EP 32: How to Maintain Business Value During Crisis with Chris Mercer

Ed Mysogland  0:00  
So Chris, welcome to the show. 

Chris Mercer  0:15  
Thank you, Ed. It's a pleasure to be here. I wish the times were a little different than they are. But we're living when at the time that we're living. 

Ed Mysogland  2:06  
Well, the good news is that we're living. And that's, that's the that's the important thing. I gave a little overview before you got on about you and Mercer capital, can you kind of give your just a brief overview of of you and the services that Mercer capital has been providing all these years? Sure. Well, I have been in the business appraisal business since 1978. I went into business at Mercer capital in 1982. And we've grown over that period of time to where I think we're one of the larger independent firms in the country. We've got offices in Memphis and Nashville, and Dallas and Houston. And we provide 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, and then people of course, fight over money. And litigation is an area where we've lived for a long time. Like say the company we have a significant resources, we have one of the largest single valuation offices in the country, making it the largest Invensys, we've got almost 30 people there. Most firms don't have that many people in one place. But we've been at it a long time, as you pointed out, and it's been a good ride. Well, I'll tell you, when, when I was younger, and I'm talking 25 years, years ago, I was my plan was, you know, I would get my chops up here in Indiana, and I would I would land in in Tennessee, and I would go work for for Mercer capital, because that was just kind of where that was the the pinnacle of, of investment banking and valuation. So yeah, what a wonderful company you've built. You know, as I was telling you, I had a script, I had all my questions laid out on how to increase value of a company to make it more valuable to sell down the road. And if you don't mind, I'm gonna go ahead and pivot into three areas that you've taught about for all these years. The first one is valuations based on three things that you've always taught about risk, about earnings and expectation. So we're in the middle of this crisis. So why don't we attack each of these three and figure out how to help business owners either stay afloat or at least preserve the value? Sure. Well, the value of business is 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 sort of an overview of the discounted cash flow model. What we have in today's environment is heightened risk. I hope that the reaction in the marketplace in recent days

Chris Mercer  1:51  
is a substantial overreaction. And that sanity will prevail. I was around for Black Monday, which was in October of 1987.

When the market dropped, maybe close to 30%, in one day, it did come back within a few months. And you know, it continued on. But cash flow is key in 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 takeout and hope that that'll pay some of the overhead, keep a few of your employees and 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. And businesses don't even think about, I went to laundry to pick up something on Friday. And I noticed that they had to shorten their hours. And the lady said that in the last week, their business had just dropped almost nothing. Because when people are staying home, they don't need directly. Yeah, but if you think about the impact on so many different kinds of businesses, and 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 flows. At this point, you know, a business like our business, we have 45 people. And normally, we have four offices. And we know where everybody is, and it's easy to communicate with everyone. Today, we've got 45 People in probably 45 different locations in Florida. Others are working from home. 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, my gosh, the only thing you can do is get depressed. Yeah, we had a pep talk this morning, with our folks about the fact that you're not alone. You may think you're alone, but you're not alone. You know, you're working together, we'll and we'll get through this. We've been through every other crisis before now. And we'll get through this one. And I think business owners have to kind of take that attitude. It hasn't hit some people yet. Yeah, well, I'll tell you, one of the things that concern me is these baby boomers that had some gas still in the tank, so they hit 65. And they're like, You know what, I'm, I'm still relevant in this business. I think I'm gonna keep going. And so now we're starting to see the influx of more motivated baby boomers. So now they're from, I'm talking six, seven years ago. So now they're at 7273. And now they have a real big problem with this thing is hit. So what do we say to those people? Yeah.

What do you say to people that are, if you will pass their prime in terms of selling their business, you better work with your team right now and focus on preserving the business and rebuilding the business because you won't get another chance. When this rebounds, all of that pent up demand is still gonna be there, there'll still be a bunch of money chasing deals, I believe.

And so you got to get to the other side. And I don't know if this is a two week deal, or an eight week deal, or, you know, a 12 week deal. But every virus that I've heard of so far runs its course. And this one, too will run its course. And my suggestion is that if you're in that older baby boomer group, and you still on your business, you better be focused on your your young people and better be focused on making sure that they are working and happy with the business because like I say, you won't have another five years to sell it.

Ed Mysogland  9:08  
So normally, we can explain situations like this as a non recurring event, and it amplifies risk a little bit but we can we can explain and say alright, you know, this doesn't happen very often and we can discount, you know, the event. I don't want to say anything in its entirety, but you can make that argument but how much of an impact on value will something like this have? If I'm a business owner, can I explain this away as a non recurring event or do I now have to really dig in and take my lumps when they come?

Chris Mercer  9:43  
Well, it is a non recurring event, but life is filled with one non recurring event after another. This, this virus and the panic that is surrounding it has taken away, you know, a third of the market capitalism lesion in the US markets in a very short period of time, it would be naive for me to think that that wouldn't have an impact on a typical business if there is such a thing on Main Street. So we as a valuation firm are 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. And then we're looking back on it. 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. You know, 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 honor. Risk. And that risk is, you know, all you have to do is drive by and look at all the restaurants that are closed and drive by and look at all the bars that are closed. And at least the Florida Governor is not seeing that the closed liquor stores yet. He's avoided pandemonium, I suppose. There's less traffic everywhere right now. And people are just kind of hunkered down. And as business owners, we're all trying to figure out, you know, is the phone gonna ring again.

Ed Mysogland  11:30  
But from a risk standpoint? I mean, can't you explain that this heightened risk is as a result of a non recurring event? So why do we need to panic with from a risk standpoint, because I do believe that a lot of us, I mean, the lot of chinks in the armor just got amplified. And now if you had a little problem in your business, you now recognize that you had many other problems that were just lurking under the surface. So my question was, so why can't we explain the risk away? Because when we do come out of this in eight or 12 weeks, every business owner is going to look to how do I get my value back? Or did I really lose my value? So what do you do with that?

Chris Mercer  12:12  
Well, number one, you do the best thing that 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. When we look at this next year, and let's hope that performances come back, maybe a year from now, or two years from now we can look back and say, Oh, yes, that was the COVID-19 Scare. And you know, we've recovered from that, and value ought to be there. 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 banks, financing is going to be considered riskier for a while. And I think 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. But my guess is that two years from now, if we look back, the value of smaller businesses and private businesses that you work with, that we work with, and bigger private businesses will be back to quote their normal levels free COVID

Ed Mysogland  13:24  
Well, but when, like the access to capital, the capital that you're referring to, I mean, are you talking private placement capital, or are you talking conventional financing, or SBA financing? Because I, and I don't know if they they passed the whatever, $1.4 trillion stimulus bill as of now, but I mean, it seems as though they're doing everything that they can to stimulate, you know, capital,

Chris Mercer  13:50  
right, the federal government, I don't think anybody who's right thinking really wants a deep recession right now. And what you're seeing in Washington, is a massive effort to stimulate the economy early, before it has a chance to go too much in the tank. And if those stimulus efforts work, then the recession will probably be short. And not so deep. In the absence of that. I mean, you're talking a world economy that has changed suppliers on the far east and then backed up people that I talked to say that they're Chinese and other suppliers are coming back on stream now, and maybe back on stream soon, but we haven't even been hit with all of that yet. I'd like to tell you that we're at Mercer capital, we're experts in working remotely, but this is a new deal. And we're like, we're gonna have to figure out you got to figure out you know, how we're going to do business. Just the the basic things like keeping staff productive and key Bring staff motivated, it's much harder if you can't see anybody.

Ed Mysogland  15:05  
Now, I mean, we, we went and dragged everyone into the Zoom environment where you know, that an hour meeting, you know, daily, you know, just as a huddle, and we've been pretty blessed by following some of these startup companies, and you know, what, what all they're doing in order to stay connected to their, you know, millennial workforce. And, and that's the playbook is, you know, somehow some way they're able to virtually reside as dark as this period is, that's one of the lessons, I think that we've seen is some of the ingenuity of some of these companies to figure out how to preserve, you know, their corporate life, it is really fascinating to watch. And I know it's painful for them. But I went to the butcher shop, and they had in their waiting area, they had measured out six feet and had little x's, and you just follow the x's, you couldn't touch the windows, you know, you had to stay three feet away. And I mean, it was just, you felt okay, going in there. And you know, and it's those kinds of things. So, yeah, the boy,

Chris Mercer  16:14  
you take that exponentially, and what business owners are going to have to be doing is focusing on every aspect of their business so that, once again, I've said it three or four times, generate cash and conserve 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. Yeah. I mean, it's hard to depend on the government on a government bailout for a small business.

Ed Mysogland  16:41  
Yeah, I keep seeing that, at least on the micro in the smaller businesses south of 25 million. I mean, we're seeing daily things coming from the SBA about help and immediate help. And I don't know whether that's a good thing, or a bad thing. But I do know that, and this is what we've been telling all of our sell side clients is, you know, good businesses sell in any economic climate, it's like you said, it's true. I mean, if you've developed a business you, this is a speed bump, it's not the end of your business. And if you need to take it off the market and wait it out, then you'll be fine, too. But boy, it is an interesting time to to be a small business owner, you know, trying to fight this and not knowing when it's going to end. I think that's the the biggest challenge. It's huge. Yeah, it is. One of the things that I had heard was as a result of the China shutdown, it forced a lot of companies to look for alternative sources for for manufacturing. And it appears that India may be coming more prevalent in the manufacturing space. Have you guys heard any of that? And again, it just may be speculation, but I just thought I'd ask that. Do you guys trace them? Well, no,

Chris Mercer  17:58  
it's a logical thing. I mean, India has been very heavily into business services support for American businesses for a long time. I mean, I think it's only natural that they see the opportunity with the shutdown and confusion in China, and are attempting to get some of that business in India. That'd be an interesting dynamic. Yeah.

Ed Mysogland  18:24  
So we talked earnings, we talked a little bit about risk. Where does the threshold of risk lie now? And I know the development of discount rates and so on, so forth, and you may want to give a give your your quick primer on that. But as you develop a discount rate, I mean, is this now the risk embedded in the company specific risk? Or where is the risk line? Because it seems it's everywhere?

Chris Mercer  18:51  
Well, the traditional buildup starts with some measure of long term treasuries, you've got an equity risk premium, that equity risk premium, you know, many people have been saying it's in the five and a half 6% range 5% range in that range. And that risk premium sometimes gets adjusted by beta. Well, I think right now, the equity risk premium is huge. I mean, because that's the only thing that will that can explain, at least for the short run. That's the only thing that I can see. That will explain the downturn and market prices. The interesting thing about it is is that, you know, the weaker gonna get weaker, and I think some of the strong are gonna 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

Ed Mysogland  19:44  
make it. That's interesting. Yeah, I didn't look at it that way that you're exactly right, though. But right

Chris Mercer  19:49  
now call it a bubble. But the bubble is real. If you look at the stock, if you look at the stock prices, the stock market right now, a futures were down this morning. And then they came back, I don't know where the market opened, I haven't had a chance to look. But it's just one more day of uncertainty. While people try to figure out what is going to happen, and who the big losers are and who the big winners are, it's just a very strange time. In the backdrop of all of these foods, all of those boomers you're talking about, is that they probably lost 30 or 40%. Of the value of everything else that they've accumulated, if they're exposed to the market there. So it's a it's really a double whammy for a lot of folks.

Ed Mysogland  20:37  
Yeah. And that's where I was, that's where I was going with this is that, you know, we're, we're all your wealth is tied up in your business. And even if you were taking chips off the table over the last five to seven years, yeah, those chips just evaporated, or at least a lot of them did. And so that leads you to what, you know, what do you take the discount, as you're saying, I mean, you're not going to get another crack at this, you may want to, to take what you can, while you still can,

Chris Mercer  21:07  
right? I don't think I'd be trying to sell a business for the next three months. So it's in the process of being marketed and people are, you know, are already talking and halfway committed. That's one thing. But it's buyers are aware of what's going on in the market as well. Sure. Like seeing the same stock market that we all

Ed Mysogland  21:28  
have? Well, and that leads to, you know, what, what do you do if you're knee deep in the middle of a deal, because if I'm, if I'm a buyer, I'm taking full advantage of of this, this makes your business more risky, or this, you know, it gives me 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. And you know, you've been in the business long enough to know that time kills all deals. And you know, that seller does not want that buyer to walk away, because chances are they're not coming back. So you know, how do you offset something like that?

Chris Mercer  22:03  
It's very different. You know, I said, one time and I wrote it down, so I can quote myself. If you wait until it's too late, it's too late. That's, that's what I think a lot of owners do in terms of waiting to sell their business, or waiting to if they don't sell it, or get it under, you know, different management hands or a different arrangement so that other people are benefiting, and maybe they maybe they have less benefit, I think you're going to find some business owners that are going to be holding their stock are holding a piece of their stock, they may have to give up some of their stock, you know, to keep people in the coming in the coming year or two or three in order to keep it all together. But that might be a whole lot preferable to, you know, losing the team.

Ed Mysogland  23:02  
Yeah. Well, speaking of the team, one of the things that fascinated me with your practices, you convert it into an ESOP. And I don't know how many years ago, and that was a first for an advisory firm like like Mercer capital, right. I had never seen anyone do. You know, I've seen you know, obviously, you know, various professional services like architects and things like that create Aesop's, but I had never seen something like like an investment banking firm. Can you speak to that and how did that roll out? And are you still pleased with that decision?

Chris Mercer  23:39  
Sure. Well, we sold half of the company to the employee stock ownership plan. On January one 2006. The took out a loan 100% loan to buy that stock, the ESOP data, the company data and loaded to the ESOP and paid it off in eight years. The ESOP is, you know, provides a valuable additional benefit to our employees, we still have a profit sharing plan and still make a generous contribution to the profit sharing plan. But we also have the ESOP. So folks who have generated the value that skin the shares, but our ESOP is an S corp piece up and its contributions and distributions are not taxable. And so it is, in addition to the value of the stock accumulated substantial assets that are invested, unfortunately in the market.

Ed Mysogland  24:48  
It'll come back.

Chris Mercer  24:50  
I think it'll I think it will come back. President Trump yesterday was hopeful that it would come roaring back and I do believe that it will, but He saw it was a good decision for us. It's been, it's been, it's been very, very good. The service firm we generate, you know, cash flow, and we were able to service the debt. And now it's it's just an additional significant enhancement to the retirement plans of our employees.

Ed Mysogland  25:21  
Yeah, well, like I said, you've always had Mercer capital has always been one of those Pinnacle firms out there that that you just kind of follow along and, and hope that you can learn from afar is probably the best way to put it. Well, I was

Chris Mercer  25:34  
just thinking about that business owner that you're talking about. And I guess my suggestion to them, or him or her would be the same that I gave to our staff in a memo a couple of days ago. And that is that 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 like I said, there probably won't be another chance for a lot of folks in that age category.

Ed Mysogland  26:16  
Well, my last question, it has to do with with expectation, the forecasting of a small business already starts at next impossible. So if I'm a buyer, how do I even begin to forecast the sucker punch that the target that I'm looking at just received? How do I take it from there?

Chris Mercer  26:38  
That is an enormously difficult thing I think it will call for increased, you know, increased due diligence. I think it'll slow down the pace of deals, and it will kill a lot of deals. Certainly over the next six months, yeah. Because 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 then you then you can begin to think about forecasting. But how would you like to forecast for a hotel right now? Or for a restaurant? I'm valuing the company that owns the number of restaurants in resort locations, whatever forecasts they had? Makes no sense right now.

Ed Mysogland  27:23  
Now, I'm in the same camp, I have a portfolio of, of restaurants and I'm and what do you do? I mean, I'm trying to figure out whether or not in six weeks from now, are they even still in business? Do they want to be in business? So yeah, I hear you. I want to be sensitive to your time. Like I said, you have such depth and wisdom and have seen so many different things. I guess I'm I'm hoping you have any parting guidance. For you know, those folks that are that are out there hurting and trying to figure out how to keep afloat?

Chris Mercer  27:57  
If I have any guidance, it would be to keep looking forward. optimistically, thinking 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 thing. It will help you get through this time period. And it will help you rebuild and put things back together when the markets a bit more favorable.

Ed Mysogland  28:25  
Yeah. Well, Chris, you know, truly, I'm so grateful for the opportunity to have visited with you like, like I said, you have you have made me a better appraiser better deal guy. Thank you, you know, and I'm just so grateful that you took the time under the circumstances because I'm certain you guys are scrambling the way we are. So thank you for being a defender of business value, and I hope we can we can do this again under under better circumstances.

Chris Mercer  28:53  
I look forward to that in for sure.