2Q2008 - Strong Demand Fuels a Healthy Market for Privately Held Companies
Last quarter we commented on the general state of the merger & acquisition market. The market remains very healthy; in fact, the same factors that have slowed the pace of mega-transactions have increased the demand for many privately held companies. This quarter, we take a deeper look at the demand for stable, profitable companies by investigating three categories of buyers: private equity firms, strategic corporate buyers, and high net worth individuals.
Private Equity Funds: Cash-Rich, Deal-Poor
Private equity firms raised a record-breaking $313 billion in 2007, and 2008 is proving to be just as strong as 2007 in terms of private equity fundraising. In the first half of this year, 185 funds in the United States raised $132.7 billion – just 3 percent less than the war chest they accrued in the first half of 2007. Despite sitting on so much cash, private equity funds have put less than $20 billion of their money to work in the first year, compared with $255 billion in the first half of 2007. Global private equity deal volume for the first half of 2008 was more than 80 percent lower than in the first half of 2007, and private equity accounted for just 9 percent of M&A deals in the first half of this year, compared with 20 percent last year. Private equity fund managers are now under immense pressure to put their money to work. Many funds are investing more equity into their transactions, and using less leverage; another trend among private equity funds is to look for smaller deals. For owners of lower middle-market companies these trends are extremely positive, as they can serve to increase demand.
Strategic Buyers: Putting Reserves to Good Use
While private equity was on an acquisition spree in 2006 and 2007, many strategic buyers hung back in the shadows, banking cash from profitable years and biding their time. When private equity dealmaking slowed in the first half of 2008, strategic buyers stepped in to pick up the slack. The combination of strong cash flows from many profitable years and lines of credit established when interest rates were extremely low has left many strategic buyers flush with cash, ready to pursue an acquisition-based growth strategy. After a slow start to 2008, M&A deal volume in the United States picked up steam, with June 2008 topping June 2007 by more than 22 percent. European acquirers are also finding U.S. companies to be attractive acquisition targets, due to good management and regulations and favorable currency exchange rates. Strategic buyers are on the lookout for good acquisition opportunities, and any company with stable, recurring revenues is a strong target.
Individuals: Tighter Lending Guidelines Filter Out Weak Buyers
Of the three categories of potential buyers, individuals may have been most affected by the credit crunch. In addition to the obvious tumult in the stock market, which may have reduced the holdings of high net worth individuals, individual lending guidelines have been tightened to guard against defaults. Most significantly, the Small Business Administration, which backs loans to individual acquirers, now requires buyers to show more relevant industry experience than it did a few years ago. The SBA also expects acquisition targets to show cash flows sufficient for debt service for the past three years, while it previously put more weight on cash flows in the most recent year or two of operations. Although the tighter lending guidelines will weed out weaker buyers, the impact to strong companies with a history of stable revenue growth should be relatively limited.
As we move into the second half of 2008, some buyers are still experiencing the strain of the credit crunch, while others are sitting on cash and actively seeking out acquisition opportunities. Although individual buyers may face additional challenges, strategic buyers are taking advantage of cash reserves, and private equity is like a tightly coiled spring. As a result, stable and profitable companies in the lower middle-market size range are still very much in demand.
Finally, a note to would-be sellers for whom the strong demand translates into an unsolicited offer: remember that the unsolicited buyer is not the only prospective buyer for your company. In fact, the presence of an unsolicited buyer may be a clue that your company would be attractive to many potential acquirers. If you have received an unsolicited offer for your company and would like to discuss it, we invite you to call us for a confidential conversation. Call 425-450-4800 or email info@asgpartners.com.
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