Last month Firmex, a leading provider of virtual data rooms and Mergermarket, a leading proprietary M&A intelligence vendor, released a fascinating analysis of factors currently impacting middle-market dealmaking. The two organizations assembled a panel of experienced dealmakers, equity firm professionals, and legal advisors to get a pulse of where the market for transactions is now and where it is heading through the end of the year.
Most interestingly, from the perspective of the panelists, one of the major issues impacting deal closings during the first part of this year has been a growing valuation gap between sellers and buyers. This tends to happen during “seller’s markets” as business owners with profitable, well run companies tend to hold out for the best offer as opposed to “buyer’s markets,” where a scarcity of buyers causes sellers to take any offer that comes their way. This is how a couple of the folks on the panel described the situation:
Joseph Feldman, President, Joseph Feldman Associates - From my perspective, the responsibility for the valuation gap is probably more on the sellers’ side than on the buyers’ side. In my discussions with business owners over the last year, fairly often I’ve encountered what I would say are unrealistic expectations about valuation multiples.
Andrew Lucano, Partner, Seyfarth Shaw - I definitely agree that there is a valuation gap going on. The biggest factor is that sellers’ expectations have been raised very high, as Joe mentioned, because they’re looking at the multiples in these mega-merger deals and then trying to apply those same multiples to their middle-market companies. But it doesn’t really always translate.
Andrew Hulsh, Partner, Pepper Hamilton - The current valuation gap that we’re seeing lately has resulted primary from the substantial competition among private equity sponsors and strategic buyers for high-quality investments and companies and the availability of relatively inexpensive financing.
This trend is both good and bad news for owners of middle-market businesses. On the plus side, significant buyer interest is creating substantial competition right now for good deals. The key here is the word “good.” Even with competition and relatively inexpensive financing available, professional buyers are still being selective and are doing extensive ROI (return on investment) analysis prior to making any acquisition.
Which leads us to the bad news: the valuation gap. And based on the input of the folks on the panel, which is obviously skewed from the buyer’s side of the equation, unrealistic valuation expectations on the part of sellers is the primary cause of the gap.
We have seen this time and time again in seller’s markets from the first year M&A statistics were kept. As the market heats up and demand for deals rises, so too do the expectation on the part of sellers to obtain top dollar for their businesses.
This is why the proven Generational Equity M&A process begins with a complete and thorough evaluation of a client’s business. Not only does this step allow us to determine the current business enterprise value, it also enables us to ensure that our client(s) have a realistic expectation of a value range prior to going to market. This is very, very important. Not every client agrees with our estimate of value. However, it does give each an important measurement of where the value most likely will end up.
If you are a business owner and will be approaching buyers without professional M&A representation, you need to be aware that there are some strategies you can use if offers you are getting are lower than what you think is fair (within reason of course). Be aware that each of these has some downside risk intrinsic to them, according to the Firmex and Mergermarket report:
Andrew Hulsh, Partner, Pepper Hamilton - There are three primary ways that sellers and buyers are able to effectively close the valuation gap and get a deal done. The first way is to structure a portion of the purchase price as an earn-out. The second is by requiring an even higher proportion of management equity rollover. So, where in the past we might have seen 15%-25% of the total equity rolled over by existing management one way to share that risk is by requiring management to roll over substantially more of their equity – for example, from 25% to as much as 45% of their equity in the target company. Finally, the third way is bringing in co-investors – taking a lesser portion of the entire transaction by bringing in co-investors.
Joseph Feldman, President, Joseph Feldman Associates - One way that I’ve seen the gap bridged is through a contingent payment. When a valuation gap is based on specific exposures, for example, we’re also seeing more deals done that have a general escrow and then a situation-specific escrow.
Essentially, one way to bridge a valuation gap with your transaction is to cross it via contingencies. That means you shoulder part of the risk of the success of the post-acquisition entity. And, if you are willing to accept this risk, agreeing to structure in a deal can actually provide you with an opportunity to obtain more for your business over the longer term.
If you have wisely hired a professional M&A firm, they will work diligently to help you achieve your personal financial goals in any deal created. If you are on your own, it is wise to learn as much as you can about deal structure before beginning negotiations with buyers. A great place to start your education process is by attending a Generational Equity exit planning workshop. The investment of a few hours of your time will reap tremendous benefits for you in the long run. Attendees of our seminars report that the information they learn surpasses what they anticipated and that they are much better positioned to close a deal with an optimal buyer.
Most importantly, listen to the market and its indications of value. If the offers you are receiving are all in the same valuation range, and this range is below your expectations, it would be wise to realize that perhaps professional buyers are telling you something: Your valuation hopes may be too high.
Carl Doerksen is the Director of Corporate Development at Generational Equity.
© 2016 Generational Equity, LLC. All Rights Reserved.
The information we learn from customers helps us personalize and continually improve your experience. Here are the types of information we gather.
We receive and store any information you enter on our Web site or give us in any other way. We do not sell or rent your personal information to others without your consent. We use the information we collect only for the purposes sending promotional information, enhancing the operation of our site, serving advertisements, for statistical purposes and to administer our systems. We DO NOT use third parties to provide customer service, to serve site content, to serve the advertisements you see on our site, to conduct surveys, to help administer promotional emails, or to administer drawings or contests, but reserve the right to do so in the future without advance notice.
Generational Wealth Advisors’ affiliates are all part of one corporate family, they work with one another and may work together to provide services to you. The sharing of your information among affiliates enables Generational Wealth Advisors to serve you more efficiently and makes it more convenient for you to do business with Generational Group. Generational Wealth Advisors is permitted by law to share information with its affiliates. All of our affiliates follow similar privacy policies.
For reasons such as improving personalization of our service, we might receive information about you from other sources and add it to our account information.
Generational Group may license the use of its intellectual property including but not limited to its name, likeness, and logo for the use of affiliated offices. Such affiliated offices may not be owned, controlled, managed, supervised or staffed by employees, officers, or agents of Generational Group. Affiliated offices may be independently owned and operated. For more information about a particular office, please contact Generational Group at its office in Dallas, Texas.
This page may contain other proprietary notices and copyright information, the terms of which must be observed and followed.
Information on this web site may contain technical inaccuracies or typographical errors. Information may be changed or updated without notice. Generational Group may also make improvements and/or changes in the products and/or the programs described in this information at any time without notice.
Generational Group does not want to receive confidential or proprietary information from you through our web site. Please note that any information or material sent to Generational Group will be deemed NOT to be confidential. By sending Generational Group any information or material, you grant Generational Group an unrestricted, irrevocable license to use, reproduce, display, perform, modify, transmit and distribute those materials or information, and you also agree that Generational Group is free to use any ideas, concepts, know-how or techniques that you send us for any purpose.
Our computer system protects personal information using advanced firewall technology.
Information Generational Group publishes on the World Wide Web may contain references or cross references to other products, programs and services that are not announced or available in your country. Such references do not imply that Generational Group intends to announce such products, programs or services in your country. Consult a Generational Group representative for information regarding the products, programs and services which may be available to you.
Generational Group makes no representations whatsoever about any other web site which you may access through this one. When you access a non-Generational Group web site, please understand that it is independent from Generational Group, and that Generational Group has no control over the content on that web site. In addition, a link to a non-Generational Group web site does not mean that Generational Group endorses or accepts any responsibility for the content, or the use, of such web site. It is up to you to take precautions to ensure that whatever you select for your use is free of such items as viruses, worms, Trojan horses and other items of a destructive nature.
IN NO EVENT WILL Generational Group BE LIABLE TO ANY PARTY OR ANY DIRECT, INDIRECT, SPECIAL OR OTHER CONSEQUENTIAL DAMAGES FOR ANY USE OF THIS WEBSITE, OR ON ANY OTHER HYPERLINKED WEBSITE, INCLUDING, WITHOUT LIMITATION, ANY LOST PROFITS, BUSINESS INTERRUPTION, LOSS OF PROGRAMS OR OTHER DATA ON YOUR INFORMATION HANDLING SYSTEM OR OTHERWISE, EVEN IF WE ARE EXPRESSLY ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
Furthermore, all information contained within this website is the property of Generational Group.