July 6, 2020
Why Bulkley Capital Launched its Blog Series
The inspiration to create a blog series on corporate finance topics affecting business owners was spawned by the multitude of questions we have fielded over the last 35 years as a resource to private and closely held companies. Our goal was simple – to offer practical insights that address some of the more important, but often unfamiliar, financial matters a business owner faces.
Whether the topic was factors influencing company valuation, the importance of succession planning, how to access private equity, insights into the deal process or when and how to engage an investment banker, there are several common threads:
- The company should be viewed as an asset in the owner’s (or family’s) portfolio.
- Preparedness is a critical element in maximizing value.
- Do what is right for the business long term – not for the moment.
- Succession and liquidity mechanisms must be incorporated into an owner’s plan.
- M&A and capital raising is a process, not an event.
- Today’s capital markets provide access to a wider range of transaction structures, capital types and investors to more businesses than ever before.
- When buying, selling or re-capitalizing a company, it is imperative to enlist experienced professionals.
- Business owners cannot stagnate during this challenging period – with crisis comes opportunity.
Each of these points is important. A few deserve just a bit more attention.
The Most Valuable Asset in the Portfolio
Very few owners think of their company in its context as an asset in their family’s financial portfolio – even though it frequently comprises most of their net worth. As such, they fail to apply the same sound investment decision-making rigor to company issues as they do to their other financial holdings. The tendency is to be short-term focused; that is, put out fires, concentrate on day-to-day operations and grow current earnings.
These are important issues, to be sure. But decision-making should be driven by a balanced, longer-term perspective based on maximizing shareholder value. Achieving this balance may mean investing in the company’s growth at the expense of near-term profits, or backing away from business that would increase concentration or exacerbate other risks for the company.
As an owner ages, it is prudent to further diversify. Most prudent investment managers advise their clients to spread exposure across a basket of companies and sectors. Akin to this, an owner nearing retirement – who is, perhaps, still not ready to sell – could see great sense in diversifying his investment by taking some chips off the table today through a recapitalization. A complete sale could happen a few years from now after realizing additional growth. Meanwhile, a portion of the value that has been built is re-invested elsewhere and, ideally, protected from the market factors that affect the business.
It’s not rocket science – just a simple diversification strategy. But many owners fail to apply this thinking in the context of their businesses.
Governance: Planning for Succession and Liquidity
Having a succession plan in place is critical. It is also one of the most important responsibilities of an independent board, which will help an owner with these and other difficult issues.
Chief among these issues is liquidity. Private companies simply don’t have the luxury of immediate shareholder liquidity that is characteristic of their public company counterparts. In fact, illiquidity of holdings is one of the most common causes of private and closely held company break-ups – where one or more shareholders require liquidity and there is no formal means of meeting their need short of selling the entire company.
Private companies need to have a liquidity mechanism to effect partial repurchases consistent with a succession plan that is reviewed annually.
Sound governance practices, including the presence of a qualified and truly independent board, contribute to knowledge that comes only from experience. They can also help an owner maintain the discipline of staying focused and level-headed in the heat of the moment to make sound decisions that are in the shareholders’ long-term best interests.
The Need for Preparation and Sensible Thinking
Sometimes, company owners come to our offices glassy eyed and stressed due to an unanticipated circumstance that requires their immediate attention. The “crisis” can be in the form of an unsolicited purchase bid, an acquisition candidate with a limited time frame to act, the inability to fund a much-needed capital expansion, or minority shareholders demanding liquidity and placing financial strain on the company.
To be sure, these are not everyday events, but they still occur frequently enough for most successful middle market businesses that owners can take actions to be prepared. Moreover, they lead to some of the most important decisions an owner will ever make. However, the tendency of many owners saddled with everyday demands is to push all the “other stuff” off – mistaking the urgent for the important.
The consequence is a reactive – versus a proactive – response. When unprepared, sudden demands coupled with strict time constraints result in muddled thinking and frantic responses marked by limited attention to potential alternatives. The odds of making mistakes increase exponentially. These misjudgments can wipe out years of value an owner has worked so hard to create.
Buying, selling and recapitalizing are processes, not events. Creating a positive outcome is often a function of two key variables: knowledge of the undertaking and the ability to proactively control timing.
The Range of Financial Alternatives Today is Wider Than Ever Before
It wasn’t long ago that private companies had very limited options. Most financial alternatives were reserved for public entities. But times have changed. Bank financing is more readily available and institutional equity is now plentiful. Private equity firms are actively seeking opportunities in the lower end of the middle market. In fact, far more opportunities exist than most owners realize.
Optimal decision for the organization cannot happen without complete knowledge of all the possibilities. However, some of these options are not readily apparent. High-quality and experienced advisors understand the alternatives available to business owners and can navigate them toward the best outcome on value and beyond. And, markets are ever-changing. Owners need to engage a party with in-depth and up-to-date knowledge of the financial markets and an understanding of the unique needs of privately held companies.
In deciding to recapitalize or sell, follow the rule of “first, do no harm.” Be discrete and conduct a highly selective process to avoid damaging the company. Although it may seem counter-intuitive, broad auctions can injure a company. Proprietary processes may be compromised, and valuable employees – and customers – can flee. Not all deals close. First, do no harm.
Engaging the help of third-party experts is critically important. Pursuing some of these financial alternatives is complex and becomes a full-time undertaking. Managing ongoing operations and a transaction process is ill-advised because one will suffer. Engage an investment banker who has a longstanding track record of success (read: satisfied clients) who understands the unique needs of closely held or family owned businesses and aligns with the interests of shareholders. Above all, look for trust.
Whether selling, acquiring or recapitalizing, take a long-term view. Actions and decisions that save a few bucks in the short-term can become very costly if they prevent shareholders from maximizing value.
With a Crisis Comes Opportunity
Finally, today owners face the immense challenges and change brought on by the current health crisis. Meeting these challenges requires an enormous time commitment and can feel overwhelming. Yet, no one can afford to stand still.
A Warren Buffett quote comes to mind, “Be fearful when others are greedy and greedy when others are fearful.” Use this period of economic lull to strengthen the business, establish goals for ownership and prepare for a transaction so you are able to strike when the time is right. That acquisition opportunity that may previously have been untouchable may now be possible.
Preparation, planning, strong governance and the right advisor will help accomplish key objectives essential to maximizing shareholder value.
For more insights from the series, The Path to Private Company Liquidity: A practical guide to M&A for business owners, click here.