Transcript
Speaker: Four things a business owner can do right now to preserve, protect, and increase the value of that business on the next episode of The Market That Moves America. Welcome to The Market That Moves America, a podcast from the National Center for the Middle Market, which will educate you about the challenges facing mid -sized companies and help you take advantage of new opportunities.
Speaker: Today's podcast is about the actions business owners can take now as we work through the pandemic and its consequences to protect and grow the value of their businesses. I'm Tom Stewart. I'm the Executive Director of the National Center for the Middle Market at the Ohio State University's Fisher College of Business. We're the nation's leading research group studying the mid -sized companies that account for a third of private sector employment and GDP.
Speaker: and the lion's share of economic growth. It's the market that moves America, and the National Center for the Middle Market is a partnership between Ohio State and CHUB. As you all know, the National Center for the Middle Market has been studying and reporting on the impact of the COVID -19 pandemic on middle market companies in a number of forums, including on this podcast and through our own data. And with me today is a special guest who can talk about the implications of
Speaker: this time that we're going through for business owners and some of the decisions that they ought to be taking and might not be thinking of taking. Our data shows that a lot of companies have put on hold some plans for investment and plans for transition.
Speaker: changes in ownership, changes in their investor or their capital base. And that's not necessarily the right kind of decision to make. The person who's with me to talk about this is an expert on taking a look at what some of these opportunities, and maybe some of the dos and some of them, maybe some of the don'ts.
Speaker: that are in this environment. He's John Brown. John Brown is the founder and chairman of the Business Enterprise Institute. BEI is a Denver -based consortium of companies and experts focused on business and exit planning, as well as on operational improvements. John is a recovering lawyer and, as I said, the founder of BEI. And John, it's delightful to have you on the market that moves America.
Speaker: Tom, it's great to be with you as always. I'm excited and thrilled to be here today. So talk to me a little bit. As I said, some of our data show that mid -sized companies have pushed the pause button on some investment plans and also on pushing the pause on some
Speaker: you know, transition issues. I mean, if I was a CEO and planning on selling my business, have I missed the boat or is it impossible to get on the boat?
Speaker: Well, my training as a lawyer, Tom, would say my answer is it depends. It depends. And it really does in a lot of different ways. The first thing I would say is there's a general focus in, I guess, the advisor and business owner world that the way an owner is going to leave her business is by selling it to a third party.
Speaker: In our organization, we've got many hundreds of advisors who do exit planning and execution every day, and we find about 60 % or more of the owners who transfer ownership do not transfer to outside buyers. They transfer to their children or to their management team.
Speaker: So the reason I mention that now is that affects the planning because in the third party sale world today,
Speaker: According to the investment bankers that we speak to and who are BEI members, third party sales are pretty much on hold. And you and I had an earlier discussion of what are the big threats today to this whole transition world? And the biggest threat is uncertainty.
Speaker: I just don't know what the value of my company is, right? Even that, but even more, lenders who, of course, are the supplier of all the money, they don't know. They're uncertain. And when lenders are uncertain, they don't lend. Nobody knows what's happening. So that's one thing. And then the other, I guess, area of
Speaker: uncertainty in a sense, is that some businesses are doing just fine. Some businesses are doing better now than pre -COVID. And as you know from your surveys, about 60 % or so of the businesses are not doing as well. So it's a mixed bag of owners and businesses that are
Speaker: approaching leaving their business. If your business is not performing well, it's gonna be very difficult to transfer it even to insiders. And if it's doing well, knowing owners as we do, a lot of them are saying, well, now's not a good time to sell because we're gonna take advantage of this whole crisis because it's helping us. So what we find in general is transfers of ownership to third parties is almost, it's paused.
Speaker: And the last thing I'd say in talking to investment bankers is most of them are of the opinion that this is relatively short term, that it will recover. And when it recovers, there's going to be some backup of owners wishing to exit. And they think it's going to be a pretty vibrant M &A marketplace. But again, they're not certain. I've also got to assume that not only sellers
Speaker: backed up behind a dam, but with all that private equity dry powder, there are buyers backed up behind a dam with sort of a need to put it to use. So when the pause button comes off, there may be a bit of a rush, right? Absolutely, because I mean, the money that's sitting in the checking accounts of the private equity firms need to be deployed. So that would suggest that one thing that a company should do right now, if I was planning to sell,
Speaker: is I should, and if the button is on pause, there may be things I could do now to actually do a sale or do some transition. But one thing I definitely ought to be doing is I ought to be cleaning the windows, vacuuming the piles, fixing the bathroom, doing all of those things that will make me more attractive when the market opens up. So do all the behind the scenes prep that you'd want to do anyway to really position the company in terms of operations, working capital management, talent,
Speaker: all that deal -ready stuff, right? Yeah, and that's a great point. I mean, that is a great point. The biggest problem in selling a business, generally speaking, is that the business isn't prepared well enough
Speaker: And the owner sometimes isn't emotionally prepared to really part with the business. So this is a good time to take a look at what owners can do today to prepare their business for an eventual transfer. And I can give you two or three or four actions that owners can at least think about. Precisely. Well, what are they?
Speaker: Well, the first one, and this is not a thing that's original, a lot of people are looking at that, and that's growing the business through acquisition. And I know from your surveys of middle market companies that that is a primary growth
Speaker: approach that many middle market businesses take is to grow their companies through acquisition. I think your statistics, if I remember right, is that it's not uncommon for middle market businesses to be acquiring more than one other business every three to five years. Yeah, I mean, those to do it. So what you're saying is, well, take advantage of the fact that everybody else is on pause. And if you're in a position to do it, if you got the cash, the guts, and the target,
Speaker: Now might be a time to acquire a company or maybe not even the company, maybe just its assets, right? Absolutely. You probably don't want to acquire the company. Most acquisitions are asset acquisitions, not stock acquisitions. What do you mean? Like assets such as?
Speaker: Well, it might be something in a smaller business simply buying the customer list of a floundering business and just acquiring the customers and negotiate a sale where maybe the acquiring company is just going to pay a percentage of the revenue resulting from the customers it's acquired. So it can be something as simple as that. It might be a construction company, we acquire some of the equipment.
Speaker: But I think even really what's important because historically what's been difficult the last decade or so is for really strong companies to acquire good outside talent because unemployment's been almost zero. Well that's has changed.
Speaker: not just top management, but middle management, knowledge workers, all of those people will be more available than last year. And again, it's very fact dependent. But if I'm a strong company, I've got a fair amount of cash, I wanna grow my business, I'm gonna go out and I'm gonna try to find businesses that are struggling
Speaker: and acquire maybe just some of their assets. But it's an opportunity that we shouldn't pass over for those businesses that are doing well. And again, it might be acquiring company assets. It might be just acquiring talent that we haven't been able to find in past years. And I can just say, speaking of my own company, we've just done that. We've hired people that we probably couldn't have hired.
Speaker: six or eight months ago because they were happy doing what they were doing in their former employer. So talk about John. So that's one thing. I can, first of all, do all these great things, working capital management, getting my books in shape, making good deals with my existing talent to protect. I can do exit planning even if the market is paused. Right.
Speaker: If I've got the capability and the funds of the banker, I can take advantage of other people's pause and other people's distress and acquire people, customers, equipment, various things I might be able to do. So I could do some sort of mini sort of acquisitions like that. What about things? I mean, are there ways that I can take advantage of the
Speaker: the fact that valuations are down? I mean, that would seem to me to be, first of all, if I'm acquiring a company, I might be able to do that. But there might be, are there other like tax strategies or things like that? Yeah, absolutely. Absolutely. There are. And you're right, valuations are down. And in terms of acquiring other businesses, and I'd probably add to that, it'll probably be more
Speaker: easy to acquire other companies or assets, not using all cash, me or cash and debt. There might be some very good acquisition terms, low interest rates. I mean, interest rates are not low in terms of the federal discount rate, which interest rates for banks then follow. So it's a great time for acquisition because of the valuation's low interest rates.
Speaker: Another area that doesn't deal directly with the business itself, however, does deal with business owners, especially family business owners. I know you've got hundreds of businesses that are family owned businesses. About 30 % of the middle market is family owned. Here's a few things for owners to think about. Again, hopefully they've already been contacted by their attorneys and their insurance advisors and other estate planners.
Speaker: Food for thought, one, valuations are down, significantly down. Even though your business may not be suffering, the multiples and so on and the unavailability of getting financing is going to drive down value. So it's a perfect time to consider gifting. So gifting to
Speaker: My daughter or son, right? Or an ESOP or employees or something like that, right? Yeah, well, mostly for family because we can have a lower valuation and we can use a minority discount.
Speaker: as well. And a lot of owners will be thinking about, yeah, but you know, there's like an $11 .5 million federal state tax exemption. Why should I really be so concerned about valuation? And with my spouse, it's about $23 million of total exemption. And that's true today. That could change. True this year.
Speaker: If post -election, the Democrats, and believe me, I'm not trying to be political here, but it's a fact that if the Democrats gain control of both houses and the presidency, I think everybody believes one of the first targets is going to be to reduce the estate tax exemption dramatically. And also, I'm thinking that's probably true, but I'm also just thinking of the
Speaker: exemption for gifts to miners, you know, a $10 ,000 gift every year is a few more shares of your stock this year than it was last year. You know, I mean, or anything else, I mean, or, you know, or, I don't know if they're trusting, you're the Lorenz, but I'm just saying, they're giving away the store, there are advantages
Speaker: in the fact that right now it's valued up. Exactly, exactly. And, you know, giving transferring ownership to children or grandchildren, and for larger estates, it's going to always be in some kind of a trust for probably for the benefit of the children. The other benefit I would just suggest that may be a benefit is that post -election
Speaker: There's a step up in basis for capital gains when someone dies. That may go away. There also was a lower
Speaker: tax rate on capital gains than ordinary income. That may go away. And I don't know what's going to happen. Nobody knows what's going to happen. But if that's a consideration, if owners are planning on gifting some business ownership anyway, this year is the year to do it. And one other thing, and then I'll be quiet,
Speaker: Advisors. We just did a poll of our of a bunch of advisors that were doing some training for right now to ask them how their businesses doing. So this would be lawyers CPAs financial advisors insurance advisors. How is their business. They're busy.
Speaker: They're very busy. CPAs in particular, I just spoke to one of our members last week. She said, and they have a mid -sized CPA firm. They said, we are slammed. Those were her words. We're slammed with CPP work. So the point is, if you want to do some tax planning, it's the middle of the year right now, professionals are very busy.
Speaker: But it also suggests that if you want to get in the queue, you might have to get in the queue earlier than you otherwise would. They may stay busy, and this is not necessarily a call to make on December 15th. Exactly, because if you're going to transfer ownership, you have to get valuations. Evaluation people are busy, so it's going to take longer than we might think. So let me stick this together. Let me stick this together.
Speaker: I mean, in our data, one of the things, you know, the thing we saw, you know, serious negative impacts for most companies from, from COVID, one of the biggest impacts more than half said, said that like the ongoing uncertainty was their biggest like two hours, like what the heck is going on? We just don't know. I I'm assuming that those clouds will start to dissipate that the ongoing uncertainty will diminish as we, you know,
Speaker: As time goes on, we see what's working, we see what's not, but still uncertain. So I'm the owner of a company. I got to make sure I'm dealing with my capital base, my bank, my investors, and that's protected. And I've got to make sure I've got revenue coming in. Those things are first aid, and I've got to do that. And I clear that up, and I've got to start thinking, all right, what are my plans? And I think I heard us say, and you say four things. One, clean up the business.
Speaker: Run the tightest ship you possibly can. Get your books in order. Stop with the tax accounting and start putting gap accounting. Get, you know, do all, get good relationships with your key employees. Do that stuff. That's one, right? Get your ops strong. Two, find things that you can be,
Speaker: Take advantage of opportunities that are there. Pounce on opportunities that might be there while the rest of the world is quiet. So be alert and put yourself in a position to take advantage of an opportunity that might be there. That sounds like a second one. The third one sounds like actually get your head about what your planning could be and what your exit plan or business transition plan could be.
Speaker: The fourth might be, now might be the great year to actually take advantage of that uncertainty and low valuations to get some real tax and other benefits in doing that. Are those the four arrows in this quiver?
Speaker: Those would be those would be the arrows in the quiver that the last acquiring talent and acquiring acquiring bits and pieces, including talent. That would be I think talent and talent finding is critic is really an opportunity now, but also protecting the talent that you've got. Yeah. Yeah. With incentive plans and things like that. Yeah. And that's also true in the long term. One of the things we found in the study of M &A is that the human capital side of talent planning,
Speaker: Well, the human capital side of M &A planning was something that people tended to pay too little attention to, especially when it came to key expert employees. And they thought, oh, wait a minute. We want to make sure that Jane or John stays in the company. What have we planned for it? And they often do that too late. Yep. And then there's the risk of losing that talent in a time when you can ill afford to lose them.
Speaker: Especially if you're suffering. Now, if the business is not doing well, we need to make sure that there's great communication with our, with the talent we want to keep and maybe we incentivize them to stay. So I want to ask you one more question before we leave. I know you guys work with a whole lot of advisors, ranging from, you know, lawyers to investment bankers to M &A or tax firms and, you know, advisory firms and so on and so forth.
Speaker: And they're busy. As I'm an owner right now, if I were, is there something that you would advise me about how best to use my advisors in this sort of critical next three months?
Speaker: That's a good, you know, I haven't given that a lot of thought. That's a really good question. I think the most important approach and the approach we would use is working with an advisor who can coordinate the efforts of all the advisors so that the owner's not saying, I'm going to talk to my lawyer. I'm going to talk to my CPA. I'm going to talk to my bank. I'm going to talk to my insurance advisor and my financial advisor.
Speaker: you know, what exit planning about for our company is to train advisors to become an advisor who's at the head of that planning. The general contractor in a sense. Yeah, he's a general contractor and he only then or she will only use other advisors as needed and it's a much more time efficient, cost efficient, and more effective
Speaker: means of owners to deal with the advisors. And I think advisors, or I'm sorry, I think owners need to work with advisors more closely now than when times are going great. When times are going great, we can afford to be a little sloppy maybe, but not now. Yeah, but as my dashboard is full up with all the things I got to do to keep the business safe and honest down for the getting back to business, the last thing I need is to try to negotiate.
Speaker: appointments with 10 different advisors, better figure out how the advisor steering committee can be pulled together so that that's one item on my agenda, not 20. Right. That's exactly right. That's a great point. Yeah. John, this has been an awesome conversation as it as it always is. I love I love talking to you and hearing hearing your perspective on things. And I think we came up with a few things that that that business owners should be thinking about now as as as as they're working their way
Speaker: from the initial impact of the COVID pandemic to a long -term operational and strategic response. So thank you so much. And for those of you listening, the Business Enterprise Institute has a whole lot of fantastic stuff on its website. It's exitplanning .com, www .exitplanning .com is the DEI website. So check that out.
Speaker: And thank you all for listening to The Market That Moves America. I'll never miss a new episode. Subscribe to the podcast on iTunes, Stitcher, Google Play, or wherever fine podcasts are found. Or you can subscribe and learn more about us, about the National Center for the Middle Market at our website, which is middlemarketcenter .org. Thank you and stay safe.
