No. 1 Merger and Acquisition Specialist Charts the Future : RICHARD RODNICK : Q & A

When it comes to creating, building and selling a company, 58-year-old Richard Rodnick has had plenty of personal experience.

He sold five of his own firms before he decided to make a living by arranging mergers and acquisitions for others.

Rodnick founded Geneva Corp. in 1977 as a one-man merger and acquisitions firm. It has since grown to more than 350 employees and is one of seven sister companies owned by the Geneva Cos., a Costa Mesa-based holding company he created.

All the firms are geared to servicing mergers, acquisitions and divestitures involving middle-market companies--firms valued at $1 million to $75 million. Geneva has regional offices in Florida, New Jersey and Illinois , and a network of affiliates worldwide.

By concentrating on the middle market, Geneva Cos. last year outdistanced better-known Wall Street firms by initiating and closing more mergers and acquisitions than any other intermediary.

But changes in the tax law now make mergers of lower-valued firms less attractive financially. So Rodnick recently started the latest Geneva company--Cash Asset Conversions--to help new firms grow and prepare them for sale when they reach $4 million to $5 million in value. He expects CAC to serve as an incubator for Geneva’s future deals.

Rodnick took some of his own company’s advice and sold more than half of Geneva to Chemical Venture Partners, a subsidiary of Chemical New York Corp., a bank holding company. The 1986 sale left him with less than 10% of the stock. He had been a majority owner.

In an interview with Times staff writer James S. Granelli, Rodnick discussed the volatile merger and acquisition scene in Southern California and his expectations for future activity.

Q. Why did you choose Orange County as the location for your operation when the major companies handling mergers and acquisitions have Wall Street addresses?

A. Going back to 1977, California was--and still is for that matter--one of the fastest-growing areas of the United States. Secondly . . . in our business, you could be located anywhere as long as you’re near an international airport. And I was attracted for several personal reasons. Our daughter was in college here at the time, and the weather was right. I don’t know whether I used business reasons to justify the personal or vice versa.

Q. Was there much activity at the time--or now--in Southern California?

A. Yes. California, especially Southern California, has always been a one of the prime markets. There are about 16,000 public companies in the United States, and in the middle market there are about 750,000. So it’s clearly a larger market, and it’s also a market that’s been under-served. Those 750,000 middle-market companies predominately follow population trends. We estimate that 13% of them are in Southern California.

Q. Orange County is a major center for small businesses. How does it compare with other areas of the country in its merger and acquisition activity?

A. If you raise the measurements to Southern California for a moment, what’s interesting is that the middle market here is 13% of the total (U.S.) market, yet over the past four years, (middle-market) sellers in Southern California represented 29% of the total deals. It’s running at a rate 220% greater than the U.S. average.

Q. Will Southern California be able to maintain that edge?

A. California is a population leader both in individuals as well as businesses. So California is a prime market. But looking ahead, at least at this point, I believe Florida has more new businesses starting than any other state in the United States by a substantial percentage. The average seller, if you were to profile him, would be someone who has been in business about 13 to 19 years. If I were to look ahead seven to eight years from today, I would say Florida would be the biggest because their businesses would be reaching that point of maturity. It’s already a major market.

Q. Geneva ranked No. 1 in the number of merger and acquisition transactions initiated in 1987, well ahead of Wall Street firms. Do you see any significance in the fact that a non-Wall Street firm heads the list?

A. I don’t believe there is a provincial answer to it, but rather I believe there’s a cultural answer to it. Geneva is a company of about 350 professional and support people dedicated to the middle market, and we have stayed with this market niche. We have, over a period of time, developed resources that would not be justified if we didn’t have our present volume.

Q. What kind of resources does Geneva have?

A. We have a proprietary buyer data base that is in excess of 12,000 middle-market buyers throughout the world. Second, we have a lender data base that also goes into the thousands. Third, because of the number of evaluations we’ve done, we have built an econometric data base. And we can demonstrate with empirical evidence in a statistically valid way what constitutes acceptable performance for a small company. In total, we actually have about 640 unique data bases, and we have seven major data bases that are unique to us and that we have never published nor will we publish.

So Geneva was very precisely chartered in the beginning to serve this middle market. And I guess it’s perhaps the dedication of resources to one specific market the makes us No. 1. Nobody has initiated and closed more deals. And if you say the United States is the biggest market in the world, which it is, then whoever’s No. 1 in the United States is No. 1 in the world.

Q. Has the pace of mergers and acquisitions slowed since the record level of 1986?

A. No, it hasn’t slowed up. However, I don’t know whether the pace isn’t somewhat artificial. You have the Tax Reform Act, which clearly rushed a lot of people into the market in 1986. I think today, the pending legislation for a value-added tax on all transactions, including mergers and acquisitions, becomes an accelerator.

As a matter of fact . . . in 95% of the five-year increments the past 100 years, there has been a recession in the United States. Also, in half of those periods, the prime rate has doubled.

Q. What conclusions have your drawn from that study?

A. For whatever it’s worth, our own forecast is: (A) There will be a recession, probably at the end of ’89 or the beginning of ’90. The odds are obviously in our favor, 95 to 5. (B) We believe the prime rate will substantially increase. Again, the odds are in our favor. And (C) We also believe there is a high probability of a value-added tax to be passed before 1991. It will be tremendously punitive not only to the values of companies but to the survival of companies that are not cash-rich. So we feel it’s highly likely that when you put these factors together, merger and acquisition activity will continue strong this year and then will take a dip. We believe that sometime in mid-1991 through 1992, there will be another boom period, and then there will be severe changes.

Q. What severe changes do you see in the next boom cycle?

A. It will be a presidential election year. We should be coming out of the recession that we’re predicting we’re going into. The settling out of businesses hurt by value-added tax will have occurred.

Q. So mergers and acquisitions should be running heavy now?

A. The market is reaching, we feel, the end of an era. But yes, it’s running heavy. And of course, the intensity of the market is being fueled by one of the lowest corporate tax rates in the world. Ergo, we are attracting more and more offshore buyers. Indeed, 20% of our deals are done with offshore buyers, and it’s climbing. The erosion of the American dollar is a further attraction to a foreign buyer. And so is the very real fear that we could as a government eventually put in some type of legislation that will make it more difficult for foreign buyers to make acquisitions in the United States.

Q. Who are the primary foreign buyers?

A. The principal foreign buyers are from the United Kingdom, Scandinavia, Germany.

Q. Not from the Pacific Rim?

A. There is minimal activity--growing interest, but minimal activity--from the Pacific Rim, primarily Japan. Interest in mergers and acquisitions is growing, but not necessarily the consummation of deals. More than 50% of the U.S. economy today is driven by service businesses. The Pacific Rim buyer, we find as a general rule, has a harder time relating to a service business as opposed to a smokestack business. Now, when you’re talking about plants, and real estate and this sort of thing, it’s much easier to do the deal with them.

Q. Are there major changes now in the merger and acquisition market?

A. The major change that we see is that the lower end of the market is beginning to erode. We ourselves are even shaping our own business differently. Whereas today you will take a $2-million or a $3-million company to market, it becomes increasingly difficult to justify the cost of taking that type of company into market. The change in the taxes are going to make it increasingly questionable.

Q. So right now it’s a seller’s market?

A. Absolutely. Absolutely. Just hands-down. It’s overwhelmingly a seller’s market right now. You’ve got foreign buyers because of the corporate taxes and eroding dollar. Large companies always buy because it’s cheaper, smarter, faster to buy assets rather than build them. Most entrepreneurs can drive a company to a certain point. And, really, the very thing that helps drive the company to that point can become a deterrent. They themselves become the bottleneck. The risk-taking capacity has dropped. And the company is better served, its customers and its employees are better served when the company is acquired.

Q. One of the things that the stock market crash did, of course, was to devalue the stock prices of many companies. Has the crash spurred activity for mergers and acquisitions?

A. In a privately held marketplace, it has not had a great deal of effect. And even in the publicly held, it has not had that great an effect. . . . The strategic buyers, who were buying an account presence, a technology and so forth, have not changed. The movement of the market did not move their strategy.

Q. In terms of strategic buyers, who are the kinds of companies or investors that are looking to buy?

A. They tend to be (A) fairly large companies that are buying rather than building assets. (B) They tend to be investor syndicates, who again are making a strategic call. And I would say (C), to a very lesser degree, deep-pocketed individual buyers.

Q. And what are they looking for?

A. Strategic buyers commonly are buying account bases. We recently did a deal in Southern California, for example. The seller’s business was the manufacture and maintenance of truck tailgates. The buyer we found for him was a Swedish company whose business was also tailgates in Europe. And apparently this is a business that is a razor blade-razor thing--there are gears that wear out and so forth. It was a perfect marriage. There were certain parts of the technology in the U.S. that were not present in Europe and vice versa. So technologies were merged, and warehousing, standardization of parts and many economies were gained. That was a true strategic buy.

Q. Do your studies show who is buying Southern California companies?

A. Our research shows that 40% of the buyers of Southern California businesses were located outside the state. An additional 10% of the buyers of California businesses were located offshore. So one-half of the buyers came from outside the state. Probably of greater interest, about 72% of the buyers are not in the industry in which they’re buying into. That reinforces the strategic issue.

Q. Are buyers purchasing typically to control operations, take over companies or to make investments?

A. Offshore buyers are usually buying to have involvement at the directorial level only. A major part of the transaction is that key management will stay in place. They have no desire to buy and run a company “across the pond,” as it’s put. Within the U.S., you will find the more sophisticated buyers again are not buying to run. They’re buying to be involved in the strategic end of finance, marketing and organization. They are rarely if ever interested in getting involved in the day-to-day operations. And the larger the buyer, the less the interest. The smaller the buyer, the greater the likelihood of wanting day-to-day involvement.

Q. Besides getting a good offer, why would owners want to sell a company?

A. We have done repeated surveys over a period of many years and with literally thousands of potential sellers. The No. 1 reason is boredom. Again, if you take a look at the seller profile--in business 13 to 19 years, average age of 58 to 63, risk-taking capacity greatly diminished--they have reached the point of comfort that boredom begins to set in. If you’re unwilling to do something new, you’re almost beginning to destroy one of the facets of an entrepreneur--the thrill and the challenge of building and creating.

The second reason, and a deep second, is one of health. More often than not, it’s not the health of the seller, but rather the sense or realization of mortality. You’re reaching an age where, unfortunately, you’re going to more funerals than weddings. And the sense of mortality grows. Those are the primary reasons. From there on, I would say the reasons are spread all over.

Q. How do they know when it’s time to sell?

A. We find there are a very limited number of sellers who literally have an exit plan. There is an unfortunate lack of knowing when is the right time to sell. And the concept of going into business with the idea of going out of business is not one that is taught necessarily at the graduate school level--or even talked about that much. I think the advantage of a very definite long-range plan for an entrepreneur is a self-established measuring point. They know when is the optimum time to leave the business, which is key.

Q. Part of what you do is to advise on divestitures. Do you expect to see any increase in the number of divestitures or the amount of divestiture work that you’ll be doing?

A. We believe there will be a modest increase in divestitures. We don’t see a rush for divestitures. I would say that as the value-added tax receives more press--there are two bills currently in, and they have received very little press so far--I think there will be a great deal of measuring of subsidiaries insofar as their ability to throw off cash. And that will start triggering some divestitures.

Q. Are there any other reasons why there has been a modest increase, other than tax reasons, in divestitures?

A. Shifting corporate strategies, I’d say, is the primary reason. We recently handled a divestiture for Westinghouse. It’s a fine division and a fine company. The division just no longer necessarily served the defined goals or targets of Westinghouse. It’s not at all uncommon.

Q. Besides getting rid of a losing proposition or shifting corporate strategies, are there any other perhaps more subtle reasons why a company would divest itself of a division or a subsidiary?

A. Yes. When the parent has grown too large, it may not be able to effectively manage certain divisions. Some companies grow so large that the line of communication to the subsidiaries is no longer the best. The size begins to threaten, if not destroy, the culture of the subsidiary. We see that happening repeatedly. The parent is no longer able to influence the growth of a particular subsidiary--ergo, divestiture.

Q. What happens after you sell or divest?

A. Immediately after the sale as a general rule, there is a sense of fear, there is a sense of guilt and there is a sense of numbness. That’s the first reaction. The numbness is understandable because before a deal is done, it will get to the edge, fall apart and then be brought back again. The sense of fear is to suddenly see a very large cashier’s check. It’s one thing to fill out a balance sheet and say that my home is worth X and my business is worth Y. It’s another thing to see a cashier’s check for substantially more than what one had captured as the net worth of the business. And the fear is what to do with it. The sense of guilt is very much tied to the fact that most of the sellers today are 58 to 63 and are Depression babies, and it’s almost, “Am I entitled?”

Having started, built and sold several of my own companies, I exactly fit the profile. Our own experience has taught us that those feelings will stay for six months to a year. Then the realization sets in, and the second phase is one of almost elation--the elation that I am able to provide for my loved ones. And that elation is what I think becomes a permanent part of the person’s psyche.

Q. And then they go back to work?

A. Yes. The third phase is to re-enter the business world in an area that gives them great personal satisfaction. They’re regenerated. It’s amazing the number of people who I have seen who have lost weight and have literally changed. They get themselves involved, either in a different business or at a different level, where they’re sharing and giving guidance and counsel. They don’t want the day-to-day involvement, but they stay in. Their interest levels are up. It’s a fascinating syndrome.