We’re awash in coronavirus updates daily and seeing unprecedented changes to our lives as a result. Every day, business owners ask us if it’s going to impact their business. Unfortunately, we’re seeing that the answer is “yes”.
You can mark on your calendars that private company valuations peaked BCV (before coronavirus). You can expect to see the market move back to “normal” valuation multiples the next 7-8 years with a likely overcorrection to the downside in the next 18 months. Over the last two years, we had hundreds of conversations noting that company valuations were at the cycle peak for lower middle market companies and note they wouldn’t last forever.
Well, as a business owner you’ve lived through cycles before and you’re about to live through another one. For example, the $2M-$5M EBITDA manufacturing company that “normally” sold for 4-5X EBITDA was selling at 6-8X EBITDA (or more) the last two years. $5M-$10M EBITDA companies that would “normally” sell for 6-8X were selling for 8-10X or more. The disruption the coronavirus is having on investor confidence and the financial markets is putting a chilling reality check back into lenders as they realize many of the big loans they made the last couple years tied to a perfect growth model will not perform as expected.
When this happens, the companies they backed will breach loan covenants and need to cut costs. This only exasperates the economic recovery. With a fresh reality check, the market will go back to “normal” with traditional valuation multiples applied to lower EBITDA numbers. Think $1M EBITDA companies at 3-4X; $2-5M EBITDA companies 4-5X and 5-10M EBITDA companies to 5X-7.5X multiples.
If you have healthy financials today, you might want to consider taking your chips off the table now. Even if your multiple is lighter, recognize the probability of having a lower EBITDA multiple applied to a much lower EBITDA number 24 to 36 months from now when the market over corrects.
The typical M&A valuation cycle runs 8-10 years from peak to trough to peak, with the overall time depending on the general economic cycle. We don’t see it being any different this time. If you didn’t sell in the last two years, you likely missed the peak, unless your company won’t be impacted by a softer economy. We can all remember when our houses overappreciated and then the housing crisis happened and the market overcorrected knocking values down. Then slowly over the last 8-10 years, our home values rose back to pre-bubble prices. Prices for companies will lower as business performance and multiples decline and we should see a trough to valuations in 24 months or so. We believe the climb back will take several years.
So, here we are. What should you do now?
If you plan to sell in the next 2-4 years: Think about accelerating those plans and get a transaction done while you’ve got good numbers in your trailing twelve-month period. The multiple will likely be a little lower than it was last year, but it will still be good and it will be applied to “good” numbers.
If you plan to sell in 5-6 years: Hunker down on your cost structure and look to limit the pain to the downside. If you’ve been a business owner for 20 or more years, you weathered 9/11 and the housing recession of 2010 to 2011. Plan for a similar 7-8 year period of drop off and retracing to get back to what your business was worth a year ago. Know that buyers look for performance during bad years and they want to see limited downside. If your business falls off 50% due to recession, you’ll get clobbered. Having the economy tank and you fall off 15-20% is much better received. Taking action now will help you limit your downside performance the next couple years.
In closing, we communicate either in person or by email with about 200 business owners a month (or about 2,400 a year). We’ve heard many owners say, “I wish I would have sold prior to the housing collapse or the dot-com bubble, or 9/11”. We’ll hear a lot of stories from folks who wished they would have sold prior to the COVID-19 pandemic. In the end, we believe the COVID-19 will be materially kicked over the next 6-12 months, but the damage and impact to the global economy and financial markets will last a while. It’s likely that it will drive business valuations back to “normal” levels for the next 8-10 years. If you’d like to talk about how your business would be valued and perceived in today’s market, let’s chat. There will be outliers to what we outlined here.
Companies with little exposure to economic down-turns will still be in high demand like utility services firms, industrial service firms, municipal services firms, food manufacturing, SaaS companies, critical infrastructure support firms, security firms, etc. Cyclical companies will be discounted heavily.
Stay safe and let’s get through this together. Now is when your company faces a challenging long-term period. With that said, you may have an opportunity for an acceptable transaction, albeit at lower value than the last two years. A solid transaction today can change your life and set you up for retirement, more time with family, gifting or charitable purposes.
We’d love to talk further and provide you with complimentary guidance on where the market would shake out for your company.