Mercer Capital's Financial Reporting Blog

When It Rains It Pours: Middle-Market Deal Activity Is Picking Up

The following guest post is authored by Jay Wilson, Vice President at Mercer Capital. Jay’s practice includes valuation services for banks and financial technology companies. Follow him on Twitter @MercerFinTech.

“When it rains it pours. Maybe the art of life is to convert tough times to great experiences: we can choose to hate the rain or dance in it.” – Joan Marques

With the first half of 2014 now in the rear-view mirror, the business press has started to reflect upon what occurred in the first half of 2014 and key trends emerging for the year. One emerging theme that has been commented on in several pieces is the uptick in deal activity both globally and domestically. On the global front, a Bloomberg piece recently noted that deal activity was particularly robust with $1.2 trillion in announced deal value in the second quarter of 2014, which was the first trillion dollar quarter for takeover offers in seven years. In the same article, Jeremy Grantham, of Mayo, Van Otterloo & Co. noted his expectation for a “deal frenzy” with deal activity potentially on the verge of a “veritable explosion, to levels never seen before.” A number of potential deal activity drivers were cited including a sluggish economic recovery, lower borrowing costs, and relatively high profit margins.

Focusing more specifically on the US, PWC noted that U.S. deal values surged to $982 billion in the first half of 2014 compared to $570 billion in the first half of 2013. PWC also noted that larger deals (those whose transaction value was greater than $10 billion) accounted for a higher proportion of deal activity (50% for the first half of 2014 compared to 30% in the first half of 2013). PWC went on to note that a shift was underway towards transformative deals that “fundamentally change their business model or the scale of their enterprise to strengthen long-term growth prospects.”

On a micro and personal level, even I got carried away with deal excitement and was quoted in a Bloomberg Businessweek article on the uptick in deal activity in the payments industry in the first half of 2014. In the article, I noted that payments deal activity going forward could be expected to continue and perhaps increase as deals may be driven by prospects for improving profits through greater economies of scale. The payments industry is a diverse and growing segment within the Financial Technology Industry, an industry that I pay particular attention to and one that has also seen and is expected to continue to see a growing number of venture capital and private equity funds allocated to it.

As the factors behind this deal activity increase and whether it will continue from here may be up for debate, the numbers clearly indicate that a rebound in deal activity is certainly underway in 2014. While this has implications for financial statement reporting professionals who may already be experiencing increased deal related valuation work such as purchase price allocation and contingent consideration, I want to shift away from the larger, headline grabbing stories and take a moment to focus on the small and middle-market deal landscape in the US for the first half of 2014 and what the implications might be for the typical business owners within this group.

Middle-market deal activity in the US did increase in the first half of 2014. Thompson Reuters noted that middle-market deals (defined as those whose deal value was less than $1 billion with a US company as either the buyer or seller and that closed during the time period noted) increased in both the number of deals and the deal values. Deal values were up compared to the first half of 2013 (1,057 deals valued at $137.9 billion in the first half of 2014 compared to 996 deals valued at $123.5 billion for the first half of 2013).

A recent Forbes article also described an increase in middle market deal activity and Andrew Sherman, a partner at Jones Day, noted several long-term trends that could continue to drive middle-market deal activity:

  • Aging baby boomer entrepreneurs/owners;
  • The rise of millennials who may be entrepreneurial but not necessarily interested in stepping into their parent’s old-line companies;
  • The large global private equity overhang, which is the amount of cash raised by PE funds but not yet deployed;
  • Cash stockpiles of public companies; and,
  • An increase in shareholder activists pressuring companies to use cash.

While we know from personal experience that succession and transition planning is difficult for all companies, but particularly for small and mid-market companies, it is advisable for these owners to be prepared in light of the forecast for an active and robust deal environment for small and middle-market companies.

Sherman’s suggestion for preparing for a potential acquirer includes three steps: “1.) an appraisal, 2.) a mock due diligence exercise done with the help of an expert like an M&A attorney, and 3.) a financial recast that backs out of your numbers any factors that might be important to a buyer.” Sherman then goes on to note that: “It costs you tens of thousands now and is worth millions later.”

In addition to Sherman’s advice, we would also suggest a discussion with an appraiser or adviser about other liquidity and wealth diversification options that may be available to owners other than a third-party sale such as an employee stock ownership plan, regular or special dividends, or a management buy-in program (see the article from Chris Mercer of Mercer Capital entitled “Between the Bookends of ‘Status Quo’ and ‘Third-Party Sale for a Business'”).

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Mercer Capital monitors the latest financial reporting news relevant to CFOs and financial managers. The Financial Reporting Blog is updated weekly. Follow us on Twitter at @MercerFairValue.