Dr. Earl R. Smith II

Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com

For some time after the bubble burst in the late 90s, the most viable alternative to going public was building the business or intellectual property of a company to the point where it could either be an attractive acquisition target or have enough dry powder to embark on a acquisition program of its own. Recent indications from the M&A space have shown just how difficult that alternative has become.

Dealogic has reported that a record number of M&A deals were canceled in 2008. Their research shows that in 2008 companies abandoned 1,309 transactions valued at a total of $911 billion. When you compare that to 2007 when 870 deals valued at $1,160 billion were withdrawn, a pattern starts to emerge. Not only were there more deals abandoned in 2008, the average value of those deals dropped significantly. This seems to reflect a downward pressure on valuations as well as an increased tendency for deals to be abandoned short of the closing table.

A significant percentage of the abandoned deals were in the financial space. The crisis credit crisis clearly adversely affected financial institutions and their clients. Many of them faced a new and much more difficult world. As a result, many were driven into negotiations with buyers who clearly had the whip hand. However, the credit crunch also sounded the death knell of cheap capital to fund acquisitions. This trend began in mid-2007. The net effect has been to make the position of buyers even stronger and the post-letter-of – intend period much more difficult for the seller.

It seems clear that for most of 2009 this condition will continue. The strategies and tactics of strategic buyers will no doubt become even more predatory and the marketplace for sale by acquisition will become even more favorable for those buyers. The shortage of credit will favor strategic buyers with strong balance sheets and cast to spend. The prudent buyers will realize that it is in their interest to press their advantage in negotiations about terms and price. Private equity will continue to be diligent and aggressive when it comes to cutting deals. Many of them will wait until the very last minute to make a final decision.

I have heard from several companies that have had new rounds disappear before their eyes. Investors who have been badly burned by the downturn are pulling in their horns and many of them are refusing to consider infusing new capital into companies that they have already invested in. In many cases they are simply withdrawing their support and looking to the management to find a way.

Therefore, the question of exit strategy comes in high relief to CEOs and senior management teams of emerging companies. With valuations as low as they are it seems clear that the ‘back-to-basics’ strategy is by far the best – hunker down and concentrate on building the business. For most companies this means figuring out a way to do that with the assets that are currently in hand. An old friend from Texas used to say, “right now when we need more oil, we drill another well; when we need more gold, we dig another mineshaft; when we need more money, we go to a bank and borrow it. When all of that is gone, we will discover how good we really are”. Well, we are at that time and will discover how good these management teams really are.

What must be left behind are the attitudes that were adopted during those times of abundance. I recently started working with a company that makes its revenue off capital assets. In meeting with the CEO, I discovered that the company was under utilizing those assets by 40%. When I observed that revenues could be increased by that amount by simply adopting a different approach to utilization, the initial response was that ‘it is not that serious’. No company that takes such an informal approach to resource utilization will survive.

CEOs and senior teams need to refocus their attention on the tactical issues that allow their company to win day-by-day. They need to forget about exit strategies and focus their efforts on the process of building the business so that it will have value when the crisis is over and the balance between buyers and sellers is reestablished to something more approximating normal. Until then, teams with an eye constantly towards the ‘back door’ will find themselves on a ship drifting inexorably towards the reef – and we all know how that ends.

© Dr. Earl R. Smith II

Related Articles:

• Six Steps for Surviving in a Downturn
• Management Strategies in a Downturn
• Planning and Implementation
• Entrepreneurial Planning and Goal Setting
• Why Most Start-ups Fail – Part One
• Why Start-Ups Fail – Part Two
• Crossing the Boundary – Surviving the Experience

Dr. Smith is Managing Partner of The Federal Circle. The Federal Circle partners with teams and existing companies. We help them up their game and win big in the Federal space. We also arrange funding for acquisitions and expansion by acquisition. Our model is based on the belief that, if you select the very best and work with them in a highly professional and focused manner, the results will be truly amazing. He is the author of Amazing Pace: Turbo-charged Business Development – a book that shows how Advisory Boards can dramatically increase revenue. Dr. Smith is also the author of Dream Walk: Parables for the Living – a book of Raven Tales and exploration.

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