Thanks to strong economic growth in recent years, private equity firms, family offices and corporations continue to hold record amounts of capital, but attractive assets are scarce and what’s available is expensive. That’s a problem for buyers, but it may not be a challenge for long.
An expanding economy, a favorable regulatory environment, beneficial tax policies and low interest rates have fueled an active deal environment, according to Citizens Bank’s annual “Middle Market M&A Outlook” survey. However, while 71 percent of potential buyers surveyed are either actively engaged in an acquisition or open to pursuing one this year, only 62 percent of potential sellers are doing the same.
Abundant demand is good news for sellers bringing companies to market, but historically high valuations and intense competition are impeding buyers—although not for much longer, says Charles Aquino, managing director at Citizens Capital Markets. “It’s a temporary phenomenon.”
Just how temporary? Almost half of the 600 companies surveyed by Citizens Bank said they anticipate an economic slowdown within the next two years. To stay ahead of an approaching downturn, buyers are accelerating their M&A strategies, said Ralph Della Ratta, head of M&A Advisory at Citizens Capital Markets, in a press release. The survey showed that buyers are attracted to high-growth verticals such as technology, health care and business-to-business services rather than consumer services and industrial sectors, which tend to be vulnerable when economic conditions decline.
That urgency is prompting buyers to write bigger checks and potentially take on greater risk, but Aquino says not to worry about speculative bubbles. “Unfortunately, it’s hard to see those in advance, but there doesn’t seem to be that kind of a concern.”
That’s because buyers are much more careful in how they evaluate targets. Acquirers are increasingly relying on third-party experts to gather intelligence and looking more closely at earnings analyses and financial audits to justify larger purchases. “We’re seeing all types of buyers doing that,” Aquino says.
While experts and analysts generally agree that an economic downturn is on the horizon, there is no consensus on its scale or scope. Some, like Alex Chausovsky, a senior consulting adviser at ITR Economics, doesn’t predict an all-out recession. Speaking at ACG Kansas City’s recent Annual Economic Forecast Breakfast earlier this month, Chausovsky said he expects a slowdown between late 2019 and mid-2020.
It may even present an opportunity. Aquino anticipates an economic downturn to lower valuations, which could turn the tables for investors and strategic acquirers, and lay the groundwork for the next expansion.
“I don’t think there is any magic formula preventing what you can’t see in the future,” he says. “All you can do is be as careful and detailed in your work up front as possible and trust that your assumptions were reasonable and that your thesis was sound.”
Benjamin Glick is ACG Global’s marketing and communications associate.