Myrtle Beach, South Carolina, December 31, 2008—Highland Global Business Valuations, a premiere business valuation firm for the southeast United States, is pleased to announce that Robert M. Clinger III, CBA, AVA has participated in a podcast hosted by Peter Siegel for USABizMart, a nationally known portal for business owners, business buyers, and business brokers/advisors. The podcast can be accessed via the USABizMart website, www.USABizMart.com, or the Highland Global website, www.HighlandGlobal.com. The transcript of Mr. Clinger’s interview follows.
Mr. Siegel: What impact has the economic downturn had on the valuation business?
Mr. Clinger: Surprisingly, the business valuation profession has largely benefited from the downturn. Throughout my career I have observed that this profession is relatively, and I hesitate to say it, recession proof. When the economy was going strong, we saw robust activity in the M&A markets, which helped the valuation profession. Sellers obviously want to sell at the top, and buyers were financially sound and looking to invest in growth opportunities. Then, I was typically the party that buyers and sellers came to when they reached a stalemate in negotiations over price.
Now that the economy has weakened significantly, we’re still seeing a lot of valuation activity. Some companies are looking to sell if they are under financial stress and others are getting pretty close to retirement and really don’t want to see the business through this what may be a protracted downturn. And by the same token, buyers are looking to get some good deals when the chips are down, so to speak.
Buyers are not only coming in the form of companies seeking growth opportunities but are also individuals who may have been made redundant as a result of cutbacks in the workplace or who are expecting to lose their job. Most of the individuals are looking to buy a job for themselves and sometimes their family. Their risk profile has shifted from being content on collecting a weekly paycheck from their employer in highly uncertain times to taking on the risk of owning their own business and trying to make a go of it on their own. It’s the philosophy of taking charge of their own destiny. These buyers mostly seek bank financing, often times with an SBA loan guarantees, which necessitates a business valuation. Having an independent valuation by a professional business appraiser obviously gives the bank or lending institution a level of comfort that the buyer is not overpaying in the transaction.
So, really the valuation profession has held its own in these difficult economic times.
Mr. Siegel: What effect has the economy had on valuations of businesses?
Mr. Clinger: Obviously valuations have come down, in some cases significantly, as a result of the economic climate. This is, of course, industry specific. Retail has been hit harder than say service oriented businesses. In general, however, it is important to remember that the value of any asset, whether it is publicly traded shares or shares in closely-held companies and small businesses, is the sum of the present value of the cash flows associated with the asset. Most businesses have seen a slide in financial performance in the last year—sales are down, profitability is down, etc. The biggest question right now is “How deep is the current downturn going to be?” Are we going to have a short-lived recession or does this downturn signal a structural shift in economic performance? That is the sixty-four thousand dollar question and is one of the biggest impacts on the valuation of a business. If management and the business appraiser forecast more positive performance than what actually materialized because of mistaken assumptions regarding economic performance and the impact on the business, the value of the business may be overstated and vice versa.
Let me give you a quick example. I was engaged to do a valuation about two years ago of a manufacturing company that provided a specific product to residential and commercial contractors. At that time, we had started to see a cooling of the real estate markets. In preparing a forecast of performance for the company for the next three years, the company’s management forecast a drop in revenues of about 5% the first year, 10% the second year, no growth in the third year, and growth of about 3% beyond the third year. In actuality, the revenues dropped about 30% in the first year (compared to a 5% forecasted drop) and about 25% in the second year. This drop was much more severe than many would have forecasted, simply because the magnitude of the decline in real estate markets was much more pronounced than anticipated. In essence, revenues were nearly cut in half from the time the first valuation was conducted until now. Obviously the value was predicated upon the company’s ability to achieve its forecasted performance. With the more significant decline, the value also has dropped. However, the problem that the business brokers have now is that the owners of the business still have expectations that the business is worth the original valuation estimate. Doing a valuation now would give them a much needed wake-up call.
Now, I should point out that if we were to do a valuation now the forecast would be based upon expectations of performance from this point going forward. Given the current environment, there is no set of reasonable assumptions that would get the company back to its level of performance prior to the collapse of the housing markets in the near term. This isn’t to say that the company can’t achieve strong growth and cut costs to improve the bottom line. But there has been an economic shift that has brought today’s value down towards fundamentals.
This creates a disconnect between the seller’s expectations of value and what the buyers are willing to pay. Buyers are generally pretty savvy, and, of course, they’re looking for a deal. The buyers are looking at their investment parameters in the current environment, and based on their expectations for the future the multiples they are willing to pay have come down. This puts their values more in line with my valuations.
Needless to say, this doesn’t necessarily make me the most popular person with business owners and their business brokers. I get to be the bearer of bad news that shatters their illusions as to the value of their business. But having a valuation as part of an exit strategy is certainly a helpful exercise for the seller of a business in setting reasonable expectations for value in the current environment.
Mr. Siegel: What is your outlook for the valuation profession short-term?
Mr. Clinger: First, I think the economic downturn that we are currently experiencing will likely continue well into 2009 and probably into 2010. I don’t see a quick turnaround in the near future. This, however, probably bodes well for the valuation profession. There are still going to be buyers and sellers in the market, even though credit has tightened. With the banks being more judicious in their lending practices and the SBA requiring valuations on loans they are backing, business appraisers will likely see steady demand for their services. There are probably going to be more business owners looking to sell their businesses in this period of economic weakness, so that should keep business brokers busy with deal flow.
Second, I think business brokers are going to start relying more upon the services of independent business appraisers to bring their clients’ expectations of value into line with the reality of the current environment. Brokers want to sell their clients’ businesses; that’s how they make their living. It’s pretty hard to do that if the expectations are set too high. Buyers will just pass on it if the price is too high. In addition, business brokers are able to use the valuation for negotiating purposes when there is an offer to show the buyers an independent party’s opinion of value of the business. Since the brokers have a vested interest in selling the business, buyers may be reluctant to accept the broker’s analysis regarding the value of the business.
Third, we may well see a resurgence of valuations for estate planning purposes. I think it is safe to say that the estate tax is going to come back when current legislation sunsets in 2010. The next Congress is not likely to extend President Bush’s tax cuts from 2001. So, while in the last few years estate planning valuation work hasn’t been as strong, it looks as if we’ll be busy again with that type of work pretty soon, particularly as we see more and more baby boomers starting to retire or successfully selling their businesses and seeking a tax efficient way to begin transferring that wealth to the next generation.