It might be time for some owners to considers selling.

While management teams and ownership are continually beset with an overwhelming set of daily challenges, there are two issues that should usually cause some pause. These issues are creating new value through the achievement of a company's next-level development, or realizing existing value though a sale of ownership, whether in whole or part. This article is dedicated to the latter because the vibrancy of the marketplace is, or should be compelling the attention of owners.

If you have ever retrospectively concluded "I think I missed the boat" or "if I only had connected the dots earlier" in regard to some opportunity (well, we all have), consider this your unambiguous notification regarding the current attractiveness of liquidating some or all of your ownership, which if nothing else, will preclude the chance to claim some excuse years from now.

Since 2001, the present marketplace in relative terms is close, if not equivalent, to demonstrating optimal conditions for sellers of ownership. This claim is directly supported by high valuations driven by demand from strategic and financial buyers, and indirectly supported by the level of transaction activity witnessed over the recent past, and expected at least through the end of year. Before addressing this condition, some background regarding valuation might prove useful.

Your company will either be valued on the basis of some operating metric, or its assets value. With respect to the former, the predominant measure of a company's value is its economic fertility, which is best expressed by its cash flow. From a valuation perspective, cash flow is called EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization), and this metric is normally adjusted upward by adding to EBITDA certain expense related items such as excess compensation, discretionary expenses, some non-recurring expenses, and other expenses that serve to dilute the clarity of the intrinsic and recurring return profile of the enterprise.

To be complete, please note there are other iterations of cash flow, such as Free Cash Flow (Adjusted EBITDA less principal payments on debt and capital expenditures), and there are a number of valuation nuances. Given the mandate of this article, it is just important to understand the definition of adjusted EBITDA. With respect to asset valuation, which is a subordinate and typically less attractive valuation alternative for profitable companies, a company's assets are in effect, marked-to-market, and as such, asset value may be greater or less than book value.

Once adjusted EBITDA is determined, the cash flow valuation of a company is derived by multiplying adjusted EBITDA by a "Purchase Price Multiple," or PPM. The calculation produces a company's Enterprise Value. The PPM is derived from the marketplace based on a combination of comparability analysis, entailing the prior valuation of similar companies, and required returns, reflecting the current demand by buyers, and the opportunity cost of available capital. Most owners have a difficult time becoming comfortable with PPMs since a PPM is somewhat abstract and cannot be reconciled arithmetically. In summary, a PPM is the marketplace's quantified expression of valuation as applied to a cash flow, which is typically adjusted EBITDA.

Over the past few years, PPMs have steadily increased, and today the overall sentiment in the marketplace is that valuations are presently very high. This means that all things being equal, value of your company in today's environment is the highest it's been over the past few years, and this is a good thing if you are a seller, or might thinking about selling at a propitious time. Note the following PPM data validating this position.

Naturally, the resulting questions are "will valuations increase further" and "how long will valuations remain at a high level"? In absolute terms, of course no one knows. However, since there is an inverse relationship between interest rates and valuations (discounting future cash flows by higher discount factors), and interest rates are incrementally increasing, at first glance it might be concluded that valuations might be declining thereby narrowing this present window.

It is my opinion while the probability of valuation increases is very modest, the probability of valuation declines is also modest over the short, and possibly medium terms, notwithstanding the circumvention of mathematics, because the demand by buyers for outright company purchases, majority interest investments and minority interest investments is extremely strong.

As noted, the overall higher level of valuations is being driven by strong buyer demand. On a year-to-date basis, there was 6,180 M&A transactions totaling $527 billion in 2004, and in 2005, there have been 5,722 transactions totaling $628 billion. This is a 30% increase in value. In addition, the 438 announced acquisitions, which are valued between $10 million and $500 million, during the second quarter of 2005, is the highest total since the second quarter of 2001.

This feeding frenzy is being fueled by three sources: 1) strategic buyers, seeking new levels of value creation given diminishing returns from productivity increases, 2) financial buyers, represented primarily by buyout funds and private equity firms, seeking to deploy capital, and 3) the providers of debt financing seeking to provide access to capital thereby enabling buyers with the ability to execute transactions which afford affirmative return profiles based on the ability to engineer conducive capitalization structures.

While buyout funds and private equity firms raise money from large institutions, for purposes of buying, or investing this capital into, pre-dominantly private companies, these sources of demand currently possess a tremendous amount of un-invested capital. Given the need to deploy this capital, demand from this segment of the marketplace has, is and will continue to support valuation buoyancy.

Jeffrey R. Knakal is the Managing Partner of Growth Partners, which is a private investment banking firm specializing in value creation and value realization activities and transactions, based on M&A, capital formation, and special platform development competencies. He can be reached at 818-713-8000.

Enterprise Value
($mil)

                2004   2005 (YTD)

Less than $25   6.3x     6.8x
$25 to $100     7.6x     8.3x
$100 to $250    7.2x     9.4x

Source: Thomson Financial.