Hires And Development Are Delayed
It exacerbates the situation if the crisis forces you to delay much needed hires. Often, a firm needs three or four successors to replace a founder (it’s better risk management). A crisis delays those hires and then the period of time they need to acclimate and grow (and further derails the timing).
Sellers Are Reluctant To Sell
While buyers are nervous, sellers are very reluctant to sell too. There is a well-known phenomenon in psychology called attribution error. If you set up a romantic dinner with your partner and they arrive late, they are likely to blame something very specific, like traffic, while you are likely to blame them (“You are always late.”) When a firm’s profits go down, something similar happens. Founders tend to wave it off as a onetime thing, even if it’s severe, but successors see it as a symptom of something worse, and likely think it will keep happening. “What we have here is failure to communicate,” as they say in Cool Hand Luke (a line I first heard in a Guns N’ Roses song).
Valuations Come Under Question
It is very difficult to value a house on fire. You have to put out the fire first and then assess the damage, perhaps even fix it. In a crisis, buyers and sellers have a very hard time agreeing on the assumptions needed for a valuation. It is easy to see why. The most important components to any analysis are questions such as “What is the expected rate of growth?” How can you answer that when you are declining? “What is the expected profitability?” It would be nice if we had any at all. “What staff do you expect to hire?” It would be nice to not have to fire anyone.
Done Deals Are Undone
Even as I write this, we have already seen some carefully negotiated succession transactions get suspended. Unfortunately, succession deals don’t do well on the “back burner.” It is tempting to try to suspend a deal until things recover, but like a meal unconsumed, it might go bad. Either the buyer or seller or both might decide it’s not what they want. It’s possible, but hard, to find creative solutions to preserve the deal.
One way to reconcile the needs of buyers and sellers in an environment like this is to structure the payments and make them contingent on certain profitability milestones the firm has to reach to restore itself to its pre-crisis condition. For example, a buyer may base the purchase price on the pre-crisis EBITDA, but the guaranteed up-front portion may be driven off the much lower revenues endured during the bear market while the remaining payments are made when EBITDA reaches the pre-crisis level and then exceeds that threshold.
Beyond Institutional Buyers
Many firms delayed their plans after 2008 (which led to a boom more recently). The buyers also changed quite a bit between 2007 and 2019. Many of the most active ones in 2007 did not weather the storm well. Banks acquired a lot of firms, but these were “unacquired” afterward when the buyers found themselves with vulnerable balance sheets (they had used a lot of financial leverage).
This is why founders need to continue trying to save internal succession, even if it’s tempting to give up. Even institutional buyers prefer firms with internal succession. It comes down to commitment. In 2008 and 2009, a few firms persisted and continued to sell equity to new owners. But for most firms, that may not be possible. But when the generations can come together to go down that path, they might not only survive together but also create new and perhaps more resilient plans. The problems are many but when there is a will, there is a way.