What are the current expectations for interest rates?

One of the important factors that effect business value is macroeconomic conditions which include interest rates and the cost of capital. Business owners who want to know what is going to happen to interest rates should be aware of new leadership at the Federal Reserve.

On February 5, 2018, Jerome “Jay” H. Powell took the oath of office as the new Chairman of the Board of Governors of the Federal Reserve System, succeeding Janet Yellen.

The Federal Reserve System (“the Fed”) is the central bank of the United States. It performs five general functions to promote the effective operation of the U.S. economy and, more generally, the public interest.

One of the Fed’s functions is to conduct the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. The Fed sets the federal funds discount rate to influence the interest rates banks and other lending institutions charge to business and consumers.

What does the change in leadership mean for interest rates and the economy? The new chairman is stressing continuity as he takes over as Fed chairman, which suggests the central bank will keep gradually raising interest rates in 2018, unperturbed by recent market volatility and signs of firming inflation.

Interest rates have been at historical lows since the Great Recession but are expected to continue gradual rising toward more long-term historical levels. For business owners, knowing where interest rates are headed can help in planning both ongoing operational financing needs and in understanding buyers cost of capital. If you are a business owner considering selling, now is a good time as expectations are for continued growth in the U.S. economy, and interest rates are at historic lows.

For more information on the effects of interest rates and macroeconomic conditions on business valuation and M&A activity, Email Louis Cionci at LCionci@exitstrategiesgroup.com or call him at 707-781-8582.

Is 2017 a good year to sell my company?

Sellers often ask us if it is a good time to sell their business. My response is usually, “yes, but it depends”.  The optimum time to sell a particular business depends on many factors, and this article discusses some of them.

First of all, timing depends on the company:

  • How are its business fundamentals?
  • Is it growing? Flat? Shrinking?
  • Is it profitable? How is the quality of earnings?
  • What is the outlook for the business for the next 5 years?
  • Does the company have a good management team in place if the owner leaves?
  • Does the company have intellectual property? Is it robust? Is it protected?
  • Does the company have concentration risk? Customer, supplier, etc.?
  • How many family members does the company employ?
  • How many personal expenses does the owner run through the business?
  • Is working capital being optimized?

The state of the industry is important too:

  • How are industry fundamentals?
  • Is the industry growing? Flat? Shrinking?
  • Are there industry buyers?
  • Is the industry consolidating?
  • Are there any trends or changes on the horizon that could have an impact (good or bad) on your company?

The economy also matters, and market conditions factor in. When the world, U.S., state or local economy stalls, it can be difficult to sell businesses, at any price. Economic factors include:

  • Is the economy growing? Flat? Shrinking?
  • Is the economy stable? Any risks looming?
  • What is going on with interest rates?
  • What is the status of the Mergers and Acquisitions (M&A) market? Are strategic buyers and Private Equity Groups (PEGs) active or sitting on their wallets?
  • Are lenders lending?
  • At the low end of the market, are individual buyers buying? This may be contra-cyclical. In good times, individuals may not want to leave lucrative jobs. On the flip side, when people lose their jobs, some decide to buy a small business.

Last, but not least, your situation as the owner has a major influence on sale timing:

  • Why sell? Retirement? Illness? Death? Divorce? Burnout? Generally its best to have a good reason.
  • What are you planning to do post-sale?
  • If the business sells at its probable selling price, will you have the funds to support those plans, after taxes? Will you need all cash, or can your provide some seller financing?
  • Are you interested in retaining a stake in the company for investment?
  • Do you have family or management that want or expect to take over the business? Are you willing to leave some money on the table (vs. a strategic sale)?
  • How do you want to be involved with the company after the sale? Is there a time by which you have to be completely out?
  • How important to you are the ongoing success of the company, continued employment of staff, customer or supplier continuity, etc., versus maximizing proceeds?

There are more questions, but this is a good start. The point is, deciding when to sell a business is complex and deserves thoughtful analysis. Some of the answers will be easy, others require more analysis and assistance.

So, is 2017 a good year to sell?

For the first time in a long time, most small-to-medium-sized businesses can look back and see five solid years of financial performance. And, importantly, owners and investors can look forward with an expectation of good years to come. It has taken almost a decade, but most companies have completely shaken off the effects of the Great Recession. Furthermore, in most industries, strategic acquirers, private equity groups and lenders are writing checks and valuations are strong.

So, fundamentally, YES, 2017 is a very good year to sell, in the U.S., in California and in the Bay Area, and in nearly all industriesOf course, the full answer depends upon your specific company and personal circumstances.

Contact Roy Martinez with an immediate need or for further information on exit strategies and the market for your business.

Economic indicators help put the current U.S. economic climate in perspective.

I have four common gauges of U.S. economic activity that deserve a few moments of your attention today: stock market, interest rates, inflation and unemployment. Let’s look at graphs of each of these measures for a visual perspective on the state of our economy.

Stock Market. The Wall Street Journal, Equities pg. B17, January 25, 2017 reported the DJIA rose 100 points amid expectations of increased government spending on infrastructure projects.  The DJIA crossed the 20,000 mark during trading on Wednesday, January 25.US-stock market

Interest Rates. The Federal Reserve raised the target range for its federal funds by 25 basis points rate to 0.5 percent to 0.75 percent, during its December 2016 meeting.US-interest-rate

Inflation. Inflation has been hovering below 2%, the Federal Reserve Open Market Committee has indicated a long-term goal for the inflation rate at 2%.US-inflation-cpi

Unemployment. The unemployment rate has been dropping slowly and steadily since it peaked during the Great Recession.US-unemployment-rate

Overall, the present U.S. economy looks good with rising stock valuations, low interest rates, low to moderate inflation, and declining unemployment. While we can’t predict what the future holds, we can look at recent history to get a perspective on current economic conditions. Thanks for your attention!

U.S. Manufacturing Gears Up

Here is some good news to start your year.

The Institute for Supply Management announced yesterday that its PMI national manufacturing index came in at 54.7 for December 2016, which is up from 53.2 in November and is the highest monthly reading of 2016. (Any reading over 50 signals growth.) This latest Manufacturing ISM® Report On Business® shows new orders, production and employment growing, inventories contracting, and supplier deliveries slowing.

The PMI is based on data compiled from purchasing and supply executives nationwide, on a monthly basis. It’s a measure of what and how much manufacturing companies are buying now so that they can produce from those supplies in the near future. The PMI is not a measurement of actual manufacturing activity or output, but is considered a solid short-term leading indicator of performance.

The ISM report also points out that the overall U.S. economy grew for the 91st consecutive month in December. Let the good times roll!

Click here to view the full report.

Exit Strategies Group, Inc. pays close attention to performance trends in the manufacturing and supply chain sectors of the California and U.S. economy. If you’re in need of business valuation, succession planning or M&A brokerage services for your manufacturing or wholesale distribution business, give Al Statz a call for a confidential consultation at 707-781-8580.

Rising Rates and Investment

Since July, the benchmark interest rate, the US 10-year treasury bond, has risen from 1.35% to over 2.55%. That’s a very big move in a short-period. Post-election day the rising rate trend accelerated. We saw a similar spike in 2013, only to see rates retreat. Is it different this time?

Valuation Building Block

Markets seem to believe that current rates are sustainable and can keep rising given the lower tax and infrastructure spending pronouncements coming from the new president elect. Interest rates are building blocks in asset pricing. Generally, when rates change business, individuals, and investors will re-examine their assets and shift them around to reflect their risk and return preferences. The expectations for changes in asset prices can take on near-term speculative fever: “Wait, I need to buy before it gets more expensive!” or “Wait, I need to sell before this thing tanks!”

Stability vs return; fear vs. greed (the two emotions that drive market prices). What return can you expect on your investments – be they stocks, bonds, real estate, or a business? It’s seldom a simple calculation. If predicting financial markets were only about numbers, math professors wouldn’t need to profess!

Since the election, US equity markets have climbed and bonds prices have sunk. Bonds reaction to rising rates is predictable. Bonds are “fixed-income” meaning its coupon rate remains the same regardless how interest rates move; however, when rates rise bonds lose market value because newly issued bonds have higher coupon rates, hence more value to you.

Will the Trump rally continue its ascent? Investors will eventually begin the stability vs. return tug of war. The Federal Reserve announced its intention to raise rates three times in 2017. This may or may not materialize. However, if bond yields do rise, many will trade bond stability over higher, more volatile equity returns which could create less demand and lower prices for equity – both public and private.

Is the “New Normal” Fading?

The “new normal” camp sprang from the 2008-09 crisis. Proponents argued that an aging U.S. population and high debt levels would bring on a Japanese style deflationary environment; and that technology and automation would depress middle-class wages and reinforce lower price trends. In fact, wages have stagnated for over 10 years and rates have stayed historically low. The long-term average on the 10-year treasury bond is 5%; even with the rapid rate rise since July, we are still at half the long-term average.

On the other hand, lower prices spur consumption; and wages have started to show some improvement. Add some fiscal stimulus, a deregulatory minded White House, and government spending: Boom – Keynesian animal spirits will prevail!

However, a few wild cards worth considering: will political rhetoric be matched with real action that might incite a trade war? Will lower taxes and government spending on infrastructure spur growth without impacting the U.S deficit? Will financial reform of Dodd-Frank create the same mess that brought us to Dodd-Frank?

These type considerations will impact our domestic economy and the business environment. Low rates have helped prop up equity valuations, made real estate more affordable, and allowed businesses to lower their capital costs. Rising rates may create a headwind.

Risk of Return

Indeed, rate increases mean the cost of capital is going up. We business appraisers use the “build-up method” which begins with the US Treasury rate and “builds up” a required rate of return based upon various risk factors. If the rise in rates is accompanied by higher growth in revenue and profit, valuations can remain high. However, if rates climb, growth stagnates, or inflation eats into profits, it most likely will have a downward push on business value (both public and private markets).

Jerry Matecun is based in Orange County, California. To contact Jerry for exit planning and business valuation services, Email jerry@exitstrategiesgroup.com or call (949) 287-8397.

Dental Practice Valuation Insights

It seems that every time I value a dental practice the industry has undergone or is going through significant changes. Patients and the medical community are rapidly recognizing dentists as oral health specialists which is expanding the services being offered by the dental industry. The dental professional is looking beyond the mouth. Connections between oral health and whole body health are allowing for more collaboration around sleep problems, oral cancer, facial esthetics, and periodontal health. This trend combined with increased patient education and demand is driving growth in dental consumables, equipment, and technology. Finally, young professionals buying and transforming existing practices, as well as, merger and acquisition activity continues to grow as small startup dental support organizations (DSOs) empower value driven entrepreneurs.

The National Association of Certified Valuators and Analysts March/April 2016 issue of The Value Examiner includes a three-page article entitled Valuation Insights in the Dental Industry by Maria G. Melone, CPA, CVA. Ms. Melone spent ten years working at one of the largest DSOs handling all aspects of the buy-side of dental transactions and she has helped facilitate hundreds of transactions. She offers many valuable insights including:

  1. Most sellers do not know the value of their dental practices, and as a result, rely on a broker to provide an opinion of value.
  2. Many people in the dental industry refer to the value of a practice in terms of its percentage of last year’s collections.
  3. With the influx of private equity money in the industry it is becoming more common to use a multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization).
  4. As it relates to dental practices, the Income Approach is the most relevant and effective method of valuation. For a majority of dental practices, the significant value lies in future earning potential and the transfer of the patient base (an intangible asset) from the seller to the buyer.

Finally, many buyers, sellers, and brokers focus on production but in today’s third-party payer systems production and collection may be very different. Comparing collection to production provides an initial and meaningful way to measure the operating efficiency of a practice. Generally speaking, a more efficient practice is a more valuable practice. The creation of DSOs is allowing dentists to maximize their practice value with the support of professional office management. The DSO model enables dentists to focus on the patient while maximizing operational efficiency.

If you are buying, selling, or need help valuing a medical practice in the dental industry please contact Kenny Pierce, MBA, CVA, MAFF at 916-724-1675 or kpierce@exitstrategiesgroup.com.

The Federal Reserve and Interest Rates

The Federal Reserve controls the three tools of monetary policy — open market operations, the discount rate, and reserve requirements. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate.

Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services [1].

As shown in the graph below, the federal funds rate has been at .25% from 2009 through the end of 2015, primarily as a result of the 2008 financial crisis and the lingering effects on employment and the economy. At the end of 2015, the federal funds rate target was increased to .50%.

Historical United States Federal Funds Rate

usfedfundsrate
Now is a good time for a Company owner looking for an exit strategy, as federal funds interest rates at historically low levels contribute weight to a seller’s market.

[1] More information on the Federal Reserve can be found at their website, http://www.federalreserve.gov/default.htm

Interest Rates Likely to Rise After December FOMC Meeting

It is widely believed that the Federal Reserve will raise the rate it charges banks for overnight deposit lending, commonly called the federal funds rate at the December 15-16 meeting of the Federal Open Market Committee.

The Federal Reserve controls the three tools of monetary policy–open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate.

Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.[1]

As shown in the graph below, the federal funds rate has been below .25% since 2009, primarily as a result of the 2008 financial crisis and the lingering effects on employment and the economy.

 

More information on the Federal Reserve can be found at their website, http://www.federalreserve.gov/default.htm


[1] http://www.federalreserve.gov/monetarypolicy/fomc.htm

Small Business Transactions Up 18%, Sellers Earn Higher Sale Prices – According to Industry Report

It’s a very good time to be a seller.
According to a report released on October 16, 2014, U.S. small business sale transaction levels are on pace for a record-breaking year. And while the post-recession market has generally favored buyers, a shift appears underway, with sellers now receiving higher selling prices, higher percentage of asking prices and improved cash flow multiples.  The full results are included in BizBuySell’s Q3 2014 Insight Report, which aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide.
Report Highlights
  • The number of closed transactions in Q3 represented both a 17.9 percent increase from last year and the highest number of small business sales recorded in a third quarter since BizBuySell began tracking data in 2007.
  • The median sale price for businesses sold in Q3 rose 5 percent compared to last year.
  • The average cash flow multiple jumped nearly 9 percent.
  • Service-related businesses led the way with a 17 percent increase in closed transactions, while manufacturing was up 16.2 percent and restaurants were up 13.3 percent compared to last year
  • In addition to an increased number of closed sales in Q3, there was also a growing number of businesses offered for sale.
  • 2014 remains on pace to record the highest number of closed transactions reported since the BizBuySell Insight Report’s inception in 2007.
Our View
Without a doubt, as business financial results and the economy continue to grow, and as buyer liquidity and acquisition financing options continue to improve, Exit Strategies is seeing more buyers and sellers entering the market here in California, at both the main street and middle-market levels.  Set amidst the backdrop of an aging baby boomer business owner population, low interest rates, plenty of private equity dry powder, and the potential for future tax rate hikes, we expect this trend to continue into 2015.
Business owners without a successor who have an eye toward retirement should look closely at entering the market. The sale process takes 9 months on average. Add time on the front end to evaluate and prepare the business, and on the back end for management transition, and a full year or more is not uncommon.
For more information about current market conditions or to understand how your business is likely to be received by prospective buyers, investors and lenders, feel free to contact us, in total confidence.

U.S. Manufacturing Purchasing Managers’ Index rises to highest level since April 2010

Today, just after a gorgeous Labor Day weekend here in Northern California, I thought I would share some encouraging news for U.S. manufacturers and everyone who serves or invests in them …
The U.S. Manufacturing Purchasing Managers’ Index (PMI) — which is designed to signal changes in prevailing business conditions in the U.S. manufacturing sector — registered 58.0 in August, up sharply from 55.8 in July and the highest reading for over four years. All five components of the Manufacturing PMI had a more positive influence on the headline index than in July, led by a robust and accelerated increase in employment.