By Perry Campbell, PhD
After 6 years of analysis of nearly 700 business sale and recapitalization transactions in the lower middle market and the upper end of Main Street some “timeless trends” have emerged. The deals are all transactions conducted by the members of the Alliance of Merger & Acquisition Advisors. Data were submitted by M&A Brokers, M&A Advisors, and business buyers. Over the years these data have appeared in the semi-annual “Deal Stats” report issued by AM&AA. I chair the committee responsible for these reports.
AM&AA members predominantly serve the lower middle market and the upper end of Main Street businesses. There was a large enough sample size in each size category to provide for meaningful statistics. Just over half (52%) of the companies had revenues less than $10 million, and just under half (48%) had revenues over $10 million. Very small “Main Street” companies with less than $1 million in revenue comprised 11% of the sample. Larger companies with over $50 million revenue were just 13 % of the sample. Companies with revenues between $1 million and $25 million made up 64% of the sample size.
Sixty-eight percent of the reported deals were valued between $1 million and $25 million, with 30 percent in the $1 million to $5 million range. Fourteen percent were small deals valued at less than $1 million. Seventeen percent were valued over $25 million.
The Deal Multiples
We saw a wide range of multiples across all the done deals. We all know that an average is just a measure of central tendency, and there can often be a wide variation in individual results. This is certainly the case with the multiples attending done deals for small and mid-sized businesses. We see small companies with less than $1 million in revenue closing deals at more than 10 x EBITDA (Earnings Before Interest, Income Tax, Depreciation and Amortization), and we see large deals for companies with over $50 million revenue closed at less than 3 x EBITDA. Yet there are trends. More than half of all the deals reported by AM&AA’s members (57%) were in the range of 3 x to 6 x EBITDA. Less than 10% of the done deals carried multiples greater than 10 x EBITDA. Done deals at less than 3 x EBITDA weren’t as rare as those over 10 x EBITDA.
This is basically a somewhat skewed bell-shaped curve that tails off to the right with some relatively rare high-end multiples. Our members visit that high class neighborhood on the right side of the graph (the over 10 x EBITDA neighborhood) from time to time, but we spend over 70% of our time in the lower multiple (less than 6 x EBITDA) neighborhood where most deals get done. Fully 82% of all of our done deals had multiples of less than 7 x EBITDA.
This distribution of done deal multiples represents a timeless trend in the lower middle market and down at the intersection with Main Street businesses. Frequencies can be viewed as probabilities, so there is a better than even chance that any random company in these size ranges will sell in the range of 3 to 6 x EBITDA. There’s a 70% chance that it will sell for less than 6 x EBITDA, and over an 80% chance that it will sell for less than 7 x EBITDA. Some companies will do better, of course, but if we look at the overall market for these private company sales from afar, relatively few companies will achieve really high multiples when they sell. A company has to be pretty special to get a high multiple. To add to the picture, there are also some distressed companies that will sell for a high multiple of EBITDA, simply because they have very little EBITDA and the value of their assets creates an artificially high multiple. For such companies, the buyers are really looking at the assets on the balance sheet and ascribing no additional value to the earnings of the company. Only a small portion of the deals with multiples over 10 x EBITDA were distressed deals like that.
Effect of Deal Size on Multiple
The graph below includes data from done deals in a wide variety of industries, grouped according to deal size (total consideration). It provides a beautiful illustration of the deal size effect in which larger deals tend to have the highest multiples of EBITDA. Some of the big deals had very low multiples and some of the small deals had very high multiples, but on the average this is a timeless trend. The bigger the deal is, the higher the multiple will be.
Effect of Revenue on Multiple
The next graph comes from the same set of done deals, but grouped according to company revenue. Here we see a nice illustration of the general trend that larger companies will generally get higher multiples of EBITDA when they sell. The deal size relationship and the company size relationship are two sides of the same coin. Bigger companies tend to have higher prices, higher priced deals tend to have higher multiples, so bigger companies also tend to have higher multiples.
Once again, some very small companies got very high multiples when they sold and some very large companies got very low multiples, but on the average this is a timeless trend. The bigger the company is, the higher the multiple will be. This trend relates in part to the perceived risk of investing in small companies compared to investing in large companies.
The Reasons for Variation in Multiples
In addition to size, one should add profitability (EBITDA as a % of revenue), growth rate, and industry, as well as a number of other value drivers. Our friends at GF Data Research have done some research on private equity deals in the $10-$250 million range. They’ve seen a size premium, similar to what we see here. They’ve also detected a difference in multiples when comparing companies with above average EBITDA/Sales ratio to those below average. Another factor they’ve looked at for these private equity data is the effect of management continuity, seeing slightly higher multiples when management stays on board after a transaction. A high growth rate can also lead to a higher multiple at closing, but sometimes that extra multiple is realized as a contingent part of the purchase price after the growth is realized, what we call an earn-out. Industry can be a factor, but generally that’s the case for particularly “hot” industries that have a sometimes short-lived surge of demand, or for particularly “cold” industries that buyers decide to avoid for some reason. Appraisers call factors like these “value drivers”.
Applicability of Data to Your Situation
In almost 700 deals covering a range of sizes and multiple industries, there has necessarily been a lot of averaging to come up with these graphs. There’s a natural tendency for someone to want to take these graphs and compare them to a particular company, perhaps one that you own, but there’s a lot of variability from deal to deal. I’ve seen a company with $2 million EBITDA sell for $25 million, while another with $2 million EBITDA might sell for $6 million. How can that possibly be, when EBITDA is the same? It’s because different buyers view things differently and also because EBITDA alone, while a good indicator, is an insufficient measure of company value. A common difference is that one company might be growing and another might be shrinking. Any rational buyer will pay much more for a growing company than for a shrinking company, so the fact that EBITDA was equal for the two companies wouldn’t be sufficient to define their respective values.
One way to look at things is to ask yourself is my company average in terms of key factors like revenue, profitability, growth rate, competitive position, etc.? If you think you’re in the middle of the pack, perhaps you can use the company revenue vs. average EBITDA multiple graph to get yourself in the right ball park. If you’re below average in some regard (for example if you have a lot of volatility in revenue from month to month or year to year, perhaps in a cyclical industry) then you’ll probably be looking at a substantial discount from the average multiple for your size. If you’re in a hot industry or if you have a patent on a necessary product for a strategic buyer, perhaps you’ll be able to command a premium multiple.
One thing we know for sure, the marketplace has the answer. A confidential, but competitive auction process is the way to find out who will pay the most and how much they will pay. Averages, graphs, and valuation models all have their place, but they simply can’t predict with certainty what any one company will sell for. I love talking about all the theories and debating the fine points, but I’d rather be going back and forth with multiple buyers, convincing them to sharpen their pencils and bid their very best price and terms. After all, my client isn’t very likely to take the average price from among all of the bidders. The highest price, or the best overall deal is likely to win the day. That’s the fun part of my job.
If you’d like to learn more about the possible value of your company, exit strategies or the business sale process that will maximize value please drop me an email or give me a call at 1-800-240-4609.
Is This the Right Time to Sell?
This is a timeless question that I hear from business owners year in and year out. Let’s look at the fluctuations in average multiples for manufacturers, our most prevalent industry in the AM&AA Deal Stats surveys. We can see that sometimes the average is up and sometimes it’s down, but I believe predicting the direction in advance is a fool’s game.
If you could predict a recession a year or two in advance then maybe one could try to sell before things go bad, but I honestly believe this is less likely to succeed than timing the stock market ups and downs since you can sell a stock in the public markets today but you have to plan far in advance for a private business sale that might close a year or more from now. Market timing for private business sales just isn’t going to work, given the lag between the decision to sell and the uncertain closing date. Some owners will get lucky and hit the timing just right, while others won’t. It’s pretty much a random walk through business sale multiples. The long term weighted average for this manufacturing data set was 5.36 x EBITDA, and there are perhaps some explanations for every increase and decrease in the half-yearly averages, but it probably makes the most sense for an owner to focus on the average rather than the ups and downs, and to figure out the things that can help a business to do better than average whenever a sale might take place.
The most honest answer that anyone can give to the question “Is this the right time to sell?” is this:
For most private business owners in this size range, it’s the right time to sell if
- Your company is doing well financially now and you expect it to continue to do well in the coming year
- You have prepared the company for sale (you’ve done that if you can go on vacation for 2 weeks and not need to respond to any problems while you’re gone)
- You have a compelling reason to want to sell, e.g., retirement, plans for a new venture, etc.
- It’s not an emergency sale due to death, disability, divorce, partnership dissolution, etc. that puts you in a weak negotiating position (such situations may be unavoidable, but they’re not ideal)
- You’ve thought about it long and hard, and decided that you’re ready to begin a transition to new ownership
- You’re not just reacting emotionally to an approach by a single buyer, but you’ve really tested the market in a logically planned and executed process
- The economy is not entering into a recession.
There are always buyers, even in the depth of recessions, but you’ll tend to do a bit better as a seller when panic isn’t the order of the day. Outside of recessions, which a few folks believe they can predict, the ups and downs in the averages are impossible to predict with any certainty.
Is Business Owners’ Behavior Logical?
That was the title of an email I received from a private equity group, Hamilton Robinson.
Interestingly, there’s a bit of denial of mortality among business owners these days. Last week I met with the president of a business who was in his mid-70s who wanted to talk about an exit plan for the owner who was in her mid-90s and still working in the business! I hope she gets some time to enjoy the fruits of her labor in the next few years, but I did think she’d waited a little long to start her business exit plan. When the “right time to sell” question came up in the conversation it sure didn’t make sense to me for her to wait any longer, no matter what price she sold for. But that’s just me. She might decide to stick around for another 10 years to increase value and get a better price. More power to her, if she does.
Here are some excerpts from the Hamilton Robinson email:
“There is an interesting dynamic occurring regarding middle market acquisitions – valuations are up, leverage is up, and financing costs are down – should be a great time to sell, right? Then why are the number of middle market transactions down? (click here for Pitchbook 2Q14 data) Is it the buyers or the sellers?
Several key factors suggest it has more to do with the sellers. Here are a few factors to consider:
- Many of these businesses are “lifestyle businesses”, which enable the owners to enjoy a lifestyle that appears to be impossible to replace with income generated from after-tax proceeds, making them very reluctant to sell.
- In his article titled “Where Have All the Sellers Gone?” Andy Greenburg, CEO of GF Data, suggests many of these owners survived the recession and are skeptical of claims that security and comfort comes from diversifying wealth, and thus remain very comfortable keeping much of their wealth concentrated in a business they perceive, they can control.
- According to the Employee Benefit Research Institute 2013 Retirement Confidence Study, changing demographics are further reducing the impetus for owners to sell. The number of people who expect to retire after age 65 has increased from 11% in 1991 to 36% in 2013, a significant shift from a generation ago.
Many of the familiar, logical reasons for selling may not be very compelling in today’s economy. So how can we be “smarter” partners in this new dynamic? How can we translate the factors above into compelling reasons for a business owner to bring in a trusted partner?
With owners wanting to stay engaged longer, we present a scenario where they can generate immediate income from capital gains by selling a portion of their equity and then rolling the remaining into the new company. They retain an active role in their company, continue to participate in its future, and now have the opportunity to see their equity position expand again to offer “a second bite out of the apple”. This approach fits our proven strategy of building new partnerships, not just making investments. It fits our commitment of taking the long term view with each of our partner companies, working together as stewards of their hard work to date, but now with the expanded capital and managerial base so critical for successfully accessing new opportunities.
For all of us working in this space, understanding the factors that motivate owners are the keys to unlocking opportunities and effectively positioning ourselves for more deals in this market.”
I agree with Hamilton Robinson on this. It is important to understand those motivating factors. In my practice owners that I’ve first spoken to 5, 7, 10 or 12 years ago will come to me and say they’ve finally reached a decision to sell. That’s a really long sales cycle! Throughout that time period they’ve shown “approach-avoidance” behavior wherein they get close to the idea of selling, then back away. What’s the underlying issue? I think it’s often fear of the unknown. For owners in their 50s, 60s, 70s, 80s, and even 90s this is often somehow associated with fear of admitting their own mortality and the absolute certainty that they can’t keep running the business and enjoying the associated life style forever. It takes a leap of faith for them to finally admit that time keeps marching on and make the decision to sell, and they must have faith in me to guide them through the process. This is no simple matter. It may be dollars and cents to the buyer, but not to the owner. For the owner any transaction represents a big change, even if it’s a two-bite deal where the owner will stay on board like many private equity groups pitch. There are relationships to consider with friends, family, employees, customers and suppliers. There is concern about loss of prestige as a retiree. There is concern about financial security. There is concern about what comes next… is there life after a business sale? What will that life be like? This is not all logical facts and figures. There are plenty of emotions involved. In fact many good deals have been apparently made only to see the owner walk away at the 11th hour before closing. Logical? Maybe not, but this is the reality of business sales in the lower middle market. The decision to sell is a very personal and difficult one.
Thank you to all of the attorneys, accountants, financial planners, wealth managers, bankers, business owners and others who have referred clients to us. We greatly appreciate the trust and confidence you have placed in us. If you would like to refer a business owner to us for value consultation, business purchase, business sale, management buyout, management buy-in, or re-capitalization, please be assured that all of our services are totally confidential. Call me today at 800-240-4609.