Is Now a Good Time to Consider Selling Your Business?

I’m having an increasing number of conversations with business owners recently where they have asked whether it’s a good time to sell their business. If you run a successful private business, you have probably been approached by private equity firms gauging your interest in selling or taking on a big investor. Anecdotally though, it seems that these approaches are becoming more frequent and the valuations on offer higher than ever. 

The current situation reminds me of 2006 when I saw a surge in people exiting businesses at fantastic prices. Shortly after that, the GFC hit, and it all came to a grinding halt. Obviously, it depends on lots of factors including your age, your industry, your motivation, and stage of life. But subject to those personal considerations, my answer is increasingly, yes, now is a great time to sell a business. 

It starts with the largest investment institutions, big superannuation, pension funds and wealth management firms. With share markets hitting record highs, they are trying to diversify and find better value opportunities. Many of these organizations are mandated to invest these funds regardless of valuations. Increasingly they’ve poured billions into private equity. 

With a flood of money into private equity funds, managers are looking across the country at private companies they can buy or invest in to deploy these funds. What happens in situations like this is there’s more money and more managers competing for the same number of deals. In such a competitive environment they have a choice, pay more than they’d like to or stay disciplined and miss out on the deal altogether. 

Here’s where it gets tricky. Often the funds are deployed even though it puts future returns of the fund at risk. Why? Well, firstly it’s not their money. Secondly, if they don’t deploy the cash their investors will want their cash back. Either way, if they don't find businesses to buy then they don’t get their management fee.  

While many PE firms will be disciplined, many aren’t, and this is when bad investments are made. As the late great investor, Charlie Munger once said, “show me the incentive and I’ll show you the outcome”. So, the deals will get done and this flood of money will find a home. That’s why as the landscape becomes increasingly competitive the price earning multiple on private deals starts to ratchet up. 

In many cases, the profits of these businesses are not increasing dramatically to justify the higher prices private equity will pay, they are simply prepared to pay a higher multiple of the profit. It’s also the reason I’ve completely avoided private equity funds for my clients. They sound great but in this current market, it’s possible you’re paying $1 to buy 80 cents.  

Conversely, it's a great opportunity for a business owner who might have been thinking of selling in the years ahead to bring forward their timeline. Why? It’s because this situation isn’t sustainable. This is the frothiest part of the market cycle. Once the music stops business owners will see these offers dry up and they be leaving tens if not hundreds of millions of dollars on the table. So, is it a good time to sell?  

Yes absolutely. 

The next question I get is what’s the timeline? 

If these elevated prices on offer are not sustainable then when does it end? How long do you have before things change? I continue to be surprised by how high and how long both the share market and property market have continued their rise. The level of growth needed to justify current valuations is very high. This is especially so in an environment where higher rates are taking so long to cause the slowdown they are intended to create. I think we are already overdue for a pullback in share markets and economic growth, so I'd get on with it sooner rather than later.  

Then it's about how to structure a deal when you sell your business. Usually, deals are structured as a mix of cash, shares and an earnout based on hitting agreed metrics in the years ahead. If you think there’s a risk business conditions might deteriorate significantly, then logically you’d want to take as much of the sales proceeds in cash as possible. Signaling is important in these transactions. A founder who wants all cash is a red flag for investors, so you need to temper your enthusiasm in this regard and ensure your selling narrative is for the right reasons. 

Often business owners take more in shares and much less in cash if they feel there is still high growth ahead. But unless you are convinced of the upside growth opportunity a higher cash component is worth considering given you won’t have the same level of control or autonomy over the company post-exit. And no matter how well it starts it’s always difficult for founders to manage with the new regime and increased bureaucracy during the earn-out phase. While a three-year earn-out phase is the norm, if you can negotiate a shorter period, it might be better for you. 

This is, in my opinion, a once–in-a-generation opportunity for business owners to potentially obtain a price that they may look back on in a couple of years and regret not taking. Like 2006 and even 2021 for tech, once the music stops and the downturn is in full swing, these deals dry up and the valuations fall to much more normal or even depressed levels. So, if you have been thinking about selling your business in the next few years, I would strongly suggest considering whether current higher prices coupled with the potential for an economic downturn ahead, make it worth acting much sooner.  

General Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Land Mines

From the rapid increases in interest rates to the aftereffects of the pandemic, there are multiple generational events that the global economy is continuing to digest. However, there is increasing evidence of financial problems hidden beneath the surface that are raising some concerns. Investors need to watch their step.

I have been warning for a while now that central banks cannot increase interest rates from 0% to 5% with no consequences. Higher rates impact the entire economic system, not just people’s mortgages and businesses. Large corporations through to entire countries with high debts are feeling the pinch. So far, their impact is taking longer than I expected to flow through and cause a financial or economic mishap, but they will eventually.

There have been a couple of recent near misses. There was the run on the regional banks in the US that brought down Silicon Valley Bank and a close call for the UK pension funds. In both cases, disaster was averted but it is worth remembering that the underlying issues that created those problems are still lurking.

A recent property transaction in New York City highlighted just how much the world has changed in the past 5 years. Earlier this month there was an office building sold in NYC for US$50m. What stood out was that it was sold at a 67% discount to its 2018 purchase price of US$150m.

In 2018 interest rates were low, we hadn’t heard of covid and working from home was unusual. Compared to 2024 with much higher rates and office vacancy rates at much higher levels, the numbers and cash flows look radically different.

The real problems begin when owners in financial difficulty are forced to sell, or worse, the banks seize the property, and are selling. You end up with a glut of properties, no buyers, and increasingly desperate sellers. Prices fall and continue to fall. This leads to even more sales as desperation to get out before you cannot sell at all.

There are other signs too. Many organisations including BlackRock and Charter Hall have suspended or limited withdrawals from some of their office property funds. They are doing this preemptively to prevent investor withdrawals requiring them to sell assets at lower prices, potentially realising losses. This has not raised alarms so far, but it should have attracted much more attention than it has.

There are many of these funds holding billions of dollars of office property assets managed by large and small fund managers for investors. The proliferation of unlisted funds for everything from property to private credit raises real questions for investors as to how they get their money out if markets go the wrong way.

I have not seen a set of circumstances like this since the GFC and here in Australia not since the early 1990’s recession when record-high interest rates created a property and loan default crisis that almost sent Westpac Bank broke. This time around the big banks seem more conservative. The risk may well be with the organisations who filled the gaps.

I am not predicting this for the entire property market, but the office property market specifically has all the hallmarks for a situation like this to unfold. How that implosion, should it happen, flows through to financial markets and the general economy is a real risk. My concern is that the office building in NYC is not a one-off, but that it might be the first domino of many more to fall.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

China Slowdown

The much-heralded China economic reopening doesn’t seem to have materialised in the way markets anticipated. At various points during Covid, the prospect of China reopening for business post covid sent markets rallying higher on the expectation of higher demand driving the global economy. But so far, the reality has been underwhelming and it appears there are more economic challenges ahead for China than many anticipated.

Yesterday’s inflation figures for China show the once-powerful engine of global economic growth to now be heading for deflation. The CPI rate of -0.3% for the period was lower than expected and the flow-on effects are massive. Lower inflation and the prospects of lower economic growth are genuinely problematic for a nation that has been all about growth for the past 30 years.

In the past, China has had many long-term trends playing into their favour driving their growth. But suddenly there are a number of these trends are being reversed and we are now starting to see these factors impacting the country negatively. China has been the biggest beneficiary of globalisation over the past 20–30 years. Combining that with a huge population and rapid urbanisation sparked decades of investment that turned China into the world’s second-biggest economy.

Yet what China faces now is a totally different situation, and I am not sure the world has really considered what all of these variables combined really mean. All these issues are well known but China has been such an economic juggernaut it’s difficult for people to look at the situation with fresh eyes and consider what all these issues converging really mean for China and the world.

The catalyst for changing these trends was Russia’s invasion of Ukraine effectively waking the world up to the economic consequences of a conflict on the global supply chain. National security became the number one issue for every nation in the world and overnight it commenced the slow reversal of globalisation. As countries extricate themselves and their supply chain dependency from China this new trend will weigh on the Chinese economy as decades of investment is slowly unwound.

Meanwhile, emerging economies such as Mexico, India and Vietnam are booming as the USA and other Western nations are reshoring their supply chains and manufacturing. Make no mistake the process of untangling the global supply chain is still underway. The global supply chain dependence on China is a bigger vulnerability for the Western world than Germany’s dependence on Russian energy. There is no quick fix so all sides are working as quickly as they can to mitigate their risk. That’s a problem for China’s long-term economic growth.

Another overarching theme is their changing demographics. China’s population is aging and by 2035 an estimated 400m people will be over 60. Population won’t be the driver of growth it once was. But the trend that really accelerated the Nation’s growth over the last 20–30 years was the urbanisation of China. As people moved from the country to the city there was massive investment in infrastructure and property. Entire cities were seemingly built overnight. But simply developing infrastructure and buildings isn’t sustainable, in fact, it might be part of the current problem.

China is now at a crossroads.

The spectre of large amounts of debt has hobbled the economy. Economic growth has been lower than expected and in the past that was the signal for stimulus from the government. More often than not in the form of infrastructure and property development. It’s unlikely to be the case this time around and those past actions are part of the problem. Large debts at all levels of government, especially local government, were used to build projects that didn’t necessarily stack up financially. There are large amounts of infrastructure and property development that provided economic stimulus and jobs at the time but sit vacant or barely used now they are completed.

This is a serious problem.

It means that many of these projects haven’t delivered the returns needed to pay for themselves. But more importantly, faced with slowing growth, it may stop the government from being able to roll out the old playbook because they have effectively over saturated the market. The property and debt issue in China has been lurking since the collapse of Evergrande back in late 2021 and there remain serious problems and questions with regards to the entire sector. I am sure grand announcements of government stimulus and investment packages are coming but China need a new strategy to reignite growth.

By way of investing in Chinese equities, I still believe the country remains uninvestable. As I’ve previously said in these notes before, regardless of how big the opportunity may seem I am not interested in investing funds where a country’s government can torpedo entire companies or even industries overnight on a whim. Business is difficult enough at the best of times and I have no interest in the space and wish those brave, naïve, greedy or silly enough to invest there good luck.

With all of these long-term trends reversing, it will be extremely difficult for China to grow in the same way they have for the past few decades as they go forward. It’s time for investors to think carefully about what these changes mean and reevaluate what the flow-on effects are not just for China but more importantly for the companies in your investment portfolio that are heavily exposed to China. Australia has benefited enormously from the growth of China but if the Chinese economy faces a genuine slowdown and they are unable to resort to their usual ‘just build more playbook’ in the same way they have in the past there are huge implications for Australian companies of all sizes.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Signs of Distress

There are some troubling figures starting to emerge in relation to a jump in bankruptcy, insolvency, and mortgage stress. These areas have all spiked recently as the covid era business protections are removed and markets are left to function more normally. Keep in mind that these figures are coming off a low base, but it signals a new phase for the economy. Here in Australia according to the latest insolvency statistics from ASIC (Jul 2023), insolvency rates are climbing sharply now too. During covid, insolvencies were in the 4,000-5,000 range annually. In the last 12 months, this figure has increased substantially and is now in the 8,000 to 9,000 range with 866 businesses being wound up in May alone. This is emerging across the world with places such as the UK particularly severe. The key concern is the flow-on effect through the economy. Increased bankruptcy means less jobs and less money being spent by both consumers and businesses in the economy. It snowballs from there.

At the same time, here in Australia, we are starting to see a spike in borrowers in mortgage stress. According to Roy Morgan research, over 1.4 million Australian borrowers are facing mortgage stress, up 78% from a year ago. The figure means almost 30% of all mortgage holders are in mortgage stress, which is the highest rate since the GFC. The most troubling aspect of these figures is that they’re at these alarming levels despite the economy not being in a recession and at a time of record low unemployment. If we see the unemployment rate materially rise in the months ahead, which I believe we will, these figures spike even higher. With so many people already struggling now while most people have a job, imagine the economic carnage when the unemployment rate rises. Mortgage stress means consumers have less money to spend on everything else. It slows economic growth, and it becomes a vicious cycle leading to more insolvency, less jobs, less spending and so on.

The added issue with mortgage stress for the property market becomes forced selling. It’s been a long time since we have had a situation like that with property, but I think it’s now a possibility. Distressed property owners selling drives prices down fast. Even during the GFC here in Australia, we didn’t really experience property issues in the same way the USA did. You really need to go back to the early 1990s since we’ve seen a scenario like that. It’s simple supply and demand. When you get distressed sellers, a glut of properties form and supply becomes greater than demand. The prices start to fall to meet demand. As people become more desperate prices fall even faster. Compounding this issue is the fact that buyers realise if they wait, prices will go even lower. So then demand starts to dry up and the situation becomes even worse. I’m not saying that will definitely happen, just that it could occur in this cycle. It’s on my radar and it hasn’t been before.

When we start comparing statistics to the GFC era, you need to keep in mind that in many cases we are talking about the maximum pain points that peaked at the end of the GFC in 2009. What came with that was a whole range of government stimulus and borrowing that was designed to make the upfront pain easier in order to spread out the pain over time. But we never stopped making things easier. Now, we’ve created inflation and as the economy gets worse, there isn’t a lot the government can do to help. Businesses, consumers, and families are going to have to wear the pain. Governments will lower interest rates, but we have the spectre of inflation hanging over us now so governments will be hamstrung with the policy moves they can make. So, while the GFC was bad, it wasn’t as bad as it was meant to be. Governments kicked the can down the road. We are getting closer to the end of that road.

The convergence of these variables doesn’t happen very often, but we have all the requirements for these once-in-a-generation scenarios forming in the background in this economy. It’s one of those things that when you say it, people think you’re crazy, but then when it happens, those same people will say it was obvious. Now interest rates may well still be low historically, especially compared to the 1990’s but it’s all relative. Someone borrowing as much as they can at 3% is going to be in trouble when their rates double to 6% or worse. As slow as the downturn has been to arrive once it is here it will be a problem for the whole economy and all asset classes. We’ve already had a false start in 2022 and since then everyone wants to pretend the worst is behind us. Diversify, be patient and be prepared. You don’t have time to position for it later. The time to position for the bad is when it’s still good. It’s too late to batten down the hatches once the storm hits.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

How We Are Investing in the AI Boom

From both a business and a lifestyle perspective, AI is the single most exciting technological development I’ve ever seen. It will be the biggest game changer in the history of the world. Not only will fortunes be made here but it’s going to change our lives in so many ways. There are going to be massive gains in productivity and huge reductions in friction in every type of daily task. If I was a young person looking to start a business, it would be in the AI field. If you are in business, you need to be looking at incorporating AI or you’ll be left behind. It is genuinely revolutionary.

But what is the best way to invest in AI from a long-term portfolio investor’s perspective?

How you access this theme depends on the level of risk you are willing to take. For most investors, there are 4 common ways. I utilise 2 of these in our portfolios and 2 I steer clear of.

• Big tech companies

• Listed AI companies

• SPACs or Themed ETFs

• The broader market

The big tech companies are seeing the most immediate impact in share price movements as the market grasps the enormity of the opportunity and those who are poised to benefit the most. The big tech companies such as Microsoft, Alphabet, Amazon, Apple, and Meta have broadly seen a resurgence on the back of this theme. Most of these companies are great businesses and we hold them in our client portfolios. Right now, for a few reasons they are probably close to fully valued though. While the AI angle has driven share prices up the bigger factor is the flight to safety. In times of uncertainty, the big tech stocks have replaced consumer staples as the ‘recession proof’ businesses for investors who believe consumers will continue to use their products no matter what. Similar sentiment drove their prices up in covid too.

Listed AI companies are all the rage right now and most of them are speculative, expensive and will likely fail. I see this every time a new technology arises from the internet dotcom boom and bust in the late 1990’s and early 2000’s through to the crypto and NFT boom and bust more recently. The key point to recognise is that just because a technological theme is real or going to change the world it doesn’t mean all the companies in the space will. This will play out just like those booms and busts before them. There will be some companies that will flourish and will be what Amazon was to the dotcom boom and bust. But it is really difficult to find individual winners in an emerging technological theme. It takes a massive amount of capital investment to get a technology into the mainstream, very few win, most will lose. Go back as far as you want from air travel to the automobile, it’s the same story. For these reasons, we avoid direct investment in listed AI companies in the early phases.

Similarly, Special Purpose Acquisition Companies (also known as SPACs) and Exchange Traded Funds (ETFs) are often created by fund managers in one way shape or form to provide investors access to a theme that is popular. They raise funds and invest in many different companies or shares within a theme on behalf of investors who don’t have the necessary expertise themselves. However, I’ve seen these types of structures surface in different forms over the last 25 years and I have rarely seen them work in practice. Managers charge huge fees and hold millions of dollars in cash to invest in the popular theme, it collectively drives up prices and the funds end up having to invest the funds at overinflated prices in lots of companies that ultimately fail. The theory of diversification to access the theme doesn’t seem to work as well as promised when it’s a new technology. I would avoid these structures and investment vehicles.  

Lastly, AI’s impacts across all industries will see many untapped areas for long-term investors to access the benefits of AI in the same way that worked for many in the internet boom. The introduction of the internet didn’t just provide great results for technology companies, it was ultimately adopted by almost every industry and delivered incredible benefits for revenue, productivity, and cost reduction. There are many examples of this. Just think about the way the banking industry has changed in the past 30 years. There are many blue-chip companies that integrated the new technology and remain blue-chip companies today. But there are also many examples across so many industries from entertainment, retail to newspapers and travel that didn’t and ended up going bust. This is where the real theme of AI will benefit investors over the next decade. Understanding the existing industries that will benefit and those that will be disrupted is key, and then the impact on all the individual companies in your portfolio. It will be just as important to avoid the losers as it is to pick the winners.

The most important thing to remember as an investor is to be patient even though everything seems to be moving fast. AI technology is still in its infancy and as exciting as the opportunities are right now it’s very uncertain and going to be very volatile along the way. Some businesses will be too early, some won’t execute, and many will fail. But make no mistake, this will be a massive opportunity for more than a decade. It is still super early, and AI’s capabilities are going to grow exponentially over the next several years. This is going to be a truly once in a generation opportunity that will manifest over many years in many ways, many we can’t even envisage yet. So become familiar with AI and learn about it because it will impact every company in your portfolio in one way or the other in the years ahead.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.

Why I’m Selling this Rally

In a world beset by geopolitical tensions, high inflation and interest rates, banking collapses and uncertainty, the stock market has been surprisingly resilient this year. So far in the calendar year 2023, the Australian stock market is up 3.8% while in the USA the S&P500 is up 6.9%. The NASDAQ is up an astonishing 19.4%! That’s more than resilient, that’s almost a bull market. Now obviously stock markets are still well off their highs of 2021, but it does highlight the difference between what is evolving in the global economy and how stock markets are reacting.

I’ve said before that the share market looks out 6 to 18 months ahead of current economic issues. So, does this recent rally indicate that the market is comfortable with where the global economy is heading? I think the answer to that is a simple no. I also think that there is so much uncertainty in the world right now that the usual playbooks have been ripped up and it’s almost become every investor for themselves. Investors are confused and there is little advantage in knowing what others are doing because, well, they are probably wrong.

The big question is are we through the worst? I think that’s unlikely. I think we are only getting to the end of the beginning. As tricky as the last 12-18 months have been, the real economic woes are yet to play out and until we have that phase underway, share markets will continue to be confused. Right now, that confusion has resulted in stocks being higher than they probably should be. I believe this is an excellent opportunity to sell further and add to the cash in our client portfolio’s.

While share markets have been relatively resilient, we are seeing real volatility in markets that are traditionally very stable. For example, the yields on 2- and 10-year US bonds have been moving up and down like a yo-yo in response to the re-rating of risks from bank collapses to inflation expectations. The yield on the 2-year US bond has moved from 4.06% to 5.05% and back to 3.79% over the last 10 weeks. These are incredible moves that are anything but normal. It highlights the conflicting nature of much of the data coming through and just how difficult it is to get a read on critical data. How the data ultimately plays out will determine the direction of both the economy and the share market.

I am still convinced that the share market will pull back as it becomes clearer that we are heading into a global slowdown. I expect the market to retest those lows of 2022 and possibly head lower. To me, there is so much evidence that points to a slowdown that I think it’s prudent to sell further into the current strength we are seeing in the share market. It’s impossible to know where markets go in the short term so you can only ever make decisions that are prudent for the long term. Cash remains king. If the market continues to go up after we sell a little, I am more than happy to sell some more.

As resilient as the share market has been I don’t believe that this is an accurate reflection of where the market should or will be. One of the simplest tests for whether you have enough cash when you enter a downturn is how you feel as the market falls or when the next crisis arrives. Are you excited because of the opportunities you see becoming available or are you worried as markets fall? If you’re feeling nervous, then that’s a pretty good sign that you don’t have enough cash.

Our current focus for our client portfolios is weighted to protecting capital and minimising losses in the event of a market downturn. This is a unique time in the history of the world. There is really no precedent for the current situation and so it is difficult to predict how badly the global economy will be impacted. A lot of this is mitigating those risks and being ready. It is not about making money right now; it’s about protecting it. If in the next year or so the world has muddled through and it turns out there is no major downturn, then that’s great. There will always be opportunities to make more money when times are good or at least more predictable. But in the next year or so we will know for sure just how all the current events and variables have collided and their impact on the global economy. Sometimes treading water is what you need to do to ensure you survive.

General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.