What is Driving M&A Activity in the Lower Middle-Market?

By Generational Equity


The International Business Brokers Association (IBBA) and the M&A Source, in partnership with Pepperdine Private Capital Markets Project, conduct a quarterly survey of M&A intermediaries. Entitled “The Market Pulse Report,” the survey gives timely and accurate data regarding trends and issues impacting and affecting the lower middle-market mergers & acquisitions (M&A) industry.

Two hundred fifty respondents from 42 states completed the first quarter 2014 survey. The majority of respondents (54 percent) had at least 10 years of experience in the M&A industry. Participating advisors reported closing 235 transactions in first quarter 2014. The survey revealed several interesting trends, as reported in the Green Bay Press Gazette:

“Business buyers are talking about a ‘frothy’ market again. It's a challenge to compete in this active market and get a company that makes sense for them. Still, all that activity isn't deterring buyers. In reviewing the Market Pulse results for Q1 2014, we noted that confidence appears to be strong for buyers in the lower middle market (deals valued at $2 million to $50 million).”

Generational Equity is seeing the same trend in our business as well. Buyers are more aggressive than they have been in several years and are looking specifically for well run, profitable, lower middle-market companies (we tend to value this range from $2 million to $100 million). Because deals of this size tend to be structured using a combination of capital sources, The Market Pulse Report also revealed this interesting deal structuring trend:

“What we're seeing is that many buyers are going all in and putting all their eggs in one basket. Buyers are cashing out their 401Ks, taking out additional mortgages on their homes, and tapping friends and family for help to finance their deals, at significantly greater rates than this time last year.”

This is an interesting change indeed. It tells us two things: Buyers have more confidence than they have in years in investing in smaller, privately held companies AND they are choosing to invest their capital in lower middle-market businesses despite the risk associated in doing so.

Let’s face it: Acquiring a privately held business in any market carries with it a certain amount of risk. However, what buyers are saying today is that risk is low in relation to the ROI (return on investment) they expect to earn during the next 5-10 years or more.

What M&A intermediaries are learning in today’s environment is that the return in the stock market, although at historic highs, carries with it the bad taste of the financial crash of 2008 and 2009 when we experienced an economic contraction of historic proportions. And given our record low interest rates, who is making money in any bank right now?

So savvy, high net-worth investors are strategically choosing to acquire lower middle-market businesses as an investment for the future. Here is how Green Bay Press Gazette put it:

“But so far in 2014, buyers seem pretty confident in their own abilities. Instead of doing a smaller deal and leaving their retirement and home equity intact, they're going all in and using cheaper, more personal, riskier methods of getting equity. And if their instincts are right, they will be very happy with the results down the road.”

Of course buying a smaller privately held business is not for everyone. You have to be prepared to work hard, you have to love the business the company is in, and be willing to make a myriad of personal sacrifices to make it work. However, buying an established company with a recognized brand, a market niche, loyal customers, and solid employee base is far LESS risky than starting a business from scratch.

Buy vs. Build

Interestingly, far too many sellers forget that point. They undervalue the intangible assets in their business, often because they are burned out from running the company. They forget that in the hands of someone enthused, perhaps younger, and with more capital, the business can grow dramatically.

In fact, across all valuation ranges, retirement and burnout were the dominating seller motivations in the latest Market Pulse Report. When a business owner reaches that point in his or her life, we have found that the business will usually stagnate and stall on its growth trajectory, making it a perfect opportunity for a new buyer.

And this is what we are seeing in today’s environment: Younger buyers with a willingness to risk it all for the opportunity of earning a greater return than they can anywhere else.

Many of you reading this may have unknowingly reached the burnout phase of your business ownership career. If you no longer find fulfillment in the daily grind and if you don’t look forward to going to work in the morning as you used to, it may be time to consider looking for a buyer. And right now, even if you own and operate a very small company, buyers may find you of interest.

To learn more, please attend a Generational Equity exit planning workshop. While there you will learn more about buyer activity in today’s market and leave the meeting with a significant knowledge base that you did not have before. Our seminars are complimentary, educational and are designed with one goal: to help business owners learn how to monetize their most prized possession. Call us at 972-232-1193 or fill out a contact form to learn more and to find out if your business qualifies you to attend.

And special thanks to the IBBA, the M&A Source, and Pepperdine’s Private Capital Markets Project for once again taking the pulse of the lower middle-market and giving us new food for thought about current trends.

Carl Doerksen is the Director of Corporate Development at Generational Equity.

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