Is a Tsunami Brewing in the M&A Market?

By John Herubin, Managing Director

There are several factors indicating that a large wave of sell side activity is on the near-term horizon. Much like a tsunami is created by earthquakes occurring below the ocean’s surface, sell side activity may be welling up below what is visible in the day-to-day financial markets.

As much as I don’t like using natural disasters as analogies, you don’t want to be an unsuspecting beach walker (unprepared closely held or family business owner) when the theoretical M&A tsunami hits. Preparation of your business will enable you to successfully ride the wave and not be swamped when it hits or sucked back out to sea when it retreats.

Investment bankers can act as a market seismologist/meteorologist to read and interpret the conditions and signals warning of an impending wave of activity (unlike the local television weather meteorologists, we must be correct more than 50% of the time to keep our jobs).

The last significant wave of sell side activity occurred in 2021 as many businesses recovered from the Covid pandemic in conjunction with the tremendous amounts of pent-up liquidity in the M&A markets that had been ready to purchase companies. This virtual Tectonic shift in financial market conditions resulted in peak amounts of volume and value for sellers at that time. Business owners who were prepared to take advantage of these conditions often realized unprecedented values upon the sale of their business.

As financial seismologists, our market seismometers are telling us that conditions in the financial markets are again ripe for another massive wave of activity in the foreseeable future.

These rumblings include the following:

• Mature Private Equity (PE) funds seeking to sell existing portfolio company investments to generate returns for investors. Many PE funds are nearing the end of their holding periods for their investments and will be active sellers. This should spur a domino effect so that buyers of these companies will be looking for smaller “add-on” companies to increase their value and ultimately return on investment when they subsequently sell. This will make potential add-ons more attractive if properly prepared for sale.
• We’re sensing from on-going conversations we have with privately held business owners, that they are happy having made it through the Covid pandemic and achieved pre-Covid levels of performance. This happiness comes with the self-realization that they are five years older and may not possess the stamina to withstand what may be the next financial/global crisis that could affect their business (future pandemics, war, election impacts, etc.). If the circumstances look favorable for a liquidity event, they are open to that possibility more now than five years ago.
• PE fundraising has remained steady and growing in many sectors, which provides a ready market of buyers who are motivated to seek out either platform investments or subsequently add-ons. Recent surveys have indicated that significant “dry powder” (unspent investment capital) is available for buying attractive companies in the Industrials, Business Services, and Healthcare sectors (Antares Capital – July 2024).
• The wave of activity can be accelerated by anticipated cuts in bank interest rates which will provide more affordable capital for purchases of companies thus contributing to the growing wave. Cheaper lending costs can also impact valuations, making better prepared privately owned companies more attractive and valuable to potential buyers.
• Additional below the surface factors include potential changes to the Federal Estate Tax rates set to sunset at the end of 2025. Without further Congressional action, Federal estate tax rates are set to increase on January 1, 2026. Business owners have a quickly closing window to do tax planning in advance of a potential sale to minimize Federal estate and possibly income taxes. Failure to adequately address these issues may result in missing an opportunity to maximize value from a sale when the wave rolls by.
• The proliferation and availability of information has expanded exponentially this century (I know, master of the obvious). Business owners even contemplating the possibility of a sale now or in the future are bombarded with information and solicitations. If you’ve never been in these tumultuous waters before, it’s wise to have a skilled guide to ensure you’re going to “Hang Ten” while navigating any M&A wave (I couldn’t bring myself to use a “Jaws” reference in deference to our highly valued PE partners).

Our best advice to business owners of all ages and regardless of their circumstances, is to always be prepared for a wave of activity. Many owners who had no intention of selling were tempted by the frothy market of 2021 to prudently consider a sale. Not having the business positioned in the best light to pursue that path can be financially costly.

Just like earthquakes that silently happen below the surface, there are other financial and non-financial early-warning signs telling you to be prepared and head to higher ground. Like the U.S. Geological service in a tsunami, a good advisor can help you know when the optimal time is to ride the wave.

I love looking at the ocean but would prefer to be safely on high-ground and well-prepared to ride out the tsunami when it arrives. The better prepared you are for the tsunami of sale activity that is anticipated to arrive, the greater the likelihood you will be high and dry when everything subsides.

If we get it wrong, we’ll blame it on Doppler Radar!

© Copyright 2024 by John Herubin, Managing Director, EdgePoint Capital, merger & acquisition advisors. All rights reserved. John can be reached at 216-342-5865 or on the web at www.edgepoint.com.