Supply chain issues, labor shortages, pent-up consumer demands, excess cash & inflation fears led to surge in Global M&A activity in 2021 shattering the record set in 2007 ($4.5 T) by topping $5 Trillion globally in early December and expected to exceed $6 Trillion before the end of the year. A year without any mega-deals ($50 Billion+), the largest deals were Time Warner-Discovery ($43 B) and two chip-makers NVIDA-Arm ($40 B) and AMD-Xilinx ($35 B). Statista estimated for the 12 months ending June 30 that there were 583 deals over $1 Billion.
What about the Lower-Middle Market?
While global activity was setting record dollar amounts, record setting deal activity did not find its way down to smaller deals which were actually down. The same Statista report estimated for deals under $50 Million, 2021 dropped in number of deals by nearly 20%.
However, the Lower Middle Market is setting a different record. While the number of deals are down, the IBBA has reported multiples for deals between $5-$50 Million are seeing record highs. The Average deal in that range over the previous 5 years was going for 5.62x EBITDA while 2021 is reporting the average of 6.8x EBITDA in 2021!
A business doing $1.5 Million EBITDA, on average from 2016 - 2020, could expect a sale price of around $8.43 Million.
A business doing $1.5 Million EBITDA in 2021 can expect, on average, to see a sale price of $10.2 Million, a 20% premium!
While each industry was hit at different times and with different severities, many businesses had a downward impact at some point over the past year and a half. The multiple is rising, to a degree, because of historic profit being down. Ultimately, this means buyers are willing to overlook covid-related struggles.
What if a business grew during covid? Buyers would still likely be willing to pay the higher multiple as that is what has normalized out. Ultimately, willing to pay a premium for that stability.
The pressure on businesses today is very high. Strained supply chains and labor shortages are a key component impacting most businesses and industries. That pressure can cause Buyers to see more value in an acquisition that provides depth in the supply chains, more reliable materials, and well-qualified labor, in addition to the traditional synergies.
With few deals on the market it can cause valuations to be higher for those that do take their businesses to market. There is a general expectation from Owners that they need to get things back to normal, before taking their business to market, often referring to normal inventory, pipeline, or employees and not necessarily recent performance. This hesitation, while understandable, has led to a premium for the businesses that are on the market.
Looking towards 2022
While it is impossible to predict the future; being aware of current factors and their expected, continued impacts can help make educated decisions. Going into 2022, there are several factors that can help us understand expectations of M&A in the Lower-Middle Market:
Shutdowns (government or self-imposed) seem to be less frequent and less intense, but still come in waves. New strains continue to appear and there is uncertainty with each, these will continue to impact business, supply chains, labor markets and customer demand.
Supply chain disruption is huge and may not normalize for a very long time. A premium is likely to applied for strong supply chains, especially if products are domestically sourced. Additionally, buyers seeking vertical integration should play a bigger factor than pre-pandemic.
Labor shortages hurt small businesses more than larger companies. Larger companies often have more flexibility to pay higher rates and offer better benefit packages. Additionally, larger companies can allocate higher utilization of employees. Employees will likely play more of a role in the short term, both in due diligence and determining interest.
Fewer Businesses on the market
Fewer businesses on the market may cause buyers to pay a premium for available opportunities and/or spend money seeking off-market deals. Businesses going to market should see more activity and likely higher variation in offers.
Interest rates play a factor in values. If buyers can leverage more, they can afford to pay more. Since most deals have some lending associated with it, this does play a factor. Should interest rates rise, there may be a short-term pause and/or slowdown in activity. However, demand is high since many buyers currently anticipate an interest rate rise and seek to structure deals before that happens.
Inflation fears continue to go around. Official estimates calculated by CPI are 6.8%, the highest since 1982; although general sentiment is that CPI understates true inflation. These fears push capital sitting on the sidelines into play, as holding cash loses value. Inflation will also push wages higher. Companies with a large labor component will be impacted most. Depending on the industry, price, sensitivity, and cash flow there could be permanent reduction in profits.
While Washington continues to deliberate Build Back Better and other tax changes, a lot of talk is focused on increasing â€œtax on the wealthyâ€. Biden has promised to keep changes for Small Business Owners and/or families making $400,000 or less to be at a minimum. However, several of the high-profile proposals are aimed at Capital Gains. From limited tax credit for losses to raising the highest rate, this is a scary factor for any Owners looking to exit. Capital Gains Tax is typically the rate applied to proceeds. While there may be little impact on tax bills on Owners making less that $400,000 each year, the proceeds of an exit are almost always applied in a single tax year and will easily exceed $1,000,000 in a single. Several proposals are pushing to tax this as income at the highest rate, 37%. The latest proposal would increase the top rate for Capital Gains, currently at 20%, to 31%. This would be an immediate 11% decrease in proceeds at closing. Should this or other measure pass, it may not impact taxes for 2022, but it could cause an influx of potential sellers, seeking to avoid that penalty in 2023 or beyond. As the number of businesses hits the market the overall multiples should normalize or even reduce.
Reliable Revenue â€“ Reliable revenue streams always attract more potential buyers and command higher multiples (and better terms) than project-based revenue. Going into 2022, we expect this to play an even bigger factor in demanding interest and create further disparity in multiples between the two. Buyers to forgive any COVID-related pauses in Reliable Revenue, as long as recovery is shown for at least a couple months.
Reliable Revenue resembles anything recurring, subscription-based, measurable repeat business, contracted work, or from a very wide customer base with no customer concentration.
Compare that to any Revenue related to onboarding, installation, one-time fee, project-based, one-time events, or from a concentrated customer base (just a few large customers) â€“ all which can create large swings (or delays) and likely more prone to volatility that may still be expected in the near future.
One Final Note
A survey of Business Owners by the IBBA with businesses between $1-50 Million indicated 55% of Business Owners who sold in 2021 had no exit plan prior to their engagement. The majority of those that did, started planning less than 1 year before going to market.
Acquivest focuses on Sell-Side Advisory for Businesses between $2 Million and $100 Million in Revenue. We can assist with valuations, planning, or even Buy-Side Advisory to help you find that missing piece needed in your company. It is never to early to start the conversation. When Owners react to economic factors (taxes, inflation, covid), business matters (losing a client, supply chain problems, labor issues), or personal matters (health related, family issues) it sets up an urgency that leaves money on the table. Owners create a proactive plan to exit set themselves up to get TOP DOLLAR, often simply by remaining knowledgeable and being able to identify proper timing of their exit.
Feel free to reach out to us if you would like to speak about a specific situation.
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