Mergers and Acquisitions Trends 2022: An Analysis of Q4 2021

Can Deal Characteristics in Q4 2021 Help Up Understand What 2022 Has in Store?

The IBBA and M&A Source recently published their Q4 Market Pulse Report giving insight into the trends that can be expected in the current market for mergers and acquisitions trends 2022.

The Q4 survey was conducted from January 1-15th, 2022, and was completed by 416 business brokers and M&A advisors covering 379 transactions.

We have summarized some of the key topics below and offered our own insights. While the topic on everyone’s mind is Russia’s invasion of Ukraine, according to certain experts, the effects on US domestic lower and middle-market dealmaking are likely to be limited.

Let’s begin by looking at common elements across most transactions.

Seller Employment / Consulting Agreements Post-Sale

It is nearly universal that the seller will be asked to remain with the business post-sale for a transition period.

Some agreements include a prolonged transition period during which the seller is either hired on as an employee and paid a salary and benefits, or is retained as a consultant.

Buyers and sellers may want to arrange an employment contract for a number of reasons, such as when the business is reliant on the owner’s knowledge and relationships, or when a seller wishes to stay with the business but wants to be relieved of the pressures of ownership.

Seller employment agreements (of one month or longer) were used in 16% of Main Street deals and 31% of lower middle-market deals, according to the survey.

We find these results interesting as it has been our experience increasingly that sellers of middle market+ businesses are asked to remain with the business 6+ months following the sale. If anything is shifting, we believe that the tightness of the labor market is forcing owners to remain with the business longer than they initially desired and that this trend will become persistent, particularly for middle-market and larger deals.

For smaller Main Street deals, there is simply not enough profit to retain both a new and previous owner, hence the minimal transition period. Additionally, Main Street businesses are small and often easier to understand with limited time.

The graphs show months employed post-transaction. Source: IBBA.

Non-Compete Period

Non-complete clauses limit a seller’s ability to operate or engage in a competing business for a set length of time after the transaction is completed. According to survey results, the most common non-compete period is three to five years. This period of time has remained largely consistent for years and we do not anticipate that it will change. Given that the vast majority of owners are selling due to burnout and a desire to retire, non-competition agreements are rarely overly contentious.

Business Value – Mergers and Acquisitions Trends 2022

In the Main Street market, business valuations have remained relatively stable, ranging from 2.0-3.3x SDE on average. These multiples have stayed reasonably consistent over the history of the survey. However, as businesses become more desirable targets for both financial and strategic buyers alike, shifts are more likely to occur in the lower middle market.

Businesses with an enterprise value of $5 million to $50 million earned an average multiple of 6.0x EBITDA (a survey peak) and averaged a final sale price that was 113% higher than the benchmark. While we agree that multiples and valuations are likely to remain strong in this range, we have always believed that the range utilized by the IBBA is too broad, and therefore the average is not representative of the range. For example, according to GF Data, which analyzes transactions in the $10-250M enterprise value range, Q4 data across 151 transactions revealed an average EBITDA multiple of 7.5x. Drilling down further, it is revealed that among deals in the $10-25M range, the average EBITDA multiple was 5.9x. An inference that can easily be made is that deals that are $5-10M are trading for <5.9x EBITDA. In that range, we are presently seeing offers most commonly between 4-5.5x EBITDA.

Time to Close

In Q4 2021, the average time to sell a small business decreased slightly and ranged from six to ten months. The smaller the deal, generally the shorter the time from start to finish. Deals in the $5-50M range averaged 10 months. Following a signed letter of intent or offer, on average, approximately 60 to 120 days are spent in due diligence and execution.

2021 Active Buyers Overview

The Main Street Market was dominated by first-time buyers, followed by serial entrepreneurs and existing businesses. Individuals accounted for 75% of business buyers in the Main Street market. 40% of these individuals were first-time buyers and 31% were serial entrepreneurs.

40% of buyers in the lower middle market were existing companies. This makes sense, given the strength of the balance sheets and the lending environment being favorable for acquisitions. Due to the state of the labor market, companies are having difficulty finding the talent needed to grow, further prompting businesses to move toward acquisition.

We have noticed an uptick in bank competition in recent months. Now that many of the government programs that came into existence as a result of COVID are winding down, banks are once again having to compete for lending to drive fees.

Exiting Without a Plan

More than half (54%) of all small business sellers were planning to retire in 2021. Despite retirement being the number one reason for sale, the large majority of sellers, particularly in the Main Street market, do not engage in a proactive planning process. In general, the smaller the company, the less likely the owners are to plan ahead of time before going to market.

Time spent planning for a sale based on transaction size.

Overall, while we are accustomed to owners not spending much time planning for their exit, we are dismayed by this. There are many things to consider, for example, tax consequences, the time required for a transition, net proceeds and whether they will be enough for retirement, etc. We strongly recommend that owners review our list of items to consider to increase business value and make the transition smooth. Additionally, please consult with your CPA, estate planning attorney, and wealth advisor before pulling the trigger on a sale process. Not planning for a sale is on of the mergers and acquisitions trends 2022 that we would most like to reverse!

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