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
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
a Strategic Buyer for Your Firm
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
Strategic Acquirers Are Now Accessible Candidates to Acquire Your
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
Absence of Upside
Volatility in Middle Market Deals
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
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.