Winning at Entrepreneurship. Rod Robertson
(insurance companies, pension funds, etc.) that had been held back on the sidelines. This harvesting continued for years, but the playing field was soon flooded with multitudes of buyers. This naturally drove up the price of the selling companies as family-owned businesses soon understood the new rules and positioned themselves for even more lucrative paydays.
Roll-up: the purchase by an investment group or large company to buy smaller competitors in the same business locally as well as nationally.
As the stock market sky rocketed and public firms were trading shares at all-time highs, a parallel universe was unfolding in the mergers-and-acquisition world for small to medium-size businesses. The private-equity and hedge-fund investors were paying extremely high prices for operating businesses that were not sustainable. Auctions were often undertaken for sellers where over one hundred bidders would be interested and a selling frenzy would ensue. The private-equity firms were amassing portfolios of companies to use to attract other businesses. They also tried to conduct roll-ups—buying similar operations in different geographic footprints. These roll-ups were conducted in every conceivable industry, ranging from funeral homes to medical centers. In the beginning, they were called category killers, but as time unfolded, the roll-up syndrome began to show a multitude of issues that bedeviled these new chains of like operations.
Back-end Synergies: financial benefits resulting when one company buys another and reduces costs in one or both companies because of redundancy.
During 2006-2008, the private-equity deal level was almost on par with deals done by strategic players, which had traditionally ruled the M&A domain. These private-equity firms, however, did not have the back-end synergies of being able to cut costs in operations by eliminating duplicate personnel or job functions as strategic buyers could. Many strategic deals were done with the intent of post-closing mass firing and elimination of real estate held by the company just bought. This was a competitive edge over the private-equity firms that had no back-end synergies, thus cost cutting. This led to private-equity firms with large war chests to overpay for many firms in the craze that led the peak of the private-equity surge.
Strategic buyer: a company that is usually a large player in an industry seeking to buy smaller companies.
THE GREAT RECESSION WAS THE WORST POST-WORLD WAR II CONTRACTION ON RECORD.
Real gross domestic product (GDP) began contracting in the third quarter of 2008 and, by early 2009, was falling at an annualized pace not seen since the 1950s.
Capital investment, which was in decline year-on-year since the final quarter of 2006, matched the 1957–58 post-war record in the first quarter of 2009. The pace of collapse in residential investment picked up speed in the first quarter of 2009, dropping 23.2 percent year-on-year, nearly four percentage points faster than in the previous quarter.
Domestic demand, in decline for five straight quarters, is still three months shy of the 1974–75 record, but the pace—down 2.6 percent per quarter vs. 1.9 percent in the earlier period—is a record-breaker already.
The onset of the Great Recession led to the catastrophic end for many companies bought with leveraged money. Banks with huge operating loans to companies were suddenly drilling down into their clients’ financials and were aghast at the number of their portfolio companies that were out of covenant. Literally thousands of firms were forced to take draconian measures to tighten up their financials, which led to cuts in head count, inventories, and the reeling in of accounts payable. All this had a domino effect on the marketplace, and the witch-hunt by the banks unfolded. Companies that were profitable were suddenly driven into insolvency, and they became a sinkhole for other firms related to them. This plague spread and engulfed much of the small-to-medium-size business market. If these events did not drive companies to bankruptcy, they certainly pushed a huge multitude of firms back years in their development. Yesteryear’s 10 to 20 percent growth was now replaced by operators pleased with just breaking even after having made gut-wrenching cuts. These cost-cutting measures kept the recession running strong. This vicious cycle of cutbacks and conservative business practices, augmented by the banks’ backlash, ensured the Great Recession would drag on for years.
Out of covenant: for a company with a loan, breaking the terms of the operating guidelines of the loan.
During the recession that ran from 2008 to 2010 and beyond, companies at first took drastic corrective action and then plowed through their reserves. Business owners and entrepreneurs were determined to ride out the recession, but its dreary month-aftermonth effects finally led in 2010 and 2011 to a tremendous number of businesses closing and filing for bankruptcy. They became easy prey for industry predators that swooped in and bought them for pennies on the dollar. A new industry took wing. Self-proclaimed work out specialist firms and consultants set forth to do triage work on many a company and oftentimes butchered their clients. Fortunes were lost, dreams were crushed, and there was a huge correction afoot. The tide was out, and left on the beach were the flotsam and jetsam of many a fine firm.
Work out: a troubled company working through its issues.
For years and into the recovery period of 2011-2013, the firms that weathered the recession by being in a good industry or by adroit management had their earnings reports depressed. These owners who did not have to sell, hunkered down and began to spin the wheels of commerce once again as the economy recovered and banks began to supply working and operating capital. The majority of these well-positioned companies would not consider selling on depressed earnings and just soldiered on. Many firms, however, that were caught up in the recession had no choice but to sell, and for four years, the marketplace was dominated by large numbers of these troubled sales. By mid to late 2012, however, the resiliency of the American small-business ownership once again came to the forefront.
A new era has unfolded with scarred and savvy business owners who have truly become captains of industry. The recession and aftermath has cleansed much of the market of firms that were riding artificially high during the private-equity boom years. Firms with sloppy business habits and strung-out accounts receivable/ accounts payable and other sins against the machine have mostly been eradicated or sold off. The year 2013 saw prices rise once again to near pre-recession highs. But the firms getting these excellent valuations deserve them. In 2013, there was much less deal activity, and the number of firms sold though less, still had many competing buyers ferociously bidding for fewer and fewer quality deals.
And what kinds of businesses are selling? Geneva Business Services in Irvine, California, set forth the following different types of buyers.
According to data from “The State of Small Business” report, “55% of all US businesses have sales volume under $500,000 and 74% the sales volume of less than $1 million.” In terms of employees, the Small Business Administration estimates the breakdown of companies as follows:
To go one step further, the SBA estimates that the small-business market is broken down into four common types of companies as follows:
But no type or size of business is immune to the forces of a recession. Sound business practices matter in good times and bad. During 2013-2014, a higher percentage of deals failed due diligence than ever before. The buyers have learned through trial and error that intense scrutiny on deals of all sizes is necessary. Due-diligence costs have risen dramatically as teams of specialists swarm companies to ensure what the seller has set forth is in fact true. Many sellers are unpleasantly surprised to find out the dirty underbelly of their operations that they have lived with for years does not pass muster. The teams of specialists that take the company through due diligence range from the usual suspects of accountants and lawyers and now have grown to include many other disciplines. Psychologists