How Inflation will Affect M&A and Funding

With all the new government initiatives in place, experts are expecting the United States money supply to increase by about 50% from the beginning of 2009 to the end of 2010. To provide you with some perspective, this is far greater than any other increase in money supply in recent history. You might remember from high school economics that increases in money supply generally take form in two ways: 1) economic growth, and 2) inflation. While no one is expecting 50% growth anytime soon, most economists agree that it is quite apparent that this increase in money supply will rear its ugly head in the form of major inflation. Although we are mostly likely to see the beginning of economic recovery take place either later this year or early next year, when hyperinflation occurs, we may end up being placed in a similar situation to what we are in right now.

Let’s look at what happens to the capital markets during inflation. In order to curb inflation, governments try to reduce the money supply by increasing interest rates and sometimes increasing taxes as well. When interest rates increase, the cost of financing an acquisition is much higher and such increased cost usually discourages buyers from acquiring. Secondly, most buyers use a valuation method that uses some form of a discounted cash flow model. When calculating the amount by which to discount your projected cash flow, the starting point is usually the Treasury rate (or risk-free rate). This means that when the Treasury rate is higher, the discount is higher because a buyer could safely park their money in a risk-free investment with high interest. The result is that buyers are likely to discount your company even more to accommodate the additional risk. Ultimately, all valuations will probably decrease if the interest rate is increased. Also, as you are likely aware, as taxes increase, investors decrease risk and don’t make as many efforts to generate money through investments. As taxes increase, business owners themselves are also less likely to cash out due to the increased tax consequences from any such sale.

Therefore, if we see significant inflation similar or greater to what we saw in the 1970’s, our capital markets will continue to be in a difficult situation. This will be terrible for corporate growth, funding for startups, and M&A and in general. Inflation, coupled with the large number of baby boomers that will need to exit their business within the next ten years, will most likely affect valuations. Because there will likely be “mini-M&A” wave coming later this year and next year as money supply increases, but before inflation hits, you should consider identifying your options for a timely exit, given that it generally takes 6 to 12 months to find a buyer. An M&A intermediary or an M&A advisor such as Orion Capital Group can assist owners of companies valued between $3 and $50 million plan their exit and find buyers. Visit our website at www.orioncg.com for more information.

What To Do if Someone Wants to Buy Your Company

Imagine you get a call from one of your competitors or their representative. As you speak with them, they are sizing you up and finding out how well your business is running and how motivated you are to continue running your business. They want to set up a meeting with you to discuss the possibility of a merger or acquisition. What do you do?

First of all, set the meeting far enough in advance to do some research, but not too far out to lose momentum on a potential deal. Give yourself enough time to gather enough information to be confident about valuations in your industry and businesses in a similar size range as your business. Also, give yourself enough time to think about how motivated you and your family are to exit, but don’t discuss this with anyone else at your company. When dealing with an experienced buyer that has bought many companies, it is important that you understand your company’s value. The buyer will gauge your actions and words carefully, and it is important to stay alert but not scare off the buyer by being too defensive. Since they are already interested in your company, you should be confident about your position but listen very carefully to what they are suggesting.

While it is not very common for companies under the $50 million valuation mark to receive unsolicited offers, it does happen. When it happens, most buyers offer a low price because they think the business owner might accept and has not researched other options or sought other buyers. For instance, they may offer you $20 million when your company is really worth $40 million to them, and if you don’t know how best to value your company, $20 million may seem like a fair value to you. Keep in mind, valuations are very subjective and can range immensely between any two valuation experts. However, knowing the criteria of those valuations and your own company’s situation will really help you become comfortable and suave in your negotiations and conversations. Valuations can be a little confusing and the value can depend on what the buyer is interested in: cashflow, IP, talent, product offering, etc. Feel free to contact us if you need help understanding valuations.

If you do have interest from a company, you may choose to go ahead with that buyer, or you may retain the services of an M&A intermediary, M&A advisor, or boutique investment bank (generally synonymous terms) to help you leverage the existing buyer’s interest in order to find other buyers willing to pay more than the offer you may receive from the interested party. If you are a scalable business with revenues over $3 million, resist the temptation to use a business broker. More likely than not, they won’t be able to give your company the exposure it needs to obtain a quality buyer. A professional M&A firm will obtain the optimal price for your business by procuring several buyers in various geographic areas, similar industries, and even various types of buyers. As with most competitive bidding situations, having one interested party is about as good as having no interested parties.

Whether you decide to proceed with the interested buyer or use an M&A firm, it is important to ensure you are being represented by competent, experienced, and cost-sensitive attorneys and accountants. They are crucial in completing due diligence, reducing tax liability, helping you understand what is “market,” and negotiating the letter of intent and purchase agreement. It is important to note that while these professionals are there to protect you, their protection may also cost you the deal. An experienced M&A team will generally help to finalize the deal because of their experience in seeing deals through and putting the pieces back together when issues arise in due diligence.

Orion Capital Group, Inc. (www.orioncg.com) is an M&A advisory firm that specializes in advising clients and finding buyers for companies valued between $3 and $50 million and we are constantly in touch with buyers looking for investments in various industries. Numerous times we have come across companies that were acquired without having gone through a competitive bidding process because it was convenient for the shareholders or because they were unaware they had other options. Ultimately, many were taken advantage of by the buyer due to low valuations or below-market terms. If a company offers to acquire you, call us and we can inform you of your options and guide you in your decision making process at no cost. Even if you are just looking to find names of good accountants or attorneys, we know many professionals who can assist with other aspects of the deal process.

Why It’s Crucial to PLAN your Exit

The strategy behind of any type of proper planning is to visualize an endpoint, anticipate the actions needed to get there, and mitigate risk along the way. An exit plan accomplishes the exact same objective. However, as you may have seen in our survey last year, 90% of all business owners have not initiated the exit planning process. Unfortunately, most clients come to us when they are ready to sell their company, but without having done any advance planning. When a comprehensive exit plan has been implemented and validated by your various business, tax, accounting, and personal advisors, you are likely to have increased shareholder value, improved the chances of a sale, reduced your future tax burden, and increased the wealth to pass on to subsequent generations.

Every entrepreneur is told that they should create an exit plan at the same time they create their business plan. However, most people think that an exit plan only encompasses when and to whom they want to transfer their business and don’t actually go through the planning process. As skilled and as successful as most business owners are, they cannot, working alone, create and execute their exit plans. Even your attorney, CPA or financial and insurance representative, individually, are usually unable to craft a successful exit plan. Successful exit planning is a multi-disciplinary effort that requires you and your advisors working together. For your exit plan to succeed, you need your legal, financial, tax, and investment banker input. In addition, having an exit planning professional on your team should help you lower the costs incurred by these professionals and assist in keeping your exit plan on the right track.
Whether your endpoint is a sale to a third party, a transfer to family member, an orderly liquidation, or something in between, each outcome will have a separate set of actions needed. For instance, if you are selling to a third-party, your end objective should be to maximize value. Alternatively, if you wish to transfer to family, you would want to minimize the transfer value.

You will also have to address as part of this planning process, what would happen to the business and to your family in the event your death or disability preceded your planned exit.

Below are the most common objectives of a thorough exit plan:

• Minimize taxes now and/or following the transfer of the business
• Minimize estate taxes when you transfer your wealth/business to family
• Determine how to meet your retirement goals
• Prevent business value from crashing upon your death or disability
• Communicate your goals and expectations with your family and keep them on the same page, supportive, and cohesive
• Build value within the company to maximize eventual sale price and terms
• Improve chances of sale because of certain features implemented
• Understanding the value of your business
• Determine who would be the best type of buyer (family, third party, employees, management, partner, etc.)

Once you have finished your comprehensive exit plan, it is important to implement it otherwise that plan is only an expensive piece of paper. Save your money on getting a plan done if you have no intention of implementing it. Just like your business plan, your exit plan will probably change along the way and it is important to adjust it accordingly. However, that isn’t an excuse to avoid the planning process. Remember, now may be a good time because you may have more time on your hands and might be able to negotiate for some leniency on rates from professionals.

Go to www.orioncg.com to learn more about exit planning and even take our survey to see how you compare against other business owners. If you are interested in learning about how we can do them at no charge, contact us.

Will Obama’s Stimulus Package Fuel the next Mergers and Acquisitions Wave?

According to our Magic 8-Ball: Yes. Of course it is difficult to predict what will happen as a result of Obama’s American Recovery and Reinvestment Plan, but as this issue demonstrates, there is definitely a possibility we will hit another “mini M&A wave” within this year. In our opinion, this wave will take a different form and happen as a result of necessity and opportunity (and at more realistic valuations) as compared to what the industry saw two years ago.

With hundreds of billions of dollars being allocated to information technologies, healthcare, biotech, communication technologies and energy technologies, it is inevitable we will see substantial intellectual property (IP) changing hands. Presently, intellectual property is increasingly affordable as many large companies focus on their core competency and shed IP holdings in the process. Additionally, many small IP-rich companies are wondering how to survive and are selling innovative processes, products, and other IP in the process. Technologies in the above-mentioned industries have a history of changing so rapidly that squatting these technologies for a few years may deem them worthless. Unless the stimulus plan imposes restrictions, the funding that companies receive from the Stimulus Package will be heavily used for technology acquisition and internal research and development.

M&A activity will also increase as a result of other forces. Distressed industries such as banking, automotive, homebuilding, retail and others will focus on consolidation as a result of necessity. Owing to an increase in economies of scale and reduction in fixed costs, the historic trend of consolidation during poor economic times will likely continue. As stimulus funding becomes available, you should expect to see an increased number of acquisitions as we witnessed recently in the banking industry. As many economists still believe, the worldwide bank problems are still far from over.

Surprisingly, we may even see a wave of cross-border M&A arising from both Europe and Asia. Recently, the Chinese government announced that as part of their stimulus package, they would support local Chinese companies in overseas acquisitions in the energy and chemical industries. Asia’s reduced dependence on credit provides them with a stronger cash position to acquire more depressed US companies right now. Moreover, the stricter “Buy American” clauses implemented in Obama’s new Stimulus Plan will most likely draw investment from foreign manufacturers looking to acquire US-based businesses in order to break into the US market. US companies are still inexpensive by worldwide standards even though the dollar has gained strength against many currencies in the last year.

Overall, we’re not implying that the mergers and acquisition industry will return to the level it was at two years ago. Valuations will still be lower. “Mega-deals” may become prevalent for industries that need to have consolidations such as banking and automotive. On the technology side, we expect to see the small intellectual property deals valued up to $100 million depending on the allocation and limitations on stimulus funding. If you are a technology or intellectual property-based company, you should be considering how the American Recovery and Reinvestment Plan is going to affect you and your industry over the next few years. We suggest that you speak with an M&A advisor about your company to entertain the options that might exist for you. Orion Capital Group, Inc.'s (www.orioncg.com) M&A advisory team is specialized in information technology, healthcare, biotech, communication technologies and energy technologies and would be happy to have a complementary consultation with you about your options.

When Will M&A Return?

As we have mentioned in previous blogs and in Orion Capital Group’s Northstar Newsletters (www.orioncg.com/mergerslibrary.php), market timing is one of the more crucial factors in determining the price and terms you get for your business. During times of high deal flow, you are likely to get better terms and vice versa. So the question is: what are the factors in the market and economy that affect deal flow? We have detailed each of the major factors and how they effect M&A and what we see happening.

Credit Availability

We all know that availability of credit is low now. The Fed has cut interest rates to an unprecedented low and injected capital into where they think it will have the biggest effects on credit liquidity. The banks and automakers (which have a big hand in the credit market) are going to use their initial help from the government to suture up their critical wounds before they even try to get aggressive again in making some profits. While this will take time, we have seen that in the past few weeks, we have seen banks starting to get more active in trying to get new mortgages and SBA loans. So the process of credit recovery may be in sight.

Target Company Cashflows

Although companies do acquisitions for intellectual property or future blockbusters, the bulk of deal flow is done based on cashflow. We believe M&A will pick up again when most buyers see positive signs of cashflow beginning to return. This will most likely depend on consumer spending and inflation trends. We have yet to see any signs of recovery on that front.

Investor Risk Appetite

In recent years, private equity groups and hedge funds fueled large growth in M&A because of large capital availability from high investor risk appetite and good returns from these types of funds. However, limited partners in these funds require a return premium for keeping their money in illiquid funds. Depending on the types of returns these funds ultimately yield their investors will determine how long it will take for private equity groups, hedge funds, and venture capital firms to successfully raise new funds in the future. Going forward, investors may be leery about locking up their capital and not being able to react to market conditions.

Buyer Company Balance Sheets

With most corporate profits being affected the past couple of quarters and poor outlooks, many company balance sheets will not be where investors and top management want them to be at the end of this recession. That may cause most companies to reduce acquisitions until they improve their balance sheets again.

Capital Gains Tax

If the capital gains tax increases in upcoming years, it will reduce both sellers’ interest in selling and buyers’ interest in buying. Whether the incoming administration and legislators will increase the capital gains tax is anyones’ guess. However, changes will almost definitely have an effect on the future of M&A.

We don’t intend to provide a grim outlook on M&A, but the fact is that overall M&A is down and probably will be down for at least another year or two. However, there are certain areas that haven’t been affected as much. Intellectual property (including patents, brand names, and trade secrets) is doing relatively well because companies are trying to buy them from cash-strapped companies at a steal in anticipation of future profits. Smaller deal sizes (middle-market) under $200 million, has remained relatively intact because there is less of a need for leverage, investors are looking for bargains and some buyers feel that they can incorporate and grow their newly acquired companies during the slow time.

If you have further questions or wish to learn more about Orion Capital Group’s outlook, please go to www.orioncg.com to learn how to contact us.