State of the M&A Marketplace: Present & Future
As we entered 2020, all indicators pointed to another active year in the business-for-sale market. Despite US-China tariffs dominating headlines, the health of the small business sector hit all-time highs in 2019. A combination of record financial performance, available and affordable financing, and retiring Baby Boomers created a robust mix of supply and demand. The result was a third straight year of a historically strong main street M&A market.
This trend continued for the first two months of the year, with small business transactions in line year-over-year according to BizBuySell’s Q1 Insight Report, a nationally-recognized economic indicator which aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide. Then, COVID-19 began rapidly spreading in the U.S. causing shutdowns across the country. The stock market crashed and panic about the financial climate and national economy spiked.
Since the initial shock, the federal government approved several relief acts aimed at helping support small businesses. Perhaps the most significant for the business-for-sale market is the Small Business Administration Debt Relief Program. Under the program, the SBA will pay (not defer!) the first six principal and interest payments on behalf of the borrower for SBA 7a loans. All existing 7a loans and new 7a loans closing between March 27th and September 27th, 2020 are eligible for this historic program. Factor in historically low interest rates and acquisition costs are markedly lower than even 3 months ago.
According to M&A advisors representing businesses valued between $2 million and $50 million, 48% of their deals have been delayed and another 12% canceled due to COVID-19. 36% said their deals remained unaffected, while 4% said they represented a business that had increased in value due to the outbreak.
Most business owners also believe business will be back to normal within 7 to 9 months, according to BizBuySell’s survey, with the highest percentage of respondents expecting a recovery in 4 to 6 months. Owners are encouraged by the actions of the federal government that will help small businesses navigate uncharted territory. 55% of respondents believe the federal government is doing a “good” to “very good” job. Another 23% said “average”, with the remaining indicating “poor” to “very poor” at 13% and 9%, respectively.
While most of the first quarter was business as usual, we expect to get a better view of the impact as data continues to be released. If you are interested in having a one-on-one discussion regarding your business and current business-for-sale environment, please contact us.
Median Sale Multiples
The median sales multiples have remained fairly consistent over time for main street businesses. However, there was a notable decline in multiples in Q1 2020, especially for higher valued businesses.
As of Q1 2020, the median multiples based on transaction size as reported in IBBA’s Q1 Market Pulse were:
$1M-$2M: 3.0x SDE
$2M-$5M: 3.3x EBITDA
$5M-$50M: 4.3x EBITDA
Based on this recent data and data from the 2009 Recession, broadly speaking the best time to sell has past for the time being. There is little reason to be forlorn longer-term as history suggests that declines in multiples are V-shaped and that any window for “bargains” will be short-lived.
Selling Price Versus Asking Price
In Q1 2020, final sale prices came in between 92% to 101% of the pre-set asking price or internal benchmark, on average.
A challenge moving forward will be in assessing a fair business value considering many businesses will have little to no profit for the duration of government-ordered shutdowns. Generally, business values are determined by cash flow over a 2 to 3-year period. Despite the pandemic, it is only natural for owners to desire prices based on their long-term track record, rather than a months-long anomaly.
Buyers, on the other hand, may want to negotiate based on perceived future risk. With fewer customers, revenue and cash flow are reduced which reduces business value. To bridge the gap, both parties will need to consider creative ways to provide value and mitigate risk.
Year-over-year trends for cash at close and seller financing are relatively consistent. The chart below details, by transaction size, the amount of cash at closing, seller financing and earnout portions of deals.
We will likely see increased use of seller financing and earnouts to bridge valuation gaps in the months ahead, which would be consistent with how many deals got to the finish line post-2009. Buyers may ask for earnouts as a way to reduce risk and banks will likely require more equity from sellers/buyers, to which seller notes can contribute.
Our assumption is that Q2 stats will reflect less cash at close. For smaller transactions that use SBA funding, earnouts are not an option, so we will likely see larger seller notes. For deals that do not involve SBA funding, we expect increased use of earnouts.
Time to Close
The average length of time to sell a small business is shown below based on transaction size.
Due to the COVID-19 pandemic, most advisors expect delays. Shown below is the estimated length of delay (in days) that advisors expect for deals between $2M and $50M. Over 35% of advisors expect the extra time to close deals could exceed 90 days.
Top Selling Sectors
In the lower middle market, healthcare, manufacturing, and wholesale distribution transactions were most common.
$1M to $2M
- Construction/Engineering (20%)
- Personal Services (17%)
$2M to $5M
- Manufacturing (23%)
- Construction (14%)
- Wholesale/Distribution (14%)
$5M to $50M
- Healthcare (27%)
- Wholesale/Distribution (20%)
- Business Services (20%)
Reason for Sale
Retirement is the number one reason for small business sales.
Wrapping It Up
As discussed in a previous post, we anticipate that many themes from the past may reveal themselves again as we head into the future, however, with some differences, chiefly:
- Unemployment: High unemployment and industry disruption will breed a new and robust generation of entrepreneurs. Presently, Calder is processing high volumes of buyer inquiries and we expect this to continue.
- Latent Supply: Sellers will pull back temporarily to focus on their companies and also because they believe now is not a good time to sell. This is interesting to us because on a macro level this dynamic is should spur a massive demand for business acquisitions and high competition for quality businesses. While it may feel counterintuitive to sell now, there are reasons to be optimistic.
- Distressed Businesses: Unfortunately, many businesses will be unable to continue profitably. In these distressed situations, if the stakeholders are able to react timely, there is often value significantly in excess of liquidation value that can be preserved and realized.
- Baby Boomers: Retirement remains by far the top reason for sales. The youngest Baby Boomers will turn 56 this year and despite any financial disruption that may have been borne by COVID-19, Boomers will continue to transition their businesses.
- Banks: As we saw post-2009, lenders are presently and will continue to tighten up and scrutinize acquisition candidates and buyers with enhanced diligence. Fortunately, this time around the government has reacted quickly, giving the SBA 7a program a boost.
Overall, Calder remains bullish about our prospects to continue to break our own closing records. With creativity and persistence transactions will continue!