How to Maintain Business Value During Crises with Chris Mercer
Today’s podcast is a little bit different. Ed visited with one of his valuation heroes Chris Mercer, of Mercer Capital. When people talk about thought leaders – these days they throw that around as if everyone is a thought leader. Well, Chris really is! He has been a leader in the business valuation community for years. Ed wanted to talk to him about how to increase business value, and how to help business owners make saleable companies. Well, at the time of this recording, we’re knee deep in the middle of COVID-19.
So rather than talk about how to increase value, we’re just going to talk about how to maintain value in crisis.
2:25 – Who is Chris Mercer and Mercer Capital?
4:31 – How can a business owner preserve value in times of crisis?
8:06 – Advice for a baby boomer that thought they were in the final stages of building value in their business to sell it and retire?
9:43 – Can you position this crisis downturn in business as a non-recurring event?
12:12 – When this is over how can a business get their value back?
13:50 – How will the government stimulus play into a businesses ability to recover?
17:58 – Should a business owner try to sell right now?
18:51 – How has this crisis affected the threshold of risk?
20:38 – What advice do you have for the business owner counting on their business value to retire?
23:39 – Tell us about the decision to convert Mercer to an ESOP?
26:38 – How can a buyer reasonably forecast whether a business is a good investment right now?
Who is Chris Mercer?
Chris Mercer has been in the business appraisal business since 1978. He went into business at Mercer Capital in 1982. Mercer Capital has grown over that period of time to become one of the larger independent firms in the country. They have offices in Memphis, Nashville, Dallas, and Houston. Mercer Capital provides valuation services for a broad range of companies and for a broad range of reasons – gift and estate tax purposes, financial reporting purposes, employee stock ownership plans, buy sell agreements, etc.
How can a business owner preserve value in times of crisis?
The value of the business is the present value of all the expected future benefits. That is, the cash flows from the business discounted to the present risk adjusted discount rate, and that’s a sort of an overview of the discounted cash flow model. What we have in today’s environment is heightened risk. The reaction in the marketplace in recent days is a substantial overreaction, and that sanity will eventually prevail. Cash flow is key. And every business is going to have to during this period of time, focus on either conserving cash or generating cash – or a combination of those two things. If you’re in the restaurant business, and the state has closed you down, there’s not much you can do except perhaps offer take out service and hope that will pay some of the overhead and keep a few of your employees in business. If you’re in the airline business, you’re just slowed down. If you’re in the car rental business, you’re probably slowed down. But if you think about the impact on so many different kinds of businesses, they’re all trying to do either to generate cash or conserve cash, because that’ll be the key to coming out on the other side. It’s hard to talk about the growth of cash flow at this point.
Today, we’ve got 45 people in probably 45 different locations and we’re trying to figure out this new reality – how to stay productive and optimistic and a time when if you read the press or listen to the news, the only thing you can do is get depressed. You’re not alone. You may think you’re alone, but you’re not alone. You’ll get through this. You’ve been through every other crisis before now, and you’ll get through this one. Business owners have to have that kind of attitude.
Advice for a baby boomer that thought they were in the final stages of building value in their business to sell it and retire?
Business owners need to work with their team right now and focus on preserving the business and rebuilding the business because you won’t get another chance. When this rebounds, and all of that pent up demand is still going to be there. there’ll still be a bunch of money chasing deals, so you want to get to the other side. Every virus runs its course. And this one, too will run its course. If you are in that older baby boomer group, and you still own your business, you better be focused on your young people and better be focused on making sure that they are working and happy with the business because you won’t have another five years to sell it.
Can you position this crisis downturn in business as a non-recurring event?
It is a non recurring event, but life is filled with one non recurring event after another. This virus and the panic that is surrounding it has taken away a third of the market capitalism and the US markets in a very short period of time. It would be naive to think that that wouldn’t have an impact on a typical business, if there is such, as laying off Main Street. So a valuation firm is attempting to figure out how to address valuation in this light. Because it’s not like we can fast forward to the end of 2020. We have people doing deals right now, and we have to be talking about valuation right now. This is going to impact a lot of people. It’s kind of counterintuitive. Treasury rates are down at such a low level that would infer that other things being equal, that value would be up there. But value is not up, value is down and value is down because of that thing called risk. That risk is – all you have to do is drive by and look at all the restaurants that are closed. Drive by and look at all the bars that are closed. There’s less traffic everywhere right now. And people are just kind of hunkering down. As business owners, we’re all trying to figure out, is the phone going to ring again?
When this is over how can a business get their value back?
Number one, do the best thing you can do right now to generate cash and conserve cash. Number two, you do everything that you can to make the numbers of your business look as good as they can, under the circumstances. Let’s hope that performance will come back in the next year. Keep in mind, some other things are happening. There’s a lot of deleveraging going on right now as people are trying to find sufficient liquidity to stay in business and the bank financing is going to be considered riskier for a while. Financing is going to be a little harder to get. So until we get through and see what happens on the financing side, we really won’t know about value. Two years from now, if we look back, the value of smaller businesses and private businesses and bigger private businesses will be back to their normal levels.
How will the government stimulus play into a businesses ability to recover?
Nobody who’s right thinking really wants a deep recession right now. And if those stimulus efforts work, then the recession will probably be short and not so deep. In the absence of that, the world economy will have changed. The suppliers in the far east have been backed up and other suppliers are coming back online now, but the US economy hasn’t even been hit with all of that yet. At Mercer capital, we’re experts in working remotely, but this is a new deal and we’re going to have to figure out how we’re going to do business. The basic things like keeping staff productive, keeping staff motivated – it’s much harder if you can’t see anybody.
Should a business owner try to sell right now?
What business owners are going to have to be doing is focusing on every aspect of their business that generates cash and conserves cash, because cash will be the determinant as to who comes out on the other side. If you run out of cash, it’s pretty hard. It’s hard to depend on a government bailout for a small business. Good businesses sell in any economic climate. If you’ve developed a business, this is a speed bump, it’s not the end of your business. If you need to take it off the market and wait it out, then you’ll be fine.
How has this crisis affected the threshold of risk?
Many people have been saying it’s in the five and a half or 6% range 5% range. That risk premium sometimes gets adjusted by data. Right now, the equity risk premium is huge. That’s the only thing that will explain, at least for the short run, the downturn and market prices. The weak are going to get weaker, and some of the strong are going to get stronger. Walmart and Amazon are hiring. And they’re hiring at the expense of Main Street businesses who may not have the capital to make it.
What advice do you have for the business owner counting on their business value to retire?
It may be best to forego trying to sell a business for the next three months. If it’s in the process of being marketed and potential buyers are already talking and halfway committed, that’s one thing. Buyers are aware of what’s going on in the market as well. A buyer may take full advantage of this because this makes the business more risky. It gives the buyer a chance to pause and say, “You know what, let’s just table this for 90 days and let the storm go by and then we’ll revisit it.” Time kills all deals. If you wait until it’s too late, it’s too late. And that’s what a lot of owners do in terms of waiting to sell their business or waiting to get it under different management hands or a different arrangement so that other people are benefiting and maybe they may have less benefit. Some business owners that are going to be holding their stock or holding a piece of their stock, may have to give up some other stock, to keep people in the coming year, or two or three, in order to keep it all together. But that might be preferable to losing the team.
Don’t let the psychology overpower you. In other words, take charge of your attitude and be as optimistic as you can while you’re working on cash flow, and get to the other side, and then do what you need to do in a very reasonable period of time, because there probably won’t be another chance for a lot of folks in that age category.
Tell us about the decision to convert Mercer to an ESOP?
Mercer Capital sold half of the company to the Employee Stock Ownership Plan on January 1, 2006. Mercer took out a 100% loan to buy that stock, the stock data the company data is loaded to the ISA and paid off in eight years. The ESOP provides a valuable additional benefit to Mercer employees. The company still has a profit sharing plan and still makes a generous contribution to the profit sharing plan. But the ESOP is an S Corp and its contributions and distributions are not taxable. Management felt it was a good decision for Mercer and it’s been very, very good. As a service firm that generates cash flow and the company was able to service the debt. It’s just an additional significant enhancement to the retirement plans of Mercer employees.
How can a buyer reasonably forecast whether a business is a good investment right now?
Forecasting is an enormously difficult thing. Crises like this will call for increased due diligence. It will slow down the pace of deals and it will kill a lot of deals. It’s hard to take into account what might come out on the other side when you’re in the middle of the market slide. Basically, all you can do is slide until you get to the bottom and then you can begin to think about forecasting.
Keep looking forward optimistically – the downside of being optimistic is nil. The downside of being pessimistic is great. So to the extent that you can affect your attitude, keep a positive attitude through this time. It will help you get through this time period. And it will help you rebuild and put things back together when the markets are a bit more favorable.
Connect with Chris Mercer
You can connect with Chris through these channels:
Official Company Twitter: @MercerCapital