Scrap Metals Supplement - Should I Sell Or Should I Hold?

If you’re like most business owners who operate in the lower-middle market (i.e., the value of your enterprise is from $5 million to $50 million), a substantial, if not most, of your net worth is invested in your business. Most well-respected wealth managers are now touting preservation of wealth and diversification of investments as the themes of the day. During this volatile economy, how do business owners diversify or preserve their investments in their businesses so they are not risking the majority of their net worth?

For owners who wish to take some of the chips off the table, plenty of options are available, such as ESOPs (employee stock ownership plans), mergers, laddered equity offerings and recapitalizations.

After 25 years of blood, sweat and tears, many small business owners are watching the equity value in their businesses wither away. For businesses that are still growing, most owners are scrambling to preserve their current entity value. Their main focus is cost-side restructuring and increasing market share through aggressive discounting.

But what happens when you have wrung out most of the costs, and the prices are barely covering the overhead? In these tough times, savvy owners can stand apart from the pack by executing alternative solutions, such as acquiring or merging with synergistic companies or selling a stake of the business in an effort to diversify and preserve the years of hard work that went into building the business.

The last CEO I spoke with about the issue of diversification said, "I agree with the diversification strategy, but I hear about owners who have attempted to sell all or part of their businesses only to receive lowball valuations and/or a lack of bids or no bids at all."

Strong companies are always in demand and command a premium price. For companies that are facing difficult times, merging with another company that also is facing serious challenges can result in preserving equity value while creating substantial cost saving synergies as well. Owners of companies that are flat or growing should know they are in the minority and are considered outperformers. The fact of the matter is that the reduction in the number of attractive companies has far exceeded the reduction in investment capital. While the amount of U.S. buyout fund-raising through the second quarter of 2008 has been reduced by approximately 16 percent, on an annualized basis (See chart on Page S46.) the percentage of middle-market companies that are flat or growing or that have strong growth opportunities have shrunk by an estimated 70 percent relative to 2007 levels. This supply and demand imbalance translates into premium offers for outperforming companies.

If you don’t have upwards of a five-year time horizon and capital resources to withstand a potential serious downturn in your business, then the time to sell is now. Currently, the biggest challenge for the private equity groups (PEGs) is finding good companies to invest in, as opposed to capital raising.

As a firm that focuses on representing outperformers, LockeBridge is getting more inquiries from PEGs than ever before. Currently, the biggest challenge for PEGs is finding good companies to invest in, as opposed to capital raising. They simply cannot find companies with strong historical performance and/or growth opportunities at this time. As such, these companies are attracting multiple bids and premium values.

It seems that every week I get a call or two from a business owner asking me about market conditions and the impact on valuations vis-à-vis an equity offering or outright sale. As Warren Buffet has said, "I have no insight regarding the direction of the economy over the next year or two." But I do tell the business owners that we are operating in an extremely high-risk environment that may very well continue to be challenging throughout the next five years. As a potential seller, if you don’t have upwards of a five-year time horizon and capital resources to withstand a potential serious downturn in your business, then the time to sell is now, while you still have a choice. As a buyer, plenty of bargains are available for those who have the appropriate time horizon, capital resources and sweat equity to outlast the current economic havoc.

For many, if not most, people the most valuable insight into the question, "Should I sell or should I hold?" does not lie in economic simulations and forecasting models. Most of us need to look inwardly, beyond the numbers, to asses our personal life plan, an assessment that many people have never taken the time to contemplate deeply or deliberately.

As a business owner who has started several businesses and outlasted numerous downturns, at each economic down cycle, I have asked myself the following questions:

In most industries at this time, if the company’s sales are flat or growing, the business is outperforming. Relative to the number of outperformers, more buyout and recapitalization money is available than ever. If your company is indeed an outperformer, and you don’t have the gumption to ride out a potential downturn, it might be a profit maximizing opportunity to sell all or some of the equity in your company now.

If your company’s sales are down, and visibility is low, if you don’t have at least five years to ride out a potential serious downturn and the capital resources required to support such a downturn, it may be a prudent idea to consider an exit or partial exit strategy, such as an ESOP, merger or recapitalization. The idea is not to get caught in a squeeze play such as the one reported by Cerberus Capital Management, the owner of Chrysler. As Robert Nardelli, CEO of Chrysler, put it: "Looks like things have gotten so bad so fast that protecting principal is the cause of the day at Cerberus".

Too many owners have worked too long to risk losing all of their equity during the next year or two. After many good growth years, most owners still have substantial equity value in their businesses. Deciding which strategies to pursue may be complex, requiring significant analysis and external consultation.

The author is managing partner of investment banking firm Lockebridge LLC, Lexington, Mass., and can be contacted at swaxler@lockebridge.com.