Middle-Market Mergers & Acquisitions Holding Steady In 2013

Begin Planning for an Exit

by Terry Stidham, President of Target Search Group

The middle-market for Mergers & Acquisitions has significantly improved in the past two years according to The Babson College Middle-Market/Small Business Mergers & Acquisitions Survey conducted by the business school’s MBA students in the first quarter of 2013.

Yet according to the report, growth in 2013 will be flat versus 2012 because of a stalled economy, challenges in Washington around tax and estate issues, hesitation by business owners to relinquish, and the gradual recovery in the debt market.

The Babson Survey directed by Babson College Professor Kevin J. Mulvaney in collaboration with members of the Association for Corporate Growth (ACG) and Exit Planning Exchange (XPX), assesses and defines current trends that impact buyers and sellers of businesses. The survey population included leading national middle-market investment banks, large business brokerage firms, advisory professionals, and commercial bankers.

The M&A environment for both small and mid-sized business exits or recapitalizations is stable and may improve in the coming years,” commented Mulvaney, “ It is a very good time for entrepreneur owners to begin planning for their capital event.



Among the survey’s key findings:

Middle-Market Volume is Strong - Small Business M&A Activity Grows at a Slightly Slower Pace

• The volume of middle-market deals is steady and a majority of respondents project a continuation of the current level through the rest of the year. Only 20% of respondents foresee volume increases as the year unfolds.
• Services industry sector remains the strongest with increased activity reported in e-commerce, health and medical services, and aerospace and related industries.
• The small business arena is growing more slowly (an average of 0.5 times increase in EBITDA valuation over 2012) with no expected rise this year in valuations.
• The environment for M&A activity is about the same as a year ago. Babson authors project an increase in the number of private equity buyers in the next eighteen months because of increased debt availability on more acceptable terms.
• Underperforming or weak companies are not viable deals and receive lowball offers and very little interest from financial buyers. The market is willing to pay a premium for revenue growth potential and predictable EBITDA performance.

Buyers Demand High ‘Seller Assistance’ for Smaller Companies

• The percentage of seller assistance (earn outs, deferred money, etc.) continues to be high. The smaller the company (on a $1-100MM survey scale) the higher the demands for seller assistance from the buyer.
• Good news for sellers – the deferred component of the purchase price has dropped from an average of 30% to 20%. The survey also found that sellers are beginning to dig in their heals demanding a larger component of cash up front.

Timeframe to Complete Deals Lengthens

• Due diligence by buyers who have concerns about a sluggish economy and perceived challenges to building revenue will increase deal-making timeframes by a month (formerly 6-9 months). Strategic buyers are also organizing more outside expertise than ever before to prepare their due diligence reports.
• Sellers need patience and must be prepared with information and the ability to respond quickly to buyer requests to increase chances of closing deals within six months. Like buyers, seller success is dependent on acquiring the right legal and deal-making expertise.
• It is still a seller’s market for quality companies. Whether selling or restructuring capital, sellers must develop a knowledgeable game plan to evaluate options and potential deal partners.

Financing for Buyers Grows and Terms Improve

• More financial lenders are making loans with terms that represent a fair balance between what the lender and borrower feel is acceptable.
• The Babson survey projects an increase in the number of opportunities for every type of middle-market financing. This is good news for private equity buyers when balancing leverage versus equity contributions for new M&A deals.
• For smaller deals, there has been a strong rebound in SBA loans especially from community banks, that will help contribute to the growth of small business deals moving forward.
• Surprisingly, the survey found an increase in the percentage of equity needed by qualified buyers of small businesses. This had been a minimum of 20% but some experts see an increase to a minimum of 25%. The increased equity demands from lenders may have contributed to the slow growth of small business sales.
• Middle-market stability is reflected in increased pressure on pricing for financial institutions involved in M&A deals. Yields on mezzanine debt dropped to 12-14% from historical averages of 15-20% and financing costs declined as the volume of financial buyer deals increased.

Generalist Funds Prevailing

Capital is Available for Funds that have Delivered Strong and Consistent Results

Mary Kathleen Flynn with Source Media recently wrote the following post on how firms like Huron Capital Partners are going against the common wisdom of the last few years that generalist funds were waning.

“Huron Capital Partners LLC is among a handful of private equity firms that have recently raised new generalist funds, going against the common wisdom of the last few years that generalist funds were waning. At $500 million, Huron Fund IV is the Detroit firm's biggest fund to date. Like Huron's previous funds, it will make control investments in lower middle-market companies.

The fundraising climate today is "tough overall," reports partner Gretchen Perkins. "But capital is available for funds that have delivered strong and consistent results."

Although the firm raised funds quickly - fundraising began in October, and the fund closed in December - the process was more challenging than it had been for the previous fund, which was raised during the exuberant market of 2007.

"Limited partners are much pickier today," explains Perkins. "They conduct a far greater level of due diligence, and it requires more resources internally to respond to all of that."

Huron went into the process well prepared, Perkins says. "We found that great LPs were prepared to move, with lots of detailed, comprehensive backup."

The firm added some new investors, as well as retaining past investors.

The new fund will invest in companies with the same criteria as previous funds, without a focus on particular industries. "While we do invest in a range of industries and sectors, we do focus very specifically on solid companies where we believe we can improve operations to create value," explains Perkins about the firm's investment thesis.

"We will continue to invest $10 million to $50 million of equity in lower middle-market companies in the new fund. Additionally, we can invest up to $100 million and, therefore, close deals with no outside financing."

The last three businesses that Huron has invested in from its third fund are "representative of the types of businesses in which we will continue to invest from our new fund," she says. These include Six Month Smiles, a provider of cosmetic orthodontics; Ronnoco Coffee, a coffee roaster and distributor; and Bloomer Plastics, a producer of engineered plastic films.

When asked how the dealmaking environment is shaping up in 2013, Perkins responds, ‘I would say stable. We are closing on three companies now, which is on pace with 2012."’

Terry Stidham is the founder and principal of Target Search Group. He is a B2B Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment.  He has served as the head of entrepreneurial organizations as well as Fortune 500 companies.  He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions.  Mr. Stidham has been instrumental in aiding thousands of business owners prepare their businesses for eventual sale by teaching them how to maximize efficiencies in operations leading to significant increased cash flow.