In an optimistic economy that seems to churn out favorable economic indicators on a weekly basis, the continued decline in deal activity we have experienced on the local and national level may seem startling at face value. Deal activity in the U.S. declined 22 percent in the third quarter versus five-year third quarter averages, and Northeast Ohio M&A activity followed suit, declining 21 percent in the quarter versus five-year third quarter averages.
M&A activity is typically correlated with healthy, growing economies and most economic indicators are telling us that the U.S. economy still has room to grow. So why the recent decline in activity? The answer boils down to value. We are experiencing full valuations in both private and public equity markets. Strong corporate earnings and favorable growth prospects continue to push valuations higher, and a never before seen buildup in private equity has pushed up private valuations. Generally, this is great for sellers.
But prudent buyers will only pay full value if it is warranted, and will scrutinize business risks like customer concentration, project-based revenues and exposure to cyclical end markets more closely in high-valued environments, which can ultimately cause valuations to fall below expectations. Frequently, buyers uncover these risks during their due diligence, creating an unexpected divergence in value expectations between buyer and seller. To mitigate the risk of an unexpected purchase price adjustment late in the process, sellers should retain an adviser who can help identify these risks upfront. Identification of potential risks will help set a reasonable value expectation for the seller, and ensure a smooth path to close.
Matt Sweet is an associate and Matt Roberts is a vice president with MelCap Partners LLC. MelCap Partners is a middle-market investment banking advisory firm. For more information, please visit www.melcap.com or email [email protected] or [email protected].