December 16th, 2015 brought this hardest of realities. The warning that interest rates, the single biggest determinant as to what your private business is worth,have begun their path upward as long predicted.
Quantifying the financial pain this first of many increaseswill bring should be a wake-up call. This Fed Funds increase is both compelling and actionable as it is probable that you disregard this event at your considerable financial peril.
Here’s what we know from history.
*Low interest rates PULL CONSUMPTION FORWARD and DELAY BUSINESS FAILURE. The Fed has, in effect, had us on a magic bathroom scale … where we all appear 10 pounds lighter; until their policies can’t be maintained and the system collapses. Then the real results become known, and the pain of that truth palatable.
*From the mid 1930’s to the early 1940’s interest rates were stagnant. Almost 60 years passed till we saw that occur again, December of 2009 till December of 2015. The likelihood of a repeat of that stagnation is de minimis in the lifetime of your ownership.
*The currency of purchase will be one or some combination of these three: cash from the borrowers coffers, monies borrowed against the buyers’ balance sheet, or swap of their common stock. All three are at their nadir or zenith. Again, it is highly unlikely you’ll again experience this conflation of these extreme and favorable conditions.
*Two major events stopped the market dead in its tracks twice in the last 14 years; the 9-11-01 attack … the 9-15-08 Lehman failure, for FIVE years.Have you either the stomach or the time to risk the market collapse brought on by the next exigency?
*The last time interest rates increased they went from 1% to 5 1/4% in 24 months! On 12-16-15,Chairwoman Yellin PREDICTED they’d go from 0% to 3 1/2% in 2018.
As the prime is usually about 3% above the Fed Funds rate, the following is the concrete calculus of howthese rate increases will devalue your business.
The buyer of your company will be accountable to the hardest of dictators, a taskmaster with zero compassion or understanding. It’s called IRR: Internal rate of return.
These Rate Increases
Will Devalue Your Business!
Study this real life example.
Acme Munitions out of New Mexico has been in business 30 years, has a reliable vendor base, a high quality work force, a great history of increasing revenues and profits and a loyal and disperse list of Roadrunners as customers. Revenues are $10,000,000 … profits are $1,300,000.
A buyer group requiring a 10% return offers $10,000,000 for the company, knowing that their borrowing costs at 3% ($10,000,000 X 3% = $300,000) will leave a $1,000,000in profits ($1,300,000 profits – $300,000 debt service) satiating their 10% criteria.
The owner rejects the $10,000,000, citing some arbitrary excuse: ( I’m a bit young to sell, I’m going to sell when my last kid is out of college, I want to wait till I’m 65, next year’s sales might be better ). Seemingly harmless, until what happened on 12-16-15 happens!!!
Two years elapse and now that arbitrary event has happened (college,birthday,etc.). Thankfully, financially, nothing has changed … still $10,000,000 in revenue, still $1,300,000 in profits.Or, so it seems.
But one thing has changed. The prime isn’t 3%, it’s now $6%. No big deal? Sorry, VERY, VERY big deal.
The owner calls up the buyer group and they revisit and make a puzzling offer. They offer ONLY $7,000,000 … not a penny more. How is that possible?
The answer is the 4thgrade math, no need to reference Euclid or Pythagoras.
The debt service at 6% reduces the net profit to $700,000 ($1,300,000 profits – $600,000 debt service). To get the same 10% return now, the buyer group will pay ONLY $7,000,000.
The owner works two more years, has two years of risk to this bitter result … $3,000,000 less in sales price!! And for what reason … the business owner was afraid to cash out too early? And almost ALWAYS for some mind numbing illogical reason … waiting 2 years till they’re 65? As if cashing out at 63 is … a bad thing?
The case to act now has NEVER been more compelling. Act now!
We will provide a FREE MARKET EVALUATION to those owners seriously interesting in exiting their businesses in the BEST MARKET EVER. This offer is made by no other M&A firm in the country and is valued in the many of thousands of dollars.
Let’s talk.
William S. Leib Sr.
Managing Partner
August 2016
wleib@emerge-ma.com