Middle Market

Increase in PE-Backed Companies Seeking Add-ons Could Maximize Your Exit

September 20, 2018 By Dr John Binkley - Generational Equity

With his extensive experience in the industry, Dr. John Binkley has seen trends and movements come and go within the U.S. financial landscape. One current phenomenon that he has observed with interest is the popularity of additive deal making, or “add-on” acquisitions, among middle market businesses by private equity firms.

While Dr. John Binkley and other professionals at Generational Equity have observed and commented upon the increase of add-on acquisitions in recent articles on the subject, the latest evidence shows that this trend has escalated significantly.

Add-ons Becoming Another Norm

Newly emerging figures are suggesting that additive deal making on behalf of private equity funds is no longer simply a significant contributor to the volume of U.S. middle market M&A activity, but that add-ons have become the primary means by which mid-size American businesses are now acquired.

According to PitchBook, compared to 15 years ago when less than 20% of buyouts globally were add-ons, so far this year they account for more than half, with this figure breaching two-thirds in the U.S. So, for a U.S. middle market business owner exiting their company this year, there is a significant chance the buyer will be a private equity firm aiming to bolt on the business to an already held platform company.

This clearly has huge implications for business owners picturing how they will one day exit their company. Given this shift in how and why middle market firms are acquired in the U.S., sellers will have to plan differently and look beyond their competitors as potential buyers.

For business owners with a limited understanding of the behavior of private equity funds, and the increasing complexity of exit transactions where private equity is involved, seeking professional advice on exit planning is now more essential than it has ever been.

The Traditional Model

When we consider M&A activity, we typically envision the situation where existing businesses expand their own operations on the ground by buying up competitors and associated businesses. The appeal of acquisitions to an operating business are quite clear:

Acqui-hiring: Recruitment can be costly and time consuming for businesses. By acquiring an associated business, the buyer effectively hires that company’s core of trained employees that are more prepared to hit the ground running.
Geographical expansion: Acquiring a business with a strong record in a target location can be a great way for a company to expand its reach while minimizing risk.
Economies of scale: Operating on a larger scale can deliver savings through the consolidation of job roles, and bulk buying of raw materials, wholesale items or goods not for resale and other such economies.
Diversification: By acquiring a business with a different focus from the buyer’s own, the buyer can introduce new functions onto their existing holdings immediately.
Supply chain: Acquiring a business that supplies yours, or even acquiring one that your business supplies, can cut costs or increase margins for the resulting entity.
Consolidation and alleviating risk: A consolidated business may have more capacity to take on larger contracts with larger partners. Such a business might also be offered some measure of stability and protection should they lose a key business partner.

In other words, good old-fashioned growth. You buy another business similar to your own to expand your operations, or an associated or disparate business to acquire new functions or capabilities. That much is clear. However, the market share represented by this traditional model is dwindling.

Same Game, New Players

This is despite the clear benefits of the approach and the fact that M&A activity is thriving. In fact, according to Deloitte:

“[A]bout 68 percent of executives at U.S. headquartered corporations and 76 percent of leaders at domestic based private equity firms say deal flow will increase in the next 12 months.”

However, rather than businesses buying other businesses, Dr. John Binkley has seen the M&A landscape shift with the rise of acquisitions through private equity funding. It may come as a surprise to many that private equity investment is now rivalling this traditional model in driving M&A. So, what has changed in terms of market benefits that a smaller percentage of acquisitions now stem from the corporate sector?

In an important sense, nothing has changed in the way that businesses benefit from consolidation. All the above benefits to expansion certainly still apply. These deals are still happening – and at record volumes – for the same reasons and achieving the same beneficial outcomes as they always have. All that has changed is the players involved. The difference lies in who is spotting the opportunities and building the deals.

What has occurred in the last decade is that the success and profitability in middle market M&A activity has attracted the attention of the substantial private equity funding that currently covers the market. Now, the players bolting these companies together are sophisticated “big picture” finance professionals who always have financial outcomes in sight – generating the maximum ongoing returns or divesting with the greatest profit.

What is in it for Private Equity?

But don’t these funds exist to dip in and out of industries, buying low and selling high? What interest would they have in buying a business as an add-on to another business that they have already acquired?

On the face of it, developing businesses with add-on acquisitions is the interventionist, labor-intensive, time-consuming activity you might not expect from private finance. However, where the returns justify it, PE has proved itself willing to roll up its sleeves and get involved.

According to an analyst note published earlier this year by PitchBook, the proportion of businesses held by private equity firms that have undertaken at least one add-on acquisition has increased from less than 20% in the early 2000s to over 30% in the first half of this year.

And the results for PE have been rewarding. Funds with a high proportion of add-on holdings have been posting greater returns than those with fewer such holdings. According to PitchBook, the two sample sets of add-on heavy funds that they analyzed demonstrated greater total value to paid-in ratios than less add-on loaded samples. The PitchBook report goes on to conclude that:

“36.3% of add-on funds beat the top-quartile hurdle rate, while just 10.0% of funds fell into the bottom-quartile, indicating that funds that employ the buy-and-build strategy generate superior returns.” Additive Dealmaking: Part II – An analysis of add-ons’ effect on fund performance PitchBook

So, with add-on heavy funds outperforming those with fewer add-ons, why wouldn’t PE pursue this buy-and-build policy through additive deal making? Over 25% of private equity add-on acquisitions are undertaken by funds that had already completed at least 5 add-on deals previously – demonstrating that those funds’ successes in pursuing buy-and-build made it worth their while to repeat the policy on multiple occasions.

Private Equity Influx Changing the Complexion of the M&A Market

With his vast experience in the industry, Dr. John Binkley interprets this move towards private equity add-on purchases as a culture shift within the industry that has been in the works for some time. Brokering business sales is no longer a matter between fellow business owners. The days of the business owner bowing out while negotiating a mutually beneficial deal with a local competitor are disappearing.

The current booming seller’s market remains a huge opportunity for sellers. The reason PE firms are clamoring after the American middle market is because it is so attractive and profitable to them right now. This level of demand can mean business sellers are in a position to realize extremely favorable valuations on their businesses, exiting with higher sums than they ever thought possible – but only with professional advice to match the shrewd business strategies of this professional buyer.

If you are a middle market business owner, exit planning warrants serious consideration. But without an understanding of your prospective buyer, that planning will be of little use. As we have seen, it is increasingly likely that your buyer will come from the private equity sector, and most business owners can be forgiven for having a limited understanding of how that sector operates.

Learning about the profile of your buyers is just one of the areas covered in Generational Equity’s complimentary conference – so arranging to attend could be a very wise move given the shifting complexion of the M&A market.

M&A Seller’s Market – 7 Reasons It’s The Strongest in Decades

June 29, 2018 By Dr John Binkley - Generational Equity

One of the abilities Dr. John Binkley considers essential for business owners looking to sell their company is determining when the M&A industry is in a seller’s market.

Why is this? A seller’s market in M&A is when conditions give more pricing power to sellers as opposed to buyers. These cycles are when the values of businesses are at their highest, with buyers willing to pay significant premiums for attractive targets.

Being able to distinguish the features of a seller’s market is a vital technique for business owners who want to maximize the offer they receive from buyers. While it is possible to achieve a great deal if you follow a proven exit planning process, the process is likely to bear more fruit during active seller’s markets.

Fortunately, now is a great time to educate yourself on the components of an M&A seller’s market – we are currently in the midst of one of the strongest seller’s market in decades. Owners preparing to exit have picked an ideal time to achieve the optimal value.

Dr. John Binkley has identified below the 7 key reasons why the current seller’s market is so powerful right now, which will hopefully result in two things:

Business owners sitting on the fence about selling will now understand why the present represents their best opportunity to maximize their return on investment.
If you’re not ready to exit yet, you’ll be aware of the factors that could add value to your business in the eyes of buyers, so you can begin to put these processes in place now.

Why 7 reasons? Well, not only is it many people’s lucky number, but it has special significance for Dr. Binkley at this moment. Generational Equity recently closed their 700^th transaction, a number unrivaled by any other M&A firm working exclusively in the middle market.

So, if you’re interested in discovering the reasons for the incredible strength of the current M&A seller’s market, whether to reinforce your decision to sell your business or help you recognize how to add value to your business, follow on below.

1) The Laws of Supply & Demand in M&A

This first one is fairly self-explanatory, but it is undoubtedly one of the most important – there are a lot of buyers out there looking for exceptional businesses to acquire. The laws of supply and demand command whether we’re in an M&A seller’s market or not, and being able to recognize when numerous transactions are going on is key to knowing it’s an ideal time to exit.

Of course, it’s not just that simple – just because professional buyers are actively looking right now doesn’t mean they will invest their money haphazardly. You should get guidance from a trusted M&A advisory firm to make sure you’re fully prepared and will catch the eyes of buyers, and right now buyers are searching for well-prepared companies with a lot of potential.

2) Growth in the Number of Private Equity firms

One of the more marked changes that Dr. John Binkley has observed in the 21^st century has been the emergence of a greater number of incredibly active Private Equity firms.

In the US alone, the number of active Private Equity firms has quadrupled from fewer than 2000 firms at the turn of the century to around 8000 last year, according to the Global Private Equity Report 2018 compiled by Bain and Company.

What does this have to do with lower middle market business sellers in the US? Well, these firms generally have an appetite to enjoy economies of scale through growth, and their preferred means of growth, certainly in recent times, has been through “add-on” business acquisitions – bolting a smaller company on in order to grow a larger holding.

In fact, Bain also revealed in their aforementioned report that add-ons as a proportion of all Private Equity transactions reached an all-time high of 50% globally in 2017. The competition to buy businesses pushes up their valuations – great news for entrepreneurs ready to sell.

3) Record Levels of Dry Powder in M&A

The amount of capital made available to Private Equity firms by their limited partners, or “dry powder” as it’s known, has reached record levels – an estimated $1.7 trillion at the end of 2017 according to Bain. This is because the limited partners (LPs) are so keen to invest that they have committed vast sums to PE firms, who then need to deploy that capital right away in order to start reaping returns.

With this capital burning holes in their pockets, PE firms are highly active in M&A markets right now. While this is fantastic news for business sellers, it also presents a challenge for individual business owners, who need their particular offering to stand out amid the maelstrom of activity.

An M&A firm like Generational Equity can help business sellers to pinpoint the areas of their business to emphasize, to ensure that they can capitalize on this rise in “dry powder.”

4) Confidence of Middle Market Business Owners

For middle market companies trading in the US right now, business is good – and they know it. Over $10 trillion is being generated annually by nearly 200,000 companies in this bracket.

Unsurprisingly, this boom has caught the attention of both private investors and growth-minded businesses seeking consolidation, leading to a middle market M&A transaction rate of around 2000 deals per quarter, according to Thomson Reuters.

Positivity among middle market business owners is lifted by the knowledge that they can grow through M&A activity, that the value of their company is likely to be very healthy compared to a few years ago, and that they can sell for a good price when they need to.

5) U.S. Tax Reform’s Impact on M&A

2017 saw tax reform legislation passed that cut the corporate tax rate down from 35% to 21% and repealed the corporate alternative minimum tax altogether, vastly reducing the amount of tax payable by U.S. businesses to the federal government.

This reform has been a double-positive for the M&A market.

On the seller’s side, a reduced tax burden has boosted profitability for their businesses, and a more profitable company is a more valuable company, contributing to this strong seller’s market.

On the buyer’s side, from conversations with corporate buyers, Dr. John Binkley has learned that much of the dividend resulting from lower tax bills is being spent on business acquisition – even more than is being spent on R&D and employee incentives.

6) Increase in Cross-Industry Transactions due to Greater Digitization

The emergence of new technologies is affecting established companies, forging new ones and forcing together previously separate arenas of industry.

In his decades spent analyzing the composition of the business landscape, Dr. John Binkley has seen the way digital technology has gone from a niche industry, to an auxiliary part of every industry, to now a driving force of many industries – and the way this movement has impacted M&A markets.

We have seen merger activity where previously disparate industries have converged thanks to new technologies. We have seen established businesses source technological capabilities through the acquisition of smaller companies. We have also seen those businesses acquire budding companies harboring technological innovations that could disrupt and threaten their interests.

This cross-industry M&A activity makes Generational Equity’s expertise across all industries a valuable tool for its clients.

7) Strategic M&A is the Fastest way to Grow a Company

Finally, while we have heard above about the economies of scale sought by Private Equity firms when bolting smaller acquisitions onto larger existing concerns, it has become increasingly evident that firms are seeing acquisition as the way to grow.

In fact, there are many benefits in growth through acquisition:

Your new business arm has a tried and tested track record, which removes the element of speculation from expansion.
You hire a skilled and cohesive workforce in one hit, removing troublesome recruitment issues.
In acquiring a rival, you may expand your operations further.
In acquiring a supplier or a customer you may benefit from supply chain efficiencies.

These benefits have not gone unnoticed by businesses who have seized upon M&A activity as a tool for growth, especially where their industry allows little scope for organic growth.

So Sell Now – But Sell How?

Hopefully these 7 tips have helped you become aware of why now is one of the strongest seller’s market in history, and which elements to look out for to spot one in the future. But knowing when to exit a business is just half the battle – you also need to know how.

Dr. John Binkley, through his leadership of Generational Equity, has worked hard to extend this knowledge to thousands of business owners each year. You can discover more about the process of exiting a company through Generational Equity’s in-depth M&A insights.

How Can Your Business Capitalize on Record-Breaking Private Equity Activity?

May 25, 2018 By Dr John Binkley - Generational Equity

When determining your exit strategy or looking to attract investment into your company, it is important to remain open-minded with regards to who classifies as an “optimal buyer.”

Something Dr. John Binkley has identified among business owners in his time with Generational Equity and in the wider M&A market is the presumption that their eventual buyer will be someone from within their own industry (and likely a competitor), and it will be a straightforward 100% sale.

For some, this will be how their exit process pans out. But, there are alternatives. This piece is focusing on one of those options that can prove to be a win-win for all parties involved in a transaction – investment from a private equity firm.

Why highlight this now? Well, as Dr. Binkley has previously emphasized, we are in the middle of one of the strongest seller’s markets in recent history. But, beyond this, many are projecting that private equity activity in 2018, particularly in the middle market, may set new records after an already stellar 2017.

In this article, Dr. Binkley will outline what a private equity firm is and how a partnership with one can benefit business owners, explore the recent growth in private equity activity, and explain what business owners considering a partial or full exit of their business can do to market to these firms.

What is a Private Equity Firm & how do they operate?

“Private equity is capital that is not listed on a public exchange. Private equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies, resulting in the delisting of public equity.” – Investopedia

In practice, a private equity firm seeks to enhance the value of a ‘platform company’ (or portfolio company), which they will then exit at a later date for a greater valuation. In order to do this, they will often earmark smaller add-on companies to support the growth of their larger investment.

These smaller companies are usually strong synergistic fits for the platform company, giving it access to improved technology, additional capital, access to new markets and more skilled staff, among other benefits.

This continued investment into the platform company will often be carried out over a number of years in pursuit of an optimal return, both for the private equity firm and the original owners of the business, who often stay on during this process due to their expertise and understanding of the company’s culture and industry.

In Dr. John Binkley’s experiences as part of Generational Equity, these private equity firm transactions are most often established through a partial sale. In these scenarios, the equity firm acquires 51% or more of the target company, existing management is retained, and the firm continues to invest into the growth of the company over time.

What are the benefits of working with a Private Equity Firm?

As a result, partnering with a private equity firm through a partial sale presents significant benefits for business owners who have reached their ceiling in terms of building their company’s value, or aren’t looking for a complete exit from their business. With investment from a private equity firm, a company might experience:

Greater investment of capital into areas of their company
Expansion of their operations
Increased brand awareness in new or existing markets
Implementation of more efficient processes
Introduction of new staff/management
Institution of improved technology and equipment
Enhanced marketing and sales acumen

An example of this in action can be seen in the sale of Tate’s Bake Shop to Mondelez International for $500 million. Tate’s Bake Shop was previously a portfolio company of Riverside Company, a private equity firm specializing in the lower middle market.

Thanks to the guidance, support and funding provided by Riverside, Tate’s was able to grow beyond its pre-existing means at an exceptional rate to achieve this valuation upon their sale. For the owners of the company, this meant they were able to pursue further growth with the help of like-minded individuals and receive a return on investment upon their exit they would likely not have achieved otherwise.

Is now an ideal time to consider Private Equity Investment?

Having a firm grasp on what private equity firms do and the benefits it can have for your business, whether you’re planning on selling the business or investing in its future growth, is invaluable in the current market.

As Dr. Binkley mentioned earlier, we could be on the road to a record-breaking year for private equity activity. According to PitchBook’s recent US Middle Market PE Report, $54 billion was invested in middle market private equity activity in Q1 2018, continuing the pattern set in 2017’s record-setting year for both acquisition value and volume of transactions completed.

Almost $55 billion worth of capital was realized in 2017 upon exit, a 55% increase on the previous year and only slightly short of the 2015 peak. However, it should be noted that 2017 represented a consistently strong seller’s market that was not skewed by one great quarter or a couple of standout transactions – both Q2 and Q4 were worth over $15 billion.

In addition, add-ons now represent more than half of all buyout activity, a much higher percentage than even a few years ago, while nearly 30% of companies backed by a private equity firm undertake at least one add-on acquisition per year. Furthermore, with the baby boomer retirement wave expected over the next decade (10,000 baby boomer business owners already retire every day), now is considered an ideal time to pursue investment before the market becomes crowded.

Why the interest in lower middle market companies? The numbers don’t lie – there are 350,000 companies with an annual revenue between $5 million and $100 million, compared to just 25,000 between $100 million and $500 million. So, with private equity firms sitting on a record amount of dry powder ready to be invested, they will look to the largest volume of companies to devote their time and money to, which also have lower risk associated with them.

It is easier for private equity firms to score runs with several one- or two-base hits than it is to score with a single swing that has the intention of hitting a home run.

How can I take advantage of increased Private Equity Activity?

With demand high for middle market businesses among private equity firms, the best advice Dr. John Binkley can offer is don’t delay in marketing your company to these groups. As previously mentioned, the market is set to become crowded over the next decade due to the retirement of baby boomer business owners, while at present private equity firms are urgently searching for new investment opportunities.

Whether your business is chosen as a potential platform company for a private equity firm, or identified as an effective add-on for a pre-existing portfolio company, there are plentiful opportunities to achieve an optimal value. With effective collaboration and investment, all sides stand to benefit and generate more revenue in the long-term.

It is encouraged to reach out to an M&A advisory firm like Generational Equity for further guidance, and to ensure you locate private equity firms that align with your own business goals. Realizing the potential private equity investment can have on your business is often predicated on a strong partnership and shared culture between all parties. So, getting professional support in assessing your options is essential in making the most out of a relationship with equity firms.

If you’d like to learn more about private equity and how it could play a key role in both the future growth of your business and eventual exit strategy, you should browse Generational Equity’s in-depth M&A insights. Their website contains numerous valuable resources on the topics of private equity, add-on acquisitions and exiting for the optimal value.

For more from Dr. John Binkley, be sure to visit his blog for further exit planning advice, management tips and recent updates from his activities.