Private company owners nearly always focus on the inside attributes of their companies when they think about selling. Do I have a management team that will add value in a sale? Are my margins good? Do I have a problem with customer concentration? How good is my intellectual property? How much growth can I project in the next five years? How good are my control and reporting systems? Are my sales people driving revenue?
These are all good questions, but in fact, at least today, the answers to these questions are not the main driver of the market value of a private company. The most significant question about company value right now is the question that is rarely asked.
The unasked question is: what is the demand for companies from buyers of private companies? The answer to that question is: in the last ten years, we’ve never seen such a strong sellers’ market.
In spite of the aging of the Baby Boomers who are now in their 50s, 60s, and early 70s, who should be selling, there are fewer private company owners who have made the decision to actively market their companies. At the same time, the appetite for private companies is very strong. Strategic buyers (those in the same industry as the seller) have over $800 billion of cash on their balance sheets. Financial buyers (private equity investors) have over $400 billion of available capital that they need get invested in order to achieve returns for their investors and get paid themselves. And backing all this up, the banking system has $1,000 billion (yes, a trillion dollars) of available capital to loan to acquiring companies.
All this means that buyers are competing hard to buy the few private companies whose owners are committed to selling today. Our office receives multiple inquiries every week from buyers that call or email to find out what companies we are selling. Now, we are even getting calls asking what companies we think might retain us to sell in the next six months. On recent deals, we have had from 30 to 70 buyers evaluate the opportunity and multiple bidders as our clients make the final selection of the buyer for their company.
This imbalance between the number of buyers and the number of sellers has been building for the last three years. It has driven up pricing metrics significantly. While hard data on private deals are thin, anecdotal evidence from experienced dealmakers indicates that price/earnings multiples are up by one to two “turns”. This means that a company that would have been valued at 5 times EBITDA (earnings before interest, taxes, depreciation, and amortization) may be sold for 6 to 7 times EBITDA in this market. That’s a 20% to 40% value premium to those sellers. The owner of a company with an enterprise value of $20 million in a balanced market could sell for $4 to $8 million more today.
We often hear owners say that they want to build up EBITDA for another year or two to maximize their exit value. Understanding the current market conditions means that they are better off by selling at a market-driven premium today than by spending two years increasing earnings by 20% and selling at a much lower multiple in the soft market that is coming when more owners become active sellers.
Article originally published by Corporate Finance Associates on November 18, 2014, http://www.cfaw.com/library/100/market-conditions.php