A few weeks ago, I participated in a webinar with Kyle Madden, partner at KLH Capital, to discuss the current state of mergers and acquisitions in the lower-middle market. Since the M&A market is on fire right now, we had a lively conversation and received great questions from attendees.
In case you missed it, here are a few of the topics we discussed:
What multiples are buyers paying?
It should come as no surprise that this question came up first.
Let me start with a caveat: Multiples are dangerous territory. Quoting an average can be like throwing a dart at a dartboard. It’s impossible to determine a multiple for a specific opportunity without taking a closer look at it.
However, we have been seeing higher multiples now than we’ve seen historically, and there has been a record-setting amount of deal flow.
Cautiously, I can say that the average range of multiples in my market—businesses that generate between $5M and $100 in enterprise value—falls somewhere between 6.5-7X EBITDA. I’ve also seen some businesses trade at multiples of eight or nine, and others trade at multiples of five or six—we’ve had outliers that rise above or fall below that average.
Ultimately it comes down to the market—the more competitive the market you create, the more you can maximize value.
Think of buyers and those who acquire businesses as a triangle: At the top of the triangle are the strategics—the smallest group of investors that pays the highest multiples. Then you have the financial buyers and private equity investors in the middle, followed by individual buyers at the bottom—the individual buyers represent the largest group, but the lowest valuation.
The value of your business and the multiple it attracts will depend on which segment of buyers are attracted to your business. When you attract more buyers, you create more competition, and competition drives value.
Whenever someone asks me what multiples they can expect, I ask them to tell me about their business so I can understand what they’re offering for sale. From there, I can better understand the value, and in turn, what multiples they might expect.
What are the hottest industries right now?
Overall, we’ve seen an uptick in buyers looking for automation and cybersecurity businesses. With the cost of labor rising, many buyers are turning to automation. Service businesses are also surging—this includes HVAC service businesses, landscaping businesses, and other residential home service businesses.
We’re seeing massive deal flow in construction, for both production and installation. As people spent more time at home last year, home improvement projects exploded, along with the sale of tiling, roofing, flooring, doors, windows, and other building materials. And as those sales climbed, installers were also in high demand.
The one thing we do know about these businesses is that they’re inherently cyclical, especially when it comes to residential. However, for service-based businesses with recurring revenue streams, there’s lasting value for buyers if the business scales appropriately.
Do multiples differ between construction-based and service-based businesses?
The short answer is yes. We’re seeing a backlog in the pipeline, which means many businesses are unsure what three years of revenue looks like.
But more broadly speaking, businesses with non-recurring revenue streams won’t trade as high as businesses with service contracts. For those businesses with maintenance-based revenue streams and a commercial customer base, there’s a significant amount of untapped value.
What’s in store for 2022?
I wrote candidly about this topic in a previous blog post. No one can predict the future with complete accuracy, but as I mentioned before, the predicted rise of the capital gains tax has many on edge. We foresee a record number of companies changing hands in Q4, driven by aging owners and rising taxes. If Q4 is as active as we expect, we’ll likely see a slower Q1.
That being said, many business owners are still weighing their options. Legacy businesses in particular, especially those that are family owned and operated, are unlikely to exit because of a pending capital gains tax increase.
It’s not always about buying or selling—it’s about solving problems.
Many business owners approach REAG because they’re facing a challenge. Some want to sell their business, but many have certain aspects of the business they must address first. Perhaps they’re approaching retirement and tired of reinvesting money back into their business. Or maybe a business has multiple partners with conflicting opinions on selling.
Not everything happening in the market is black or white. There are gray areas. We can help you navigate those areas and maximize value in your business.
Do you still have questions about the market? Reach out to REAG today!