High Valuations Don't Always Mean It's a Good Time to Sell

CRAIN'S CLEVELAND BUSINESSIssued the week of January 9, 2017
By Tod Wagner


Company valuations today are at the highest levels we've seen in years. So if you're a business owner thinking about a liquidity event, now would be a good time, right?

Not so fast.

Even though the value of their companies is at historically high levels, many business owners have suddenly become reluctant to pull the trigger on a sale. What's happening to cause a pause in their thinking?

On a macro scale, there has indeed been a slowdown in merger and acquisition activity. Thomson Reuters reported that as of the third quarter of 2016, announced M&A values worldwide fell 27% compared to the prior year. There are a lot of theories as to why this slowdown, from Brexit to political volatility in the US, but no one determining factor tips the scale

Let's peel that back a bit to see how this is affecting the small business owner.

On the one hand, there are a variety of factors that are leading many owners to conclude that now is the right time to sell or transition the business to the next generation:

Baby boomer business owners are at retirement age or giving serious thought to a second "encore career." Many are truly grappling with the question of how they want to define their legacies.

The introduction of new technology and overall pace of change is leading many owners to conclude that it is a good time for a new, perhaps more adaptable generation of leaders to take their companies further. Or they often conclude they no longer have the appetite to invest new levels of risk capital — or personal energy — needed to remain competitive.

The low unemployment rate is creating a war for truly outstanding talent which is becoming more and more difficult to manage.

Some proposed regulations coming down from the IRS may also be creating a sense of urgency behind owners' thinking. In early August the IRS issued proposed regulations for Section 2704 of the tax code that, if enacted, would significantly limit some estate planning techniques and increase tax costs of intra-family transfers. In brief, the change would reduce discounts that are considered when valuing the transfer of a business interest to a family member. Some industry watchers feel the IRS has overstepped its bounds with these proposals, and given the outcome of the recent election, they may be altered significantly or even shelved. However the regulations eventually are finalized, the fact that they were introduced created some impetus among many business owners to get their succession plans moving forward.

Coupled with the high valuations many have for their companies, and perhaps even these IRS proposals, many factors are coming together to create a peak moment when the closely held business owner is stepping back to consider long term family, financial and philanthropic objectives. They've worked their entire lives with a simple plan in mind – grow the business, build long-term value in the enterprise, and sell at some point to create a nest egg that will continue to support their lifestyle at the same level as when the business provided their incomes.

These historically low interest rates we're seeing and recent post-election run-up in public equity markets are giving many second thoughts with their succession planning, even in the face of currently high valuations. Here, the owner is on the cusp of retirement at 50-70 years old and wants to take some risk off the table or perhaps build a portfolio that's more diversified than being tied just to one business.

But when that owner meets to plan his or her future with a financial adviser, it becomes clear that it will be a struggle to generate the same amount of cash flow and match pre-sale income levels by investing the after-tax proceeds of sale. Today's low yields from fixed-income investments are making it harder for that portfolio to generate a sufficient return post-liquidity event without taking more risk than is desired with alternative equity investments. Back to work for another 10 years? Regardless of what action you decide is best, the greater hesitation we're seeing today underscores the need to plan for liquidity events in decades, not a few years.

Business owners who have been following a plan for some time are nearly always better insulated from the short-term impact of any current market conditions. It's a common, even tired piece of advice: true financial freedom and lasting legacies require long-term planning, not short-term quick steps.


Theodore A. Wagner, CPA, CVA
Cleveland Managing Partner
216.373.2519
Email


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