Dear friends, colleagues and clients,
Welcome to 2014!
From conversations with many of you about expectations in 2014, there seems to be one word that dominates: UNCERTAINTY. Although you are somewhat happy with the 2013 improvement over 2012 along with the record highs in the stock market, you are still discouraged with government regulations, political uncertainty, future tax rates, economic uncertainty, and access to capital.
In some of those same conversations I often get asked: what does the deal environment look like for 2014, i.e., is it a good time to sell or recapitalize my company? So here goes…
Econ 101 – supply and demand
For businesses in the lower middle market selling for $50 million or less (our core market), we are expecting business values to be very strong in 2014. It comes back to supply and demand. On the supply side, business owners are dealing with a mixed bag of emotions. Many smaller companies still haven’t recovered from the past downturn and are still waiting for better returns and higher values before selling. Yes they are discouraged by the concerns noted above, but many are not quite ready to throw in the towel as they think there are still improvements to be made to help them capture the true value of their business at a later date. And many of those baby boomers with attractive, growing businesses are happy to stick it out another year or two before turning over the keys.
On the demand side, individual investors are generally feeling wealthier due to high dollar portfolios in stocks and bonds, but want higher returns and more diversification into private investments through equity funds – either small family based funds or large private equity funds. In turn, fund managers are pressed and financially motivated to put that money to work, and more of these managers are chasing a limited number of good solid deals coming to market for the reasons previously noted. Combined with continued easing in bank lending and free flowing funds from the SBA, all three categories of buyers in our space are increasing – strategic buyers, private equity and individuals; and chasing fewer attractive opportunities.
As one of my more admired colleagues in the industry put it: “…almost all are looking for companies with scale, defensible proprietary advantages and demonstrated high levels of growth. For those companies, values will be strong.”
If you are on the other side of the equation as a buyer or investor, there may be some good news coming soon in the future. Some believe that the supply demand equation may flip as higher valuations may not be sustainable for smaller businesses. As more of the 76 million baby boomers in the U.S. look to retire, those owning small businesses will need to exit, and those unable to do so during the downturn are feeling more confident about doing it today or next year. And their past “three year performance” looks better – they get to drop off 2010 results as they show 2011 – 2013! Combined with their lack of visibility into the future, budget deficit issues, unemployment and Obama Care, they do not necessarily see brighter days for their business going forward. And they have been educated by brokers and bankers to sell on the uptick rather than wait for a downward trend in sales and profitability.
What about deal multiples?
Based on the 2014 Pepperdine Private Capital Markets Survey, the table below shows EBITDA multiples for the lower middle market companies by size and industry:
Source: Pepperdine University Graziadio School of Business and Management, 2013 – 2014
Average deal multiples on transactions from the prior 12 months as observed by respondents varied from 4.2 to 7.7.
I think it surprises very few to see healthcare, technology and energy high on the list. Financial services and business services are also very strong, partly due to the changing government regulations, taxes, healthcare plans and fiduciary requirements stemming from the changing and uncertain economic and regulatory environment we live in.
The table also shows what most of you already know, i.e. that in this lower middle market segment valuation multiples increase dramatically with size, supporting many owners desire to grow their companies back to “saleable” levels.
Summary
Those owners ready to exit but lacking those positive attributes in their business may want to focus more on growth or transformation of their business in 2014, rather than go to market. Their exit may need to be more of a 2-3 year process than a sale this year, and they should already have a plan in place to do so. Others should look hard at today’s values and do what most brokers and bankers suggest: sell on the uptick rather than wait until the business has leveled out or turned down. Buyers buy the future, not the past!
Closer to home, 2013 was a good year for Transact Capital. We closed 9 sell-side transactions, three buy-side advisories, two major debt placements for clients along with numerous valuation assignments. We expect 2014 to be stronger with several closings already set up for Q1.
Any of us here at Transact would be delighted to sit down with you and share a more detailed look at the deal environment, your business and your industry, along with opportunities we see going forward. If you are an owner considering if now is the right time to exit, we can fill in many of the blanks for you and determine if we can help you meet your personal and business goals.
In the meantime, have a fantastic 2014!
Best wishes always,
Steve Zacharias
Managing Partner
Transact Capital Partners
Office: 804.323.6868 x102
Transact Capital Partners is a full-service business brokerage, mergers and acquisitions advisory firm headquartered in Richmond, VA with offices in Roanoke, VA, Lexington, KY, and Orlando, FL. Transact focuses on the needs of small privately held companies in the lower middle market with enterprise values up to $50 million. With extensive experience in owning, running, or investing in private companies or divisions of public companies, the firm’s principals are able to help many business owners exit their companies or explore other opportunities. Security transactions are offered through Transact Capital Securities, LLC. Member FINRA and SIPC.
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