Harvesting your wealth

Transaction timing

In the wealth-harvesting process, transaction timing can increase a private business owner’s wealth from a shareholder liquidity event more than any other single factor. Both macroeconomic and microeconomic factors can influence this timing.

Economic and political macroeconomic factors frame the assessment of enterprise value and the relative worth of the financial assets owned by private companies. The company’s performance, financial condition, near-term expectations, management depth, and business succession plans can significantly affect enterprise value.

The following shareholder considerations can make wealth harvesting even more challenging:

• Company legacy
• Family ownership continuity
• Employee and community loyalty
• Investment risk tolerance

Amid all these factors, determining which shareholder liquidity alternatives may yield the most benefits for private business owners typically requires experience, commitment, discipline, and favorable timing.

Economic influences

COVID-19 has disrupted the global economy and changed our understanding of the connection between the broader economy and the stock market. By the start of September 2020, the S&P 500, the index most attributed to the US economy, had climbed to an all-time high, while other metrics that track broader economic strength were raising red flags. The NASDAQ Composite is now up over 30% on the year, despite dropping over 20% during the height of the crash. From trough to peak, the NASDAQ has grown over 70% in just 5 months.¹

As GDP fell 32.9% in the second quarter of 2020, many have begun to notice the disconnect between the overall U.S. economy and the performance of its underlying stock market. The value placed on liquidity, especially amongst large-cap stocks, is a key factor driving the increased demand that’s led to higher stock prices.

Worldwide economic turbulence stemming from the global pandemic has significantly impacted the U.S. This report dives into the pandemic’s effect on M&A, capital investment, forecasting, and other key factors that are important for middle market business leaders to consider when contemplating a transaction.

Capital market signals

Competition to complete deals has remained strong since 2013, leading to strong valuations among both financial and strategic acquirors. Financial sponsors are increasingly bidding up valuations as they seek returns for large amounts of capital they’ve raised. That said, the steady run up in U.S. middle-market M&A volume has waned in light of COVID-19, and as a result new trends have come about:

• Carveout and divestiture activity for middle-market private equity funds is on track to reach its highest level in six years.
• Deals closing in 2020 are increasingly equitized as lenders place higher scrutiny on underperforming businesses, cautiously underwrite, and increase pricing and LIBOR floors across the spectrum of their lending products.
• The decade-long boom in increased add-on deal activity has only escalated since the start of the global pandemic as tighter debt markets hinder capital availability for larger transactions.

Shareholder liquidity transactions

Maintaining flexibility throughout the liquidity process can increase investment competitiveness. An example of this is preserving the board’s ability to transition to internal liquidity strategies (frequently referred to as “hedge strategies”), such as debt recapitalization or an employee stock ownership plan (ESOP).

While typically providing less liquidity, these strategies don’t require a change of control or material corporate governance alterations. The hedge is derived by maintaining the ability to effectively execute a material liquidity event if the board is underwhelmed with the market test response.

Typical capital sources for hedge strategies are excess corporate cash, senior-based asset and cash-flow lenders, and subordinate debt and mezzanine providers. When executing a market test/hedge strategy, the ability to seamlessly transition to a transaction alternative without losing deal momentum can reduce the risk of an aborted shareholder liquidity event.

The time to start

Macroeconomic and capital market conditions in 2020 appear to be less favorable than in recent years as a result of COVID-19 and the upcoming runoff elections in Georgia to confirm the Senate. There are many considerations for a shareholder when thinking about a liquidity transaction—and transaction timing is key. If you decide to explore the many alternatives available for such a transaction, prepare yourself for an exciting but demanding process.

At the same time, if you leverage a disciplined transaction approach, along with the experience and resources of a well-regarded corporate finance adviser, you can address many of the risks that lead to surprises and disappointment. Such an approach can help you gain a clear understanding of what to anticipate from a liquidity event, choose a path that is likely to produce the ROI you expect, and gain insights into important decisions and milestones you’ll likely face on your path forward.