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The shifting and crazy state of M&A — Have you missed it?

July 25, 2019

By Martha Sullivan, CPA, CVA/ABV, CM&AA, CEPA
Partner, Succession Planning Practice Leader

Martha leads HK’s succession and exit planning services division and is a regular contributor to Wisconsin’s InBusiness digital magazine.

Every summer, the Alliance of Mergers & Acquisitions Advisors gathers over 300 professionals in Chicago to discuss the state of the market, opportunities to work together, and how to create value for businesses. The mix of professionals is broad. It includes investment bankers, financing partners, private equity funds, accountants, lawyers, business valuators, financial planners, marketers, and business improvement, HR, and family-business consultants. Pretty much every type of professional who serves a business owner from the time their company is formed to the time they exit attends. The conference itself is a blend of speed dating and education. There’s as much energy in the presentation rooms as there is in the hall where people connect and collaborate.

Throughout the speed dating, everyone is curious about what the other guy is seeing in the market. How much activity are you seeing? Are your deals getting the needed financing? What multiples are you up against? Where are you having success? Where is stuff hitting the fan?

The tone of this year’s conversations was decidedly different than even 12 months ago. Last summer, everyone knew that we were in one of the longest bull runs ever and the market was not showing many signs of cooling. Buyers were hungry hunters looking for quality companies and were willing to pay for them.

Today’s conversations were different. Sure, buyers — whether a corporation looking to make a strategic acquisition or a private equity fund/financial buyer looking to invest — still seek quality companies and, when they find one, are willing to jump. Health care, high tech, and online/SaaS companies are in high demand. Companies for sale that aren’t attractive enough or meet buyers’ investment criteria are being turned away just as they were before. So, what’s changed?

Two dynamics are appearing:

  • Buyers are being cautious and conservative, worried that the run is slowing. Many buyers are pulling their chips back. They still have the chips, they just aren’t as eager to jump as they were before.
  • Multiples for attractive platform1 companies are “insane,” as more than one buyer put it. Some companies are going for multiples as high as 12 or 13, which is extraordinarily high for even golden opportunities.

These dynamics may appear to be at odds with each other, but they aren’t. There are several factors driving this.

The haunting of 2008

For many experienced buyers of companies, the current economic environment is beginning to feel like 2007 and 2008 before the economy shifted. Multiples were also high then. Funds were being pressured by their investors to deploy the capital and make investments into portfolio companies. Investors bought at a market high, often using significant amounts of debt to fund it.

Then the wheels fall off. Economic growth opportunities stall. Portfolio companies sputter and they may or may not be struggling to survive. Access to financing for the substantial growth initiatives, such as implementation of a robust ERP system or acquisition of an add-on, shuts down. The ability to get a return on the investment, let alone the original targeted return and timetable, are seriously compromised. Some investments are upside down on their debt.

Fast forward to today. Eleven years have flown by and investors and their portfolio companies recovered. But the memory of 2008 is still fresh in the minds of many seasoned buyers. They have no desire to relive the pain of having paid good money at the market top to then watch it free fall. Buyers are decidedly more cautious about pulling the trigger on a deal, particularly for the platform companies.

Platform companies are ones that the investor buys to aggressively build and grow. To be a platform company, the business needs to be scalable and ripe for significant growth and improvement. Investors go into the deal knowing that they will provide capital and talent to take the business to a new level. The growth strategy may include acquiring other smaller companies that complement or supplement the business of the platform company. These smaller deals are often referred to as “add-ons” or “tuck-ins.”

The pressure to deploy

That said, private equity and other financial investors exist to deploy capital into businesses that show promise for growth in revenue, profitability, and return on investment. The private and institutional investors who invest in the private equity, family office, or other funds expect a return on their money, which places the financial buyers under pressure to buy companies.

Competition for the good companies

The supply of good companies for sale is not what you might think given the current demographics. Many businesses are up for sale. However, few meet the investment criteria for buyers. The rule of thumb is that for every 100 deals that come across the financial buyers’ desks, only 1–2 percent make it to the point of serious discussion. The criteria include, among other things, a certain level of earnings before interest, taxes, depreciation, and amortization, a functioning management team, strong customer diversity, and an upside potential for the buyer to take the company to its next level. That can be the proverbial “needle in the haystack” given all the companies that come across their desk.

When “the one” comes along, the need to act is accelerated. The smart seller entertains multiple buyers through a controlled auction, which forces the interested buyers to sharpen their pencils and drive the multiples up. Depending on the pressure to deploy capital, bids go higher than they normally would, such as is occurring now.

The takeaway from all this is that while health care, high tech, and anything with a SaaS in it are still in a hot sellers’ market, the market for bread-and-butter companies has shifted to a buyers’ market. The window of opportunity to take advantage of the bull run appears to be slowly closing. Future sellers will face increased competition to be the chosen one at the dance and to achieve their desired value. The need to improve the transferability of a company so it is always ready to sell is only going to get bigger.

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