You’d be forgiven for thinking the mergers and acquisitions market would be upset by the past year of uncertainty, that the prospect of selling your business in this environment might be daunting and any plans you had to exit would have to be delayed.
But many M&A industry experts say the market is strong and conditions favorable for owners considering a sale of their business.
“Valuations have definitely not come down, which I think people were assuming would happen,” said Cheryl Aschenbrener, partner and national leader of transaction advisory services for Illinois-based Sikich. “It peaked a lot of potential sellers’ interest,” she added. “Busy isn’t even the word. We’re on warped speed.”
“We’re back to the seller’s market we had pre-COVID,” said Ann Hanna, managing director and founder of Milwaukee-based investment bank Taureau Group.
“My phone is ringing as much as ever with people wanting to sell their companies,” said John Emory Jr., president of Milwaukee-based investment bank Emory & Co.
“We’re busting at the seams signing up transactions for 2021,” said Tim Oleszczuk, managing director of Milwaukee-based investment bank TKO Miller.
“I’m really optimistic that 2021 is going to be a really nice year from a deal flow standpoint,” said Sequoya Borgman, managing director of Milwaukee-based private equity firm Borgman Capital.
There’s even potential for activity to increase in the coming months.
“Once people get a feeling that their value won’t be greatly impacted by a couple-of-quarter drop, I think you’re going to see this year and next year people saying … ‘now’s a good time to come out,’” said Paul Stewart, co-founder of Milwaukee private equity firm PS Capital Partners.
For business owners thinking of selling their company, or perhaps looking to buy one, the obvious question seems to be why is the market primed for so much activity? The next question might be how long will this last?
The simplest explanation for “why” is money – as in, buyers have it and are willing to spend it.
Combined private equity and corporations have trillions of dollars in capital they are looking to deploy.
Stewart said the collection of capital in private equity is driven by how money is allocated at major gathering points like pension funds, life insurance companies and endowments.
“Those are big pockets of capital out there and they play a diversified strategy for driving returns for the overall management of the capital they have,” he said.
For those looking to balance their investments, private equity offers an alternative investment to use along with bonds and the public stock market, Stewart said, adding that some pension funds are also overweighting in private equity in hopes that higher returns will help them meet anticipated shortfalls.
Corporations and other strategic buyers are also well positioned with executives, owners and boards showing increasing confidence, said Robert Jansen, managing director of Milwaukee-based investment bank Bridgewood Advisors.
“That translates to greater emphasis on making strategic acquisitions, which also drives significant activity,” he said, noting a variety of reasons, from geographic expansion to diversification to new technologies driving corporate acquisition appetites.
There’s also a growing hybrid approach where private equity-backed companies are now looking to do acquisitions of their own to help them grow.
And not all deals need to be funded with cash given the current low interest rate environment. Hanna said debt markets are “very cooperative,” and Borgman said banks are stronger than they were after the Great Recession.
Sellers are also contributing to what many expect to be an active year.
For starters, there is pent-up supply as companies that considered selling in 2020 return to the market this year having weathered the COVID storm.
“It’s generally known that it’s a good market. … Values are about as high as we’ve seen them, so sellers (are) understanding that there’s a lot of demand in the market. We believe they’re going to choose to come to market now versus three years from now,” Hanna said.
Jansen said his buy-side clients are drawing a different response when approaching businesses that are not necessarily for sale.
“What we’re finding is the motivation of that business owner and interest in at least entertaining a conversation is greater than it was a year ago,” he said.
The profile of a typical seller has changed over the past five to seven years, Oleszczuk said. In the past, sellers were founders or owners in their early 60s and looking ahead to retirement. Now, more sellers are coming to market in their late 40s or early 50s.
“A lot of them are not thinking about their business as their legacy but maybe the value of their business as their legacy,” Oleszczuk said.
The COVID-19 pandemic has accelerated the trend and pushed more people to think about selling in general.
“It’s caused people that never really think about selling their business to start having discussions,” Oleszczuk said.
A year ago, of course, the market was just entering the COVID-19 pandemic and most M&A activity ground to a halt. Tom Kintis, president of Pewaukee-based CGK M&A Advisors, figured he would be taking the summer off after COVID hit, but 2020 ended up as a record year for him.
Hanna said after being down significantly in the second quarter, the M&A market bounced back in the second half of the year. Ultimately, deal value was down about 21%, and deal count declined 5% from 2019 levels, she said.
“The deals that got done were generally premium, high-quality deals. They were strategically motivated, they were in industries that were not negatively impacted by COVID or they were in industries that had a quick or clear path to recovery,” Hanna said.
Aschenbrener said one benefit is that COVID helped shine a light on companies, highlighting strengths and weaknesses that may not have been obvious otherwise. Some changes or issues may be permanent while others are temporary.
“All you can do is ask the questions and try to figure out what that forever change is,” she said. “The best thing you have to go on still is history.”
Emory said for many industries it is “pretty clear” if they are doing well despite the pandemic.
“Buyers are comfortable paying big prices for companies that are expected to benefit from the changes to the economy,” he said.
COVID-19 did throw a wrench into the financials of many companies, with massive fluctuations in at least one quarter of the past 12 months. The question is: How should those financials be normalized for the purpose of valuing the business?
One option is to substitute 2019’s second quarter for the same time in 2020 when the economy was shut down, Stewart said. Or a company could use its planned 2020 performance if executives can demonstrate the validity of that plan and a track record of delivering.
“There’s a couple of ways to piece together the logic flow for what is sort of the normalized earnings of (2020),” Stewart said, noting that private equity wants to get comfortable with the logic and identify systemic changes to the business.
“Buyers are really looking to see where the company is trending to get a better understanding of value,” Hanna said.
A business’ experience with COVID and 2020 generally falls into one of several buckets, Oleszczuk said.
Some were beneficiaries because they made personal protective equipment or an in-demand product for consumers stuck at home. Owners of these businesses may be thinking they can capture a premium for their company as they come off a record year. Oleszczuk said that is possible, but the window may close if the pandemic is brought under control.
Those with little or no impact from COVID-19 make up a second group and can benefit by going to market without a major swing or question mark in their operations, taking a risk factor out for buyers.
Companies hit hard by COVID fall into two other groups. Those seeing some return in their business might be looking to get out after surviving a stressful year. Oleszczuk said that with a good strategy and the ability to quantify what happened during 2020, sellers can still capture a similar value to what they would have seen pre-pandemic.
“Buyers are fairly forgiving,” he said, cautioning they will still look at a business closely.
That leaves the final group, those hit hard by COVID with no expectation the business will return to normal levels.
“They’re kind of facing the grim reality of ‘maybe I should have thought about diversifying some of my wealth or selling my business earlier,’” Oleszczuk said.
The plight of these business owners is not just on the minds of those hit hard during the pandemic.
“Frankly, that type of impact is what we’re seeing filter through all these business owners,” he added.
After last year, business owners do not need a reminder of how quickly the economy and world events can change. Still, most signs seem to point to the strong M&A market continuing.
“If I were to have a crystal ball, I’d predict the market is going to stay strong for a couple of years,” Hanna said.
“If anything, all the factors that we’ve been seeing pre-COVID for many years, in many ways, several of those factors are even better now,” Jansen said.
An economic downturn or an increase in the cost of money could dampen the market, and Hanna pointed out that while things seem good, “no one anticipated a worldwide pandemic.”
“Things can change so quickly and by the time they’re changing it’s too late,” she said.
There is one looming factor that may alter the M&A market this year. During the election, President Joe Biden campaigned on increasing the capital gains tax rate from 20% to 39.6% on those making more than $1 million annually. The change would mean business owners need to sell their company for a lot more just to see the same proceeds.
Some deals pushed to close in the final months of 2020 to avoid the possibility of the tax increase being applied retroactively, Kintis said.
What’s unclear, however, is if or when the tax increase might come up in Congress and how it would be structured.
It seems unlikely it would be applied retroactively to the start of 2021, but an increase for 2022 is possible, Oleszczuk said.
How the increase takes place – all at once or in multiple steps over a few years – could also shape how it plays out in the market, according to Stewart.
“It’s not going to change someone who says ‘I’m going to work for another five years, no matter what,’” he said. “But if someone is thinking ‘should I go now or should I wait another couple years?’ That may be enough of a motivator to make them move.”
For owners thinking about selling, closing a deal just after taxes increase would be far from ideal, but rushing to get a transaction done before a hike kicks in could also cause problems.
There are, however, several steps a seller can take to prepare for a potential sale.
Aschenbrener compared the process to painting or improving landscaping before selling a house, advising owners to address potential skeletons early and clean up books and machinery. Limiting potential issues will help the process.
“Time kills all deals,” she said.
Borgman pointed out that unlike selling a house, selling a business can be a long process.
“You have to start thinking about it years before you actually sell the business,” he said.
Hanna said sellers should start formulating answers to questions about the business’ performance during COVID and opportunities for growth.
“Any buyer is going to want to come in and understand ‘where are my growth opportunities,” she said, suggesting an owner identify the top five things they would pursue if they were continuing in the business another 20 years.
Emory said it may be worth investing in higher quality financial statements and to keep better records generally. In addition to de-emphasizing the owner’s daily role, he suggested strengthening the next level of managers and considering noncompetition agreements that a buyer might seek from key employees.
He also said it is important to continue running the business as normal and to not skimp on capital expenditures, albeit with a caveat: “Be thoughtful about whether you make a big capital investment with a long-term payoff because you might not get that back in the purchase right away.”
Oleszczuk said that whether a sale is in an owner’s plans for the next several years or they haven’t considered selling, they should at least give it some thought now given the current market.
“You can’t always control what is going on in the marketplace and so the time when you think it’s best to sell might not be what the market thinks,” he said, noting a business doesn’t have to hit the exact peak and it may be better to be a little early rather than a little late. “Now is certainly as good a time as any and it may not be as good a time as any in the next three to five years.”
