How Does the Current M&A Cycle Affect My Company?

Although recently published headlines regarding M&A activity may be of concern, you may be surprised to learn that the middle market is just as vibrant as it was before the credit crunch. Even more encouraging, now is still a great time to take a middle-market business (typically companies with less than $500 million in revenue) to market.

Essentially, highly leveraged deals (deals where a significant portion of the deal is financed via debt), are very difficult to close right now. Many banks and other lending institutions made substantial investments in what turned out to be very risky loans. Sub–prime loans, as they are known, were thought to be relatively safe. However, when interest rates began to rise, and home values started to decline, financial institutions found their loan portfolios were at risk and began to tighten lending policies, especially for large loans for highly leveraged deals.

This had a major impact on private equity groups (PEGs) who specialize in highly leveraged deals and has resulted in delayed closing, restructuring of deals and stalled transactions. Due to their size, these deals often receive considerable media attention. The headlines today reflect that with tightened financing, PEG mega–deals are slowing. Since PEGs have played a critical role in the growth of M&A activity over the past five years, the slowing of their acquisition pace could affect M&A activity in general.

However, The March Group believes that there are several factors which will mitigate the impact of the credit crunch on middle-market deals:

Middle-market deals are not as highly leveraged as larger deals.
Debt is simply not as significant a component of the typical middle-market deal. According to data from S&P Portfolio Management, average total debt to EBITDA multiples for middle-market deals was 5.2 last year. In much larger transactions, especially those in excess of $1 billion, debt to EBITDA multiples are usually double digits. This is why you are hearing that the M&A market is slowing for very large deals.

PEGs have a significant amount of capital that needs to be invested.
According to Buyouts Magazine, private equity funds raised $173 billion in 2005, $198 billion in 2006 and $167 billion this year. While PEGS may have chosen to finance deals with debt, it’s important to remember they still have cash available, and the firms will not let it remain idle for long. It will need to be invested in the market over the next few years.

PEGs will move “downstream.”
Deals in this segment require very little leverage, and The March Group expects PEGs will expand their focus on the middle and micro–middle market given that little debt is required to structure these deals.

Strategic buyers and foreign investors will jump in on M&A activity.
A decrease in PEG activity will encourage two groups to be more active: strategic buyers and foreign investors. Both groups will benefit from multiples dropping due to less competition for deals from PEGs. Keep in mind that strategic buyers can use cash off their balance sheet or stock to close deals. Their need for debt financing, especially for middle–market deals, is not as critical. And foreign investors, especially buyers from Europe, can take advantage of the dollar and buy U.S.–based companies at favorable exchange rates.

The March Group believes these factors will combine to somewhat insulate the middle–market from the current credit crunch affecting larger deals. It is safe to assume that multiples will decline slightly across the board, and that it will take longer to close deals in general. The March Group is seeing a gradual return to solid deal–making principles. This is a natural market correction that was overdue and will strengthen the M&A market. Rest assured that despite what you may read in the news, there are still active buyers in the market looking for well–run, profitable, middle–market companies to acquire.

If you would like to learn more about the current state of the M&A cycle and why now is still a good time to sell a middle–market company, please sign up to attend one of our informational M&A workshops. While there you will learn more about the entire process of successfully selling your company in today’s market and how to sell it for a premium. Please call us at 800-783-8520 or visit us on the Web at www.marchgroup.com to make a reservation.