If two words could sum up the collective attitudes of those who buy and sell businesses, they’d be “enough already.”
They’ve been sitting on the sidelines since 2008, experiencing the economic equivalent of watching paint dry. Now, looser lending policies and stronger balance sheets are encouraging them to believe that the worst is over, and three years of pent-up supply and demand are converging in the business-acquisition marketplace.
It’s still harder to sell a business today than it was in 2007, especially in the Sacramento region, but the volume of business sales is poised to reach its highest level in three years, and for buyers and sellers alike, the future looks promising.
Market observers agree that the climate for business acquisitions has been heating up for the past six months. The picture is slightly better at the national level than in the Capital Region, but at least the numbers here are starting to show a pulse.
The median price for a small business in the Sacramento region is up more than eight percent from a year ago to about $227,000, according to Mike Handelsman, group general manager with BizBuySell.com (BBS), the nation’s largest online business-for-sale marketplace. “The volume of listings for the first quarter of 2012 is still fairly flat compared to the first quarter of 2011, and the actual number of sales transactions only went up from five in [the first quarter of] 2011 to seven in [the first quarter of] 2012, but the higher median price shows there’s optimism,” he says.
BBS only tracks listings registered on its website, so it’s not an exhaustive study of the local market. Also, as a brokering resource it tends to deal only with very small businesses (under $1 million), not the mid-sized business transactions that can top $50 million and are more the province of investment bankers and private equity funds. But there, too, optimism is swinging a bigger stick.
Behind the numbers
Experts agree the main drivers behind the upward tick in acquisitions are a mix of pent-up supply and demand, the closing gap between what sellers think their business is worth and what buyers are willing to pay, the growing availability of credit and an increasing willingness among sellers to offer financing.
On the supply side, the same maxim that has applied to the housing market for the past three years also applies to businesses — only an idiot would sell in a down market if he didn’t have to. In many cases this meant enduring months of poor performance with no option to sell.
“The biggest problem on the supply side was performance. Unless your company did really well in the recession, you were reluctant to sell it when you had crappy results,” says Gilles Attia, managing partner in the Sacramento office of DLA Piper, one of the world’s largest mergers-and-acquisitions law firms. “A lot of companies chose to gut it out until things got better.”
Furthermore, the process of selling a business is practically all-consuming. Between the due diligence, entertaining prospective buyers, documenting and negotiating, it can take nine months, which is rather appropriate since by the end it can feel like you’ve just given birth. Few owners fighting to keep their business afloat between 2008 and 2011 were keen on signing up for that.
Market observers all say that by late 2011, companies that survived had done so by working smarter, shaving costs, restructuring debt and operating more efficiently. That bolstered revenues and balance sheets, which meant owners could get close to what their business was worth.
“Many owners have gotten past the denial stage of valuating their businesses based on the good years and are becoming more realistic,” says business broker Aron Culver from the Sacramento office of BTI NorCal, one of the largest independent brokerage firms in the West. “That’s making deals easier to close.”
The downward trend in valuations may have its roots in economic realities, but it is also fueled by the simple fact that some owners just want out. They’re done wishing they’d sold in 2007, and now that things are looking better, they’re ready to sell while they’ve still got a few good years left.
“You’ve got aging baby boomers who want to retire and need a diversified asset pool instead of having the bulk of their net worth tied up in a business,” says Curt Rocca with Roseville’s DCA Partners, which advises and invests in middle-market companies. “Others are just tired. They’ve been rowing into the current long enough. … They’re ready to head to shore.”
In a rare convergence, as the pent-up supply breaks loose, it is being met by the pent-up demand of buyers who’ve had little action in three years.
“A lot of acquisition resources have been sitting on the sidelines since 2008,” says Neil Paschall, managing director with the Sacramento branch of The McLean Group, an investment bank and M&A firm. “By the end of 2011, private equity groups had about $425 billion in dry powder, and strategic buyers, collectively, were sitting on close to $2 trillion. In cash.”
Business owners ready for retirement also are attracting competitors and other strategic buyers looking to grow, increase market share and take advantage of economies of scale by buying or merging.
“In some cases, it’s more a defensive strategy (on the buyer’s part),” Rocca says. “A business owner may not think they’re going to survive on their own, but by partnering with another business through a merger or acquisition, they can be more efficient and stronger in the market.”
That’s not to say buyers are hitting the market like sailors hitting the red light district; they still are looking for bargains and being choosy, but the leaner surviving companies that can show a sustained revenue stream can drive a premium.
For anything other than all-cash transactions, that means getting the financing to work.
Unlike 2008 and 2009, the current market is showing signs that lenders are ready to get back in the game.
“I think lenders are growing more optimistic — they’ve gone through a process of shoring up and getting rid of problem loans,” Attia says. “Also, the government has been encouraging lenders to get back in action, and the simple truth is, they need to lend money to make money. All those elements are playing a role.”
Some observers are a little more enthusiastic.
“The costs associated with an acquisition cannot get much lower. With interest rates still near all-time lows, now is the time to buy,” Culver says. “I know some buyers who are approved for [Small Business Administration] loans and getting an exceptional rate of prime plus 2 percent. It doesn’t get much better than that.”
Still, lenders still need to see business stabilization or growth and buyers with decent credit, collateral and at least 15 to 20 percent down. Even with all that, Culver says lenders also want to see seller participation by way of financing 10 percent or more of the purchase price. “For smaller or under-performing businesses, we’re seeing many more deals get done with seller financing — up to 50 percent in some cases — and sometimes more depending on the buyers’ qualifications,” he says.
On the high end, niche manufacturing, business-to-business and tech acquisitions are moving well. In the “Main Street” arena, standard commodity-type businesses such as convenience stores, gas stations and other retail businesses are moving if reasonably priced.
In Sacramento, the strongest sales in 2012 have so far been dry cleaning and coin laundry operations, but the popular listings are businesses in the general service sector, followed by retail.Restaurants have been hit the hardest and are the most difficult to move, cementing the opinion of one local restaurateur who says, “I’d never wish the restaurant business on my worst enemy.”
Can the Upward Trend Continue?
The tea leaves seem to foretell that what started in the first half of 2012 will continue. Boomer-era owners are aging, interest rates are expected to stay low and personal equity funds are watching the clock run out on their investment timetables. Market observers are predicting more consolidation in the interest of efficiency and strategic advantage, and the recently passed Federal Jumpstart Our Business Startups Act is likely to spur more companies into going public, possibly giving the economy a sustainable jolt.
Sacramento as a market, however, might be looking at a mixed bag.
“There’s a bit of a divergence between companies located here that serve local companies and those that serve national or international companies,” Rocca says. “The latter group is faring better at this stage of the economy.”
On the whole, Sacramento’s business growth is sluggish. Local businesses serving local customers won’t have an easy time selling those companies, but it’s certainly not a bleak future.
“I think we’re going to continue to see good activity here, good companies are going to grow and get acquired,” Gilles says. “I think a large part of our future success, however, is going to be a function of the people moving here. As long as we can make this an attractive place where people want to be, we’ll see growth.
New legislation is typically received by the business community with as much adoration as a Yankee fan at Fenway, but there are exceptions.
This year could provide some of the first expansions in bank lending since 2008. So is the market back up to speed? No. But banks are slowly and smartly increasing their appetites for commercial lending, and the Capital Region will see its share of transactions.