Richard M. Rodnick is chairman of Geneva Corp., a firm based in Costa Mesa, Calif., that specializes in advising privately held companies on mergers and acquisitions. While the major Wall Street firms advise giant corporations, Geneva advises smaller companies with $1 million to $50 million in sales. Rodnick, who says Geneva is the nation's biggest adviser to companies in this "middle merger market," recently shared his thoughts on corporate takeovers with staff writer David A. Vise.
Q. Are there any significant changes taking place in the merger market for smaller companies?
A. We are seeing midrange, privately held companies entering the acquisition game. We are seeing $5 million companies saying they want to buy. They have learned they can leverage against their own assets and it is a relatively painless transaction. They have learned it can be cheaper, smarter and faster to buy assets rather than build them.
Q. Any other changes?
A. The awareness of mergers and acquisitions has increased so much. If you said "M&A" at a cocktail party a few years ago, people said, "What was that?" Now it is an accepted, natural, evolutionary step. This has accelerated the market tremendously.
Q. Do you think mergers and acquisitions will continue at such a rapid pace?
A. I think 1986 is going to be the biggest year ever for the merger market. I see things starting to taper off dramatically toward the end of the year, and 1987 is not going to be a good year. I don't think you need a crystal ball to see it.
Q. Why are things going to slow down next year?
A. I think changes in the tax laws are going to have a major impact. I think it is more likely interest rates are going to climb. Clearly, the higher interest rates go, the worse it is for buyers to service pay interest on debt. Also, the stock market is high now. When the stock market moves up, there are fewer opportunities to take over public companies at bargain prices.
Q. If you think merger activity is going to slow down next year, how will you reposition Geneva Corp.?
A. In 1987, the lower end of the middle market will be severely constricted. I said the middle-merger market is $1 million to $50 million in sales. One million dollar to $5 million deals are going to become increasingly difficult to do. We are preparing for this change by arbitrarily saying the market will be floored at $10 million. So we have to deal with higher-valued businesses.
Q. Financially, when is the right time to sell a business?
Q. There is a cold, hard answer people have difficulty with which affects the timing. If you can sell your business for seven or more times what the business is providing you to support your lifestyle, you have crossed the threshold into that decision area. Suppose the business is providing you with $100,000 a year in salary and benefits. You pay tax on that.
Then suppose you could sell the business for $700,000, leaving you with $560,000 after tax. Invest that in tax-free bonds and you have $56,000 a year. You could make as much by not working as by working. And as a general rule, we are selling businesses for in excess of 15 times direct and indirect compensation to the owners.
Q. But isn't it possible that your formula won't work if my business grows very rapidly? Wouldn't I be better off financially by waiting?
A. We find the average seller will sell three to seven years beyond the point they should have sold. They stay at the party too long. I think it was Bernard Baruch who said, "I would rather sell one day too soon than one day too late." He said he became wealthy because he always sold too soon.
Q. Don't a lot of family-owned businesses get sold for nonfinancial reasons?
A. Sellers tend to sell for subjective reasons; buyers tend to buy for more objective reasons.
Q. If I ask you to sell my business, what happens first?
A. The first thing we do is recast the financials, redo the financial statements . We are going to pull out your direct and indirect owners' expenses and plug in the cost of professional managers. We are going to build a mirror image of public company accounting. The major market from the buyer's standpoint is still public companies buying private companies. In order to speak their language, you have to change your accounting process.
Q. Why do people sell their businesses?
A. The average entrepreneur in the position to consider selling his company is driven by the boredom factor, the fear factor or the burn-out factor. Your own business is a terribly tough task to master. People ask, "Is this what I want to do with my entire life?" This can happen at 28 or 88.
Q. What do you mean by the "fear factor?"
A. When the business is very good or very bad, the entrepreneur will usually need additional funding [from the bank]. The banking community is almost Pavlovian. The bank says, 'Here are the [loan] papers; go home and have your spouse sign them.' You are constantly stepping up to the table with everything you own.
Take Company A and Company B. A is public and B is private. Company A gets the loan it needs with a corporate signature. Company B has to have a personal guarantee. So you have this fear factor that can drive you [to sell].
Q. How long does it typically take to sell a company?
A. On average, a deal takes 400 to 800 hours from the time you say go until it is done. It can run 6 months to a year. We initiate and consummate more than one deal every 8 to 10 business days. Last year, our range to sell a business went from 53 to 275 days.
Q. What is driving the deals you are working on?
A. You have a couple of things. You have a natural market made up of people at the age point where they want to retire and a health-driven market of people, who, for example, have open heart surgery. Then you have an event-driven market where there is going to be a change in taxation. If the capital gains rate goes up, and it appears likely it will, obviously that is reaching into the selling entrepreneur's pocketbook. We are finding cases where the date to sell is being brought back closer in time due to threatened changes in taxes.
Q. What kinds of businesses are you selling these days?
A. Businesses that rely heavily on technology are less desirable today due to the risk of obsolescence. Besides that, we have moved strongly from smokestack to service businesses. Five years ago, less than 12 percent of our deals were service businesses. Now it is more like 51 percent to 49 percent service.
Q. Which industries are your primary markets?
A. We are still doing . . . lumber yards and metal-bending shops but . . . software companies and home health care . . . are desired. So many . . .buyers are smokestack-based and looking to service companies [to diversify]. Equipment-leasing companies also have been hot.
Q. Are most of your buyers domestic or foreign?
A. As a general rule, the worst buyer you can ever deal with is your local competitor. You have a great overlap of accounts and resources. The best buyers are outside your industry. Over 90 percent of our business is between buyers in different cities. Twenty percent of our deals are done with offshore buyers.
Q. If I want to sell my business, is there a simple way to figure out what it is worth?
A. There are no formulas. The ultimate test of value is what a willing and informed buyer will pay.