It was announced this morning (June 5, 2009) that the unemployment rate has risen to a 26-year (August of 1983) high of 9.4% from 8.9% in April. The silver lining though is that we only lost 345,000 jobs in May compared to a loss of 504,000 jobs in April. As I’ve been saying, it will be the 4th Q before we get to any positive growth but at least the decline is slowing.
Anthony Vincent
The media is causing inordinate economic panic with headlines such as “Economy shrinks at fastest pace in 26 years,” It’s important to realize that recessions are actually a normal part of the business cycle and do have a valuable purpose in that they clear away weak companies and make room for dynamic post-recession will last another 12 months (more or less)!
Does this mean that business owners should “hunker down” and try to wait for better times to sell their businesses? It depends on your age, personal objectives, and the financial health of your business! If your company’s health is deteriorating, we suggest that you call us to discuss exit and/or recapitalization options.
Because the “hunker down” mentality is widely shared, there is currently a shortage of businesses on the market and there is a plethora of displaced executive and private equity group (PEG) buyers seeking deals at fair prices.
As an example, we are currently performing a search for a west coast based PEG that is able to fund 100% of their deals without debt but we can’t find sellers!
Selling multiples for smaller businesses (under $100 million) have not been significantly changed by the recession. Is it a better time to sell when you are one of a few companies competing for the attention of buyers; or, when you are competing with a large number of companies who have waited several years to sell? Wait and be one of many who have postponed selling. Engage the process now and be one of a few. Under which scenario would you expect to receive the highest price?
Also remember, when the Bush tax cuts expire in December of 2010, capital gains rates will increase from 15% to 20% requiring that you sell your business for ~6% more to break even. Are you willing to keep your business for 10 more years until the political agenda (tax policy) changes?
Call us and allow us to help you determine your options.
Anthony (Tony) Vincent, President
Alpha Omega Capital Partners
The presidential campaign is heating up and upper-income clients may see an increase in taxes. For families making less than $250,000, Obama’s plan will not raise your taxes but will provide a tax cut. He wants to raise the top ordinary income - tax rate from 35% to 39.6% The Obama Plan also encompasses higher Social Security Taxes on workers making over $250,000. In contrasts Sen. McCain wants to make permanent the current federal income tax rates - he also opposes the Obama plan to lift the earnings cap on the Social Security payroll tax. Obama wants to raise the long-term capital-gains rate for families making $250,000 to around 20% or higher - but not above the 28% level it reached during the Reagan presidency. To be prudent, we recommend that business owners plan on 28% if Obama is elected. While McCain wants to keep the current structure of tax rates on capital gains and dividends - he will almost certainly be forced into compromising with the Democrats as long as they control Congress so don’t expect him to resist the increase from 15% to 20% that is already legislated to happen automatically in 2010. In summary, capital-gains rates are likely to go up more and sooner if Obama wins - even if McCain is not forced by Congress into raising the percentage, the 15% rate is set to rise automatically in 2010. Bob Willens, President of a tax-advisory firm in New York, agrees that the capital-gains rate is going up next year but argues there is no reason to rush to sell your business today since lawmakers aren’t likely to make tax-rate increase retroactive until mid 2009. We disagree because it requires 6 to 12 months to sell most businesses when efforts are made to sell at maximum value. One year from this posting puts us into mid 2009!
Mandates will make hefty amounts of rent expenses disappear as corporations account for operating leases in a new way The proposed change of the decision to amend FAS 13, a 1976 rule that distinguished between capital-lease obligations, which appear on balance sheets, and operating leases, which don’t; will boost the EBITDA of companies with operating leases substantially. Companies that tend to hold large operating leases have been fearful of the impact of the rule change. Charles Mulford, an accounting professor told CFO.com “Given how EBITDA is calculated, any company with rent expense from an operation lease is going to see an increase in EBITDA.” The EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) measures a company’s ability to service debt, such an increase could provide more financial flexibility within financial covenants without a firm’s making actual improvements in its performance. The boost in EBITDA could most affect retail and technology firms because they tend to have the largest holdings of operating leases. Financial managers need to be aware this is coming and need to start working on the potential effects of this into their financial contracts that use EBITDA. Rappeport, Alan. “Lease Accounting: Falling Rents Will Boost EBITDA.” Nov. 2007: CFO Magazine ________________________________________________________ Alpha Omega’s Opinion: Treating capital leases and operating leases the same is a good idea because it elevates operating leases from the footnotes to the balance sheet where they belong. Regardless of form, leases are an interest bearing liability and a form of financing so they belong on the balance sheet. Companies often use accounting rules to get their leases off the balance sheet. This treatment enabled them to show less debt and leverage and perhaps appear stronger than they were. It may have also caused them to obtain less favorable terms than they could have gotten with a capital lease. It’s true that this change in accounting will affect EBITDA, but it’s also true that it will affect the fixed obligations that are serviced by EBITDA. In fact, a benefit from an increase in EBITDA might be more than offset by the increase in fixed obligations. Suppose a company has $5 million in EBITDA and $2 million in fixed obligations. This company has a coverage ratio of 2.5 times. If the accounting change causes EBITDA to increase to $7 million and fixed charges to increase to $4 million, its coverage ratio actually decreases to 1.75. Of course, there are many different possibilities and perspectives on EBITDA, so the impact will vary greatly. The bottom line remains the same - any analyst must understand what comprises a company’s EBITDA and understand what has changed between reporting periods.
More than two-thirds of all working adults want to resign from their jobs to start their own businesses, according to a study from Intuit, the maker of QuickBooks. And 84% think they would be more passionate about their work if they worked for themselves. The Mountain View, Calif.-based Intuit is doing its best to help those dreams come true. The company is giving away software, launching a new small business Web site, and holding nationwide “Just Start” events to help aspiring entrepreneurs get their businesses started. One lucky person will win $40,000 in cash and $10,000 in products and services in a business contest. Two others will receive $5,000 each. The survey also reveals the deep dissatisfaction most Americans feel in their current careers: A full 67% think about quitting their jobs on a regular or constant basis. What’s stopping them? More than half are afraid of not making enough money, and 27% just don’t think they know enough about starting and running a business. For more information, visit iwilljuststart.com
Retirement Plan - Not Such a Quick Fix
If your endgame plan is to sell your business and retire off of its sale then you may want to research the market ahead of time. Not only do Buyers demand proper financial records and detailed documentation - but sales could sometimes take years to close. A recent study by the Alliance of Merger and Acquisition Advisors found that 7 out of 10 midsize businesses will transfer ownership during the next decade but that 90% are ill-prepared for those transactions. With increased competition and a slowing economy buyers are doing extensive research. With a three to seven year lead time ensure that your financial statements and business plans are organized and cutback on unnecessary expenses. When you are ready to sell, obtain professional help to figure out how much your business is worth and how to conduct the sale.
Dale, Arden. “Want to Sell a Business? You May Not Be Ready.” Wall Street Journal 8 Jan. 2008
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Alpha Omega’s Opinion:
At Alpha Omega Capital Partners we can help you prepare to exit on a long-term basis. The decision to exit should be based on compromise between three sets of issues:
1. Internal Discount Factors,
2. External Discount Factors, and
3. Personal Needs.
We offer seminars on exit planning and a “Value Mentoring” program where we coach our clients for as long as it takes - several years if necessary - to prepare their companies so they can exit at maximum value. Through strategic planning and good management, Internal Discount Factors can be eliminated or controlled. The purpose of Value Mentoring is to identify and eliminate as many of these discount factors as possible. The other two issues that must be considered are External Discount Factors and Personal Needs. External Discount Factors can only be controlled through timing and include factors such as Economic Conditions, Lender Confidence, Interest Rates, Industry Trends, Global Trends, Tax Rates, etc. Personal needs can sometimes be planned but unfortunately, they frequently dictate the schedule. These factors include Retirement, Spiritual Pursuits, Travel, Family, and Reduction in Personal Financial Risk. Unfortunately, other factors such as Health Problems and Divorce are very difficult to control. For that reason, it is imperative that every business owner operate their business as though they are going to sell it tomorrow! Alpha Omega Capital Partners can help you identify the issues that matter.
Anthony Vincent
The dizzying rise and sudden slump in the housing market has left homeowners concerned about how to make reasonable financial plans for the future - not knowing what their house will be worth. Consumers will most likely not lay out more money to buy a property that they could rent for the same price, unless they are going to make a profit selling in the future. According to FORTUNE’s calculations, prices in most markets will fall by double digits over the next five years. This disturbing conclusion was reached by comparing the median price of existing homes in 54 metropolitan areas to the annual rent on similar properties. Economy.com compared the Price/Rent ratio for each area and compared it with the average over the past 15 years, and then calculated how much it would have to decline to return to its historical norm. The average drop for all 54 markets surveyed was 28% - this coupled with the 12% rise in the markets over the next five years, prices only need to drop about 16%. The big price declines are inevitable due to the giant chasm that opened between prices and rents, and how fast it happened. The 40-year low interest rates that prevailed from 2003-2005, brought a flood of investors into the market. Lax lending standards allowed sub-prime borrowers, people with poor credit histories, and erratic employment records, to suddenly afford to buy houses, further stoking the demand. Houses were still being built to the demand of investors, which have since disappeared. Resulting in the housing industry facing an enormous amount of houses unsold, and unoccupied. The cheap and easy money is gone, but the inflated prices it created are still here. Many of the new vacant homes for sale are in the hands of builders, older homes that speculators are trying to dump, and foreclosed properties that banks are desperate to shed. The prices will keep falling until the builders work off their massive inventories.
Tully, Shawn. “How Low Can They Go?” FORTUNE Nov 12, 2007.
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Alpha Omega’s Opinion:
So what does this mean for small business owners, those of us with annual revenues of approximately $50 million or less, who may want to exit from their businesses? Although the earnings of any business remotely tied to new home construction markets will plummet, the remainder of the economy, albeit slower to grow, should not be impacted directly. Lower earnings certainly will reduce valuation levels but may not directly impact the resale demand for “larger” small businesses (those with annual revenues from $5-50 million and with EBITDA of $1 million or greater. The demand for these businesses from the private equity buyer segment will actually increase as larger deals become more difficult to find and close due to increases in leading rates and tightening of lending covenants.
Anthony Vincent
Sale-Leaseback real estate deals are helping more small-business owners make the most of their capital.
Sale Leasebacks enable you to sell your buildings, pocket the proceeds, and then lease them back, allowing you to grow your business - instead of owning real estate. You can then put the proceeds into new equipment, new hires and pay down debt. This is becoming an option for more and more small business owners. Over the past two years sale-leasebacks have had an estimated growth from 10% to 15% for small firms. Large companies have been using this strategy for years and now it is translating to small business owners as well. The Internet is providing a catalyst for small business owners where they are able to view sites where these transactions are occurring. Annual returns range from 6% to 11%; sale-leasebacks are popular with private equity players, institutional investors, real estate investment trusts and wealthy individuals. The first step is to find a capable broker, by getting referrals from local real estate lawyers, tax accountants, and bankers. Once ownership changes hands, the seller continues to occupy the space under a long-term lease. The terms vary as to how much control the former owner has and how much upkeep he’s responsible for. Deals can be creative: negotiating buy back options, and leasing also provides a tax advantage. Sale-Leasebacks aren’t for everyone; the transactions may have less flexibility than ownership.
Duell, Jennifer D. “Sell To Rent” FORTUNE Amell Business Dec 07/Jan 08
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Alpha Omega’s Opinion:
Many of you reading this will argue that this advice is the opposite of what my accountant has been advising for years! “I have allowed the business to pay for my building and it is going to be an important part of my retirement!”
We do respect and understand that “the love affair between small business owners and real estate” is a sensitive subject but the bottom line question remains “Is owning real estate recommended to maximize the profitability of your business when owning the real estate is not a business necessity?”
Let’s start by listing the reasons business owners give us for owning company occupied real estate:
o Tax Benefits - depreciation expense is deductible.
o Cash Flow - personal income from the rent.
o Appreciation - when I sell the business and real estate, I can benefit from the real estate appreciation.
o Equity - as I pay myself rent, I’m also servicing the mortgage debt which will become part of my retirement nest egg.
o Cost Control - as long as the rent covers the mortgage, I can pay myself less than market rent to keep my business profitable!
o Required to Own by the Nature of the Business (Salvage Yard) or by the Franchisor - good reason
o Control - if I own the Real Estate I control my own destiny?
Here are some counter points that challenge the belief that owning company occupied real estate is beneficial:
o Real Estate can become an Albatross - owning real estate can render you strategically inflexible when you find that the occupied real estate is not longer synchronized with the needs of your business. Possibly you need more (or less) space but have no room to expand, need to move to better serve a changing market, or you need a different type of facility and conversion cost is too high to consider!
o Investment in Real Estate can be Poor Use of Precious Capital - with the exception of the SBA, all lenders impose debt/equity limitations. Unless you have unlimited availability to capital, the growth of your business may be severely limited if you have your money invested in real estate.
o Selling the Business - the inclusion of real estate as a condition to selling your business can impact your ability to sell the business and/or obtain maximum value for the business. Why?
o Inclusion of the Real Estate limits the number of buyers that will have the necessary capital to close the deal.
o Strategic and Private Equity buyers generally will not acquire real estate. They realize that owning the real estate reduces their return on assets employed.
o It is frequently IMPOSSIBLE to obtain fair market value for both the real estate and the business. This happens when real estate values appreciate rapidly and outstrip the ability of the business to pay fair market rent. The choices left for the Seller are all bad: keep the real estate and charge the Buyer less than fair market rent (so they can afford to pay the fair market value for the business); sell the real estate to the Buyer for less than fair market value (so they can afford to pay the fair market value for the business); keep the real estate and charge fair market rent thus reducing the value of the business (available free cash flow to the Buyer); etc. As you can see, in this scenario there are no good options! In our opinion, the owner of a business should think long and hard about the decision to acquire company occupied real estate.
Anthony Vincent