M&A Today: Smaller Deals Are on the Rise

Acquirers are favoring smaller acquisitions over mega deals.

If you were to compare M&A in 2017 to previous years, you might think that dealmaking is declining, but a closer look at the data tells a different story. Although announced US deal value decreased by 16 percent in the first half of 2017, the number of deals rose by 17 percent according to Thomson Reuters data. This means there are fewer mega deals and more middle market and smaller deals being executed. The number of small deals rose by 30 percent while the number of large transactions over $20 billion decreased by 40 percent, according to Goldman Sachs. What’s driving smaller deals today?

1. Volatility

Although President Trump has generally had a positive effect on business with promises of business-friendly policies, including a tax holiday to repatriate foreign cash, there is still a lot of uncertainty surrounding the new administration. This instability may make executives more hesitant to execute larger deals, which are inherently riskier than smaller transactions.

In observing the behavior of both the stock and M&A markets, we predict more deal activity is coming soon. Typically, there is a correlation between the stock market and M&A activity; however, in recent years, this pattern has not held. From 2008 to 2013, the Dow yearly return increased steadily, but M&A activity, in terms of value and volume, remained relatively flat over the same period. The one notable spike was in 2015. Fueled by concerns related to an increase in capital gains rates, global M&A deal value that year reached a record $4.3 trillion.

There’s pent up demand for deals and under the current conditions, executives are turning to smaller transactions to execute their strategy. Once people have more confidence in where the economy, regulators, and tax reform are headed, we may see an uptick on activity and deal size.

2. Aging Business Owners

The average age of a small business owner in the US is 60.3, and 57 percent of small business owners are now over the age of 60— a significant increase from 2008, where only 38 percent were over the age of 60. This means the number of owners interested in selling their companies due to age is increasing. Although some owners exit in order to take chips off the table or to move onto their next venture, for aging owners wishing to retire, selling is a natural outcome. A common scenario is that an owner does not have any natural heirs to take over their business or a succession plan in place, so they are looking to sell. This will increase the number of lower- to middle market sell-side opportunities that are coming onto the marketplace.

3. Private Equity

Private equity firms are professionals that invest the money of their clients/partners who are typically institutional investors such as pension funds and university endowments, and accredited high net worth individuals. PE firms purchase companies, apply their management expertise to run them more efficiently for a number of years, and then liquidate them through selling or by taking the companies public.

In a rising interest rate environment, PE become more powerful because they are very good at capital allocation and have an expertise in financial engineering. Investors who are chasing yield recognize the difficulty in getting a good return on investment, so they may be willing to turn to private equity as an opportunity to get a better return. Many of the aging business owners looking to exit may be pursued by PE buyers. As part of their practice, PE firms often acquire several small companies in the same industry and combine operations to build a platform and run the companies more efficiently. This process helps them increase margins and return for their investors.

Finding Opportunity in a Changing Market

Today’s market is full of opportunity for small business and middle market companies. Uncertainty, changing demographics, and private equity are contributing to an evolving M&A market where acquirers seek smaller, more strategic acquisitions over larger transformational deals.  All of these major factors are driving change in the market. Consider how these market dynamics might play into your acquisition strategy and help you find the right deal for growing your company.

Photo Credit; Hamza Butt via Flickr CC BY 2.0