2018 shaping up to be another good year for the M&A market

Even in the face of tax reform uncertainty, 2017 proved to be a near-record year for mergers and acquisitions. Companies accepted uncertainty to avoid missing opportunities to remain competitive.

With tax reform certainty and technology convergence being major themes in 2018, most analysts predicted even more M&A activity this year. To date, they have proven to be correct. According to Thomson-Reuters, as of May 31 U.S. deal volume is approximately $900 billion—the highest since 2006.

Four factors
Numerous factors are driving volume. As already mentioned, technology convergence is a major factor. In 2013, non-tech companies acquired $13 billion worth of technology companies. In 2016, that number climbed to $128 billion. We may easily surpass that number this year as companies across every industry now recognize they are also technology companies.

Beyond technology convergence, the four big factors driving M&A volume in 2018 are:

1. Economic strength – Nearly 90 percent of middle market leaders responding to the most recent KeyBank Middle Market Business Sentiment survey stated the U.S. economic outlook is good or better. The reason for this is solid economic fundamentals. Interest rates remain relatively low, equity markets are at record highs and both consumer and business confidence is growing. When confidence is high, companies become growth-oriented.
2. Corporate Tax Reform – The recent corporate tax reform reduced the corporate tax rate from 35 percent to 21 percent. Furthermore, owners of pass-through corporations (e.g., S-corp, LLC, LLP) enjoy a tax deduction equal to 20 percent of taxable income. These lower rates increase after-tax cash flow and, therefore, corpotate valuations. Furthermore, the tax reform sent positive signals about the environment for business.
3. Strong revenue – The National Center for Middle Market survey shows the rate of year-over-year middle market growth has climbed steadily, reaching 8.4 percent for Q1 2018, the second-highest rate recorded since the center started tracking growth.
4. Cash – Tax reform is driving the repatriation of hundreds of billions of dollars and improving after-tax cash flow. While many public companies are using increased cash to buy back shares, others are investing in M&A. Other uses of this cash include expansion, equipment purchases, balance sheet strengthening and increased employee compensation.

Is now the time to sell?
Business is cyclical, and it is difficult to time when market conditions and business strategy intersect to maximize value and return. However, it is possible to make some broad assessments given the current environment.

For starters, valuations have risen as purchase multiples are above historical norms and buyers increasingly stretch to pay even more.

Also, employment gaps exist, but the labor market is very tight. The result is more companies will acquire to hire.

According to Ernst & Young LLP, 73 percent of surveyed executives of companies with more than $500 million in annual revenues plan to grow through M&A. Furthermore, 48 percent said they are willing to pay more to accelerate deal-making. Clearly, it is a seller’s market.

However, just because it is a seller’s market doesn’t mean you should sell. If you are a prospective seller, ask yourself: Is selling the company you’ve worked many years to grow the right decision for you? If so, have you maximized the value of your business? The following is a checklist of points you should consider:

• Market position;
• Industry strength;
• Barriers to entry;
• Financial performance;
• Quality of financial reporting;
• Outlook;
• Management strength;
• Personnel succession; and
• Intellectual property.

You may want to establish an experienced board of directors that can help you address each of the issues above. Also, involve a team of professionals (accountant, attorney and investment banker) early in the process. Your team will help you put together an information book, review your company’s product set and organize three to five years of financials. These are all things prospective buyers will require.

Your investment banker should have deep expertise in a variety of industries and offer an expansive network of private equity firms and corporate relationships to deliver a full range of merger and acquisition options. Your banker can also help you with valuation and finding the right buyer.

Completing the sale

Mergers and acquisitions are an involved and lengthy process, and they are complicated by the fact that the valuation model can vary from deal to deal. But in most cases, price is typically set by the financial needs of the seller and the value the business holds for the buyer.

This is why it is important for both sides to work with dedicated mergers and acquisitions professionals. The seller and their team will put together a book of information, which is then distributed to a team of targeted buyers. Potential buyers will submit letters of interest. Then potential buyers complete their due diligence to ensure the acquisition is sound from a financial, strategic and cultural standpoint.

This strategy is a win-win scenario for all players: sellers meet their goals while minimizing tax consequences and buyers obtain a valuable and strategic asset. Currently, the M&A market is hot and the conditions are favorable for both.

James Barger is president of KeyBank’s Rochester Market. He may be reached by phone at (585) 238-4121 or email at [email protected].