With the Philadelphia region and much of the U.S. lifting many of the restrictions related to COVID-19, it’s a good time to take stock of the state of mergers and acquisitions. In this brief update, we’ll cover volume and valuation as well as trends in structures and in M&A process.
Volume and Valuation
The FactSet Flashwire U.S. Monthly report for May 2021 shows that the number of deals for the 12 months ended April 30, 2021 was 15,134, a 7.6 percent increase from the same period in 2020. The aggregate transaction value increased by 28.7 percent to just over $2.5 trillion. The same report shows that U.S. Middle Market M&A (defined as deals valued between $1 million and $500 million) traded at Enterprise Value/earnings of the company before interest, taxes, depreciation and amortization (EBITDA) multiples of approximately 10 in Q4 2020 and nine in Q1 2021. This showed a sharp increase from Q2 2020, where multiples dropped below six times EBITDA.
The following three factors have influenced the rebound of M&A:
- Strategic buyers – Strategic buyers have been active in the market. Their readiness to grow through acquisition has led Private Equity (PE) funds to sell portfolio companies more quickly than usual as the valuations are attractive.
- PE money – Private equity has plenty of funds available to invest, both because they slowed acquisitions in Q2 2020 and they are selling more quickly.
- Motivated sellers – Many private business owners fear that the change in administration will result in a significant increase in capital gains tax. If they have been considering selling, they may accelerate their plans as a result.
Trends in Structure
The environment was completely disrupted for many businesses due to the pandemic. In some cases, this meant that sales suffered dramatically during 2020. In others, businesses were poised to provide critically-needed services or products. Regardless of whether profits increased or decreased dramatically, it’s tough to know what the “new normal” will look like for these businesses.
The structure that has allowed buyers and sellers to come to agreement on valuation is the use of earn-outs. With an earn-out, the seller only gets paid if the value is delivered through earnings after the transaction – in some cases, over very short periods of time of up to a year. An earn-out can be an invaluable structure, but both buyers and sellers should ensure that they are spelled out clearly in the agreements. The key is to understand how the earn-out will be measured, what information will be required to measure progress, and what motivation the structure gives both buyers and sellers.
Traditional banks pulled back from financing mergers in Q2 2020, which resulted in more seller financing of the transactions that did close in mid-2020. While banks have become more active, they lack the visibility into the “new normal” discussed above. Consequently, many have been much tougher on allowing credit for “add-backs” in the valuations.
Trends in Process
2020 was the year in which we proved that transactions could close, even if done in a virtual environment. The success of the virtual processes has led investment bankers to reach out to broader groups of potential buyers, as they can participate without much travel. We expect that, as in many things, a hybrid model will prevail in the future. Fewer members of the buyers’ teams will be on-site and more will be linked in virtually. This may make it possible to build broader relationships across the buyer and seller teams.
If you’re considering either buying or selling a business, please do not hesitate to reach out to our M&A experts so we can share what we are seeing in our marketplace.
To learn more, you can contact Jennifer L. Kreischer at Email or 215.441.4600.
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