Mid-size companies fuel state’s heated-up M&A market

Guest column

By: Craig Allsopp
   The prospects for sellers of mid-size companies in New Jersey and other states are better in 2005 than in recent years, as more merger-and-acquisition deals of all sizes are expected to close, according to industry participants and trade groups.
   This growth will be fueled by continued low interest rates, a more steady economy, cash-rich private equity groups and companies looking to expand market share and gain operating efficiency.
   Still, owners of private companies face challenges completing deals — with buyers more demanding and transactions taking longer than ever before. Valuation issues also loom over almost every transaction with sellers often at odds with investors over deal pricing and terms.
   "Buying and selling mid-size companies is a chaotic process," says Robert Groag, a veteran middle-market business intermediary. "There are no real listing or pricing standards for middle-market companies and information about transactions is hard to find. Sellers often need help to navigate this process especially when it comes to positioning and pricing a deal."
   The most active markets in 2005 include business services and specialty manufacturing with moderate demand forecast for engineering companies and durable goods distributors. Demand appears to be weakest for mining, agriculture and construction companies, according to an industry survey prepared by Tango Equity based in New York City.
   The good news for sellers is that stronger demand for quality companies means higher prices. Though valuation always is an issue in private transactions, a recent survey of investment firms by the M&A Source, a trade group, shows that buyers are willing to pay higher multiples for quality companies in all market sectors, with manufacturing leading the way.
   Sixty-one percent of the buy-side firms polled said they would pay multiples of 4.5 to 5.5 times EBITDA for a profitable $15 million manufacturing company. Sixty-five percent said they would pay 4 to 5 times EBITDA for a similar sized distribution company, while 42 percent said they would pay 4 to 5 times EBITDA for a profitable $15 million services firm.
   Depending on terms, quality manufacturing companies can expect to sell for slightly over 5 times earnings, with distribution companies selling for 4.6 times EBITDA and 4.5 times EBITDA respectively.
   These same investors also expect to see the number of transactions increase with the average Private Equity Group preparing to close three deals in 2005 versus two to three last year.
   In looking at the New Jersey market, the trends hold true. The number of middle-market businesses advertised on major Web sites continues to increase as do the asking prices of those businesses listed for sale.
   A survey of 23 mid-size companies today recently conducted by Harbourton Group, an M&A firm in Hopewell, shows that manufacturing companies are seeking the highest multiples — six times adjusted EBITDA — followed by wholesale distribution firms — five times adjusted EBITDA — and business services — 3.2 times adjusted earnings.
   "The deal drivers in 2005 are simple — cost and growth," says Greg Peterson, a partner in Price Waterhouse Cooper’s M&A practice, adding, "Deals that don’t offer growth potential won’t get done, despite cost savings — and that’s true on the corporate side as well as the private equity side."
   Notwithstanding favorable market conditions, business owners should still plan carefully before deciding to sell their companies. Firms are well served to follow the advice of veteran intermediary Ted Burbank who advocates a "Wall Street" method to selling privately held companies. This approach is so named because it mimics the process larger public companies follow prior to a sale or merger.
   This process puts a premium on planning and breaks a transaction into three parts — exit strategy formation, market valuation and deal execution.
   Exit Strategy Formation. This is the first step in a transaction and begins with understanding the reasons for selling and how to maximize value prior to going to market. A good exit strategy also considers estate planning and tax implications and provides impetus to the owner to begin his or her post-sale planning, be it for retirement or for another business venture.
   
   Market Valuation. This step sets the stage for going to market. A thorough market valuation will enable a seller to identify the right type of buyer (strategic, industry or financial) and will examine the different reasons buyers may be interested in a company. This analysis also will highlight elements that make a company attractive and will show prospective investors how past performance reflects future opportunity.
   Deal Execution. This is the final stage and ensures the transaction process stays on track. Key to successful deal execution is ensuring that company information is released in a controlled manner while still providing qualified buyers with a compelling presentation. The goal is to create an auction situation with more than one buyer bidding for the seller’s business.
   
Craig Allsopp is president of Harbourton Group LLC a mergers and acquisitions firm located in Hopewell. He can be reached at (609) 466-3100 or by e-mail at [email protected].