Why the M&A Market Is So Hot (and Why It Matters)
A quick scan of the business headlines makes it clear the mergers and acquisition market is on fire and not likely to cool off anytime soon. A convergence of trends is fueling M&A activity across many industries, causing business owners to ask, “Is now a good time to sell?”
Demand Outstrips Supply
While many baby boomer-aged business owners are ready to move on to retirement, the number of quality companies available for sale does not come close to meeting current investor demand. This scenario has created a feeding frenzy and caused business valuations to be higher than sellers or buyers might have anticipated.
Private equity (PE) firms are being particularly acquisitive, especially in the government contracting sector, where they are involved in about half of all transactions. In just the past three years, PE firms have established or acquired 50 new government services platform companies while exiting out of only 27. PE activity in other sectors like health care, technology and engineering, to name a few, is also robust.
The surge in deal making activity has caught the attention of many business owners who want to capitalize on this trend. Fear of unfavorable tax laws is also prompting sellers to act now. But demand will remain greatest for the highest quality companies.
Capital Market Conditions are Ideal
The cost of capital is at a 50-year low, with interest rates making it inexpensive to borrow money and easier to service that debt. With the stock market viewed as overvalued, investors see greater upside potential in acquiring privately held middle market companies vs. investing in public equities.
A Potential Infrastructure Bill Adds Fuel
In industries like engineering, the pending infrastructure bill has companies anticipating an influx of federal funds. That makes them attractive acquisition targets, driving up valuations and increasing competition for quality companies in these sectors.
Business Models are Changing
In the wake of the pandemic, many companies are adapting to unanticipated impacts to their business models. Whether they are affected by the work-from-home trend, supply chain constraints, or changes in how consumers shop, travel and dine, they will need to evolve to stay relevant. In response, larger companies are seeking acquisitions to help them diversify their customer base and services or products, address niche markets, or fill new customer needs. Alternatively, some smaller companies see selling as the solution to the challenges of competing in the new normal.
Strategics are More Acquisitive
Strategics (large public and independent companies or companies owned by financial investors that buy smaller firms) are more eager to acquire than ever, attracted by low interest rates and greater opportunities to diversify their revenue streams and drive growth, especially in industries like software and technology, health care and services-based businesses. With technology talent tough to attract and retain, organic growth can be difficult for companies in the tech sector, causing many to seek growth through acquisition. The low cost of capital makes this a less risky way to expand their capabilities or strengthen their competitive position.
PE Firms are Growing, But Under Pressure
The number of PE firms has skyrocketed as the next generation of investors leave established firms and set out on their own. No matter their size, they are all under pressure to deploy their investors’ funds effectively through M&A. They have also become more adept at sourcing companies, tracking emerging markets, and using technology to identify targets.
Cash is Aplenty
Pitchbook estimates that fundraising will surpass $300 billion in 2021 (an all-time high), with North American-focused PE firms holding $870 billion in dry powder at year-end 2020 after reining in their spending during the pandemic. This trapped liquidity has investors playing catch-up. In fact, 52% of those surveyed plan to use capital to grow the business this year, up from 36% in 2020. Most are pursuing platform acquisition strategies – seeking foundational companies they can build on by adding technologies, capabilities, or other companies.
While many trends are fueling M&As, there are still headwinds, including continually rising valuations that are causing some investors to drop out of negotiations early on. In this volatile environment, the best course of action for business owners is to understand the market dynamics, keep tabs on the trends, and develop a sound strategy that positions your company well to capitalize on the value you have created – whenever the time is right for you and your business.