To Sell or Not to Sell, That is the Question

For a family owned business, the decision to pursue a liquidity transaction is never taken lightly. Many families derive their identity from a connection to their business. Others view their business as an heirloom to be passed from generation to generation, providing future generations a link to the past and an attractive career alternative. Increasingly, we are finding family owned businesses at a crossroads, however, with no next generation interested in taking them helm, or sufficiently skilled do so. In these circumstances, shareholders are left to decide whether to take on professional management or pursue a liquidity transaction.

This article is not a call to arms to sell your business, but rather a guide to when you might consider pursuing liquidity. Under the right circumstances, and for the right company, the current M&A market can deliver peak valuations. That said, success only comes when there is a convergence between the macro-market, the companys readiness, and the buyers willingness and ability to pay. Here are some rules of the road in todays market:

1. When debt markets are liquid, valuations rise: Based on historical transaction multiples across industries, the most robust periods for exits have been when cheap leverage is available to the buyer. When debt is available, it brings financial buyers in as viable counterparties at attractive valuations. Private equity groups rely on leverage to pay premium multiples. The data suggests that above a transaction multiple of five times the latest twelve months EBITDA (earnings before income tax, depreciation and amortization), an incremental dollar of debt leads to an incremental dollar of purchase price. Therefore, as debt increases ability to pay increases.
2. Size matters: Data has shown that larger companies those with $5 million or more in trailing twelve months EBITDA receive transaction multiples that cannot be garnered by smaller companies. The biggest driver of this reality is that larger companies are easier to leverage, and where there is leverage attractive prices often follow. In a strategic sale, a larger deal signals strategic intent and, often times, can move the needle from a financial perspective, making the buyer more willing to pay a higher price.
3. Growth is precious: Growth is one of the most valuable assets a company can offer potential buyers. Growing businesses that address large markets generally achieve higher multiples. It is much easier to sell a business when the growth curve is positively sloping. Transaction alternatives narrow once it becomes flat or in decline, absent cost based deal synergies.
4. Understand ,market sentiment: Industry conditions also dictate the viability of a transaction. A great company in an underperforming industry may receive a premium multiple relative to its peers, but often that multiple will also be at a discount to the broader market. If your industry is out of favor, it may be best to wait out the cycle if you are focused on optimizing valuation, as opposed to being willing to sell at the market.
5. Think synergy: Revenue and cost synergies are paramount to generating interest from strategic buyers. Currently, the market is heavily favoring consolidating transactions where tangible costs can be taken out of the combined business. Companies that know the business model and currently operate in the industry are more likely to pay a premium multiple, because they can have a high level of confidence in realizing pro-forma synergies. Deals involving buyers moving into the market are generally done at a discount to consolidating acquisitions. This fact may be uncomfortable for some sellers, as sharing information and signaling an interest to sell to your competitors is not without risk. That said, managed correctly those issues can be mitigated and a positive outcome can be achieved.
6. Consider the tax implications: One of the greatest benefits to building and selling a business is the tax treatment on long term capital gains.Currently, we enjoy one of the most attractive tax environments for selling shareholders with the extension of the Bush-era tax cuts until December 31, 2012. We anticipate taxes will increase in 2013, and sellers that are considering a transaction in the current cycle should test the market in 2012. Taxes should not be the main motivating factor, however. If there is significant upside potential in your business or industry, then it may l make sense to wait to garner more value even net of the tax effect.

Pursuing a liquidity transaction is a difficult decision for all family businesses. Knowing whether the outcome you are seeking is viable is critical to determine if the time to sell is now.

Christian Schiller and Bryan Jaffe are managing directors at Cascadia Capital, a Seattle-based boutique investment bank serving companies in diverse industries, including information technology, sustainability and middle market.