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George Spilka and Associates
Investment Bankers & Acquisition Consultants

The Real Impact of Economic Conditions on
Middle Market Acquisition Prices

After 20 + years of transacting middle market acquisitions, I know the factors that affect the attainment of premium prices. Middle market acquisitions are transactions ranging in price from $1 million to $200 million. Many middle market executives mistakenly believe that external economic conditions significantly impact the timing and pricing of these deals. This is a gross misconception. Economic conditions should have little, if any impact on middle market transaction prices as long as a strategic buyer is located.

A selling owner should not allow a large corporate acquirer to cite bad economic conditions as justification for a substandard transaction offer. Instead, they should demand a deal similarly priced to one under optimal economic conditions. This is the position that a sophisticated, strong willed seller will enforce as a prerequisite to selling their company.

Acquirers are always trying to "steal" a seller's company. This psychology is a logical outgrowth of the capitalistic system. This condition exists if you are in an economic downturn, a recession, or even in optimal economic times. In addition, large acquirers by their very size and acquisitive nature are usually more familiar with the acquisition process than a selling owner. This, combined with the vast financial clout of multinational companies, enables them to approach the prospective seller in an arrogant manner demanding unreasonably low transaction prices. This is the norm. Unfortunately, most sellers fall prey to this approach and accept the norm.

The pricing of large corporate acquisitions, which have transaction prices in excess of $200 million, tends to be quite volatile. The pricing of these deals tends to mirror changes in the stock market. Contrary to these deals, the volatility of pricing of middle market acquisitions is minimal. As the upside on pricing of middle market deals during good economic times is not significant, the downside volatility of middle market transaction pricing during bad economic conditions also should be insignificant. However large acquirers try to use bad economic conditions as the rationale for substandard offers. This is complete hogwash.

During the recessions of the early 1980's and 1990-1991, many acquisition advisory firms accepted less than adequate pricing for their client's deals. During the latter period, George Spilka and Associates was able to close deals per professional person per year. All deals were fully priced, as if economic conditions were optimal. Over 90% were all cash offers. This is how middle market acquisition pricing should work during difficult economic times, if the buyer is a strategic acquirer. The reason is that middle market transaction prices should be determined by the expected future earnings (cash flow) and the risk in achieving those earnings from the business foundation given an acquirer. The expected future earnings used in developing an acquisition price will more than likely be based on the projected earnings flow through the next business cycle. Therefore, the pricing of a deal should not be significantly affected based on what point in the business cycle a company is sold.

A strategic acquirer will determine an affordable transaction price based on the expected incremental future earnings produced by the combination of the two companies. To the extent strong synergistic benefits are produced by the deal, the combined future earnings of the companies will exceed the total of both operating separately. This enables the payment of a higher premium price by a strategic acquirer, while still generating an attractive return on investment.

The aforementioned is why an owner of a middle market company should avoid selling to a private equity firm (financial buyer) that brings no synergy to the deal. Without synergistic benefits the optimum acquisition price can't be paid. In addition, financial buyers are known to be very risk adverse. They must generate extremely high returns on their transactions to keep the flow of institutional money into their funds. These funds guarantee their future existence. As financial buyers usually bring no synergistic benefits to the deal, and typically very little in the way of additional management skills, the sole way they can produce high returns for their institutional investors is by buying at vastly discounted prices. Their prevalence reflects that few middle market advisors are willing to commit the considerable time or develop the necessary expertise to locate domestic and foreign strategic players that are willing to complete a fully-priced deal.

When a seller proceeds to the market, its business foundation should be in solid shape. This has a substantial impact on attaining a premium price. A selling owner should have an acquisition advisory firm review its business foundation before proceeding with the sale. If there are any deficiencies in the foundation that would impact the transaction price, a skilled advisor can recommend the necessary changes. The implementation of these changes will facilitate the payment of a premium price. For a manufacturer, certain considerations in evaluating a seller's business foundation include: the strength of their market niche, the ability to control their customer base over a long period of time, the capability of being a cost-efficient producer, a modern plant and equipment, and the strength of the management group, amongst others. For a distribution firm, the following might be considerations: the quality of the product lines, the capability of management, the sales force's control of the customer base, the capability to maintain strong pricing, the operation of a cost efficient warehouse, and the ability to procure goods at a competitive price with their large national competitors. Other characteristics might affect the business foundation and deal pricing depending on the specific industry. An acquisition advisory firm can counsel a seller on the most important factors that define the strength of the business foundation in their industry.

There are 5 key points to remember, if a selling owner is to consummate a fully-priced deal during an economic downturn or a recession

Locate a Strategic Buyer for Your Firm

A strategic acquirer will be interested in obtaining your market niche to get the full synergistic benefits of the consolidation of the two companies. They will be interested in the intermediate and long-term benefits from the acquisition. As the short-term earnings and outlook should not be of paramount importance to them, they are less likely to allow current economic conditions to be the justification for a substandard offer.

Foreign Strategic Acquirers Are Now Accessible Candidates to Acquire Your Company

 If you are advised by a sophisticated acquisition advisory firm that is knowledgeable in fully utilizing the capabilities of the Internet in the search process, a vast array of foreign candidates becomes available to acquire your company. As business tended to become increasingly globalized during the late 1990's, the acquisition of domestic companies by foreign acquirers became a realistic possibility for selling middle market owners. However not many acquisition advisory firms want to expend the time or effort, nor do they have the expertise to master the resources available on the Internet. Therefore, they do not have access to this vast base of foreign acquirers. On two deals that my Firm is now handling, we are in serious discussions with Egyptian, Australian, Indian, Danish, Taiwanese, South African, Austrian, German and Canadian acquirers. Both of these deals are only in the transaction price range of $10 - $40 million. One of the benefits presented by foreign acquirers is that their interest in a US acquisition is usually to obtain a strategic position in this country. Therefore, it is almost incumbent on them not to fixate on short-term performance as a serious deal pricing consideration. As they want to improve their competitive global business posture by obtaining a position in a currently undeveloped market, they are not likely to jeopardize this opportunity by making a substandard offer.

There Has Been A Vast Consolidation In Many Industries

With the rapid consolidation that has taken place in many industries, the number of domestic acquirers has been greatly reduced. In some of these industries, this has made the major national acquirers brazenly aggressive in demanding substandard pricing for deals. In these industries, a seller must remain patient and be tough. They must wait until one acquirer breaks from the pack and pays a fair price. This mandates they retain an acquisition advisory firm that is extremely strong-willed and determined, and only sells when a realistic, premium price has been obtained.

Absence of Upside Volatility in Middle Market Deals

As previously discussed, the pricing of middle market deals never increases dramatically during good economic times or buoyant stock market conditions. During these conditions, the increase in middle market deal pricing is extremely muted compared to large corporate deals. Correspondingly, a middle market seller never gets the benefit of a market top. Therefore they should never accept a reduced price during bad economic conditions. Pricing for middle market deals should not vary significantly during bad economic conditions.

Impact of Reduced Earnings During Poor Economic Conditions

During prolonged good economic times, many acquirers want to discount the value of recent earnings by those that will be realized during bad economic times. After an economic downturn/recession ends, these same acquirers want to price a middle market company solely on the earnings realized during bad economic times. Don't let this happen, when the economic downturn/recession that started in the first quarter of 2001 ends. The concept to remember is that middle market deal pricing is dictated not by historical earnings, but by expected future earnings and the risk in achieving those earnings from the business foundation given an acquirer. This in fact, is the value of your business niche and should govern deal pricing during any economic condition. A large acquirer should not be allowed to take advantage of bad economic conditions to justify a substandard transaction price. Insist that your company be priced at a value that reflects the strength of your business foundation. Your niche is what a strategic acquirer really wants. It dictates the future earnings potential that can be realized from the acquisition. Correspondingly, it should determine the transaction price. This is what a strong-willed, proud, independent seller will demand from an acquirer, and nothing less.


George Spilka and Associates

Email: spilka@georgespilka.com

Phone: 412.486.8189