2019 was another strong year for middle-market M&A activity, says John Lee, senior managing director at Griffin Financial Group, much as it was in the prior three or four years. The reasons were familiar: low cost of capital, too much capital chasing too few good deals and acquisition strategies being a primary tool for growth and value creation.
“Ordinarily, I wouldn’t predict 2020 to be much different, but the early evidence is that it will be even more active,” Lee says. “We’ve seen a spike in prospective sale client meetings in November and December, typically a time when we’re racing to close deals by year-end, not pitching new clients.”
According to a report assembled by Griffin Financial Group, conditions are favorable for middle-market companies looking to get into the M&A game in 2020. A strong economy, capital availability and record-setting levels of dry powder sitting with private equity firms have created a solid dealmaking foundation heading into the new year.
North American M&A announcements are expected to increase 7 percent year over year in early 2020. In fact, slightly more executives in 2020 plan to actively pursue M&A than in the previous year. Those executives expect that inorganic activity will help them obtain new technology, enter new markets, acquire talent and protect against changes in regulation and trade policy.
Private equity markets have been very active, with more firms and more capital chasing after a shrinking number of attractive acquisitions. Total dry powder for private equity firms continued to climb in 2019, rising from $830 billion at the end of 2016 to reach a record-exceeding $1.5 trillion as of the end of June 2019.
Interestingly, minority investments, which have been a common feature among smaller growth-equity deals, have become increasingly prevalent in larger private equity transactions. Buyout funds are holding record levels of dry powder, driving them toward minority transactions in order to deploy capital. Lee says the rise of minority equity investments by private equity firms is a good example of the increasing number of exit options for business owners. Once a small part of the market, they’re now much more prevalent.
“A minority deal enables the private business owner to take some chips off the table today at a sale valuation, diversify their personal net worth, yet still manage and control their business going forward, thereby participating in its future performance,” Lee says. “In addition, it provides the business with a deep-pocketed partner eager to invest more in future growth opportunities, while also providing board-level advice on growth, acquisitions, management development and other strategic issues.
“The flip side is you have an experienced partner who will have approval rights over these significant strategic decisions, such as acquisitions and divestitures, or capital structure decisions such as dividend, debt and equity policy. In addition, such an investor will also have a liquidity right, usually within five years, such that they can require the company to repurchase their equity — typically through a refinancing or sale.”
Strategic buyers, according to Griffin’s report, continue to be very active in pursuing M&A targets. They’re finding value in growth and expense synergies, deploying cash on the balance sheet and leveraging debt over combined companies. Financial buyer transactions, comparatively, have slowed since the 2015 peak because of higher-than-expected valuations, a lack of worthwhile targets and overheated competition. Financial buyer exits are expected to continue at a decent clip through 2019.
Cloud of uncertainty
Overall, M&A conditions appear to be favorable heading into 2020. Post-recession deal activity and valuations for middle-market businesses continue to be at near-record levels. Senior debt is readily available relative to EBITDA as an acquisition currency at good terms, and mezzanine debt is abundant.
With all the optimism, however, there is some speculation that the current M&A and capital raising environment has peaked. If political control is shifted to Democrats in 2020, there is concern that corporate-friendly tax and regulatory policies could be rolled back, making the upcoming presidential election a major focal point for private and public markets. Lee says this is one reason for the spike his firm saw in prospective sale client meetings in November and December.
“By engaging with us in January, these businesses would be sold early to mid-summer, long before the election outcome has an impact,” he says.
Further, unexpected geopolitical or economic shocks could negatively affect the market, with the continued uncertainty regarding tariffs and trade wars expected to persist in the coming year. Some economists are predicting the possibility of a recession as early as 2020.
Still, in Lee’s eyes it’s a great time, while it lasts, to sell or raise capital.
“We don’t tell people when to sell,” Lee says. “They decide to do so for a whole host of reasons. Instead, we tell them what current market conditions are and always advise them to think like a private equity owner — manage the business to increase shareholder value over a five- or six-year period and make it an attractive sale candidate for a targeted buyer audience, even if you have no intention to sell in that period. If you don’t sell, then repeat that cycle again. If you do decide to sell, then you will be prepared and in a position to maximize value.”