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Owners of many privately-held businesses have sat out the recent resurgence in M&A activity while waiting for their company performance to rebound and waiting for M&A valuations to match their expectations once again. Abundant capital and fervent demand are fueling a strong M&A market, so owners should consider these five reasons to sell their businesses in 2014.
1. The strengthening US economy: Across the past 100 years merger & acquisition activity has historically mirrored the cyclicality of the US economy, with M&A activity rebounding within one to four quarters after the economy emerges from recession. With the gradual drawn-out recovery from the 2008-2010 recession, M&A activity also languished before re-emerging in late 2012 and 2013. Among the many positive macroeconomic factors pointing to continued strong M&A activity in 2014:
- The economy is rebounding quickly in the 2nd quarter, despite weaker than expected results for the 1st quarter of 2014 due to widespread severe winter weather. As noted in our Mirus Middle Market Monitor for May 2014, the Federal Reserve’s latest survey of regional economic conditions reported increased consumer spending, improved manufacturing conditions, and stronger demand for loans. As a result forecasters expect GDP to grow 3.5% – 4% in the 2nd quarter after a negligible 0.1% increase in the 1st quarter.
- Consumer confidence is strong relative to recent years as reported both by the University of Michigan Survey of Consumers, and by the Conference Board’s Consumer Confidence Index.
- Economic activity in the manufacturing sector expanded in April for the 11th consecutive month (as measured by The Purchasing Manager’s Index) as a result of favorable demand and good business conditions, which overcame adverse winter weather conditions across the country.
- US corporate profitability is at record levels: the trailing 12 month net profit margin for S&P 500 companies is at a historic high of 8.9%.
- The public equity markets are active, with 64 initial public offerings in the 1st quarter of 2014.
2. Abundant capital for acquisitions: Healthy balance sheets and low interest rates are feeding acquirers’ appetite for growth:
- Bank debt remains plentiful and inexpensive. Leverage ratios (debt as a multiple of earnings before interest, taxes, depreciation & amortization, or EBITDA) are returning to pre-recession highs, and interest rates remain at historically low levels.
- Many strategic buyers are awash in cash. For example, the total cash and cash equivalents on the balance sheets of the S&P 500 companies (excluding financial institutions) grew 14% year-over-year to a balance of $1.4 trillion at the end of 2013. Stockholders want to see their money put to work, so strategic buyers are active: in a poll of US executives by EY Americas Transaction Advisory Services, 41% said they expect to pursue at least one transaction in 2014, compared with only 23% polled a year ago. Similarly, in a recent KPMG survey of business owners, 63% of respondents planned to make an acquisition in 2014 and 25% believed that large cash reserves will be the strongest driver of transaction volumes. Evidencing that trend, here at Mirus we have sold five companies to larger competitors in the past six months.
- Private equity firms were sitting on more than $1 trillion in available capital at the end of 2013, as reported by Dan Primack of CNN Money. Private equity firms need to deploy this so-called “dry powder” or return it to their institutional investors, so they have been competing actively with strategic buyers for deals. In the 1st quarter of 2014, private equity firms closed 589 deals totalling $108 billion of invested capital – eclipsing the 1st quarter of every year going back to 2008.
- Increasingly, private equity firms are putting their uninvested capital to work by making add-on acquisitions to fold into their existing portfolio companies. 59% of US private equity transactions in the 1st quarter were add-on acquisitions. This trend benefits sellers of smaller companies, as many private equity groups will relax their usual minimum thresholds for target company revenue and EBITDA when considering the acquisition of a company as an add-on for an existing investment rather than as an initial foray into that company’s industry sector. Our most recently closed transaction here at Mirus was an add-on, as the private equity owner of a large building products manufacturer acquired our smaller client for its industry-leading product quality and premium positioning.
As a result of these macroeconomic conditions and abundant capital for dealmaking, conditions are favorable for sellers:
3. Higher valuations: Transaction valuations measured as a multiple of the selling company’s EBITDA have rebounded to pre-recession levels and are exceeding owners’ expectations. (Well, most owners!)
- This is due in part to an ongoing supply/demand imbalance: while 30% of middle market companies recently surveyed by RBS Citizens are passively or actively open to a sale, only 6% were currently engaged in a sale process. More and more healthy companies are coming into the M&A market as business owners who have stayed on the sidelines waiting for company performance to rebound are now ready to sell, but the abundance of corporate and private equity acquisition capital continues to outstrip supply.
- While transaction valuations vary by industry sector, median EBITDA multiples have increased in many sectors. Healthcare companies have recently traded at a median of 12.2X EBITDA, consumer discretionary companies have recently sold at a median of 9.8X EBITDA, and consumer staples companies have recently sold at a amedian of 10.2X EBITDA. Even basic industrial businesses, which historically may have traded at 6X or 6.5X EBITDA, have increased in value to 7.5X EBITDA. (Note that these are median valuation multiples; larger companies attract higher EBITDA multiples than smaller companies due to higher levels of company-specific risk associated with acquiring smaller businesses.)
4. Increasing Deal Flow:
- US and Canadian companies completed 2,400 transactions in the 1st quarter of 2014, an 8% increase over deal activity in the 1st quarter of 2013. This comes in the wake of 9,600 mergers & acquisitions in 2013, up from 8,995 deals closed in 2012. Notable increases by sector in the 1st quarter of 2014 include healthcare deals, up 11%; consumer discretionary deals, up 23%; and consumer staples deals, up 6%.
- A subset of this increased deal flow has been generated by private equity firms, which are actively selling many of their portfolio companies in order to lock in investment returns for their current funds before raising their next fund. In the 1st quarter of 2014, PE firms sold 152 companies for a total of $46 billion. For owners of privately-held companies, it’s a sure sign of a strong M&A market when the professional investors who run private equity funds start divesting portfolio companies at a high rate.
5. Return on invested sale proceeds: As Boston attorney Steve Honig recently observed on his blog, “One argument against selling has disappeared. Prior to the 2013 public bull market, there was no good place to invest proceeds. The 2103 bull market created investment opportunity that, if sustained, might now induce other owners to sell.”
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Business owners ask us, “Should I sell now, or wait?” We believe that the current confluence of market conditions is very favorable to sellers. While we hope these favorable conditions will continue, the M&A market is cyclical, and it’s hard to imagine that all of the factors I’ve discussed will all strengthen further in the coming year or two.
Of course the ideal timing for a sale also varies by industry and by company. If you are considering a liquidity event, please email me at email@example.com for a confidential conversation about your options and the ways in which we can help you achieve a successful exit.