In 2015, record valuations drove a boom in mergers and acquisitions activity, leaving many to wonder when the deal bubble would burst.
In 2015, US buyout firms paid an average of 10.3 times EBITDA compared with the previous record of an average 9.7 times multiple in 2007. Despite hitting a peak, valuations are still expected to remain high for some time.
So what is happening in the market today? Why are valuations so high, and how does this affect you?
One factor driving valuations higher and higher are sellers’ unrealistic expectations about valuation multiples.
According to consultant Joseph Feldman, many sellers, especially those who have never conducted a transaction before, tend to look at news articles with high-valued deals as a guide. Unfortunately, they don’t realize that those headliners are not representative of the market as a whole.
Private Equity vs. Strategic Buyers
There is lively competition between private equity and strategic buyers, but with such high valuation multiples, M&A today is still a strategic acquirers’ market, and financing remains relatively inexpensive.
Strategic acquirers have an advantage because they may be more willing to pay for higher valuations, on account of their more long-term focus. Private Equity firms tend to have have specific, short-term targets for return on investment, so they may be less willing to pay a premium.
Says Andrew Hulsh, Partner at Pepper Hamilton: “These strategic corporate buyers, unlike private equity sponsors, may not need to be quite as concerned about the short-term impact of paying a higher price for these companies and assets, and can sometimes offset the premiums paid for these companies in part through business synergies and related cost savings.”
What Should You Do?
As a buyer focused on long-term growth, you have an advantage in today’s market. You may be willing to pay a bit more for a deal that makes strategic sense and will help you realize your goals. Price is always an important concern, of course. But it shouldn’t be the overriding factor. Long-term, it’s far cheaper to pay a bit more for the right company than to underpay for the wrong company. Acquiring the wrong company can prove a very costly mistake that is not easily fixed.
I’m not saying you should pay a multiple that doesn’t make sense. As always, you should remain strategic when pursuing M&A. Does the company fit in with your strategic rationale for acquisition? Also keep in mind there may be other non-financial aspects of the deal that this the right fit for you, and make you the preferred buyer for the target. Especially in the world of not-for-sale, privately held businesses, money isn’t everything.