For business owners, “top of the market” is the (not-so-helpful) retort to the question of when to sell your company. For independent specialty finance companies, the market timing, while important, is only one of a number of factors that need to be considered when deciding when to sell in order to have a successful exit. In many ways, the best time to sell is when you do not need to, so evaluating the variables early will provide the most flexibility on deciding when to sell. Based upon our experience advising a long list of buyers and sellers in this recent sellers market, we believe that management’s commitment post-transaction, the stage in a company’s growth, and market conditions in the credit cycle tend to be the main factors sellers should take into consideration when deciding to sell.
Before addressing when to sell, it’s worth addressing who is selling. A sale process is most successful when owners and management, who aren’t always the same people, agree on timing. The overlap of owners and management is wide ranging. On one end of the spectrum, a founder and CEO may own 100 percent of a company. In that scenario, there is not a conflict on when to sell, but his or her reasons for selling and involvement post-sale will be scrutinized by a buyer. On the other end of the spectrum, there could be no overlap between owners and management, with management acting largely as employees with perhaps some phantom equity or no equity at all. Here, buyers will likely have less concern over sellers’ desire for liquidity, but there could be discord between owners and management on timing. In practice, the owner and management mix falls somewhere in the middle of the spectrum. Aligning interest of owners and management in a sale process is critical and can directly affect timing.
For the owner and CEO actively involved in his or her company — “I want to sell the company and retire immediately” — is not the guidance we want to hear. Buyers generally pay the largest premiums (consideration in excess of net assets acquired) when they see substantial value in the platform and the portfolio. Unsurprisingly, management is a key component in the value of the platform. In many transactions, management is committed to the long- term growth of the company. However, when the next step for a member of management is retirement or pursuing new endeavors, sellers need to factor in management’s intentions post-closing time horizon into the decision of when to sell. Buyers tend to expect a minimum three- to five-year commitment from management post-closing. They can secure this commitment contractually, through employment and non-compete agreements, and economically, structuring earn-outs and deferred payments. While a typical sale process runs four to six months, conservatively provisioning a year, the commencement of a sale process should be four to six years before management is looking to leave the company. Allowing sufficient lead time will avoid awkward discussions around management’s post-closing plans that could derail a transaction and enable sellers to maximize collections of any contingent consideration.
When management’s timing provides sufficient flexibility, the stage of a company’s growth should be evaluated in the sale timing decision. Companies in flat, moderate and high growth cycles can have successful exits with the right positioning and buyer universe. A sale can be commenced during a period of time when a company is shrinking, but that timing is clearly not optimal. Certain buyers, notably business development companies (BDCs) and some banks, seek a consistent recurring return on their capital and are attracted to acquisition targets that have a flat to moderate growth profile. For companies with this profile, a sale is preferably timed when operational efficiencies have been achieved and any potential adverse events such as a deterioration of credit quality appear to be multiple years off. Other buyers, such as private equity funds, gravitate toward higher growth companies. The timing challenge with high-growth companies is answering the question of “if you (management and owners) believe in the growth you are forecasting, why are you selling now?” Some situations, such as a PE owner’s fund life, provide a logical answer to this question, while other situations — management seeking liquidity for example — can send conflicting messages to would-be buyers. For high-growth companies, timing is about the salability of the story — both “why now?” and conviction around projections. Given the constantly evolving nature of a company’s trajectory, there is no single “best” moment to sell. However, being strategic about timing relative to your company’s “story,” whether time from adverse events or advent of high growth, will help maximize value in a sale.
Related to timing in a company’s growth cycle but worth addressing separately is the “age” of a company at the time of a sale. As one would think, you can never have too long of an operating history, but too short of an operating history can certainly be an issue. Today, many buyers focus on how finance companies performed during the Great Recession and can sometimes be dubious of companies founded in the Great Recession’s wake. With 2008 and 2009 a decade behind us, there are dwindling number of independent finance companies with an operating history through the Great Recession, and many “new” independent finance companies now have a solid operating history over many years. Answers to management’s intention and the stage in a company’s growth cycle will be the main drivers to sale timing decisions. However, there are a few timing decisions unique to younger companies worth noting. First, buyers like to see full credit performance for multiple years of originations. Put differently, if a company’s financing product typically has a three-year term, there could be buyer push back if a sale is pursued in the fourth year of operation with only a few months’ worth of full performance data. The need for full-asset performance data matters more for less traditional financing products. Younger companies with evolving capital structures face the added challenge of timing a sale to avoid potential change of control penalties. These challenges are best met with good organization and planning well in advance. Situationally, the age of company at time of sale matters, but it is typically a secondary consideration.
While management’s intentions post-close and the company’s stage in its growth cycle are internal factors dictating the time of a sale, the market’s stage in the credit cycle is the overarching external factor that affects sale timing. The stage in the credit cycle determines who will be the most active buyers and, consequently, how much they are willing to pay. In periods of low charge-offs and high liquidity, competition for assets puts downward pressure on yields. As competition for yield continues, demand for higher yielding assets originated by specialty finance companies creeps until banks enter the buyer universe. With high leverage and low cost of funds, banks are generally able to pay the most for specialty finance companies. Active bank buyers have a ripple effect for specialty finance companies that would not fit in a bank as non-bank strategic buyers look for platforms to replace acquisition opportunities now going to banks. Banks are active buyers now, but is now the time to sell? Perhaps, but banks have been active for a number of years — what’s to say they will not be for a few years to come? While banks will likely become less active buyers as the credit cycle turns, that turn also brings exciting growth opportunities for specialty finance companies as competition fades. The “window is open,” so if the internal factors that drive sale timing are generally in alignment, it is worth exploring a possible sale. However, if the internal factors outlined here are not conducive to a sale, forcing a sale based on market conditions is likely ill-advised.
Selling a company is a transformative event and the culmination of years of work. The decision on when to sell can have a substantial effect on success. While management and a company may go through a sale once or just a couple of times, investment bankers, consultants and lawyers have worked through many sale processes, successful and unsuccessful, and can help assess the right time to sell. Early planning provides the most flexibility allowing sellers to create their own “top of the market.”
