Shareholders rarely make more money than in the sale of income-producing assets. However, from a finance perspective, it rarely makes sense to sell. Rarely will stock and bond investments provide the year-over-year return on capital a private business can. Furthermore, taxes, fees and other costs inherent in a transaction help to take the proverbial wind out of the sales. In short, unless business owners/operators need to retire, want to start another venture or simply need “out” for another reason, holding makes more sense in most cases than selling.
Unfortunately some of today’s highest profile mergers and acquisitions don’t reflect sound financial reality. Facebook’s recent string of high-profile acquisitions is the perfect example of financial engineering run-amuk. This mentality has at least two negative impacts on general M&A. First, it gives other companies the false sense that their company is worth 10x of reality. Secondly, a skewed reality will drive sellers to believe their business is worth selling today even though they’re 35 years old, have little traction or have a wholly undiversified customer-base–just several things most pragmatic business buyers hate. Worse still, are the M&A advisors in our industry who push people to sell who have no business selling at all–which is perhaps the biggest blunder in corporate M&A.
There are a number of factors contributing to the correct concept that selling your business may not be such a good idea. The first involves the issue of taxes. When you sell a highly appreciated asset or stock, the government is going to want “their fair share.” In other words, tax liabilities play a big role in effectively dampening the potentially high-flying reality of a liquidity event. Long term capital gains taxes, combined with the additional Obamacare taxes, can make a significant dent in the after-tax earnings available for later investment in more “passive” sources. While advocating not doing a deal for these reasons alone is foolish, it should certainly be included in the decision-making process.
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Secondly, and perhaps more importantly, is that buyers rarely like to overpay. This is especially true of private equity groups looking for “proprietary” deals. Anyone with a lick of horse sense understands that money is made on the buy. When buying low and selling high is the name of the game, it’s difficult to get even the right strategic buyer to overpay enough to compensate for the factors outlined in the first point above–unless you’re working with an expert rainmaking negotiator.
Let me paint a picture with a recent real-life example from a previous client. After creating all the marketing slicks and lining up a handful of highly-strategic buyers, we were successfully able to push our clients company well above the value we expected the business would go for. His was a specialty adhesives manufacturer. With strategic buyers in tow, we walked through a very strategic auction process, hoping to boost the value of his business. When the dust finally settled, the winning buyer had offered to pay a 6X earnings multiple in a 100% cash deal.
Our client, in his mid-70s, turned it down. His reasons were logical. First, he thinks he has a long time to live and doesn’t want to get bored (both his parents lived past 100). Second, he has competent management who run most of the day-to-day operations of the business. He helps makes decisions, but for the most part takes home large draws and that’s it. Third, his business was experiencing 20%+ year-over-year growth from 2012 to 2013 and his estimates for 2014 looked comparable. He didn’t want to give away all of the upside. Fourth, he did the after tax and fee math and figured that on a conservatively discounted basis, he would be better off in five years by holding and not selling.
Some rightfully point to today’s sellers’ market as a boon to entrepreneurs and business owners. This can be especially true for the seller looking to find a strategic buyer–like in the case of our client mentioned above. But the reality is that even overpaying strategic buyers will not always sweeten the deal enough to provide the greatest amount of long term value to the seller. Somewhere, someone is going to leave money on the table and even if it’s not the seller, it can still mean the seller didn’t make the right decision.
Retirement, health and family matters are all the qualitative reasons that can and should be included in the process of weighing the right strategy to sell a business. I’ll readily admit that such matters often hold greater weight in measuring the decision to sell a company, and rightfully so. However, if strictly looking from a financial angle, it can be difficult to justify selling a profitable company.
