M&A market marked by irony, paradox

The M&A market does not usually respond well to times of uncertainty. Buyers shows signs of hesitation during an election year, uncertain about the future of the economy or taxes. But in Q3 2020, in a time of uncertainty on top of uncertainty, we’re seeing record amounts of buyer interest.

A market marked by declining seller confidence has, ironically, led to increased business values—driven by the pandemic-resistant businesses that are leading sales.

Here at Cornerstone, for example, we recently fielded 28 written offers for one northeast Wisconsin company. That’s the most I’ve seen in my career, and I’ve heard from peers across the country who are seeing a similar phenomenon. Several different market studies, out this quarter, explain why.

The issue is largely one of supply and demand. Business owners, believing that the pandemic can’t possibly be a good time to sell, are holding back. And that imbalance is driving up values. Here’s what we’re seeing in the market right now:

Lack of quality deal flow:

According to BizBuySell’s 3rd quarter Insight Report, owner confidence fell to a low score of 45 (on a scale of 100), down from 52 in 2019. Owners believe they would have received a better value if they had sold last year.

However, there’s plenty of interest in pandemic-proof businesses, i.e., those that have made it thus far relatively unscathed as well as those that were able to bounce back or adapt.

According to the 3rd quarter Market Pulse report, sponsored by IBBA and M&A Source, lower middle market businesses valued at $5 million or more received an average of 105% the internal benchmark price set before going to market. And businesses on the smallest end of the market, those valued under $500,000 received 90% of their asking price in Q3, a one percentage point increase over Q3 last year.

The BizBuySell Insight Report shows similar results, as the median sale price of businesses sold in the 3rd quarter grew 20% over a year ahead.

Buyers staying resilient through the recession:

Private equity groups are still sitting on record levels of cash that they need to put to work in the marketplace.

A report from Morgan Stanley shows that, in the past two decades, private equity funds that started deploying cash after a crisis (dot-com and the Great Recession) performed 68% higher than those that acted during late-cycle peak economic growth. Those lessons are likely spurring investors to act.

CARES Act incentives sparked action: 

Pandemic recovery incentives drove business acquisitions in Q3. The SBA is covering six months of principle and interest on 7(a) acquisition loans that were completed before September 27. This program helped move Main Street businesses across the finish line.

Buyers pmped the breaks after the pandemic hit. The Market Pulse report shows that time to close grew 60 days to an average of 8 or 10 months in Main Street sectors. Those delays likely reflect the temporary pause in deal making we saw this spring.

Main Street buyers looking for a job:

In addition to the CARES Act, unemployment is pushing some new buyers to market. According to BizBuySell’s 2020 Small Business Confidence Study, 27% of Main Street buyers are newly unemployed and looking for more control of their future.

Deal teams aren’t traveling:

COVID-19 has changed work norms, but rather than delaying deals it could be accelerating them. Buyers are at their computers rather than flying across the country to scope out deals in person. That, combined with an overall reduction in quality opportunities, means buyers are easier to reach and more responsive to communication.

The takeaway is, if you’re doing well through the pandemic, this may still be an opportune time to exit your business. Pandemic-proof businesses that are performing well are still sought after and, due to their popularity, are getting better values than a year ago.

However, if your performance has suffered, and you have enough cash to make it through, you may be better off holding until your business recovers. If you don’t have cash reserves to hold you, talk to your advisors about whether you’re better off selling now, before you experience further declines.

 

By Scott Bushkie