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Seller’s Market Driving Valuations Up for Lower Middle Market Businesses

By Generational Equity

10/01/2018

The reality of supply and demand is truly impacting the M&A market right now:

There is too much capital chasing too few companies!

According to a recent article in the Indianapolis Business Journal, the M&A market is so hot that some prospective buyers say they're interested in a purchase, but they're too busy at the moment with other acquisitions. We are hearing the same thing from many buyers we are dealing with.

The great news for owners of privately held companies is that all the buyer activity is helping to drive valuations up above historical levels. According to International Business Brokers Association, M&A Source, and the Pepperdine Private Capital Markets Project, in the first three months of the year, the typical purchase price was 6.1 times EBITDA for a company valued between $5 million and $50 million. That's up by more than a third from four years earlier.

Lower Middle Market Business Values Accelerating in the Seller’s Market

Let the last part of that paragraph sink in for a moment. Four years ago companies in the lower middle market were selling for 33% LESS than they are in 2018. That is a significant increase in valuations overall.

Keep in mind that this is an average based on deals with disclosed values. So it is not a huge sample size, since most transactions in that range have no financial details disclosed.

And, it does not guarantee that you will be able to get a valuation of that size for your company when you decide to exit, because value is affected by the quality of your business, its potential growth, and profitability compared to other companies in your industry.

However, it is a good indication that if your business is buyer ready, and you personally are also prepared to create some form of exit plan, now is a fantastic time to enter the M&A market.

How Do You Create a Buyer Ready Business?

A business that is buyer ready is one where the operations of the business have been built in such a way that the risk that buyers perceive is lower when compared to similar investment opportunities.

Right now buyers are competing against one another to locate and close deals for companies that are on the path to being buyer ready. There is so much activity/interest in lower middle market businesses that even companies in need of improvement are achieving higher valuations than they would in a typical market (like four years ago and the pending “buyer’s market”).

Because the sad reality is that as with all other market cycles, seller’s markets can quickly reverse as they are largely driven by buyer confidence in the future and are thus dramatically and directly impacted by economic fluctuations. For example, eventually interest rates will reach a level where the cost of capital will put a brake on business valuation calculations, since the ROI on the investment will justify a lower valuation.

Another factor to keep an eye on is the yield curve. As we discussed in a past post on this topic, the yield curve is the difference between interest rates on short-term United States government bonds, say 2-year Treasury notes, and long-term government bonds, like 10-year Treasury notes.

Typically, when an economy seems in good health, the rate on the longer-term bonds will be higher than short-term ones. The extra interest is to compensate, in part, for the risk that strong economic growth could set off a broad rise in prices, known as inflation. Lately, though, long-term bond yields have been stubbornly slow to rise — which suggests traders are concerned about long-term growth — even as the economy shows plenty of vitality.

At the same time, the Federal Reserve has been raising short-term rates, so the yield curve has been “flattening.” In other words, the gap between short-term interest rates and long-term rates is shrinking. When these two indices cross, when the curves are inverted, history shows a recession soon follows.

Don’t Miss This Incredible Seller’s Market – Prepare Your Exit Strategy

Now, halfway through 2018, according to The Times:

The gap between 2-year and 10-year United States Treasury notes is roughly 0.34 percentage points. It was last at these levels in 2007 when the United States economy was heading into what was arguably the worst recession in almost 80 years.

These are just two factors that can quickly halt an M&A seller’s market and drive business valuations down.

The sooner you make a move to get started on your exit plan, the closer you will be to receiving maximum value for your company.

If you would like to learn more about other factors driving company valuations up today and scenarios that may turn the tide in the other direction, you should attend a Generational Equity exit planning conference. Held regularly throughout the U.S. and Canada, these meetings enable you to bolster your knowledge of the M&A process and better plan your exit. They are very educational and come highly recommended by business owners:

To learn how you can attend a conference near you and find out how you can take advantage of the current seller’s market, please call us at 972-232-1121 or visit our website, provide us with your contact info, and we will be in touch.

By Carl Doerksen, Director of Corporate Development at Generational Equity.

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