EP 60: Catching Up on Business and Life

Ed Mysogland  0:29  
I'm at my SIG land, I help business owners understand the value in their company so that they can sell their business when they want, how they want and to whom they want. On today's show, you just have me it's been a while. And I guess the first thing is, I want to say thanks. You know, Seth Godin says, would they miss you if you're gone? And so I heard from a number of people over the last six, eight weeks, was I Okay, and so on and so forth. And so, for all you that reached out, it means a whole lot to me that you did. And I'm good. Let's play a little catch up this whole COVID thing? Yeah, it really is something personally, I mean, the kids have hybrid school. And so that's a whole different dynamic. My wife is a therapist, and she had started her practice early on the last year or so, you know, all the challenges surrounding mental health, those things are real, too. So she has a backlog. I think she's 14, deep on a waiting list. To make matters worse, her dad died and you want to talk about for all those people that have lost people during this cold COVID thing. I mean, her dad went into a went into the hospital on Saturday was in hospice on Monday died on Thursday COVID funeral on Saturday, it literally went that fast. And and as far as a sad process, it really was. So yeah, so all those people that are facing similar challenges this time of season. Boy, I feel for you, too. So then moving on to the brokerage. Everybody asks, How is the deal making world right now, I'm gonna tell you, it's not bad at all. A lot of the businesses that we've been blessed to work with, you know, they're still hanging in there and deals are getting done. So where have I been? Well, in, in the practice, a couple of things happened. One, we had a marketing director went on maternity leave, which I thought I was ready for. And it proved that I was not. Fortunately, we had some great interns that did just truly a remarkable job. But nevertheless, it took considerably more time than I anticipated. Next was our broker support person, she had resigned to take another job, and it's a great job for so no hard feelings there. But what I didn't realize, and you know, even though, you know, in doing my valuation work, you know, I do bump into just about every business owner that says Labor's really hard. And so we went out, and we were soliciting a lot of people to apply for the job. And I think I went through 283 people, 41 people that I extended interviews to, and of those, only about 20 showed up. And of those, I'm trying to think I want to say, I mean, it was considerably less than that, I want to say like eight really had an interest in the job. And so that was a little disheartening and just totally ate a bunch of time. The good news is, we found a real good person, and we're real excited that she's joined us and you know, we're going to move down the road with her. And as we're looking forward to her making bigger impact in the business. So back to the business. Yeah, we haven't missed a whole, there hasn't been a whole lot of COVID related stuff that has caused deals to go bad. We're very, very fortunate that we have not been affected now, as with most years, you know, either we're going to have a good year, or we're going to have a great year based on November, December. We're a fourth quarter organization and, and so I'll let you know here in the next couple of months. How that turns out. Moving on to today, I'm going to play a little ketchup. There's been a number of reports that have rolled out that I wanted to share with you. A couple of things I want to talk about was one, I've received a number of questions how the PPP loan, how that affects business value, so I'm going to address that the m&a source third quarter report is out as well as the deal stats third quarter is out. One of my buddies over at the National Christian foundation sent me some correspondence on charitable giving at The end of the year. And then lastly, one of my buddies over at Live Oak Bank, he shared some of their survey results with their constituents. So it's going to kind of be a potpourri kind of like you're, I'm recording this right before Thanksgiving. It's kind of like you're a potpourri of information for your Thanksgiving for your Thanksgiving dinner. So I hope you enjoy it. And so let's get at it. All right, well, first begin with the question on handling business valuation related to the PPP loan. So for those of you, you know, that it's silly for me to even say it, but nevertheless, for those of you who are unaware of the TPP, that is the payroll protection program. That was part of the Economic Security Act known as the Cares Act or corona aid, relief and Economic Security Act. And that's the acronym is the Cares Act, or that was enacted to protect the payroll for companies, self employed sole proprietors, and non for profits. Anybody that was business or an independent contractor could apply for it. And they could receive a low interest loan to help them keep people employed. So now there is discussion about whether or not it's going to be forgivable. So in the meantime, there are companies that are required to be valued, and how do you handle the PPP. So the PPP originally was basically you divided your annual payroll by 12, and multiply by 2.5. And that gave you your PPP loan. So as we move forward, you know, there's three approaches to valuation, income market, and asset. So first, let's begin with the asset approach from until we know whether or not it's forgivable, it is a liability Simple as that. And you treat it as such. So it went in as cash it was used, and then there's a liability for the PPP loan. And so if you're looking at the asset approach, which is just the assemblage of assets, that's a liability, and you have to net it out. On the income approach, it's a little bit different in developing your your capitalization rate or your discount rate, obviously, you're going to if you're using a weighted average cost of capital, you're going to need to address the interest rate for the PPP loan liability and build your capitalization and discount rate accordingly, back to the asset approach. Remember, we netted it out at the end? Well, we're going to have to net it out again for the income approach, because again, it's a liability. And then finally, the market approach like the asset approach, it's a liability that you're going to have to again, net out at the end, like any any other liability. So what happens if you're doing a deal, and there's a loan still hanging out there and it may be forgiven? Well, what we're seeing is that a lot of people are either escrowing it, or I'd say probably the majority of the people are escrowing that that amount, and waiting accordingly, how many people are holding up their deals because of the PPP loan there. Instead, they're escrowing the funds and waiting to find out whether it's going to be forgiven and hopefully, we'll find that out here shortly. Okay, so let's move on to live oak banks, q4 2020 survey. So this business balls, which is powered by bar low research associates provides a detailed analysis and reporting on small business sentiment, including economic position, economic confidence, and credit outlook for small and mid sized companies. Part of this research was 2800 companies here domestically in the United States. And so let's go ahead and take a look at this. First things first, no surprise, small business owners are bracing for the impact of the presidential election, assuming that this ever gets over 63% of the people believe that their success at least partially depends on the result of the election. Next, which I find pretty interesting is that when I shouldn't say I find it interesting, I find it telling so small business owners are holding on to their cash signaling dry powder. So dry powder means cash is increasingly important. So 47 At least half of people or nearly half the people believe that having cash on hand is important. Well, we were just talking about the PPP loan. Obviously, a number of the businesses that I'm working on working with have a ton of cash because you know, they're they got the PPP loan, but they did not have to use it as anticipated, but they they haven't and it's sitting in cash. I'm assuming that this is the same kind of thing that Cash is king at the moment. And certainly there's there's some discussion on, you know, what's going to happen to credit from this point forward.

Okay, so continuing on, as it relates to the economic position of small businesses, based on the survey, it appears that there is increased optimism, which I'd say I probably agree with, especially now there's vaccine coming out that, you know, there's reason to be optimistic, there is an increased sales and profitability of companies. Again, I have not seen any kind of big value bumps in the road. And oddly enough, Washington, oddly enough, a lot of people that, that we've worked with, have decreased hiring, so they're doing more with less. And as a result, they're increasing their cash reserves. So next, moving into the economic outlook, for the most part on this analysis, or this survey, they're finding flat confidence, meaning, you know, it's just going to going to be business as usual, not, you know, it's not going to go down, not gonna go up, it's just gonna be flat. Again, on the economy, the regardless of who is elected, they anticipate that there's going to be an increased sales and profitability expectations. And I and based on the forecasts of the clients that we're working with that, again, is staying consistent. And then the good news is that people are going to begin hiring again, and having spending money on capital expenditures. So that's the economic outlook. And then as far as credit, and in this case, this is done by a bank, you know, there's going to be a need for bank loans. And there may or may not be a, a decreased demand for additional credit. And I've said this on a number of podcasts, and I've wrote about it on LinkedIn, and so on and so forth. The bottom line is that just because we have COVID, just because we have a new president does not mean that businesses are not going to transfer. The certainly the baby boomers are still aging, and they're going to have to do something with their, their businesses. And so it would behoove the Small Business Administration to to continue to facilitate the transfer of ownership and in for 2020, here, up till I think it was September 27. I mean, they were doing all kinds of things in order to facilitate the transfer of companies, including six months of no payments, no interest, especially until the economy and this whole COVID stuff gets passed us, I think it would probably be to everybody's benefit. If credit was continued to be readily available. From here, we'll move into charitable giving. Okay, my buddy over at the National Christian foundation have sent this over to me and, and I'll share with with you a little bit about it. Now, regardless of whether or not your flag flies for the National Christian foundation or any other non for profit, it's it's still the same. So again, back to the Cares Act. Remember, the corona aid relief and Economic Security Act was passed. That's $2.2 trillion of economic stimulus that was put into the economy. So one of the things also about the Cares Act was that it included a number of benefits for charitable givers, which included an expanded charitable deduction for gifts made cash gifts made in 2020 to churches and public charities, and waiving the required minimum distributions from retirement accounts. Although, you know, this has been a real interesting year for everybody. It does create some exciting opportunities for generous people to continue to maximize their charitable giving. And like this email I'm reading from says you can give more than you ever dreamed about possible under the Cares Act, because you're able to deduct up to 100% of your adjusted gross income. So again, if you itemize deductions on your income tax returns, you can deduct charitable cash gifts up to 100% of your AGI and may eliminate or significantly reduce your federal income tax. So if you want any information on the National Christian foundation, you can go to NC F giving.com. And you can find all the information that you could possibly want about this. If you need a contact over there, just reach out to me and I'll be more than happy to make the introduction.

Let's move over to deal stats. Deal stats is a compilation of completed deals. The deal stat value index summarizes the valuation multiples and profit margins for private companies that were sold Over the past several quarters, and you can get this download at deal stats.com. Okay, let's take a look at the findings for this this quarter. Not that I expect that there's going to be anything too terribly dissimilar from previous quarters. But nevertheless, let's dig into it. The second quarter of 2020 saw businesses across the economy adversely affected by the spread of Coronavirus, right, we got that. But oddly enough, that indicated that the multiples have actually gone back up, either we're getting comfortable with the uncertainty, or people that had pumped the brakes on their deals are finally getting them done. So again, it does appear that the EBA das are earnings before interest, taxes, depreciation and amortization. Those multiples are going back up. So we had bottomed out roughly at 3.7. And now we're back up into the fives. Same thing with the net sales multiple. So that thing has climbed to a five year high. Now, who would have thought that in the middle of a pandemic, so for the deals that were done in the third quarter, the net sales multiple rose to its highest level, or in this case, 54%. That's a five year high since the fourth quarter of 2014. So that is, again, all good news, oddly enough, is that the EBIT da margins fall to 11% of revenue. That is kind of interesting. But at the same time, I don't think it's necessarily surprising, I don't think it's surprising at all, that there's suppression in the price you're paying. And the margins are the cost that you're paying probably have either stayed or gone up. And so I would anticipate the profitability margins to shrink a little bit during the pandemic. And it appears that that is, again, the same thing. So they're earning the EBIT mult margin, as a percentage of net sales fell to 11% of the third in the third quarter. So out of all these deals, if you divide your EBIT, da by your revenue, the average here is 11%. So you can judge your company accordingly. Okay, so when we look at the median multiple for EBIT, ah, it's running at roughly 4.4 times, EBIT, ah, and that's across 18 sectors, and there was a decline in professional scientific and technical services, and then not surprising healthcare Social Assistance sector went up, but I'm looking across the multiples and everything's kind of hanging in there. What do we do with this? You know, as we look at the EBIT da multiples over the course of the last decade, there just is not a whole lot of volatility. I mean, there it's it's not like the stock market, we're we're one day you're up 800 points in the next year down 800. The multiples remain somewhat consistent, you know, not deviating too much, maybe, you know, 20 30% tops. So as a business owner or an advisor to a business owner, you should be in a position to guide your client or yourself on just what kind of know that my business has not necessarily increased substantially or decreased substantially, it's still probably close to the same multiple that it originally was. Now, if you improve obviously, you it's the same old thing, you improve your cash flow margin, you will, you will certainly benefit from the cash flow multiples. Okay, the last couple things I want to share with you is asking price discounts. So the bid to ask ratio, before we went into this recession, or this economic, challenging period that the Coronavirus has brought on, it was really a seller's market, and there wasn't a whole lot of deviation between ask and sale price. And it was you know, it always ranged roughly seven to 10 points. Now it's in favor of the buyers. So the ask price at least for quarter number three. And again, this may not be necessarily too surprising to you, to me a little bit, but it went to in favor of buyers and now it was 81% of asking price. So that's a big swing, you know, 20% off of ask. That is a real interesting statistic. And I guess what I would probably think through is of those deals that were trying to to get done during the pandemic. I'm reasonably certain that you In order to get it across the finish line, probably the buyers and sellers had to do some things that they probably weren't necessarily, I don't say okay doing, but it was probably over and above what would normally happen. And so I think that 20% swing from bid to ask, asked to sale price, I think I could probably explain that through and there's probably some PPP money that's hanging out there. That's not necessarily being calculated. Again, if I'm a seller of business, I just probably going to the market, I would make sure I shore up my value, and be in a position that if I have to do or extend myself, in order to get the deal done, I'm able to do that, understanding that my, you know, I may be 10 to 20%, off of what I'm asking. And then lastly, the economic shutdown slows the pace of selling to a five year high. And this is totally not surprising is that it took longer to sell companies, you know, the average is roughly 211 days. And in this case, it was running 245 days. So an additional 30 days to get the deal done under this pandemic. I'm not certain that is necessarily a bad thing. I think if I'm a Business seller, I'm thrilled to death that my deal got done. So that is deal stats, again, deal stats, it's the EAL sta ts.com. I will have a link to it in the show notes. Okay, this last report I'd like to share with you is the q3 2020 market pulse report that is prepared by the International Business Brokers Association, m&a source. I guess what I want to make sure you understand is that some of their findings differ from deal stats. Let's look at the deals. So according to this, they're saying that 33% have delayed their closing due to not knowing what the PPP statuses meaning isn't going to be forgivable. So they're still in a holding pattern. Again, like I told you before, a lot of what we're seeing is people escrowing funds in order to get their deal done. And if it's forgiven, it's extra money. If not, then, you know, it is what it is. And it's just a liability, roughly 30% are struggling with, with risk allocations, issues in negotiations and debate, well, who is going to be responsible for the loan if it's not forgiven? Again, I don't see how that's the case. Approximately 85% of professional advisors say that the pandemic had an extremely negative impact on the m&a market. What's notable here is that more than double the number who say the same thing about this year's election activity, again, anytime it's an election year, there is always uncertainty does not bode well, in the deal making space. And it is what it is it's been it's been that way forever. Let's talk a little bit about when, based on the survey when advisors believe that they'll will return to normal. So nearly 30% believe it'll it'll happen in q1 2021 20% believe that we'll be waiting to 2022 or later, and that attempt to believe that the that we've we're already recovered and on our way.

So no surprise again. So bigger companies command bigger values, size always means increased value. And the primary reason why is is just simply risk bigger companies do not have the same risk profile. It's a smaller companies. It's been that way since since I've been valuing companies that the bigger the company, the less risk there is because there's different tiers of management, there's just levels of sophistication to own and operate a larger business is just substantially different. So again, no change here. Bigger companies command bigger values. One of the questions are, were our business valuation trending. And so surprisingly, they're not trending at all. They're just hanging in there. And based on the analysis, and the survey, deal makers are not anticipating that there's going to be a big change in business valuation multiples. And in fact, as I look at the multiples that they're surveyed, you know, the 500 to a million range dropped, maybe 10%. The same thing with million to 2 million in cash flow multiples, dropped from 3.3 to three. But again, I mean, that is certainly within and expectation, and as you heard in my analysis of the deal stats, same kind of thing. I mean, you're talking about a 10 to 20%. Swing, this is certainly not anything to do to be surprised about. So based on 2019, to 2020, under 500,000, there's really no change at a to, to multiple 2019 to 2020 500 to a million year 2.5 to 2.8. And same thing with million to 2 million and adjusted cash flow, you're looking at a three to 3.3 multiple. So there's really not a whole lot that has changed there. Same thing with cash at close. The funny thing is that, oh my goodness that, you know, it's I don't wanna say nearly identical, but it's pretty close to identical, where you're looking at cash at close, running from 80 to 86%, depending on the size of the deal. And, you know, seven to 15%, based on seller financing. Again, not surprising at all. Okay, so let's look at the time to close. Let's see, we're looking at for under half million dollars in deal size, eight months, eight to 10 months, across the board is again, no change, nothing surprising. So why is everybody selling? Anybody want to raise their hand on why? Right 70% of all respondents are saying it's retirement. Again, I don't know if the tsunami of business owners that are looking at exiting is now here. I sure hope so. I've been saying this for a long time I've been waiting most of my career to take advantage of of that tsunami, pretty much everybody is retiring. Surprisingly enough. Now here's here's the sad part is you know, they're coming into the process blind. So how many business owners who that had engaged in no formal planning, prior to the engagement sell. So under a half million, roughly 85%, half million to 1,000,075% million to 2,000,050%, two to 5 million, we're running at 60%, and 5 million and up almost 35%. So again, most of the business owners are walking into the sale process blind, they don't have any kind of idea of what they're walking into. That may or may not be a chance they may not be. It absolutely is a challenge and something that business owners really need to think long and hard about before entering the market. You know what selling so this part is kind of surprising, because under a half million dollars, the greatest area is restaurants. And I'm thinking Who's Who in their right mind buying a restaurant in the middle of a pandemic, where it's been, where the government is closing you down. So but believe it or not, the that's the high for the half million to a million dollar range, personal services, health care and retail, which is not necessarily surprising, either the million to $2 million range is construction and engineering and manufacturing, each, respectively about 25% each. So that's not surprising, but I can I can certainly understand that same thing with the two to 5 million and the five to 50 million. So they are both construction and engineering are overwhelmingly the things that are selling. That concludes this analysis for the q3 market pulse analysis or q3 market pulse survey done by the International Business Brokers Association, them and a source. So that is my findings. So I'll be returning next week when I restart interviewing people, believe it or not, before I left that three of my guests develop COVID and not just asymptomatic COVID I mean, super duper sick. And so we're grateful that they've rescheduled and we'll get back on interviewing people. So again, I wanted to thank you again, for those of you that reached out I may not I should have hopped on you know, made you aware of what was going on with man. But like said I'm super grateful that for all you that that listen on a regular basis and reached out to make sure I was good. So thanks so much. And as always, it is a standing offer. If there is anything I can do for you in any way, shape or form that will help you either exit better or get you in touch with people that will help you grow the value of your company or If I can do anything, just let me know. Thanks so much have a very happy Thanksgiving. I'm peripheral for for everybody that we all stay healthy and our loved ones do. Thanks so much again, have a happy Thanksgiving.