No matter what the economic climate, there always will be building service contractors preparing to exit the industry. So it is vital to understand what external factors do and do not affect potential selling prices, ensuring BSCs receive a true and fair price. Many middle market executives (companies ranging in value from $1 million to $200 million) mistakenly believe that external economic conditions significantly impact the timing and pricing of acquisition deals, which is a gross misconception. The reality is that economic conditions, such as those currently in place, should have little, if any, impact on middle market transaction prices as long as BSCs locate a strategic buyer.

A selling owner should not allow a large corporate acquirer to take advantage of bad economic conditions to justify a substandard offer. Instead, BSCs should demand a deal that is similarly priced to what would be expected under optimal economic conditions. This is the position that a strong-willed, sophisticated seller will enforce as a prerequisite to selling a company.

Acquirers always are trying to “steal” companies, even when the economy is good. In addition, acquirers, by their very size and acquisitive nature, usually are more familiar with the acquisition process than a seller. This, combined with the vast financial clout of large companies, enables them to approach the prospective seller in an arrogant manner demanding unreasonably low transaction prices. This is the norm. Unfortunately, most sellers fall prey to this approach and accept the norm.

The pricing of large corporate acquisitions (transaction prices in excess of $200 million) tends to be quite volatile. The pricing for these deals tends to mirror changes in the stock market. But the volatility of pricing of middle market acquisitions is minimal. When the economy is doing well, middle market deals have little upside. Conversely, during bad economic conditions, the downside volatility of middle market transaction pricing also should be minimal.

Bad economic conditions never should be considered as a valid rationale for substandard offers.

Instead, middle market transaction prices should be determined with the future in mind. Expected future earnings (cash flow) and the risk in achieving those earnings come from the business foundation presented to an acquirer. The expected future earnings used in developing an acquisition price will more than likely be based on the projected earnings flow through the next business cycle. Therefore, the pricing of a deal should not be significantly affected based on the point in the business cycle when a company is sold.

A strategic acquirer will determine an affordable transaction price based on the expected incremental future earnings produced by the combination of the two companies. To the extent strong synergistic benefits are produced by the deal, the combined future earnings of the companies will exceed the total of each operating separately. This enables the payment of a higher premium price by a strategic acquirer, while still generating an attractive return on investment.

The aforementioned is one reason an owner of a middle market company should avoid selling to a private equity firm (financial buyer) that brings no synergy to the deal. Without mutual benefits, the optimum acquisition price can’t be paid.

In addition, financial buyers are known to be a very anti-risk group. They must generate extremely high returns on their transactions to keep the flow of institutional money into their funds. These funds guarantee their future existence. Because financial buyers typically vary little in the way of additional management skills, the sole way they can produce the necessary high returns for their institutional investors is by buying at vastly discounted prices.

The prevalence of such acquisitions reflects the fact that few middle market advisors are willing to put in the considerable time or develop the necessary expertise to locate the domestic and foreign strategic players who are likely to complete a fully priced deal.

When a contractor proceeds to the market, the business’s foundation should be in solid shape, as this has a substantial impact on attaining a premium price. A selling BSC should have an acquisition advisor review its business foundation before proceeding with the sale. If there are any deficiencies in the foundation that would impact the transaction price, a skilled advisor can recommend the necessary changes.

After reviewing the foundation and preparing the company to be sold, keep the following points about selling at a fair price in mind, even in an economic downturn

Locate a strategic buyer
Strategic acquirers will be interested in obtaining your market niche to get the full benefits of the consolidation of the two companies. They will be interested in the intermediate and long-term benefits from the acquisition. Because the short-term earnings and outlook are not of paramount importance to them, they are less likely to allow current economic conditions to be the justification for a substandard offer.

Foreign acquirers are accessible
As business becomes increasingly globalized, the acquisition of domestic companies by foreign acquirers is now a realistic possibility for BSCs. The difficulty for many sellers is that not many acquisition advisors take the time or effort, or have the expertise to tap into this vast base of foreign acquirers.

One of the benefits foreign acquirers present is that their interest in a U.S. acquisition is usually to obtain a strategic position in a United States market. Therefore, it is almost incumbent on them not to fixate on short-term performance as a serious deal-pricing consideration. As they want to improve their competitive global business posture by obtaining a position in a currently undeveloped market, they will not want to lose this opportunity by trying to steal the company with a low offer.

Hold out despite vast consolidation
Rapid consolidation that has taken place in many industries, has greatly reduced the number of domestic acquirers. In a few industries, this has made major national acquirers brazenly aggressive in demanding substandard pricing for deals.Contractors must remain patient and be tough when such companies approach them. They must wait until one acquirer is willing to break from the pack and pay a fair price, which will happen if the company is an attractive purchase. BSCs only must sell when a realistic, fair premium price has been obtained.

Beware of reduced earnings excuses
When the current economic downturn ends, do not allow acquirers to use the reduced earnings generated during this period to have an exorbitant effect on deal pricing. During prolonged good economic times, many acquirers want to discount the value of recent earnings by those that will be realized during bad economic times. These same acquirers, after the end of a recession, will want to price a middle-market company solely on the earnings realized during bad economic times. Don’t allow that to happen. The key is that middle market deal pricing is dictated not by historical earnings, but instead by the expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer.

Don’t allow a large corporate acquirer to take advantage of bad economic conditions as justification for a substandard transaction price. Insist that your company be priced at a value that reflects the strength of your business foundation. This is the market niche that you give an acquirer, and it will dictate the future earnings potential to be realized from the acquisition. These are the factors that should determine a middle market acquisition price. This position, and not a lesser one, is what strong-willed, proud, independent BSCs will demand from an acquirer, before they agree to sell their company.

George Spilka is president of Spilka and Associates, a Pittsburgh-based merger and acquisition firm that represents middle market, closely-held corporations throughout the United States and Canadian contracting, distribution and manufacturing sectors. He can be reached at (412) 486-8189 or visit his Web site.




POSTED ON: 11/1/2001