By Scott Bushkie
The last two years were a bit slow for the M&A industry, but that’s about to change. Based on industry cycles and political and economic analysis, experts point to a resurgence in both buy- and sell-side activity. Some expected trends:
Slated changes to the capital gains tax should drive sellers to market. Capital gains taxes will be increasing by at least five percent, (with some camps predicting a jump of 10 or even 15 percent to pay for the federal deficit.) On top of that, there is the proposed surtax of 5.6% for the new health care bill; that equates to a 69% increase in capital gains!
Imagine the impact on a sale with a $5 million gain—that’s $250,000 to $1,000,000 more you’ll pay the government, on top of the current tax burden.
Likewise, interest rates are only going up, most likely starting in June 2010, and over time higher interest rates lead to lower purchase prices.
While we won’t go back to the extreme (and unsustainable) multiples we saw three years ago for at least the next several years but business values will be propped up by supply and demand. The economic downturn has created pent-up demand, and there are more buyers than sellers on the market.
In the last six months, several of our businesses sold for at or more than their third-party valuation. One very good business should have drawn three or four letters of intent instead we had 11 LOIs, which obviously gave the seller the leverage to achieve a higher price. It’s just considerably easier to get buyers’ attention right now.
Buyers will bring more money to the table, but seller financing will be key to getting deals done. Before, buyers could get in with little cash equity. Banks would finance 65 to 85 percent of the sale, on top of alternative financing of up to 15 percent.
The mix this year will be closer to 20 to 30 percent cash down, 20 to 50 percent traditional bank financing, and 15 to 40 percent in alternative (seller, mezzanine, other) financing. With that said, some large strategic buyers are still offering all cash at close.
Another prominent trend, in the world of business valuation, will be sellers holding a portion of their business. Owners want to beat the capital gains increase but also want to keep working. They’re selling roughly 80 percent now and being able to concentrate on what they enjoy doing in the business under new ownership. In three to five years their remaining equity should have grown—particularly if they found the right, synergistic buyer.
Unfortunately we also expect to see more activity from distressed companies. Most banks are working to get their portfolios cleaned up by the end of 2010 and will be pushing for resolution on these loans.
All in all, I predict 2010 M&A activity to increase significantly over 2009. Many buyers have large sums of money and many believe the worst is over. Sellers see taxes and interest rates rising in the future while values will remain steady or only grow moderately for a number of years to come. Here’s to a productive and prosperous New Year for all.
Scott Bushkie is President of Cornerstone Business Services, a low-to-middle-market M&A firm. Reach him at 888-608-9138 or [email protected]