“Lower middle market too hot to touch,” “M&A flies high,” “M&A activity speaks to confidence of CEOs.” These are the kind of headlines that have been dominating my news feeds lately. I’m sure you’ve seen something similar popping up in your own industry news sources.
It’s not an exaggeration. In my 20 years in the industry, this is one of, if not the best, markets I’ve seen. So why is this a seller’s market right now, particularly in the lower middle market?
Multiple factors are coming into play. First, there are substantially more buyers than quality sellers in the marketplace. It’s the old adage of supply and demand from Econ 101. Buyers are fighting over a few deals.
The number of private buyers, meaning individuals and private equity buyers, has grown over the last few years, jumping from 53.4 percent of buyers in 2014 to 64.5 percent in 2017, according to Bloomberg Law data. Beyond the increase in competition, private buyers are more likely to depend on the seller for transition support or long-term consulting. That means they have an extra incentive to ensure the seller feels like they got a fair deal.
Second, there are records amount of money out there. Private equity firms have raised more money in the last three years than any other time in history.
These firms live and die on their ability to provide investor returns, so in a way, they’ve created their own competitive problem. They’re all out on the hunt for good deals and good opportunities they can turn into investor profits.
On top of that, corporations are flush with cash. Non-financial companies’ liquid assets reached $2.4 trillion last year. Everyone horded cash through the recession, and now they want to put those funds to work.
And while the labor shortage is hampering organic growth plans, it’s helping stimulate M&A. In May, the unemployment rate fell to an 18-year low of 3.8 percent. New hires are harder to find, and those you can get come at a higher cost. That means companies are looking at acquisition as a way to grow.
Tying back to available capital, we still have strong, ongoing interest from the lending market. Banks are getting aggressive in their business lending strategies again.
Federal Reserve data shows that commercial and industrial loans increased 3.4% in April vs. the year-earlier level. While that may seem like modest growth, the Treasury Department spring risk assessment noted that strong competition for quality loans has led to evidence of eased underwriting.
And while interest rates are climbing, they remain at record lows. Money is still cheap. Back in the late 90s, the prime interest rate was at 8.5 percent and there were a lot of deals getting done. With prime today at 4.5 percent, we still have a lot of room for increases before we hit historic norms.
Meanwhile, business confidence remains high. According to the Business Roundtable’s June economic outlook survey, economic confidence among the nation’s top CEOs was at its third highest level in the index’s 16-year history. Economic confidence was at 111.1 points, remaining above the historic average of 81.2 for the sixth straight quarter.
High business confidence typically translates into increased investments and M&A activity as business leaders are confident in their ability to meet debt service and deliver return on investment targets.
With confidence and money at their peak, competition is hot for available deals. That’s driving more buyers down into the lower middle market.
Strategic buyers and private equity firms who once focused on middle market deals are now looking downstream. Whereas acquisition benchmarks once focused on EBITDA of $5 million and above, buyers are working harder and buying smaller companies.
In summary, the lower middle market is a seller’s market. High competition is making it harder for buyers to win deals that hit their investment benchmarks. But it’s easier for sellers to exit their business on their own terms. People are selling because the market is right, not because they have to sell.