With a looming recession creating a nebulous future for the banking and finance industries, it’s time for buyers and sellers to be more selective in maneuvering through the M&A process, said a panel of experts.
“There are no crystal balls, which means that we’re all anxiously trying to figure out what this recession is going to be like,” said Michael Kline, senior vice president of business banking for Harris Bank NA, speaking at The Business Ledger’s first Newsmakers’ Forum of 2008 at Belvedere Banquets in Elk Grove Village.
In 2001, banks persuaded consumers to pay their way out of the recession but the current housing market makes that scenario less feasible this time around, said Kline.
“Now we have a body of consumers, some of whom have adjustable rate mortgages and others (who) simply are aware that their biggest investment, their home, has considerably less value than it did six months ago or a year from now,” Kline said.
“Can they get over that sense of loss such that they will easily help us pay our way out of this recession or is it going to take some time to work through?”
According to Judith Roussel, Illinois district director of the U.S. Small Business Association (SBA), this feeling of recession is more in anticipation of things to come instead of what the market numbers currently show.
“During the next three months, 9 percent of small businesses say they plan to create new jobs,” said Roussel. “That’s very much better than the 2 percent that was recorded during the last recession.
“It is small businesses that are going to be counted on even more than ever to try and help reignite the economy.”
In the mergers and acquisitions area, things are not as clear-cut.
“It’s a very challenging environment out there,” said Kenneth Clingen, a partner in the Wheaton law firm of Clingen, Callow & McLean LLC.
“We definitely see multiples coming down, but that doesn’t mean there aren’t going to be buyers out there. They just may be offering more multiples and they might be strategic buyers in the industry who see an opportunity to consolidate a business or remove a competitor.”
In addition, taxes will be going up regardless of whether or not a Republican or Democratic president takes office. Both Sens. Hillary Clinton (D-N.Y.) and Barack Obama (D-Ill.) are proposing bumps of over 20 percent, while Sen. John McCain’s (R-Ariz.) ability to retain the Bush tax cuts will be undermined by the Democratic Congress, Clingen said, which should provide initiative for many business owners to sell.
“If you want to get out, now is the time to get out,” Clingen said. “As early as 2009, taxes are going to go up on capital gains.”
Tax rates aside, buying and selling will continue. The Federal Reserve recently did a study which showed that in 2005, 350,000 private businesses changed hands. For 2009, that number projects to 750,000 businesses.
“It’s just duplicating the retirement of the baby boomers,” said David Kauppi, president of MidMarket Capital, Inc. “Most of our business owners are baby boomers that are going to be looking to retire and move on.”
In support of these sellers is the $1.6 trillion in funds sitting in the treasuries of major corporations, monies from which they are not currently receiving a good return, Kauppi said.
“They need to deploy that capital,” said Kauppi. “If you can provide some strategic initiative to these (companies), it really is a decent time to sell your business.”
For buyers, the current hurdle rate in terms of acquiring the funding for acquisitions is relatively high. Much of that struggle can be defrayed with the support of an SBC loan.
“Generally, when lenders tighten their credit requirements you see the SBA lending surge,” said Roussel. “That’s because SBA guarantees lenders the loan up to 85 percent, up to $150,000 or 75 percent over that to our maximum $1.5 million guarantee on a $2 million loan.
“That’s through the 7(a) program, a general purpose business loan program. The 504 program is for long-term fixed-asset financing to acquire land.”
The 504 program works through certified development companies (CDC) and is accomplished using a three-pronged approach. A commercial lender or bank covers 50 percent of the mortgage loan and the CDC covers another 40 percent. The small business owner then only has to cover the remaining 10 percent, Roussel said.
“It mitigates some of that risk for (the small business owner),” said Roussel. “We also provide counseling training and technical assistance, as well as helping them access the $400 billion federal procurement market each year.”
The government intends to provide additional financial support through President Bush’s upcoming economic stimulus package, which will send money to middle and low income families.
This package is being met with mixed reactions.
“The notion of giving some money back to consumers in the hopes that they’ll use it to buy something new rather than pay down their debts, I think, is wishful thinking,” said Kline.
“On the other hand, if you’re a small business owner and you’re not in one of the segments most likely to be the worst hit by the recession, this might be an interesting opportunity.”
The alternative minimum tax (AMT) has been under attack recently because of its failure to account for inflation and recent tax cuts. As such, many upper-middle-income families have been subject to the AMT, which was originally intended to target only high income households.
“I think (AMTs are) going to be abolished,” said Kauppi. “That’s leaving about an $8 million hole in our tax coffers. We’re going to have to replace that with other taxes.”
The populous view, especially in an election year, is to tax the rich because they can afford it.
“I call those wealth taxes and one of those is capital gains,” Kauppi said. “When you sell a business you get a big capital gain. If you’re contemplating selling and you wait past 2009, I guarantee you’ll pay more in capital gains than if you were to have sold prior to that.”
One way to avoid such taxation is for small business owners to pass down the company to their heirs.
“If you’re trying to gift your business to your heirs, the government allows you to break that up into various family limited liability companies (LLCs),” said Kauppi.
“They do a business evaluation on each of those LLCs. As a minority shareholder, they can apply some extremely aggressive discounts to that. Therefore, families are able to pass their businesses on without having to sell them to pay the taxes.”
The current environment may also be advantageous for startup companies.
“We think that startup businesses are not only great ideas but in this market they’re going to be viable,” said Kline.
Startups can also benefit by the help offered from the SBA.
“We’ve just piloted something called rural lender advantage,” Roussel said. “This is part of our express loan program. For smaller loans, $250,000 or under, we allow a lender to use their normal documentation, make their own credit decision and get the SBA guarantee.
“There are studies that show that about 16 percent of the fundings that businesses use for startups come from capital debt, from loans,” she noted. “So it is possible for startups to get bank financing and it’s a lot more feasible with the SBA guarantee program.”
Jeremy Stoltz, Staff Writer