike corporate buyers, Financial buyers such as Private Equity (PE) firms do not benefit from the synergies of merging two companies, and therefore need to focus their efforts on acquiring underperforming and valued companies. With the pressure of higher multiples, PE firms have had to adopt various strategies to transform themselves from financial to strategic buyers.
By altering their investment approach towards a more strategic investment style, financial buyers are going head to head with corporate buyers to acquire businesses that fit their investment criteria. This fierce buy-side competition plays a substantial role in inflating the price tag of acquisition targets.
Currently the capital needed to make acquisitions is cheap.
Low Interest Rates
The capital used for the purpose of acquisition, is cheap. With low interest rates, acquirers generally have the capability to raise debt capital at a minimal cost. Over the course of the last four quarters, they have proven that they are willing to take advantage of this opportunity. For example, when the Chicago Mercantile Exchange (CME) Group issued a statement increasing the probability of a Federal Reserve rate hike by the end of the October to 93.1% from 55% in the months prior, a massive surge of debt issuance emerged in the US. Since higher interest rates would increase the cost of raising capital, everything from investment grade and high yield fixed income securities to jumbo bonds (10 billion or more in size) hit the market in record volume.
Remarkably, it was acquisition-related debt that flooded exchanges due to heightened anticipation of the raise in interest rates. Debt raised for the purpose of financing acquisitions totaled over $200 billion USD by the end of 2015, which is more than double the amount issued in the year prior. It is very likely for this acquisition trend to continue throughout 2016 as the Fed announced that it only sees “one hike in 2016” and intends on keeping interest rates at a quarter of a percent (Bloomberg, 2016).
Suppressed Canadian Dollar
Over the course of 2015, the Canadian dollar took a massive hit; losing over 19 percent of value compared to its US counterpart by the end of Q4. A cheaper Canadian Dollar has driven US-based acquirers to explore buy-side opportunities across the border. This rush to buy Canadian companies has inflated and will continue to inflate the valuations of Canadian businesses.
Canadian SME’s are seen as Profitable Alternative Investments
From an equity stand point, over the last twelve months, one dollar invested into the S&P would have generated no return from capital gains. An identical investment into the S&P/TSX i60 Index would have lost around 4% over the same period. This stagnation of returns and increased volatility of both the TSX and S&P has begun steering investors in the direction of alternative sources of returns. Investments into small and medium size private enterprises (SME’s) via direct capital investment or private equity and VC firms is giving investors an opportunity to diversify their portfolios with assets that are uncorrelated with the poor performance of the public equity markets.
It is clear that competition is boiling among different acquirers in both the private and public market space, and this competition is armed with the phenomenal in-flow of cheap capital from both corporate and private investors. These key market factors have driven the valuations of businesses to record highs and created an opportunity for owners to make a swift and lucrative exit.
So to answer the question – is it a good time to sell your business? In short, the answer is a firm “yes”.
M&A Associate, WelchGroup Consulting
Condon, C. (June 2016). Fed Reins in Rate-Hike Path as Brexit Cited in Latest Pause. Bloomberg: News.
Web. Retrieved from: www.bloomberg.com
Putman, B. (August 2015). Fed on Track for Rate Hike in September? CME Group: Education. Web.
Retrieved from: www.cmegroup.com