A couple of times a year, Pricewaterhouse Coopers LLP (PwC) produces an overview of current U.S. M&A activity. Earlier this month they released their mid-year review of 2011 M&A activity, and based on their analysis of the data, they claim that we are in a sellers’ market. This may surprise you to hear. According to PwC:
“ ‘Corporate buyers emerged from the downturn as the dominant force in the deal market having stockpiled cash from restructuring and cutting costs during a period when growth opportunities were limited,’ stated Martyn Curragh, US Transaction Services Leader with PwC. ‘At the same time, competition for quality assets is helping push up valuations and average deal value. In this type of “sellers’ market,” where assets are being strongly pursued, buyers are competing aggressively and are focused on identifying value drivers to optimize pricing. With sellers taking more control, they are in the driver’s seat and are demanding a swift diligence process with more certainty around the outcome. We have seen an increase in sellers’ preparation and diligence to enhance asset value, reduce business/management interruptions and decrease the overall diligence process time.’” (emphasis added)
This is the first analysis I have seen so far this year that indicates we are in a sellers’ market. However, based on the data, intuitively this does make sense. There is simply too much cash pursuing too few deals for it to be anything but a sellers’ market. PwC fully expects this to continue through the end of 2011, which is great news if you are the owner of a middle-market company.
Again, according to Martyn Curragh:
“An increase in total deal value in the last twelve months ending May 2011 indicates a sustained M&A cycle, and as confidence continues to build, markets stabilize and businesses look towards growth, we expect the acceleration of the M&A market to continue in the second half of 2011.” (emphasis added)
You’ll note that I highlighted a few statements in the main paragraph above. PwC clearly is indicating that despite classifying this as a sellers’ market, they are careful to note that buyers are still being selective and are looking for “value drivers” or synergies before closing deals.
Simply put, buyers are looking for long-term strategic fits. These “strategic fits” are often “off-balance sheet assets” that can combine with a buyer’s and create a much more profitable, growing entity. For those of you unaware of that term, off-balance sheet assets are intangible features of your business that make you unique. These assets are not shown on your balance sheet but do have value, especially to specific buyers. They can be patents, proprietary software, strong contractual relationships, and client lists just to name a few. There are dozens of others – every successful business has them – and when combined with a buyers complimentary intangible assets, they create tremendous deal value.
In addition, sellers are helping deals close by being prepared before hitting the negotiating table. I can’t stress this enough. The better prepared you are, the more you document your company’s operations and earnings, the odds are better that your deal will close faster and due diligence will be much smoother. Buyers of businesses are like buyers of any product: They want to make sure it works! In your case, they want to make sure that upon your departure, the business will continue to operate smoothly and generate the returns you have projected (or even better).
The Middle-Market Continues to Dominate
According to PwC, in the first five months of 2011 there were 1,276 announced transactions in the U.S. with a total value of $454 billion, representing a 39 percent increase in value over the same period in 2010, which saw 1,336 deals worth $327 billion.
The middle-market (which in this case PwC defines as deals under $1 billion) continues to account for significant deal flow, contributing 94 percent of deal volume and 27 percent of deal value in the first five months of 2011. This data is in agreement with other sources I have quoted in the past. For example, Pitchbook News, which focuses on private equity M&A activity, indicates that deals below $250 million represented about 80% of all closed transactions during the first quarter of this year. I know that this may surprise you, but middle-market deals are quite attractive acquisition targets.
Equity Firms Are Also Active
As I have stated before, equity firms are also sitting on a tremendous amount of cash that needs to be invested. According to PwC, equity firms began to bring this capital into play over the last few months. In the five-month period ending May 31, 2011, there were 230 deals involving private equity as the acquirer, representing 18 percent of total volume. Deal value involving a financial investor totaled $70 billion, or 16 percent of total deal value and a 50 percent increase over the first five months of 2010. With an estimated $477 billion on the sidelines in the form of dry powder (capital available for investing), it is a safe bet that the remainder of 2011 will continue to provide ample opportunities for middle-market companies to find equity investors.
Timing the Market
The question, of course, is how long will this sellers’ market continue? I often hear entrepreneurs say, “I am going to time it just right this time and sell when the market is at its peak.”
Of course, there are two problems with this. First, who in the world can accurately predict when we will reach the next summit in M&A activity? No one that I know of. So trying to time it can be impossible. Secondly, the optimal time to find buyers is on the upward side of the recovery cycle, not at the peak. Buyers are most active and valuations are better as we move from a recession into recovery. This is probably why we are seeing the market become a seller’s market. We are in the early quarters of the next M&A cycle right now. Or as PwC put it, “We are in the midst of a sustained M&A cycle.”
Another key point to consider in the discussion of market timing is the issue of taxes. As you know, in December 2010 Congress extended the Bush tax cuts through the end of 2012. The key tax for our discussions here is the extension of the cap gains tax rate at 15 percent. However, unless Congress acts before December 2012, on January 1, 2013, cap gains taxes will revert back to 20 percent.
On top of that, as part of the healthcare reform act passed last year, combined incomes over $250,000 will also pay an additional 3.8 percent in a new Medicare capital gains tax. This means that overall, cap gains taxes will be closer to 24 percent than the 15 percent they are now. That represents a whopping 60 percent increase in the cap gains you will pay on January 1, 2013! So you could run into a situation where you are able to “time” the market, but by delaying the sale, you could end up netting less of the proceeds. All middle-market business owners need to carefully consider this issue as they examine their exit strategies.
© 2011 Generational Equity, LLC All Rights Reserved