Do You Know Your CEO Decision IQ?

On a cold day in DeDecsion IQtroit January 5th, 1914 Henry Ford made a decision that would change history. He decided to pay his assembly workers more than twice the going $2 per day wage at the time in a desperate attempt to stem worker turn-over, and reduce errors fast.

The result was an American first; a new 8-hour work day paying an industry shocking $5/day ($120 today). That decision would not only improve workers’ lives, but also sent immediate shock waves throughout the industry and minds of all of America’s big industry CEOs back then.

But what did Henry Ford know to make his risk-it-all decision in time to turn things around?  And if he didn’t understand the impact of that decision, would Ford Motor Company still be here today?

Not sure.  But as that was then, and this is now, today’s chief executives must go well beyond whether or not the impact of a decision over time achieves the right results. More importantly and less well discussed, is the speed at which Ford’s decision did achieve the intended results.  I call this measure the “Elasticity of Company Decisions” which is by my definition “the measurement of how responsive a CEO’s decisions are to the expected rate of change from those decisions.” Think beyond time vs money, or price vs quantity, as traditional measures of elasticity. In this case it’s the speed vs accuracy of a CEO’s decision.

So how does a company’s decision elasticity impact a business? This depends on a CEO’s Decision IQ, which is to say how well a CEO can understand and predict the elastic-response of a major decision on his or her company.

Let’s take as an example two CEOs of different but competing companies. Each CEO makes the same decision at the same time, perhaps to shift marketing strategy as a reaction to falling sales, or review an opportunity to acquire a competitor. Over time, if one CEO has a very elastic organization vs the other then the speed and accuracy of that decision (as it flows throughout the enterprise) creates an inherent competitive advantage. In this case, especially in its ability to evaluate and execute as a single workforce moving in the same direction. Think start-up vs mature company. When workers are more quickly on the same page, things can often get done much faster than a competitor has time to react.

Thus as an observer — can we determine in advance which chief executives have built up the right elasticity level in their organization? The answer in part depends on what we know about the good or bad elasticity factors each CEO has layered into the management structure of the business over time. Peter Drucker (the management guru) discussed this issue in his book, Concept of the Corporation (1949) based on reviewing the organizational and decisional structure among other things inside the General Motors Corporation back then.

His suggestion was to flatten the organizational hierarchy to maximize the impact and efficiency of GM’s management decisions. CEO Alfred Sloan at the time however, took the insight as criticism of his management approach, and rebuffed it. Today Sloan might be let go for his lack of insight.  He was in effect suggesting that any decision, like Ford’s would have the same immediate and lasting shareholder benefits no matter how big or bureaucratic GM would become.

Now, consider that none of this is new. In fact there are dozens of books written about flatter organizational and management structures and the benefits they accrue across the board. But that is not my point. My point is to teach CEOs at companies big and small to identify their Decision IQ and use it to their advantage or improve it.

As an M&A investment banker I see this advantage (or disadvantage) repeatedly with CEOs and Boards of Directors at companies we consult to. What I see is that the higher a company’s decision elasticity the higher the profits, growth and enterprise value, not to mention the benefits of more expeditiously communicating any needed shift in corporate mission statements or goals.

Conversely, when I see a company’s elasticity factor is too low, meaning the company has a large built-in latency (delayed) response factor, important CEO/Board level decisions can take days, weeks or even months to make things happen. And when that’s the case, it’s time for a change.

So here’s the bottom line.

Discover your Decision IQ. And improve it by building a spreadsheet to test-measure your company’s decision elasticity by tracking the announcement date of each major decision, the number of managers that need to take action and the time it takes to get the desired results. If the results measured are poor, chances are good you may be unwittingly turning a good decision into a bad one. But, on the other hand, if your company’s decision elasticity and IQ factor is top-drawer, you can like Henry Ford, use this edge to beat the competition, increase the value of your company, and improve the lives’ of your workers too. Make sense?

2015: The Year of the Business Sale

As another year passes into the history books, it’s a Happy New Year ahead indeed. Not since 2008 has a new year looked as promising for business owners and CEOs in the U.S. Why? Because like the planets circling the sun, as trends come and go, rarely do they align. But when they do, it’s time to pay close attention. Despite the many offshore markets and economies still struggling to warm up, the USA, whose GDP is 85% domestic  is likely to get even hotter this next year. Take a look at why the start of 2015 looks so sparkling:

  •  Consumer confidence and spending (up)
  • Business confidence (up)
  • Employment rate (up)
  • GDP growth rate (up 5% Q3 2014)
  • Stock markets: Dow and S&P 500 (all-time highs)
  • Lending rates:  (still historically below avg benchmark treasury rates)
  • Energy costs: (oil and natural gas prices way down – crude oil down 50%)
  • M&A activity: (highest deal value since 2007 before the crash)

Now, could all these promising business and economic indications together be an aligning of the stars, or a mere coincidence? Most were already trending higher, albeit slowly with fits and starts for several years. But it seems the sudden drop in gasoline prices at the pump has awoken a sleeping giant; that is the US Consumer Economy. And this awakening in my view is that which will make 2015 the best year in seven to sell a business.

The catalytic drop in Crude Oil and Natural Gas prices is already driving a profit-boosting ripple effect for nearly all consumers and businesses by dropping the high cost of energy. The result is the multiplier effect, that is to say, the “animal spirits” of nature and markets that will lift demand and profits further. Think about that. Higher profits mean higher business valuations. And given the perpetuating low cost of borrowing, and abundance of idle cash still sitting on Corporate USA balance sheets while it lasts, the planets have aligned, and that means a spectacular new seller’s market will likely soon follow in 2015.

If you following me on LinkedIn you may recall my recent article A Decision Tree Exit about When to sell a Business.  In it I thought to address why, given the many moving parts and considerations that go into a decision to sell or not, most CEOs get paralyzed in the process which grinds their efforts to a halt. So I tried something different to help loosen things up, at least on paper. I used a tool from business school called a Decision Tree to actually quantify the many choices a business owner must make to get from A to Z.

A Decision Tree links several potential outcomes together, and puts a value on each path to find the best route forward. Using this method the model showed that the more I knew for certain about my business and industry trends, the higher value resulted from each decision. For instance, given the strong data points above instead of a 50-50 chance the market would go up in 2015 I changed it to a higher 80-20 chance. The model, in turn, produced a much higher value decision to sell in 2015. Absent that higher chance, the decision to sell in any given year was less compelling [see the model].

So here’s the bottom line.

Can anyone predict the future, even a mere 6 months ahead? No.  But absent any specific knowledge about a downside trend in key market dynamics, or in your business more specifically, 2015 is very likely to see the planets align for business owners. And that could in turn drive up valuations and make exploring the market for a potential sale in the months ahead a stellar move.

—— About the author: Rick Andrade is an investment banker at Janas Associates in Pasadena, Ca and finance writer in Los Angeles helping CEOs buy, sell and finance middle market companies. Rick has earned his BA and MBA from UCLA along with his Series 7, 63 & 79 FINRA securities licenses. He is also a Real Estate Broker, a volunteer SBA/SCORE instructor, and blogs at www.RickAndrade.com on issues important to middle market business owners. He can be reached at RJA@JanasCorp.com. This article is for informational purposes only and should not be considered in any way an offer to buy or sell a security. Securities are offered through JCC Advisors, Member FINRA/SIPC. 

A Decision Tree Exit: Helping business owners decide when to sell

 

Decision Tree image

Some of the oldest and most respected things alive on this planet are trees, very old trees. The oldest is called Methuselah, a Bristlecone Pine tree, which sits ten thousand feet up in California’s White Mountains 100 miles north of Mt Whitney and is said to be 5,000 years old. Methuselah is nature’s most resilient form of wisdom indeed. But there is another kind of tree just as wise if you know how to navigate its branches. It’s called a Decision Tree, and as an investment banker helping CEOs sell their businesses, I thought I would create a Decision Tree to help business owners decide when to exit and sell their business.

Like thousands of years ago, many of today’s business owners are family-owned and operated, and for them exiting the business usually means handing over the reins to family. But for a vast number of non-family-run businesses, the decision when to exit and sell the business is not so obvious. Non-family-run business owners today need more advice to answer the growing number of questions and issues that come with exit planning, and I thought a Decision Tree as a tool might be just the thing needed to help. See Decision Tree Graphic – v4

Decision Trees are not new. They are a well utilized decision-making tool used in dozens of ways. The concept of a Decision Tree is to lay out a series of branches on paper that quantify the expected value of each possible event that could happen. Each branch from tree trunk (decision) to branch tip (value) is essentially measuring a series of choices a CEO could make. Decision Trees are used in many industries including oil & gas exploration. There, for example, each tree branch helps quantify the risks and rewards (chances) of finding large oil or gas deposits underground. But Decision Trees can be used for nearly any problem.  The key is to know what to ask, and how to guesstimate the probability of each outcome.

To test my own mechanical Methuselah, I created a Decision Tree based upon a few basic assumptions for sales and EBITDA, and a few typical options or paths a business owner might include in his/her decision to sell or not. For example, assume a manufacturing company with $50M in annual sales has $10M adjusted EBITDA (earnings before interest tax & depreciation). The key decision I was seeking to determine in this tree was whether to Sell Now, or Wait 1yr (see graphic).

Selling now or waiting is one of the oldest most common questions I get from clients. While no business owner wants to sell at the wrong time, many naturally feel anxious about waiting too long and selling into a down market. So, in turn, I added a 50-50 chance tree branch that the business could improve 10% or decline 10% over the next year, and a 50-50 chance tree branch of a good market or a bad market. And these are but a few of the many common issues owners face before exit (see the list below for more.) In this simple way, these few potential outcomes are all you need to get started.

From this point building out my tree is a matter of assigning probabilities and calculating the value of each branch. The more accurate the probabilities the more accurate the resulting value of the decision. In my example (attached) the probabilities I assigned to each potential outcome stems from my personal experiences and those of other investment bankers and colleagues. Finally I calculated the values of each tree branch and tallied up the value of whether to sell now or wait.  But to my surprise the result threw me for a loop, and here’s why.

In my Decision Tree the values of the choices to proceed and Sell Now or Wait 1yr were nearly equal. In other words, absent of any key insights particular to an industry or business, a business owner should not fear waiting 1 year vs selling now in order to maximize price. The reason for the near equal value of the outcome in my example I discovered later was the 50-50 chance I gave my business to grow 10% next year. If that happened, and the market remained constant, my business value could be higher next year. On the other hand, if I instead anticipated a flat or declining sales forecast next year, the choice of Selling Now may produce a higher value decision. And this makes sense.

The power behind using a Decision Tree is that you can grow or shrink the number of branches based on the choices and decisions specific to your life and your business. For instance, many of the most common downside issues I hear from owners looking to sell at some point but for now remain on the fence include some or all of the following:

  • What if I get sick before I retire?
  • What if my business needs a large capital equipment investment to stay competitive?
  • What if I lose access to my lending resources?
  • What if I lose a key account or manager to a competitor?
  • What if I see my competitors consolidating?
  • What if I received an offer to sell now from a Private Equity group?

The idea here is to rank these in importance and put a value under each as a branch with probabilities. From there a Decision Tree that includes the likelihood of each possibility begins to grow and take shape. This may help the many thousands of business owners who come to market only when things go wrong, or worse, when they get sick, and need to find a buyer. These sellers don’t have a Decision Tree to make, but rather face the market when the time comes. A situation no business owner should have to face prematurely.

So remember this. When the time comes to consider the right time to exit your business, try creating a Decision Tree that specifically measures your business and life events. It’s not hard. And because  getting the maximum value for your business is the goal of every business owner, if you’re lucky, you’ll find a simple Decision Tree created today won’t need to hang around as long as a Methuselah to help you make a wise move. [if you would like a copy of the Decision Tree spreadsheet, please send me a note. Rick]

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About the author: Rick Andrade is an investment banker at Janas Associates in Pasadena, Ca and finance writer in Los Angeles helping CEOs buy, sell and finance middle market companies. Rick has earned his BA and MBA from UCLA along with his Series 7, 63 & 79 FINRA securities licenses. He is also a Real Estate Broker, a volunteer SBA/SCORE instructor, and blogs at www.RickAndrade.com on issues important to middle market business owners. He can be reached at RJA@JanasCorp.com. This article is for informational purposes only and should not be considered in any way an offer to buy or sell a security. Securities are offered through JCC Advisors, Member FINRA/SIPC. 

Are you a Scaredy Cat CEO?

Scaredy CatFor some it’s a new day, for others the smell of fear lingers on more than 7 years past the Great Recession when life changed in America. Back then the pace of global M&A was approaching $4 Trillion, today it’s half that. But like all cycles long or short things come back around and when they do, it’s no time to hide behind a pumpkin in the dark. According to Mergers & Acquisitions News, many fearless middle market CEOs in the U.S. are indeed pulling the trigger on new M&A deals in 2014, and they have the numbers to prove it. More than 1,250 new deals thru August topped last year’s 1,157 by 8%. And the total value of these deals exceeded 2013 figures by 12% topping $144Bil so far this year. But it should be better. So what’s behind why so many CEOs are still afraid of the dark? In 1923 University of Oxford Professor of Psychology George William Humphrey noticed a pattern interrupter in the way humans think and coined it “Humphrey’s Law.” The Law is simple, it states “…that consciously thinking about one’s performance of a task that involves automatic processing impairs one’s performance of it.” The typical application is in understanding athletic performance, but elsewhere like in many U.S. Boardrooms it’s called “analysis paralysis.” And despite evidence of an improving US economy, an improving labor market, the wealth effect from lower oil & gas prices headed into the 2014 shopping season, and a dozen other positive economic reports this past year, there still lingers far too many Scaredy Cat CEOs lurking in the shadows that should know better. Private Equity deals turning up the heat One reason for the hold-back used to be getting the financing to close a deal. That’s changed. Lending restrictions have loosened significantly in the past year and for many CEOs who see the opportunities ahead there’s no better time to make a deal. Leading the pack is Private Equity owned companies who recognize the low interest rate lending environment is just what the doctor ordered, an ability to fund a new deal at a low enough cost of capital to heat things up (See my recent CEO Magazine article: The M&A Market Is Heating Up. Is the Time Right to Make a Move?And not since 2007 has the cost of capital available for M&A deals been as affordable. The support comes from GF Data, who tracked middle market M&A activity in 2014 which shows a jump in demand for hybrid debt financings for Private Equity M&A transactions including “deals with uni-tranche financing.” So why is that important? Uni-tranche financing investment vehicles combine both senior and junior lending rates into a single debt product. These hybrid loans are considered riskier because they include a split between lower-rate secured (senior) and higher-rate unsecured (junior) debt instruments typically issued separately. Given more demand from deal makers, more banks are stepping up with more flexible loan products like uni-tranche loans to fill the gap in new deal financings. The result in effect helps to increase M&A activity, as noted, and quicken the pace of M&A deal flow across the board. The real trick is to recognize that there’s nothing to fear from the current M&A environment. Scaredy Cat CEOs can’t hide in the dark analyzing risk and market-trend data endlessly, whilst their intrepid competitors pull ahead in the months to come. Unlike S&P 500 companies with cash hordes still in excess of $1 Trillion, middle market companies don’t have the luxury of indecision any more, and must be more aggressive in the hunt for growth in this market. If Private Equity groups can continue to find ways to close more M&A deals, so too must CEOs of middle market companies step up and take a second look at the growing availability of deal financing options in an improving economic backdrop. At the very least consider if the damaging consequences and the paralyzing implications of Humphrey’s Law are working against you and/or the best interests of your shareholders. Have an objective discussion with your investment banker before year end. His job is to help you focus, take your foot off the brake and execute a real M&A strategy. Absent a plan of action Scaredy Cat CEOs who stay afraid of the dark this year might find themselves spooked out of a good M&A deal.

CEO Business Outlook Survey for the rest of 2014 doc

As a Merger & Acquisitions Advisor to middle market business owners this year has been one of our hottest since 2007 in sheer numbers of owners looking to sell or raise money. I’ve written and spoken about why that is the case, but what are CEOs themselves saying about it? And why are so many middle market business owners still coming to market now?

The answers are this quick and concise study of CEO thinking conducted by Cohn Reznick to ask CEOs what they see and expect heading into the Fall and the rest of 2014…

See if you agree: Cohn Reznick CEO – Business Outlook Study – 2H 2014

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It takes years to build trust and become your M&A Advisor… I hope this and other articles I can share with you bring us another step closer to that goal. Call anytime.

Thanks

Rick Andrade

Why Bank Lending is Up

According to the FDIC banks are adding more loans to their portfolios this year through the 2nd quarter. The 2.3% jump is the largest since the Great Recession started back in 2007.

The reason for the uptick is not just the obvious higher loan demand, lower loan loss reserves and a loosening of lending terms amidst historically low interest rates. More lending makes sense. It follows a long and growing list of US economic indicators in the last 6 months with telling signs of a better future including higher GDP forecasts, tighter employment rates, low inflation, and the increasing confidence displayed by CEOs and consumers to spend in the first half of 2014.

The biggest benefactor of more lending is likely to be small business owners whose time has finally come. So dust off your banker’s business card and give them a call. You may like what you hear.

Rick Andrade – Investment Banking

Read the article in the Wall Street Journal:

http://online.wsj.com/articles/u-s-banks-boosted-lending-in-second-quarter-fdic-says-1409234875

Why M&A is Red Hot this Summer?

It’s going to get really hot this summer. Southern California in summer; hot, dry, and happening. Despite rankings among the least friendly states to do business, when Californians get happy feet, the rest of the country starts jumping. That means as the velocity of money (spending) increases, the value of small businesses across the nation will increase as well, making for a hot summer and banner M&A activity this year.  Why now? Here’s why;

Not since 2007, has the NFIB (National Federation of Independent Business) reported that their leading index of business optimism, the Small Business Optimism Index, topped 96 in May. While 96 is still below the Index’ historical average, it’s the trend that matters. And that trend is distinctively up so far this year.  And while we’ve seen these uptrends before, this time is different. Famous last words if things don’t add up, but they do. Take a look.

The drivers of middle market business value is growth; sales growth, market growth, resource growth. And despite a frigid eastern winter which put the brakes on spending in Q1 with GDP contracting 2.9% in the US, and summer concerns over global conflicts and energy prices, for the moment at least, the economy is still projected to grow 3% or better this year. And the NFIB index projects that thinking.

Meanwhile, as the benchmark 10-year Treasury Note remains below 2.6%, research firm Factset reports Consumer Sector M&A topped $26B in the first 5 months this year, the hottest since 2008.

Climbing over a Wall of Worry, and in the face of potentially higher energy prices and job eliminating new technologies, employers are hiring more and firing less according to Dept of Labor reports this month. Consumers are feeling more confident, and signs of life and spending indicate US consumers awakening from what seems like a long Rip Van Winkle slumber and stepping up to spend again. And when the trend is your friend you stick with it, especially when in good company. The S&P and Dow indexes both continue to make new all-time highs in May and June with no signs or reasons to abate just yet. The VIX (S&P Volatility Index or “the worry gauge”) is under 12, far below the 60 high mark it hit in October 2008 during the height of the Great Recession.

So how long will this market frenzy last? And what does this mean for business owners in the middle market?

An increase in CEO Confidence is likely the most fundamental and significant leading indicator of expansion. And it’s not a data silo of one or two points either. There are many. According to S&P IQ research US companies are able to borrow more than at any time during the last 7 years. Senior debt multiples (Debt/EBITDA) could top 5x this summer. The previous high was 4x and even less during the recession. Not since 2007 have banks given such leeway. Banks have also loosened formerly more restrictive covenants. Today’s covenant-lite issuers are finding they have to compete more for quality loans, hence the easing (see the article in Mergers & Acquisitions). Covenant-lite loans open the door for more lending by allowing new borrowers access to more third-party debt, higher leverage ratios and lower interest-coverage ratios. When businesses can borrow more for less they tend to invest the additional capital in capital projects, stock buy-backs, dividends and M&A. And the sharp increase in M&A activity in Q1 2014 as noted supports that trend.

Private equity funds in the meanwhile, are still looking to find and invest in high-quality solid cash flow companies and are paying up big time. According to Factset M&A buyout deal premiums for the last three months ending May 2014 topped 56%. That’s a whole lot of over-paying in my view.

Still, with increasing competition across most business sectors and economic drivers reflecting higher GDP growth for the balance of this year, when added together the billions of bucks on the books of S&P 500 companies and Private Equity Funds are enough to continue to fuel the flames of a market on fire. And as more buyers seeking high-quality assets compete and bid prices up, like a prime cut of beef, when it’s gone, buyers tend to work their way down the slab. That’s the trickle-down effect as cycles go. They go up, they go down. And while it’s always too risky to time the ups, it’s also too risky to look a gift horse in the mouth.

My point in this summer bulletin is simple. Add all these data points and index measures together and the 2014 uptrend is clear. Increasing confidence, increasing demand, increasing consumer spending all translate into increasing valuations for small and middle market businesses this year. So if you’ve been waiting to enter a better market to sell or buy a business, evaluate your options carefully as the heat of summer looks pretty cool for the middle market this year.

US Census Reports – Baby Boom Bubble

Check out the attached Baby Boomers – 2014 US Census release. It’s an important study of the Baby Boomer population in the US from its peak of 77 million in 2012 to less than 2.5 million in 2060. As a part of this trend, if you are a Baby Boomer like me this study is a real eye-opener. Especially for business owners who are collectively headed for some big demographic changes in the next few years. So what should you do?

Well, as more business owners begin the hunt for buyers in the next 3-5 yrs, a key successful selling factor is likely to favor those SMBs with more diverse customer/product channels.

This emphasizes the need to have (or develop) a broader Value Proposition for growth, as potential buyers will seek to pay premiums for those more diverse global business players.

Best advice?

Read the report. Then decide how closely you want your business products and services to closely align with this Baby Boomer bubble. Just one thing. As time goes by… beware the law of diminishing returns.

Until then…I am always happy to hear from you…  And please remember to forward any clients that may need some friendly buy/sell advice. It’s always free.

Thanks,

Rick