New Data Drives M&A Valuations to Cyclically High Levels

Posted by John Slater on October 2, 2012


Recently the Wall Street Journal published an article entitled “The Economy Stole My Retirement”. The subcaption reads “Nest Eggs In Peril For Millions Of Entreprenuers in Their 60s And 70s Who Can’t Sell Their Companies”.

Over the years we have met many business owners who just assumed that if they waited long enough a perfect buyer would come along, offer them a great price for their business and pave the way for a timely and comfortable retirement. According to the Wall Street Journal article “Boomer entrepreneurs grew up believing in the American dream that you start a business and eventually sell it for a good return or pass it on to your kids.”

With stagnant revenues and declining profits the norm for many small businesses since the financial crisis, the sad fact is that for many business owners there just won’t be a buyer.  Even worse far too many business owners who receive a serious offer for their firms will make the fatal mistake of assuming that, if they received one good offer, they will receive more and have the luxury of waiting until sale is more convenient or the price is higher.  Many of those owners will regret that decision dearly.

After three+ years of economic recovery, we are at a point in the financial cycle that may soon provide many Baby Boomer business owners with the best opportunity they may see for selling their businesses at a good valuation. For good companies in many industries, earnings have in fact recovered significantly. In favored sectors such as aerospace manufacturing and various technology disciplines, buyers are willing to pay multiples for top performers that compare favorably with those of the mid 2000s when large middle market firms routinely saw offers in high single-digit or even double digit multiples of EBITDA.

Memories are short. We’ve been in the M&A business for the past 30 years. For much of that time this has been a highly cyclical business and even the best private companies rarely sold for more than four or five times EBITDA.

Low interest rates and the lack of good investment alternatives have driven the M&A market to historically high valuation levels in the 2000s.  There are many reasons to believe that future conditions may not be so favorable.

  1.  Since World War II the average economic recovery in the US has lasted 63 months. The current recovery began 39 months ago.  Thus we have on average 24 months before the economy again slips into recession.  We’re in the most anemic business recovery of the post-war era.  What does that portend for the timing and severity of the next recession?
  2. Capital gains taxes are set to increase January 1, 2013. Many observers expect the Bush era tax cuts be extended for 6 months while Congress hashes out some form of fiscal compromise. This would provide a nine-month window in which business owners can sell at the current low capital gains tax rates.  Miss that window and you will likely have missed it for a lifetime.
  3.  Interest rates are at the lowest levels ever seen by most Americans. Business valuations carry an inverse relationship to interest rates. When rates rise valuations will decline.
  4.  Many industries are in the midst of radical technological change. Companies that do not have the wherewithal to adopt new cost-saving technologies will be left behind. Its far better to sell when profits still exist than to wait in hope of a better tomorrow.

Pitchbook maintains some of the best data on Private Equity.  They have just published two reports demonstrating that this is a very healthy period for business sales.  The first report shows purchase multiples for a large number of private equity deals closed in the second quarter of 2012.

Per Pitchbook key findings from the survey include:

  • The average EBITDA multiple for all deals (excluding negative values) is 7.0x
  • The average TTM revenue multiple for all deals is 1.4x
  • Firms used an average of 42% equity, 34% senior debt, and 24% non-senior debt in deals
  • The average time to close a deal was just under 5 months (19.2 weeks) Per the data above, for sound middle market companies the M&A market is back to the strong purchases of the mid-2000s.  While we are not yet back to the over the top valuations for big companies of 2006-2007, a middle market company with EBITDA of $5 million+ should find a very receptive market from a valuation perspective.

The last time I wrote an article on this subject was 2005.  You can download it at by clicking on this link.  In that article I indicated that 2005 might prove to be a watershed year for business owners who were considering sale.  The valuations described in that article are eerily similar to the Pitchbook numbers for 2012.  We were a bit early in our 2005 prediction; high valuations continued for a couple more years, but the mid-2000s proved to be a uniquely favorable period for middle market business sales.  I remember advising a large kitchen cabinet manufacturer whose business was growing rapidly at the peak of the housing boom in 2005 that he had a once in a lifetime opportunity to sell.  Unlike many of his competitors he’s still in business, but my guess is that he may regret his decision to not sell.

Most likely the party will continue for a while as it did in the mid 2000s.  Per the second Pitchbook report on Private Equity Fundraising efforts, there as signs that fundraising activity has begun to pick up.  This time around it does not appear that the mega funds that drove some of the crazy public company deals that closed just prior to the crash will be the ones leading the charge.  Per Pitchbook “While average fund sizes have been on the rise, most observers doubt that we will see a return to the pre-crisis era characterized by mega-funds with more than $5 billion.  Instead, it is expected that firms will redouble their efforts on vehicles with $1 billion to $5 billion, which will concentrate their investments on the upper middle market instead of mega-deals.”  Based on our past experience, this bodes well for the lower tiers of the middle market as well.

Many Baby Boomer business owners are now in their late 50s or early 60s.  In many cases they do not have the luxury of wading through another seven or eight year cycle in hopes that things get better.

If you have been considering sale of your business or know someone who has, give us a call. We’d be happy to share in confidence our thoughts on the current market and the prospects for sale of your specific business.

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