Acquisition activity up, multipliers set to increase
By Charles Rathmann, of SBT
While the number of business acquisition deals seems to be increasing in southeast Wisconsin, a still-lethargic economy means the sale prices are depressed, according to acquisitions professionals.
However, in the coming months, increased sales figures and higher multiples should boost the value of businesses offered for sale.
This is in contrast with six months ago, when some of the same deal makers reported that deal volume was low. Sales at many area businesses were at a several-year low, and would-be sellers were hesitant to sell at a time when the market value of their business was depleted. However, a relatively small number of businesses on the market meant that there was a mismatch between supply and demand, keeping multipliers higher than would otherwise be the case.
Currently, business valuations professionals report an uptick in activity — but the resurgence is in too early a stage to be noticed by the finance sector.
"All of last year was the slowest it has ever been," Victoria Fox, director of mergers and acquisitions for Emory Business Valuation, Milwaukee, said. The company specializes in working with companies between $2 million and $10 million in revenue. "But in 2003, we are seeing a lot of people interested in selling their business."
Fox said that since autumn, she has landed four clients who are interested in selling businesses ranging from $3 million to $20 million in sales.
Ward Wickwire, managing director of Wauwatosa-based Mertz Associates, is noticing the same upward trend. Wickwire, who works on deals typically worth between $10 million and $100 million, indicated that interest in transactions seems to be increasing on the part of both buyers and sellers.
"Sometime around September or October, things started to pick up significantly," Wickwire said. "Half our practice is representing buyers and half representing sellers."
M&A pros attribute some of the trend to the fact that would-be sellers have postponed selling their business during down economic years. However, for a number of reasons including age and the need to move on to other projects, many entrepreneurs now find themselves in situations where they need to exit the business.
According to Wipfli Ullrich Bertelson LLP Business Valuations Manager Cameron Cook, who handles deals typically between $2 million and $25 million, the urgent need to sell can come because of or despite of the economy.
"The view that I have is that there is some pent up demand on both the buy and sell side," Cameron said. "There are people out there that due to varying circumstances need to transition the company. It could be poor health. People get sick and die no matter what the economy is doing. Or it could be the health and well being of the company itself. If the company is losing a lot of money, it might be time to take your benefits and run."
Economic reasons to sell might also have to do with a company doing too well, according to Wickwire.
"We are seeing a pickup in the segment of the sale part of the business — small private companies that are overwhelmed with personal problems," Wickwire said. "We have companies supplying services or products to the defense industry. These days, that kind of business can overwhelm a management team, and they might want to sell to find someone to help shoulder the load."
Increased activity seen by M&A consultants appears to be part of a wave that has not yet crested on the beaches of financial institutions. Bankers say that while they are hearing about deals contemplated in the market, they have not made it to the point where financing is required.
"We have not seen a lot of deals out there," Rob Spitzer, vice president of Johnson Bank’s Waukesha office, said. "The multiples are still down. The sellers are still reticent to sell at these prices. I still think there are buyers out there. We are still hearing from those folks that are looking for opportunities."
"I would concur with those observations," Mark Mulloy, president of First Business Bank, Milwaukee, said. "The buyers and/or the sellers may be kind of starting the process, but I think there is a lag from the beginnings of those process to the point where the financial institutions are brought into the picture."
While deals are not close to completion yet, both banks to private equity firms are bracing for busy periods later this year.
"There has been a material increase in activity in the last six weeks," said Ronald Miller, managing director with Milwaukee-based investment banking firm Cleary Gull. "We are having significantly a lot more conversations with sellers and companies that need additional growth capital. I have talked to a lot of my peers and they are seeing the same uptick. We have not had as big of a backlog in the last two years."
A pending increase in deal volume, greater optimism in the market and a willingness among financiers to underwrite a greater percentage of the sale mean multipliers should be heading skyward. Some businesses with strategic importance or high growth potential are seeing multiples as high as seven times EBITDA (earnings before interest, taxes, depreciation and amortization).
"There has been a great lack of activity in the last 18 months to two years," Mulloy said. "Multiples certainly have contracted during this time. It becomes a supply and demand thing. When there is as much uncertainty in the economy as there is a reticence either to sell or to buy at a higher multiple."
But as economic uncertainty becomes less of a concern in the market and among lenders, conditions are more favorable for successful transactions.
"There is almost a feeding frenzy for high quality transactions," Miller of Cleary-Gull said. "There is $100 billion of uninvested private equity capital looking for companies in which to be invested. That is putting pressure on private equity returns. The banks have been extremely conservative in the last couple of years, and we have waited until we were beyond the bottom of the business cycle to increase multiples."
The reticence to follow the upswing in the economy, as well as other factors, have kept multiples from rising faster than they could, according to Cook of Wipfli.
"Prices are generally sticky on the down side," Cook said. "An owner’s perception of the company is not going to decline as fast as market values. But buyers and lenders can experience a similar lag in their thinking."
The gradual nature of the recovery — and the fact that lenders still may not be willing to lend buyers as much as sellers want for their enterprises — mean seller financing will still be an important part of the deal-making process according to several of the merger and financing professionals.
"We will still see some seller financing," Cook said. "It is still very typical to have some form of seller financing to bridge the gap between seller expectations and buyers. But right now it is not uncommon for high quality companies to sell at an excess of seven times EBIDTA if they performed well through the recession."
While prices paid for businesses are not increasing quickly, some businesses are commanding much higher multiples than their counterparts.
"A company that a few years ago got a multiplier of five now might have a value multiplier of four," Wickwire of Mertz said. "That doesn’t mean some companies aren’t going for multipliers of six or seven. It is skewed a little by last year. Some companies were very good and had high multiples."
Some businesses with strategic importance or high-value intellectual property are already selling at higher price points.
"The buyers we have been talking to are looking for businesses that have a proprietary product or proprietary process that gives them some staying power," Spitzer said. "They want that special product or project that insulates them from the economy."
Military- and security-related companies and some building products will be particularly hot as multiples begin to rise, according to Miller.
May 30, 2003 Small Business Times, Milwaukee