20 Feb Pent-up Supply for Middle Market M&A
When overly-optimistic pictures are painted, it’s almost guaranteed that someone with something to sell has an agenda. Sell-side investment banking in the middle market is no exception. Much like the housing markets, in the last five years desperate investment banks have been touting the need to “sell, sell, sell.” The upper middle market has had to move south and the lower middle market is finding selling businesses has become a very soft affair–a great deal of tire-kicking with no real decisive movements. Indeed, the “business broker” side of the industry–those related closest to commercial real estate (restaurants and other brick-and-mortar-based service businesses)–have been affected the most.
But the stars may be aligning in the not-to-distant future. Here are some reasons we’re currently experiencing pent-up supply in middle market M&A and why we expect it to finally begin to dissolve very soon.
I hate to be yet another Chicken Little and blame all my problems on the state of the general economy, but the number one reason companies have pulled out of the sale is because of the softness of the general market. When the bottom dropped out, valuations plummeted and so did many business owners’ dreams about getting large sums for selling their businesses.
One of two events must happen in the near mid to near term. Company owners will adjust what they’re willing to obtain for their companies at the time of sale or the general market must eventually reach pre-recession levels. With valuations growing in certain sectors, there is a particularly perfect storm brewing as both seam to be colliding together. Unless the current bubble in bonds implodes and another recession ensues, many more companies will be hitting the market soon.
We’ve said it before, but we’ll say it again: baby boomers hitting retirement are feeling the pressure of age and will continue to look to sell. The statistics back this data. It is expected that 10,000 baby boomers will be retiring each day for the next 19 years. At 25% of the total U.S. population, the “boomers” have represented a powerhouse voting block and a force to be reckoned with in business and politics over the last 30 years. It is coming up on their time to retire. And since they own significant business assets in this country, they will be among those seeking to take advantage of market upswings as things begin to slowly improve.
Whenever there are huge troughs in the market, it often means a “correction” of sorts. In some cases, it means vast over-corrections. This is where the non-panicked make most of their fortunes: while others panic and pull out of investing, they’re out buying up all types of assets on the cheap. But unless a business is under complete duress most owners would be unwilling to sell when a valuation trough hits.
With the trough almost over, the only thing barring many business owners from selling is the question, “now what do I do with my life?”
There are a couple of types of entrepreneurs worth discussing. The first is obsessed with the company. Business is life and the rest is just details. They’ll work until the drop. We’ve had several “potential” sellers over the years who never sold and still run their companies into their 90’s. As far as I know the particular business-owner I’m thinking of is still alive and working the business. He’s made his wealth 100 times over, but enjoys it. He’s literally a lifelong entrepreneur.
The second group works the business as a utility, seeking to eventually cash out in a big liquidity event. It’s a “means to an end” and not the end entirely. For this business owner, the sale of the company means “retirement” and/or trying something new.
The first three reasons discussed above lead into the final opportunity for buy-side engagement and private equity groups: the sellers have waited long enough and some of them are extremely motivated to sell. Family reasons, including general mortality motivators has many businesses under $100 million in revenue looking to sell and move to the next phase of life. The coming months will most-likely have such emerging from the woodwork in droves.
Recovery in the mid-market is sure to come as we experience what some have appropriately called “the largest transfer of wealth in the history of the world.” This transfer is soon to take place. Mid-market operators will need to be amply prepared for the supply that may be shortly hitting the market.