State of the M&A Market as of 2Q20

The 2nd Quarter 2020 Market Pulse Report was released, giving us a glimpse into the impact of Covid-19 on the market for business transactions in the main street and lower/middle market.  The Market Pulse Report, created in partnership between the Pepperdine Private Capital Markets Project, M&A Source and International Association of Business Brokers (IBBA), is a survey of business intermediaries throughout the country on a variety of aspects on their deals, including industry, size, time to close, multiple paid, and more.

Of note, deals are still closing, albeit at a slower rate than before.  In the second quarter, respondents in the survey closed 176 transactions, down from 32% during the same time period in the second quarter of 2019.  In Main Street Business transactions, identified as deals under $2 million in value, approximately 50% of deals were either cancelled or delayed.  This is just slightly higher than the Lower/Middle Market, defined in this report as deals up to $50 million, which saw 47% of deals either cancelled or delayed. 

Interestingly, the valuation multiples in both segments of the market remained fairly stable.  Below is a trend for the last six quarters, segmented based upon the size of transactions.  It’s important to note that the multiples shown for the main street market are Seller’s Discretionary Earnings (SDE) multiples, while those in the lower middle market are EBITDA multiples.  The simple difference between the two is that SDE = EBITDA + Owner’s/GMs salary.  So, EBITDA assumes a multiple after paying everyone’s salary including the market rate of an operator, whereas SDE assumes a full time owner operator who needs to earn not only a return of investment on their money, but on their time. 

This may seem a little odd on the surface, but makes some sense when you consider what is occurring in the market.  As noted, the number of transactions closed in the second quarter was down 32% due to a high level of cancellations.  But, during this same time frame, the number of respondents in the 2nd quarter was up 25% from 288 to 361.  For businesses that are heavily impacted by Covid, those transactions are not closing and showing up in the multiples data. The transactions that are closing are, to a much higher degree, for businesses that are operating at closer to full capacity.  Whereas many sellers may be pulling their business from the market at the moment, buyers are still looking for high quality businesses. 

The key takeaway from above is that stronger businesses may find that demand for their business remains robust while those heavily impacted may need to right size the company and wait out this difficult environment.  In fact, most business intermediaries will indicate that over time, the change in the cash flow will have a far greater impact on the swing in a business value than a change in valuation multiples.