As we get to the close of the year we can look back and see – definitively – that it’s been a great year for deals in the lower middle market. From our point of view all metrics are positive: closings? Check. Full pipeline? Check. Time to closing? Getting shorter. LOI’s per deal? Robust. Aces, right? Of course now we turn our attention to FY18 and start thinking about the economy, the Administration, and myriad other issues. So will 2018 treat us well? #youbetchya #YearOfTheDeal #OneProblem (Here’s why –>)
We’ve got three overarching themes that will continue to drive the M&A market in 2018… and one concern.
Stock Market. We work in the private capital markets – i.e. we only work on deals and engagements with privately held companies – so the tendency is to ignore the stock market. And while true in some regards, the stock market sets the tone for much else. On one hand, with stock prices at record highs it means that public companies can purchase privately held companies at increasingly high multiples and still be accretive to earnings. While this doesn’t fully translate to the lower ends of the middle market (i.e. where its less likely a large or mid-sized PubCo will purchase), there still is a competition effect that increases multiples. Takeaway? This is a win for sellers.
Interest Rates / Debt Market. Most transactions have a debt component. And guess what? Cheap debt makes acquisitions more attractive.
That’s the One-year LIBOR chart since 1986. Note that we are going into approximately year 10 of a historically low-rate environment. This is good for the M&A market. What’s more: competition for deals amongst lenders remains stiff, and banks remain open to financing transactions. Takeaway? This is good for sellers.
Dry Powder. “Dry Powder” is what the Private Equity folks call those funds that they have committed but not invested. This is not good for the Private Equity Folks: they are in the business of deploying capital and generating returns…. not sitting on capital. And the amount of dry powder is not inconsequential: nearly $1 Trillion (See Forbes from last quarter). The biggest issue for such investors is finding the right deal. (Related: this is also why we have a focus on Exit Planning. Want to grab a piece of that $1 Trillion? Stand out from the crowd and get positioned for a deal.) Bottom line, though: there is equity capital available for deals. Takeaway? This is good for sellers.
Economic Cycle. Uh oh. This is the thing that we are nervous about. According to the National Bureau of Economic Research there have been 11 economic cycles since 1945. The last cycle “officially” began in June, 2009. The average cycle? Just under 6 years. For those following along, we are now well into overtime on this cycle. With interest rates rising and perhaps some “irrational exuberance” at play in the stock market, it’s fair to wonder when this plane is going to land. Experience from the last down turn suggests that it will take a good 2-3 years for the deal market to recover back to the point before the dip.
Takeaway? Wheels up, owners.
If you are considering an exit in the next 3-4 years… then wheels up, owners. Time to get this show on the road while you can. We’ve got a confluence of great events right now, but we’ve also got some pretty big concerns about how long this is going to last. Most M&A deals take the better part of a year to mature and get to a closing- factoring in 3-4 years to get back to break even, the decision becomes “exit now, or exit in 2022?” So yeah, if you are thinking of a transaction, it’s the #YearOfTheDeal for sure.