The M&A market has been strong for nearly a decade with elevated valuations driven by increased revenues and profitability, an aggressive pool of strategic and financial buyers and a lending environment that supports highly leveraged transactions. Because of these positive market dynamics though, it presents many company owners with unrealistic value expectations and dismay when a deal can’t be completed quickly or on the back of a napkin.
M&A deals are indeed complex transactions that are justified only after substantial due diligence, ROI analysis and subjective industry/customer/operational consideration. After completing hundreds of M&A transactions, I can attest there are no “easy” deals. While there are stories of buyers acquiring companies with limited to no due diligence or paying unjustified prices, these are anomalies and rarely happen in the world of investment banking. Most transactions take eight or more months to complete when going through a broad marketing process, negotiations and due diligence. Furthermore, it’s common to approach 500-plus potential buyers to drive the necessary negotiating leverage in order to hit seller’s expectations. That means if 20 parties have an interest, all the other parties (i.e. 480-plus) have passed on the deal. Also adding to the challenges of an M&A process are the many start and stops or difficult conversations that bring into question whether the deal gets done. In addition to the emotion and uncertainty of a transaction, there are hundreds of moving parts, all of which need to be analyzed as they have an impact on net proceeds, taxes and risk.
When considering a potential transaction, there are several key complexities brought about by today’s market dynamics, including:
Trending characteristics: As the nearly decade-long strong economic market continues, investors have taken certain precautions in investments to where it has modified their acquisition interests. While there are no signs yet of an imperative correction (or recession or softening), certain investors have begun to focus on recession-mitigation characteristics, such as industry cycles, recurring revenue, customer and industry diversification and customer “stickiness” to drive their interest and value considerations.
Deal size matters: Deals less than $1 million of EBITDA have a lower population of sophisticated buyers because of the scale, infrastructure and professionalism presumed to be associated with the business, which limits the interest and negotiating leverage on these deals. As EBITDA grows, new buyer groups are attracted, which can be appealing when marketing a business. In addition to the overall interest in companies, value is also impacted based on the size of a business and leveragability. Therefore, larger buyouts receive a premium to their EBITDA multiples. According to GF Data, the spread on size premiums for larger deals between $50 and $250 million compared to deals between $10 and $50 million was 1.6x in Q1 2019. For example, a $2 million EBITDA company might realize a 6x multiple, whereas a $7 million EBITDA company, all else being equal, could realize a 7.6x multiple.
No two businesses are the same: The seller-market that currently exists in the M&A market tends to provide buyers with a sense of comfort and confidence that buyers are going to be breaking down the doors to have an opportunity to buy their companies. While there are many buyers interested in making acquisitions, the quality of acquisition must also be considered. Whereas a buyer might have an interest in a growing business that sells recurring-revenue products to a diverse customer base and the owner has continued to invest in people, equipment and the facility, a buyer might pass on a business that has customer concentration, has an active owner that doesn’t want to work post-transaction or sells capital equipment that is generally a bit more volatile and unpredictable than recurring revenue products with consistent order patterns. For reference, according to GF Data, which compiles transaction data from private equity transactions, companies with a quality premium (those with TTM revenue growth and EBITDA margins above 10 percent or one above 12 percent and the other 8 percent) realized a 14 percent increase in value in Q1 2019.
You don’t know what you don’t know: It’s true, if you don’t know a good or bad deal or that a specific term is even negotiable, you wouldn’t have any idea that you just passed up an opportunity. We commonly see business owners that choose to sell their own businesses are taken advantage of because they don’t have the experience or specific M&A knowledge to know the hundreds of terms that impact their proceeds. In the current market, we’re seeing sellers focus on price alone (since the frothy pricing is widely publicized), but buyers making up for the high prices by benefiting from “unnegotiated” terms, which can equate to even more than any premium paid in price. And, to put this in perspective, we’ve seen amounts of these “unnegotiated” terms equating to millions of dollars, and notably important, increased post-transaction liabilities and risk.
Selling a company isn’t like selling a house: Selling a business is often compared to selling a house: there’s a buyer and seller, generally financing involved, a marketing process and a closing; although, that’s about the extent of similarities. Houses are tangible, they have a value that can commonly be estimated based on visual evidence and a little analysis of assessed values, comparable properties or rental income. On the other hand, businesses are mostly transacted based on intangible value derived from cash flows, assets, opportunities and relationships. It’s very difficult to value any business based on comparable valuation information because there are so many differences in businesses, trends, infrastructure and sustainability. Accordingly, businesses are commonly transacted through an investment banking process where buyers are provided substantial information in a structured process to create a private capital market where offers are compared, negotiated and ultimately selected. Lastly, it’s important to understand that increasing value before the sale of a house might include a few days or weeks of time to install new flooring, paint certain rooms or update the countertops while it often takes years to notably prepare a business for market by diversifying its customer base, upgrading its management team to survive the transaction or creating new capabilities. While the current market provides a sense of comfort for a seller to consider attempting to sell a business on his own, it’s often later in the process when the deal falls apart that the buyer realizes the complexities of an M&A transaction.
The current M&A market, while a seller’s market, still includes rational decision making and lending multiples. Therefore, we’re not seeing the same exuberance we saw in 2007, which should undermine unrealistic expectations, and, equally important, is a positive for the long-term stability of the M&A market.
For additional insight into the current M&A market and the complexities faced during today’s transactions, attend the upcoming Mergers & Acquisition Forum, Historic Proportions: How a Robust M&A Market is Paving the Way for Decision Makers on Oct. 9 at Lambeau Field in Green Bay.
About the Author
Corey Vanderpoel is the managing director and owner of the Taureau Group, LLC
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of Insight Publications, LLC.