We sat down (well not physically, just electronically) with John a few weeks before his keynote address at the EPI annual conference. We took a sample of the questions our readers have asked and posed them to him. We asked everything from the process of exiting a business to what kind of private companies is capital interested in.
What follows is an unedited version of this Q&A.
Divestopedia: John, thanks for doing this for us. Let's get started. What do you consider the most pressing issues are for private company owners who are looking to exit their business?
JKP: Perhaps the question most important to consider for business owners is: Is the timing right? Owners should think about the positioning of their business for an exit event with respect to the dealmaking and economic environment as well as their personal considerations. That said, for quality companies of significant size, this may be the best time to exit since the financial crisis hit in 2007. Valuations are strong, financing support is plentiful, and quality companies are going at a premium. There is also a lack of deal flow for middle market companies, which bodes well for those going to market.
Divestopedia: What steps should a company owner take prior to initiating the process of exiting his/her business?
JKP: It is important to start early. The exit planning process can in some instances be multi-year and will encompass valuation, psychological, relationship, retirement, tax considerations, and others. Some plans are relatively simple and others are extremely complex, reflecting the wishes and constraints of the business owner. If one doesn’t start the process early enough, he potentially suffers the risks of unexpected burnout or changing market conditions for products and/or services, dealmaking, or the economy. Additionally, the importance of keeping good financial records cannot be stressed enough. Having poor records can cause significant delays or perhaps worse, can create a situation where decisions are made with incomplete or erroneous information. Furthermore, having trusted and competent advisors on board early to help guide thinking and actions will pay huge dividends down the road.
Divestopedia: In your experience, what is more difficult for a company owner to overcome when existing a business: the emotional or financial aspect?
JKP: It often depends on the size of business. Smaller companies may not fetch a price that allows owners the luxury of early retirement so the financial aspect is very important to them. Larger companies find that they will often receive consideration in such an amount that affords them the luxury of retiring so in those instances, it is often difficult for those owners to fully disengage with the businesses they worked so hard to build. Many owners would attest to knowing the nuances of their businesses more than those of their spouses! In addition to post-closing considerations, the exit process itself can be emotionally draining as owners weigh whether they want to retain some ownership/involvement or not and navigate an often exhausting due diligence process.
Divestopedia: What size and quality of private companies do you find that capital is more likely to be interested in?
JKP: The deployment of capital generally aligns by size of business, location, and industry. There are unique financing and capital options available at each point along the relevant continuums. Sometimes the bigger challenge to overcome is owners’ lack of understanding when it comes to the landscape of financing options. Business owners often don’t think about the strategic uses of various capital and financing types when looking for money to fund their businesses. As a result, businesses make lots of mistakes when seeking capital and their satisfaction levels reflect that reality. With that in mind, larger businesses generally have an easier time finding money. Furthermore, those with positive and growing EBITDA (earnings before interest taxes depreciation and amortization) are more attractive to lenders and private equity alike. If large enough, buyout shops will likely be receptive to meeting and having conversations. We’re also seeing a trend with institutional capital creeping further downstream.
Divestopedia: Can you give us a sense of the capital availability landscape and what they look for in private companies?
JKP: At the moment, there is a good amount of capital sitting on the sidelines waiting to get into the game due to lack of quality deal flow. Between strategic and financial buyers, there exist ample opportunities, especially for larger companies. Strategic buyers are looking for strong brands that complement their other product/service lines or provide entry into new markets. Financials are looking for strong companies that will likely grow and increase cash flows over a 3-5 year holding period. There is a good amount of cash to support both. Health care, manufacturing, technology, and business services companies are in strong demand; however all companies with decent brands, positive cash flows, and favorable outlooks are likely to attract attention.
Divestopedia: What is the biggest opportunity for private company owners to capitalize on in the next 2 years? In the next 5 years?
JKP: At the present, business owners are feeling more optimistic about their growth prospects over the next year. Given this positivity, lots of liquidity, a general lack of quality deal flow, solid valuations, and a low interest rate environment, the opportunities to transact are robust. Longer term, businesses are likely to see more financing flexibility with respect to crowdfunding rules coming fully online. Companies will also see additional appeal for international expansion as a means to diversify potentially volatile domestic cash flow streams.
Divestopedia: What is the biggest hurdle in the next 2 years? In the next 5?
JKP: Over the short term there is significant apprehension with respect to a potential war, domestic economic uncertainty, government regulations, political uncertainty, access to capital, and interest rates. Longer term, businesses will still likely be navigating through many of the same waters but political uncertainty, government regulations, taxes, and monetary policy will likely be even more influential.
Divestopedia: What role do you see private equity playing in the generational transition of private companies occurring over the next few years?
JKP: Private equity will continue to play a critical role in supporting generational transitions of privately-held companies. As time passes, more private equity funds are interested in making minority interest investments and those will help to support such transitions.
More on Dr. Paglia:
John is a former Julian Virtue and Denney Professorship recipient, is an associate professor of finance, director of accreditation and chair of the accounting and finance department at the Graziadio School of Business and Management at Pepperdine University. He also founded and directed the Pepperdine Private Capital Markets Project (PPCMP) from 2007-2013.
His work on the PPCMP, which included cost of capital studies, economic forecasts, quarterly private capital access (PCA) indices and quarterly business transaction activity reports, resulted in more than 30,000 report downloads in more than 75 countries and earned him the 2011 George Award, which is given to one faculty member who best leverages connections with the business community. He was also awarded the inaugural Tom Hopkins Award for Excellence in M&A in 2011 by the Association for Corporate Growth (ACG) and the Middle Market Thought Leader of the Year Award in 2012 by Grant Thornton and The Alliance for Mergers & Acquisitions Advisors for his research on the private capital markets.
He is a frequent speaker on the topics of cost of capital, valuation, access to capital, and financing and deal trends at valuation and M&A conferences pertaining to small businesses and middle market companies.
His research has been covered in "The Wall Street Journal," CNBC, "USA Today," "Businessweek," "TIME," "The Washington Post," Bloomberg, Reuters, Inc., "Forbes," "Entrepreneur," MSNBC, ABC News, "Huffington Post," "Crains New York," "The Los Angeles Times" and "The New York Times," among others. Dr. Paglia holds a Ph.D. in finance, an MBA, a B.S. in finance and is a Certified Public Accountant (CPA) and Chartered Financial Analyst (CFA) Charterholder.