Shares Versus Assets: It is Mostly About Minimizing Net Taxes

Company acquisitions can be in the form of a share purchase or an asset purchase.  Both can accommodate the full transfer of a going concern business.  The fundamental difference is that in a share sale, the shareholders sell their shares and receive the proceeds personally (i.e. the legal entity that owns the assets changes hands) and, in an asset sale, the legal entity sells all of its assets including its name, IP, brand, customer contracts etc., and remains as a legal entity owned by the shareholders but now just has the sale proceeds as its main asset.  A second taxable step of distributing the cash to the shareholders will have to take place for the shareholders to make use of the proceeds.  Sellers that pursue this option may have plans for the company to re-invest the proceeds thereby deferring the tax impact.

So how are they different and which is better for a seller or a buyer?  Ultimately, it is after-tax free cashflow or net cash in hand that drives the value, purchase price and optimal structure.  The tax impact, whether it is reduced capital gains tax for the seller or lower go-forward income tax for the buyer, is usually the biggest driver in the decision between a share or asset sale. 

Buyers will prefer an asset purchase when the purchase price is largely allocated to depreciable assets because they will benefit from higher CCA going forward.  Sellers will prefer share sales when the $750,000 lifetime capital gains tax exemption has a material impact on the proceeds.  In some cases additional family members can benefit from the lifetime capital gains tax exemption by enacting an estate freeze and creating trusts for the children.  However, it must be noted that any shareholder will have to have owned their shares for at least two years for the lifetime capital gains tax exemption to apply so this can’t be done at the last minute. For a family with three children this can increase the exemption from $750,000 to $3,000,000; a big impact for transactions up to $5 million.  For larger transactions it becomes more complex for sellers as depreciable tangible property may incur taxable recaptured depreciation or, where a significant amount of the sale price is allocated to goodwill, 50% of the profit on the sale of Goodwill is exempt from tax.

Beyond tax there are other factors to consider such as:

-       Buyers prefer asset purchases because they avoid the issue of possible skeletons in the closet (undisclosed liabilities)

-       Buyers will seek more reps and warranties in a share purchase agreement as they look to protect themselves from potentially undisclosed liabilities

-       Sellers should consider the risks of possibly having to renegotiate key contracts with customers and employees in the case of an asset sale (where contracts include a change of control provision)

When selling your business, weigh the answers to the following questions to choose your path:

-       Will you benefit substantially from the lifetime capital gains exemption?

-       Will the lion share of the purchase price be allocated to depreciable assets or goodwill?

-       Will transferring contracts (customers/employees) be difficult?

-       Do you have a compelling opportunity to use the funds in the company?

The tax issue can be a complicated one, however, non-tax items such as obtaining customer consents, can sometimes trump it entirely and, if you are indifferent from a tax perspective, the flexibility to pursue either option may provide some helpful negotiating leverage.  For a more detailed analysis of both the seller and buyer impacts see the Veracap M&A Value Strategies newsletter here.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap M&A International in Toronto.

2012 Year-End Summary

As another year comes to an end, I thought I would organize a topic reference page around themes.  The following are select blog posts from the last two years.  Happy Holidays and if you have any thoughts for a topic in 2013, please let me know.

Terminology and Documentation
M&A Acronyms

An Overview of NDAs

What Does a CIM Include and How Do You Position It?

M&A Process

How Much Information (and when) Do I Share With Potential Buyers?

Attracting Foreign Buyers: The Benefits of M&A International

Milestones in the M&A Process: How Long Does it Take?

What is Due Diligence and What Does it Consist Of?

Winner’s Remorse: Does the M&A Process Lead Buyers to Overpay?

Preparing a Business For Sale

Normalization Adjustments for Private Companies

12 Situations to Avoid When Selling Your Business

How Do I Attract a High Multiple for My Business: The Business Factors

How Do I Attract a High Multiple for My Business: The Sale Process

Buyer Selection

Constructing a Buyer List

What Makes a Good Buyer?

Finding a Buyer: It is Rarely the One You Expect

What Will a Strategic Buyer Pay?

What Will a Financial Buyer Pay?

Is There More Than One Buyer For My Business?

I Have a Buyer For Your Business

Buyers are Currently Paying High Prices for Businesses Like Yours

Valuation

Why is a Tech Company Worth Three Times Revenue?

The Basic Math of Valuations – Why Mid-Market Companies Are Valued Lower Than Their Public Company Peers?

Why is Instagram Worth 1 Billion?

Is Instagram Worth 1 Billion… only to Facebook

More Thoughts on Price Expectations

A Multiple of What (and When)?

It is all About the Platform

Choosing an Advisor

What Exactly Does an M&A Advisor Do?

How Does an M&A Advisor Add Value to the Divesture Process?

How Does an M&A Advisor Add Value to the Divesture Process: the Intangibles

M&A/Corporate Finance Options

When is an MBO a Good Idea?

Specialised Funds for Unique Needs

What About the Form of Payment?

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

What Exactly Does an M&A Advisor Do?

In “How Does an M&A Advisor Add Value to the Divesture Process?”, I noted that M&A advisors typically charge between 3% and 7% as a success fee for managing the sale process for a company.  The question I addressed then was, will engaging an M&A advisor improve your expected sale value by at least 5%?

Here I would like to outline exactly what an advisor does in the process of a sale mandate.  At this point I am assuming that pre-mandate matters such as preparing a business for sale, value expectations and timing from a business and market perspective have been discussed and it is agreed that it makes sense to proceed.

The advisor side of the deal team typically includes a senior lead such as a Director or Managing Director plus at least one Associate or Analyst as support.  In addition, in our case, there are usually international resources involved through our M&A international alliance.  Our M&A partners can do as little as buyer introductions to as much as negotiating and structuring deal terms.

An M&A advisor will: (i) position the selling company as a strategic fit for target buyers; (ii) present the opportunity to numerous logical and capable buyers; and (iii) manage the process along a defined and orderly timeline, in order to generate the highest premium possible.  We typically identify what we are responsible for in our engagement letters as follows:

·              Conduct a review of the company in order to better understand the nature of its operations and value proposition to prospective partners including:

o      a review and analysis of the historical and prospective financial results of the company;

o      a review and analysis of operational, marketing, technical and other information regarding the factors that influence the cash flow prospects and risk dynamics of the company;

o      discussions with management regarding the operations of the company;

o      a review and analysis of public information and other available information pertaining to the company and the industry in which it competes, and

o      a review and analysis of transactions that have taken place in recent years among businesses whose operations are similar to those of the company.

·              Prepare company overview materials in consultation with the company, which will provide prospective partners with an understanding of the nature of the company and allow them to assess value;

·              Conduct a search to identify suitable potential partners, guided by any criteria provided by the company;

·              Contact and screen potential partners;

·              Assist the company in the preparation of due diligence documentation, a management presentation and related materials for review by possible partners;

·              Negotiate with possible partners;

·              Work with the company’s legal counsel, tax advisors and other advisors to assist the company in structuring the transaction so as to meet its financial objectives; 

·              Review the documentation in respect of the transaction; and

·              Other functions as required in support of the transaction, and as agreed to from time to time.

The whole process may take six to eight months and the M&A team will spend somewhere between 300 and 500 hours on a file.  M&A advisors will have a lot of familiarity with legal documents and tax issues, but ultimately lawyers and accountants are required in the areas of due diligence, purchase and sale contracts, and tax planning.

M&A advisors often highlight how competitive bidding between several eager buyers resulted in an extraordinary price for their clients but, like the over-night success story ten years in the making, a completed divestiture relies on a foundation of thorough planning and process.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

What About the Form of Payment?

Public company take-over bids typically consist of all cash or a combination of cash and shares.  This is largely because the board of directors of a public company agreeing to an earn-out will be subject to serious questions (read lawsuits) if things turn out other than expected.

Consideration in private company acquisitions will usually include a sizable portion in cash (50 to 100%) but will often include an unsecured note and/or an earn-out as well.  This is typically because: (i) the buyer does not have (or have access to), the amount of cash required to complete the acquisition (particularly in the case of an MBO), (ii) the greater risk surrounding private companies (risks such as customer concentration, dependence on key suppliers, etc.) and (iii), buyers can usually stretch to a higher price if the purchase price is not all cash.  For example, $25 million all cash vs. $30 million two-thirds cash and one-third note ...which one would you pick?

There are a number of issues to consider when assessing the likelihood of realizing deferred consideration.  A dollar not received at closing is a dollar at risk.  In the case of a vendor note, the first question is, can it be fully secured by hard saleable assets (such as land, a building or other fixed salable assets owned by the acquirer).  This is not often the case.  If the amount is under-secured (i.e. 50% asset coverage) or unsecured, the terms have to reflect increased risk and due diligence should be performed on the buyer to get comfortable with its risk profile and prospects.  The higher the risk the higher the interest rate, and the more covenants and timely reporting are required.  Perhaps the most important item is timely reporting allowing for quick remediation.  Issues such as lawsuits, product defects/recalls, loss of customers can turn the fortunes of a company very quickly.

Earn-outs are tricky as well.  Earn-outs are more prevalent when the seller presents a strong growth forecast (for which he/she wants value).  If the seller will not entertain an earn-out, does that mean he/she does not believe in the forecast? They are not usually ironclad.  Many earn-out proposals begin with a premise along the following lines.  If you achieve $5 million in EBITDA you will earn another $x amount in purchase price.  Does this mean that if the company generates $4.9 million you get nothing? … and how is EBITDA calculated?  The acquiring company could incur discretionary expenses that you would not incur, or layer on additional overhead or, most drastic, a fundamental change of business direction could be required?

There are many possible situations to consider and many creative mechanisms and approaches to making vendor notes and earn-outs work.  For example, if the seller agrees that 75% of the earn-out will be paid if 75% of the target revenues are reached then he/she should also seek 125% of the earn-out when 125% of the revenues are reached.  Earn-outs can be tied to achieving development milestones, securing customer contracts but if earn-outs are based on the financial statements, then the higher up the income statement (i.e. sales vs. profit) the better… less room for manipulation. From a legal perspective it is important that purchase and sale contracts are clear, account for all possible scenarios, and that security is properly perfected in all relevant jurisdictions.

Un(der)secured notes and earn-outs can get very complex and this is where experienced advisors and lawyers really earn their stripes.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Winner’s Remorse: Does the M&A Process Lead Buyers to Overpay?

When managing a company divestiture, there comes a point when interested parties are requested to provide non-binding expressions of interest (this is the first indication of value based on reviewing the CIM and answering select questions, see: How Much Information (and when) Do I Share With Potential Buyers? ).  An expression of interest outlines a value range, structure and other criteria, on which potential buyers are prepared to move forward.  It is requested so as not to waste the seller’s time with potential offers that will not meet the needs of the seller.  When there are multiple expressions of interest for a company, they typically form a normal curve around the company’s notional value. 

Non strategic/financial buyers are typically at or below notional value (E1..E4) and strategic buyers are typically at or above the notional value (E4..E7).  The parties engaged to go forward in the process will be the ones above notional value (E6..E7) suggesting that they may be ready to pay a higher price than fair value, however, fair value is very much in the eye of the beholder.

A strategic buyer may pay more than the notional value for a business for reasons of competitive strategy (i.e. prevent your competitor from strengthening its footprint) or when the seller has certain assets that complement the buyer’s assets thereby allowing for the potential to create value through synergies. The value of a business is different to every potential buyer.  To a financial buyer (one that does not have the potential for synergies, but may nevertheless be able to bring special expertise to the table) a business may be worth the notional value which maybe six times EBITDA, generating a 17% non-levered ROI (maybe more  than 30% with 50% debt); but a strategic buyer could pay seven times EBITDA and expect to generate even more based on synergies.

So does the M&A process lead buyers to overpay?  Not necessarily; the process extracts the highest price for the seller by appealing to potential buyers that will benefit most from the purchase.  The buyer has to weigh the risks and benefits of the price they will pay versus not getting the business. Overpayment has been in the news lately with HP writing off $8 billion of goodwill from its $13 billion acquisition of EDS and Microsoft writing off $6.2 billion of goodwill in its Online Services Division where it houses the acquisition of aQuantive (which it acquired for  just over $6.3 billion).  The onus is on the buyer to correctly estimate the realisable cashflow from a purchase and then to execute on its plan.  Many things can go wrong in execution but the fact remains that if there is more than one buyer at the table it is highly likely that the winner will have paid more than notional value.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Is There More Than One Buyer For My Business?

I have come across several niche businesses lately where they have received unsolicited interests from potential buyers and this leaves the owners wondering, are there any other buyers for my business?  Should I bother with hiring an agent and engaging in a process that could take many months to complete or take the bird in the hand?

If these companies were publicly traded there would be no question.  The board of directors of a public company would undoubtedly reject the first unsolicited offer and engage an investment bank to explore alternatives.  Assuming normal operating circumstances, a board would not fulfill its fiduciary duty if it accepted the first bid.  Due process would require at least an independent fairness opinion, but even this would not assure the shareholders that they will realize the highest share price in a transaction; only a thorough and diligent auction process can do that.

Back to the question at hand; could there be other buyers?  When a potential seller operates in a very specialized vertical with only several competitors - that may spread unfounded rumours of the company’s demise as soon as they hear of a possible transaction - it is tempting to go with the bird in the hand.  But, as I have noted several times, the best buyer is not likely to be a direct competitor.

The best buyer is likely to be a “platform buyer”.  A platform buyer will be interested in the business for one of three reasons, its customers, its personnel, or its technology.  As an example, we were engaged to sell a pattern recognition technology company in the field of product quality control.  This technology would scan a production line and “kick-out” products that did not meet certain criteria.  In this case, the ultimate buyer was the US defence department, who paid a strong premium for the business and then used the technology for facial recognition for national security purposes.  Who would have predicted that? ... but having approached large technology companies that also served defence contractors ultimately led to this outcome.

The point is, even if you feel that there are only one or two competitors that could potentially be interested in acquiring your company, we can likely find additional buyers that you have never thought of as per the example above.  It is extremely rare that we have not been able to source at least several expressions of interest for a company for sale.  In the end you only need two interested parties to create that competitive tension.

So what is a company to do?  Private companies, where owner-entrepreneurs own majority control can do as they please.  This is the luxury of owning a private company.  Company owners may not want the hassle of preparing a business for sale or they may feel the value being discussed is fair but, in the end, going to market with an experienced advisor is the only way to secure the best price for your company.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Is the IPO Window Open... and Why Does it Matter?

I have spoken before about IPO windows; when they are open, an IPO is possible and when they are closed it is not.  We have seen a number of high-profile digital media IPOs over the last year including LinkedIn, Groupon, Zynga and Facebook.  While most of these issues “popped” on their opening day, Facebook notably did not.  LinkedIn was up 109% on its first day; Facebook closed pretty much even.

Of the seven well publicised IPOs listed above, only two were trading above their IPO price as of May 22, 2012.  It is interesting to note that the richest IPO (as measured by the highest multiple of LTM revenues), actually performed the best and more than 100% revenue growth has now pushed this multiple down from over 30 at the IPO to 17 as at May 22 (still very high).

An open IPO window is a symbol of general health in the financing markets.  IPO’s return cash to VCs who then continue to invest in private companies, and they provide the now public companies with cash and a currency for acquisitions.

It should be pointed out though that the window is not open for all companies.  There are many sectors that have a tough time raising capital right now including base metal companies, solar companies and smaller companies in general.  The IPO window often shuts quickly as a result of a disastrous event or as bubbles collapse (mortgage crisis in 2008, twin tower attacks and Greece leaving the EU may do it this time).

With Facebook not outperforming on its opening day, the S&P500 down over 8% since early April and the EU not taking any concrete action on its Greece and Spain challenges, is the IPO window still open?  I would have to yes, but not very far.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Why is Instagram Worth 1 Billion?

There are many reasons why Facebook would pay a lot of money for Instagram.  Reasons such as: to improve its mobile revenues (of which it had none), to eat Twitter’s lunch, to eliminate a potential future competitor, and basically to maintain its growth and market value momentum.  Remember, Facebook is the internet's largest photo sharing site and it knows the power of photos very well but what I really want to tackle here is why 1 billion as opposed $500 million?

The simple answer is it was a privately negotiated transaction and Instagram had just recently raised money from Sequoia Capital at a reported $500 million valuation, so they weren’t going to sell for less.  Well done to get to 1 billion.  This means that Sequoia Capital and other firms that contributed money were essentially able to double their money in a very short timeframe.

Prior financing round valuations and existing investors’ requirements are value pegs but here is some theory around what price is possible.  In cases like this companies are paying a scarcity premium.  The argument being that, either by way of market position (i.e. if all your friends are on Facebook there is no point being on Orkut) or by way of proprietary technology, these targets have something the acquirer can only attain by buying them.

At this point a buyer is paying a price beyond the notional value of the target and encroaching on the value to the buyer.  The notional value is a company’s value independent of the potential strategic benefits to a particular buyer.  The value to the buyer is that amount of value the acquirer can produce with the target.  Not something they typically pay for unless forced to in a competitive situation.

To consider this by way of a generic example, let’s assume a billion dollar revenue company is paying 10 times revenue for an early stage company generating $1 million in revenues.  The target company’s technology will allow the billion dollar revenue company to increase its market share by 10%; a value of $100 million in revenues.  You can understand why the acquirer might pay $10 million for this company.

The conclusion is that a buyer paying a price below the value to the buyer is something that makes economic sense, even though the price may sound astronomical…. and if you are being approached by Facebook (estimated value of $100 billion) then there is a lot of room to pay a lot of money.  In my next post I will examine what Facebook could have paid.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

VTI Profit Margins Underwhelm

In the Spring issue of the Veracap Technology Quarterly we took a closer look at technology sector profitability.  While valuations have improved substantially, many mid-market technology companies still struggle with profitability.

On average only 55% of the technology companies included in the Veracap Technology Index (the “VTI” includes all technology sector companies trading on the TSX and TSX-V with a market capitalization between $10 million and $500 million) were EBITDA positive and, of those companies, the average margin was 12.1%.  The subsector with the most profitable companies was the IT Consulting & Services sector and the sector generating the highest margins was the Internet Software & Services sector with an average EBITDA margin of 15.3%.   In looking for an explanation of these results we believe the answer lies in the average size of the companies.  The average market cap of the VTI is only $81 million.  Of the companies not generating a positive EBITDA, 84% had a market cap of less than $100 million.  Canadian technology companies go public at a relatively small size and need to grow larger to achieve scale and improve efficiency.

The most profitable companies in the VTI were Mediagrif Interactive Technologies with an EBITDA margin of 33.6%, Enghouse Systems with an EBITDA margin of 27.2% and C-Com Satellite Systems with an EBITDA margin of 23.9%.  While nowhere near world leaders like Google and Microsoft which have generated EBITDA margins in the 40% range for years, these are nevertheless our strongest performers in the quarter. 

So do high margins translate to the best valued companies in the VTI?  In general yes, the above noted companies are in the top quartile in terms of an EBITDA multiple but there are exceptions as well such as C-Com Satellite Systems which ranks 3^rd in profitability but was valued at less than four times LTM EBITDA.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Tech Companies Explode Out of the Gate in 2012

The Veracap Technology Index (“VTI”) composite share price has been on a tear since December 2011.  The VTI has more than quadrupled the S&P/TSX Composite Index, with a return 20.8% versus 5.0% for the period from December 1, 2011 to March 1, 2012 (and this excludes the stellar premiums awarded such take-over targets as Gennum and RuggedCom).  

To refresh our readers on the VTI, it includes all technology sector companies trading on the TSX and TSX-V with a market capitalization between $10 million and $500 million (Veracap’s area of focus).  As at March 1, 2012 this included 79 companies and of these 53 were up an average of 38%.

Technology sector valuation multiples have also increased sharply from 7.4 on December 1, 2011 to 9.8 on March 1. 2012.  The strongest subsector, in terms of valuation multiples, was the Software sector where companies such as Nightingale Informatix,  Redknee Solutions, and Posera-HDX contributed to an average last twelve month (LTM) EBITDA multiple of 13.2.   The Hardware & Equipment subsector brought up the rear with companies such as COM DEV International Ltd., Smart Technologies Inc. and LOREX Technology Inc. trading below five times LTM EBITDA.

Technology sector lifters and drags for the period from December 1 to March 1 include:

Lifters                                                 Subsector                                             %

Aastra Technologies Ltd.                    Communication Technology              Up 44.7%

Glentel Inc.                                          Communication Technology              Up 40.0%

Enghouse Systems Ltd.                     Software                                             Up 39.9%

Drags                                                  Subsector                                             %

Smart Technologies Inc.                     Hardware & Equipment                     Down 29.0%

Sandvine Corporation                         Communication Technology              Down 12.0%

DragonWave Inc.                                Communication Technology              Down 5.9%

Note: for companies with a December 1 share price greater than $1.00

For more M&A information on the Canadian technology scene please see our Spring issue of the Veracap Technology Quarterly.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Has it Been Three Years Already?

In my last post I noted that now is a good time to pursue a divestiture or private equity transaction based on: (i) coming out of the recession in 2009 and seeing a general return to growth and profitability, (ii) historically low interest rates, and (iii), a tremendous amount of investible capital at private equity funds and on corporate balance sheets.  So how good is it?

The following is a chart of the S&P500 over the last three years. Since March of 2009, after reaching a low in the 675 area, the S&P500 is now 100% higher and flirting with recent highs.

The 10 year US Treasury yield index is below 20 (at a three year low resulting in a yield of 1.87%).

The facts are as follows: we are near a three year high in the S&P500; S&P500 earnings have improved every quarter since Q1 of 2010, interest rates are at three year lows and a recent study by the Wall Street Journal highlighted that "cash accounted for 7.1% of all company assets, the highest level since 1963."  In short a strong foundation for a healthy M&A market.

BUT, people are worried.  Worried about the European debt crises, US budget deficits, an ineffectual Congress, falling house prices and an unemployment rate of over 8%; hence the contradiction of improving earnings and historically low interest rates.  The expression “the market is climbing a wall of worry” reflects a scenario where the market goes up despite uncertainties.  This is positive in my mind because it represents a healthy tension between the bulls and the bears; no over exuberance with the potential of a crash but steady as she goes. According to Standard & Poor’s, the current consensus 2012 earnings forecast for the S&P500 is $103.70 which, at current levels, equates to a multiple of 13 times. Quite reasonable and therefore we are in a positive environment for M&A activity.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

The Window is Open

I noted in my last post that private company divestitures or equity financings can take between seven to nine months to complete (a financing can be quicker depending on the structure).  This may seem fast or slow depending on your perspective but that timeframe is typically not the whole story. 

Veracap's Value Enhancement Framework^TM (see “How Does an M&A Advisor Add Value to the Divesture Process?”) notes that an important part of the process is the planning stage.  For example, while preparing for sale it is critical that personal goodwill be transferred to intangible, company goodwill.  What this means is that owner-entrepreneur responsibilities and relationships are migrated to a management team that will stay with the business for an extended period of time.  The planning process may take several years to complete.

The next phase that can take years to complete is the transition phase.  Unless the owner-entrepreneur is no longer active in the business, the buyer will likely seek a period after the closing where the seller remains engaged to ensure a smooth transition and delivers on earn-outs, etc.

The planning and transition phases can add a number of years to the process, but here is the real kicker, investor sentiment and the economy.  In fact, a great opportunity to sell or raise equity at a premium may come along only once in a lifetime.  We all remember the internet bubble of 2000 and the more recent US real estate bubble in 2008.  If you assembled a good tech team and had a web related idea in 1999 or early 2000, you could fund a start-up at a significant valuation (I personally had an idea that was funded at a multi-million dollar value). 

The internet bubble crashed in 2000 and the US real estate bubble crashed in 2008 taking the whole world with it.  When a recession hits and profits are diminished, demand drops off and values naturally become depressed.  You could arguably sell your business in the 2009/10 timeframe but not at 2007 valuations.  As an owner-entrepreneur, when you thought your business was worth $20 million but you are told it is now worth $12 million, you are going to think twice about going to market.

We have seen many businesses return to strong profitability in 2010 and 2011 (depending on their fiscal year end) and with a number of years of sales and margin growth, strong valuations can yet again be achieved.  While bubbles are extremes there are always hot and cold sectors from time to time where strong valuations are realizable.  Some current examples of hot sectors include cloud based virtualization such as Software as a Service (SaaS) and Platform as a Service (PaaS), social media, mobile marketing, penny auction and deal-of-the-day web sites.  A once hot but now cold sector, ironically, is the solar sector.

We cannot predict when the next recession will begin.  The finance community refers to IPO windows; when they are open an IPO is possible, when they are closed it is not.  The process of preparing and positioning to sell your business, or equity in your business, can take many years and an economic downturn can add several more years to that.  As for right now, based on: (i) coming out of the recession in 2009 and seeing a general return to growth and profitability, and (ii) historically low interest rates, plus a tremendous amount of investible capital at private equity funds and on corporate balance sheets, I would say the window is open.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.