Merger and acquisition (M&A) activity was very strong in 2017 and 2018 has been even more robust. Most closely held businesses have substantially enhanced their balance sheets since the recession and are now experiencing record years for profits and revenue. Many also have excess working capital that can be deployed to acquire competitors and/or key suppliers.
Smart Business spoke with David E. Shaffer, CPA, director of audit and accounting at Kreischer Miller, to get a breakdown of M&A activity in the market, what’s driving it, who is realizing success and why, and how business owners can capitalize on the opportunity.
What are some of the factors driving the increase in M&A activity?
- Interest rates are still very low, by historical standards. As a result, the cost of capital remains low. Since many believe that interest rates will continue to rise, the cost of this capital could become more expensive in the future.
- Company balance sheets seem much stronger than they have been historically and owners are actively looking for opportunities to enhance their return on invested capital. There are really only four choices to deploy excess capital: pay a dividend to shareholders, buy back stock, invest in internal expansion, or merge with or acquire another business.
- Many privately-held businesses lack a succession plan. As such, aging owners may be forced to look at third-party acquisitions.
- Private equity firms are actively looking for targets to purchase and established companies to sell. During the first half of 2018, private equity completed 2,247 deals with an aggregate transaction value of $263.9 billion.
- The Tax Cuts and Jobs Act increased expected 2018 cash flows for C-Corporations and most S-Corporations. So, owners are looking for the best opportunities to put this additional capital to work.
- Technology continues to improve efficiency and profits. Plus, companies with unique technology are especially attractive to buyers.
- Business friendly legislation and policy changes are reducing the risk to potential buyers.
- M&A can be an attractive option for owners who want to expand geographically, diversify their customer base, or expand their products or services.
What are business owners currently experiencing in M&A deals?
- Purchase prices are increasing over historical levels. Larger, well-managed companies are selling at multiples in excess of seven times EBITDA.
- Companies with unique technologies are fetching higher prices. Anything that provides a buyer with a competitive advantage over other suppliers is highly valued.
- In most transactions, either the buyer or the seller (or the bank) is procuring a quality of earnings report. These reports are prepared by an independent professional and provide an objective assessment of the accuracy and quality of historical earnings and assets, as well as the sustainability of earnings in the future.
- Deals that are from a ‘book’ or have gone to multiple companies for potential purchase usually do not get purchased by private companies or families. Instead, a private equity firm will typically acquire these companies, since they are more willing to pay a higher multiple and assume a greater degree of risk.
- Banks are looking to finance these transactions. Many companies have satisfied their equipment and IT needs, so there is not a lot of loan growth and banks are seeking other ways to deploy their cash in order to maintain profitability.
Successful acquisitions require effective integration, accurate valuation in determining the purchase price, sound due diligence, and a clear understanding of the cash flow risks.
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