by Scott Bushkie, CBI, M&AMI
Business buyers are talking about a “frothy” market again. It’s a challenge to compete in this active market and get a company that makes sense for them.
Still, all that activity isn’t deterring buyers. In reviewing the Market Pulse results for Q1 2014, we noted that confidence appears to be strong for buyers in the lower middle market (deals valued at $2 million to $50 million).
What we’re seeing is that many buyers are going all in and putting all their eggs in one basket. Buyers are cashing out their 401Ks, taking out additional mortgages on their homes, and tapping friends and family for help to finance their deals, at significantly greater rates than this time last year.
For example, in Q1 2013, buyer equity in reported acquisitions was divided cleanly with 75 percent coming from liquid cash and 25 percent from outside investors. (To clarify, this is the buyer equity component of an acquisition. Senior debt, seller financing and mezzanine loans are tracked separately.)
By comparison in Q1 2014, just 50 percent of buyer equity came from liquid cash. Overall, 17 percent of other buyer equity sources came from a home equity line of credit, 17 percent from family and friends, and eight percent from a 401K or IRA rollover.
If a buyer is successful they’ll walk away with a much greater return than they ever could have gotten from your standard retirement investments. But if the deal fails, they have nothing to fall back on in retirement. The same thing goes for staking your home in a business deal—it’s a considerable personal risk.
And as for asking family and friends to help fund a purchase, in my experience that’s not something people do unless they’re very confident. Those relationships are too valuable to risk straining over an “I hope this works” opportunity.
Notably, only eight percent of buyer equity came from other investors (non-friends and family) in Q1 2014, compared to 25 percent in Q1 2013. There are still plenty of outside investors available, but those funders typically take more equity in the deal or have more stringent requirements. Third party funders are a great way to diversify your risk, in exchange for some trade-offs in returns and/or autonomy.
But so far in 2014, buyers seem pretty confident in their own abilities. Instead of doing a smaller deal and leaving their retirement and home equity intact, their going all in and using cheaper, more personal, riskier methods of getting equity.
And if their instincts are right, they will be very happy with the results down the road.
The Market Survey Pulse is sponsored by the IBBA and M&A Source in partnership with the Graziadio School of Business and Management at Pepperdine University.
Scott Bushkie is Principal of Cornerstone Business Services, an M&A Advisory firm. To request a book with advice on the exit planning process, or to discuss other confidential options, contact Scott at (888) 829.9061 or [email protected].