In almost all cases, the most value-enhancing course of action for the owner of a small business is to stay the course and not sell. Here's the math. Let us assume that you own a firm generating $7 million in revenue and are taking home $1.5 million in profit a year (around $1 million after tax). Let us further assume that you come to an agreement to sell your company at $7.5 million — all cash, no seller notes or deferred payments. This is a huge economic windfall. But if you were to invest the after-tax amount (around $6 million) in a mutual fund that you expected to return 10% a year (and that's a high estimate), you'd be making around $600k a year pre-tax and likely well under $450k a year after taxes. That's a lot less than you were making before when you owned your business. This should not come as a surprise. As the owner of a business, you are shouldering the burden of running an organization, monetizing your expertise, and taking on a considerable amount of risk. In selling your business, you are relieving yourself of the duties of an owner/operator and passing those responsibilities — along with the associated risk — to another party. This does not mean it's a bad idea to sell. There are many other good reasons to sell a business — de-risking, interest in other pursuits, retirement, health, and so on. Furthermore, there are ample opportunities to strike a middle ground by adding provisions to your deal such as rolling over some equity. If you are considering the sale of your business, you may be interested in some of the resources posted at eaglepeakcap.com/resources. And if I can be of assistance, please reach out to me at rknauer@eaglepeakcap.com. Thanks, and stay well!
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The recent rise in interest rates has had a significant impact on M&A activity over the past 12 months. The higher cost of borrowing has made it more expensive for companies to finance acquisitions, and this has led to a decline in deal volume.
Source: Board of Governors of the Federal Reserve System, accessed via
fred.stlouisfed.org on August 10, 2023. Of note, although the recent rise in rates brings them back to historical norms, it represents a break from over two decades of declining rates followed by a period where rates were near zero.
In a survey undertaken by Pepperdine University Graziadio Business School earlier this year, investment bankers reported decreases in deal flow, leverage and deal multiples,
and worsened general business conditions. (See page 38 of the report.)
According to data from Refinitiv, the global M&A deal volume in the first quarter of 2023 was down 20% from the same period in 2022. The decline was particularly pronounced in the United States, where deal volume fell by 30%.
There are a number of reasons why the rise in interest rates has had a negative impact on M&A activity. First, the higher cost of borrowing makes it more expensive for companies to finance acquisitions. This is especially true for companies that are using debt to finance their deals.
Second, the rise in interest rates has led to a decline in the valuation of companies. This is because the higher cost of borrowing makes it less attractive for investors to buy companies at high valuations.
Third, the rise in interest rates has created uncertainty in the market. This uncertainty has made it more difficult for companies to assess the value of potential acquisition targets.
The rise in interest rates is likely to continue to have a negative impact on M&A activity in the coming months, particularly given the presence valuation gaps between what business owners expect to sell their companies for and what buyers are willing to pay.
Additional Information:
By Deven Desai
You may be thinking: Why should I sell my company when I have grown and built it from the ground up with years or decades of dedication and intense effort? The fact is that if money is the primary object and you have a business that is generating a lot of cash, you'd probably be better off not selling. That said, there are certainly situations and changes in life circumstances that present good reasons to sell your business. Here are a few of them:
Retirement — At a certain point in life, you may think about retirement and taking on a relaxing lifestyle. In order to retire comfortably, you might put your company up for sale to earn a large chunk of cash at once that you can use to relocate or fund other retirement activities like travel. In addition, the release of stress and responsibility from running a business would allow you to truly enjoy the rest of your life. Spending time with family and friends or pursuing passions can be even more rewarding than running a business.
New Opportunity — As the world is constantly changing and there are so many new problems arising, you may realize that you want to pursue a solution to a different issue. Instead of completely changing your current company, you may decide to sell your current business and start a new one from the ground up. Some entrepreneurs enjoy moving from business to business and the excitement of pursuing different ideas instead of sticking to one company. Building and selling business after business can be quite profitable as well.
De-risking — There are high risks that come with running a business because of the ever changing political, economic, and cultural climates. An economic crash or change in industry regulation could seriously impact a business and cause it to go bankrupt in the worst case scenario. Consequently, if you are averse to risk, you may decide to sell your business when it is strong and still growing to exit and earn a solid valuation. You can then invest your profits in mutual funds to further de-risk and watch your money grow over time without the relative uncertainty that comes with running a business.
Industry Strength — The industry your business operates in might be attracting a lot of M&A activity with high EBITDA multiples. For example, during the depths of the pandemic, healthcare software and telehealth M&A activity was quite strong because of the focus on more contactless options to receive healthcare. As a result, many businesses within the healthcare software industry had good exit opportunities because they could command high valuations based solely on industry strength. Being in an industry that is booming due to current events and changing cultural/societal trends can influence you to put your business up for sale and try to maximize their profits while the timing is right.
Burnout — Running a business can be an extremely draining process, both mentally and physically. You may decide to sell your businesses to relieve yourself of stress, anxiety, fear, and other negative emotions. Stepping outside of an operational role and enjoying the big payout from selling a business allows you to enjoy life and take some time before finding another endeavor to pursue.
For perspective, the below chart shows the reasons why owners of business worth $5 - $50 million have decided to sell. (The information is pre-pandemic).
Everett, Pepperdine University — 2020 Private Capital Markets Report, page 80
While there are many reasons to consider selling a business, you should also be mindful of selling a business too soon or for the wrong reasons. You should also not sell your business too soon to earn some money when you believe in the long term growth potential of your company; in an extreme example, Snapchat’s Evan Spiegel refused a $3 billion dollar from Facebook because he believed in his company, and this paid off when Snapchat later filed for an IPO. In addition, if you enjoy running your business and being your own boss, you should continue to run it.
See also:
Pepperdine University — 2020 Private Capital Markets Report (See page 80 for Reasons for Seller to go to Market.)
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