Red, Yellow, or Green?: What Signals Are Affecting Your Business?

We have made progress digging our way out of the pit of economic meltdown we tumbled into in 2007, but we certainly have a long way to go before we experience the vibrant economy we enjoyed in much of the 1990s and the early to mid-2000s. For many, it seems like we are in a state of purgatory--not knowing if we are heading to heaven or hell. So where does that leave business owners today as many face critical decisions regarding exit strategies? We are finally seeing positive signs that the window of opportunity to sell businesses is open. Will it last? Many owners seem to be at this intersection, but also seem to be having difficulty determining if the signal is red, yellow, or green. Let's take a look at our view of the signals as they relate to various elements affecting the transaction world.

Worldwide economy

Yellow light, at least for the time being. This could turn to red at any point. There are well-documented troubles around the globe, and no doubt other problems that are less visible. Turmoil in the Middle East and North Africa, coupled with European financial stress in Portugal, Italy, Greece, and Spain is having a significant impact on worldwide markets. China and Brazil are still growing, but at a slower pace. Japan's economy faces major challenges. The list goes on.

Domestic economy

Yellow light. United States government spending is out of control. Deficit problems continue to accelerate with no solution in sight. Political gridlock has created an environment where virtually no progress has been or can be made on this issue. Consumer confidence has improved somewhat as the general population is no longer focused on an economic meltdown, but overall conditions are far from rosy. There seems to be more acceptance of today's economy as the new reality. Housing seems to be reaching a bottom and consumers have reduced their overall levels of personal debt, although debt levels ticked up during the holiday season. Technology continues to be stable with some segments doing very well. Retail and restaurants have improved, but consumers are cautious.

Political environment

Red light. The U.S. has become politically dysfunctional. There is strong right-versus-left sentiment, resulting in neither party being able to effectuate the critical decisions necessary to "right the ship." This polarization will play a huge role in the upcoming election. The implications for business owners, such as the cost of doing business, government regulations, personal and business taxes, and incentives to invest, are huge. But because of the political uncertainty, the direction of the impact on business owners is not determinable.

Capital environment

Green light. Capital providers are actively deploying capital. Credit parameters are more conservative (the result of tighter underwriting criteria), but lending is occurring and debt availability is improving. Equity markets are liquid and have relaxed return requirements, resulting in more favorably priced equity alternatives than we have seen in quite some time.

Deal environment

Green light. While the M&A markets have not completely forgotten the recent bottom of the economy, investors have largely moved on and are focused on the future. The marketplace is supporting new deal activity, especially non-distressed, quality companies, which have weathered the recession with positive trends. Single-tenant real estate values are also improving. And cap rates are declining because of the lack of available interest rate investment alternatives providing a reasonable return.

Brand environment

Mixed. Different brands, even in the same space, are flashing different signals. Some top-tier, national franchised brands thrived through the recession on new product offerings, value price points, and trade-down traffic. Others revamped menus with solid price-point menu items and revamped their signature products, along with their image as the recession drew to a close. Yet others continue to struggle and lose ground. At the same time, many up-and-coming regional brands, mainly fast casual, performed very well throughout the recession, and are showing very strong results at present. And certain second- and third-tier concepts continue to demonstrate excellent resiliency as they chug through thick and thin. How the market views your business is certainly affected by the overall performance of the brand(s) you are associated with.

Personal situation

Mixed. Where you are personally in your business lifecycle is also an important consideration. Some owner/operators have thought about retirement, only to have those thoughts dashed on the rocks of recession. But after surviving the downturn, those thoughts are stronger than ever as they vow "never again" to experience that. Some owners have family or longtime partners who would like to take over the business. Other owners may see that the performance of their business, even if improving, is probably as strong as it's going to be for the foreseeable future. Based on a review of your personal situation, the timing could be ideal to monetize the equity in the business or to diversify your risk with a partial liquidity event, sale of a market, or real estate holdings. Yet others may be new to the business and have a 25-year time horizon to succeed. The signal being flashed in this category depends entirely on your personal situation.

Conclusion

As we cycle out of the highly volatile environment experienced by almost every operator in the past several years, signs are pointed toward an environment in which operators have improving opportunities for deal alternatives. Restaurant entrepreneurs will be well served by taking a fresh look at their individual situation as they contemplate their business opportunities, personal situations, and liquidity alternatives available in today's marketplace. One common theme we've all learned over the past several years is that macroeconomic conditions beyond our control can have a dramatic impact on our business valuations, deal flow, and M&A alternatives. For many operators, it's an opportune time to contemplate the best course for themselves and for their business.

Dean Zuccarello, CEO and founder of The Cypress Group, has more than 30 years of financial and transactional experience in mergers, acquisitions, divestitures, strategic planning, and financing in the restaurant industry. The Cypress Group is a privately owned investment bank and advisory services firm focused exclusively on the multi-unit and franchise business for more than 22 years. Contact him at 303-680-4141 or dzuccarello@cypressgroup.biz.