Private-Equity Exits and New Acquisitions Are Lowest in Ten Years

We have witnessed a deteriorating private equity market during 2023. Private equity firm exits and new acquisitions are at the lowest level in the last 10 years. Many of our corporate buy-side clients are also sitting on the sidelines.

Several of our M&A colleagues, business owners, CEOs, clients, and senior level PE partners are very worried about the future of the U.S. business climate. Whenever uncertainty of the future exists, it has a negative impact. Consumers cut back on spending and save more. Businesses reduce production, capital investment, and stop strategic acquisitions. Banks become risk-adverse, demand higher collateral, and raise rates.

This uncertainty is caused by continued high interest rates, persistent inflation, fear of a government closure, and wars in Israel, Ukraine, and other smaller countries.

During the last third quarter, we saw PE firms cancel exits and acquisitions – large mega acquisitions or exits and smaller ones. The leveraged loan market has come to a standstill, impacting many deals.

Our research shows the value of exits in the third quarter fell over 40% to only $44 . This is more than 80% lower than the second quarter of 2021. The number of U.S.PE exits dropped over 45% lower during the third quarter, compared to last year.

New transactions plunged in the third quarter. Total value of U.S. private-equity transactions is over 50% lower than fourth quarter of 2021. Larger platform acquisitions are off over 20% this year. These large transactions deal structures use leveraged loans, which have been lately non-existent.

The difference between declining exits and lower entry acquisitions was over $475 billion this year. We are worried that if exit volume doesn't pick up, PE firms will face maturity issues for their funds and negatively impact their performance and infuriate their limited partners.

We believe an acquisition strategy in this current environment is to find deals where there is a clear case for near-term sales and profit growth. We know growth-equity investments are easier to negotiate and close in this economic troubled environment with the current hurdles. Our research reveals that growth acquisitions – investments comprised about 20% of all U.S. deals in the third quarter of this year. These growth deals were about the same as the second quarter and more prevalent than a year ago. But then with other transactions – investments falling off, this may not be all that good news.

We are working with our strategic buyers and private equity firms to be more creative in finding ways to generate good new deals and get them closed. 

This shows the trends for the near term.

Eight Key Areas to Review to Make 2022 More Profitable and Successful

Our upper middle market experience in mergers and acquisitions, has allowed us to work with many great business owners who faced significant challenges . Most of the challenges could have been eliminated with early identification of emerging problems. We have identified key areas to carefully review at year end to ensure you have no hidden areas of troubles that could arise to plague your business in 2022 or in future years.  I will post one at a time for you to review and share with your network, if you feel it is helpful. 

Number 1 - Review Your Assumptions Driving Your Market, Industry, and 2022 Sales Forecast 

As 2021 draws to a close, it’s an ideal time to reflect on how your business performed within your industry niche. How did your business compare to your competition? Did you achieve your sales and profit forecast?  

By now you should have an initial view of your 2022 sales and profit forecasts. Your forecast is driven by key assumptions on how your industry niche will perform in 2022.  

For example, a business owner we know owns a business in a very competitive industry. For this owner, it’s important to know industry expectations, forecasts, and trends to position her business for maximum success in 2022. 

What are the key assumptions and factors driving your market and sales forecast? What key economic assumptions are you using?  

It is crucial that you have all the best and most accurate information to ensure your expectations for 2022 and beyond are realistic.

Number 2 - Carefully Review Your Last Twelve Months Financial Performance 

We have worked with business owners who have large profitable businesses with consistent positive cash flow who often do not take the time to critically look at their company’s overall financial performance. It turned out to be a mistake when they wanted to sell. 

Where do you start? Begin with sales from period to period: Month over Month; Quarter over Quarter, and Year over Year. Ask questions: Are sales increasing? Why are they increasing or decreasing? Is it due to sales volume increases or just pricing increases?  

After you have a good understanding of your sales performance, next look at your profit or income.  You should look at gross profit, operating profit, and net profit. 

Of these three, you should look carefully at your gross profit margin. It tells how much you’re making from every sale after the costs to produce your products or services. Look carefully at your input costs. Calculate your gross profit margin as a percent of your net sales.  

Next, review your operating profit margin. This will show the actual profit your business makes after paying the variable costs of production, such as wages, raw materials, etc. When you calculate this ratio as a percentage of your net sales, it shows how efficient you are in controlling the costs and expenses associated with your business operations.  It is the pretax profits of your business. 

The more positive the financial performance, the higher the value of your business.

Number 3:  Create a Financial Forecast for Next Year or Longer 

Developing a yearly (or two years) financial forecast can be invaluable. This simply requires approximating or predicting how your business will perform in the future. We suggest that you at least complete a forecasted income statement. 

However, when we help business owners with a forecast, we use a three- or four-year forecast period. We help them develop six financial statements. These are the income statement, balance sheet, statement of cash flows, depreciation schedule, debt schedule, and net working capital schedule. 

Your financial forecast will help you identify trends in your historical data and it will help you identify future financing requirements for your company. If you are forecasting strong growth, your financial forecast will help you more accurately identify the future cash flow requirements to support your sales growth. There are many benefits of knowing the future financial status of the company. 

The more time spent on developing an accurate forecast, the easier it will be to manage your business.

Number 4 – Complete an Annual Review with Your Customers 

A number of years ago we worked with a business owner who was having trouble keeping customers and increasing sales. We developed a detailed questionnaire his sales team reviewed with each large client. We termed this The Annual Review. We suggested that someone other than the regular primary salesperson conduct this review to encourage the customer to be more candid in case they had issues with their current regular sales contact. 

This discussion and review with the key clients provided valuable insight into what the company was doing right and where they could improve. It helped make the company more responsive to the customers current needs. It also revealed areas where they were falling short and identified new ways to help their clients. 

This business owner found their clients response to be very positive. He stopped losing customers and his sales increased faster. The annual review provided valuable intelligence, new insight, and generated ways to improve customer service.

Number 5 – Review the Strength and Depth of Your Management Team 

One of your company’s best strengths should be your key management team. Although excellent management talent is often an intangible and hard to quantify, successful companies are those that have continually recruited, trained, and retained a great management team.  

Many successful owners conduct annual performance reviews. If you are one of them, explore with your team of key managers what they can do to improve the way your company functions. It’s a great time to find out if they are passionate about working for you and how they see their role in the long and short term.  

It’s important that you have the best and right people in your key management positions. If you have your key positions with the right people you will have great success. 

Are you pleased with your management team? Do you need to make changes?

Number 6 – Evaluate Your Advertising, Marketing, and Sales Strategy and Plan 

Most business owners know they need an effective advertising, marketing, and sales effort to be successful. Scrutinize your company's results. Develop a critical review of the following: return on investment, market share, new sales generation statistics, customer opinions, changes in sales, etc. 

Reviewing your sales and marketing methods takes some effort, but it can provide valuable management information. What worked best? What was the highlight of the year? What brought you to that success? Can you replicate it? Can you quantify your return on your investment? Have you tracked your spending to determine what was effective? Year end is a great time to make adjustments to your advertising and sales spending amounts.  

If something worked well, you may want to invest more in that area. Also, look at what your competition is doing.

Number 7 – Review Your Policies and Operating Procedures 

It’s crucial to understand what’s working great and what needs overhauling. Look carefully to find where problems could lie. Identify solutions to these problems. This review can be very enlightening, as it may reveal your organization has descended into bad practices that impede your success. 

Review all your supporting services to determine if they are meeting your current and long-term operating

Number 8 –  Review All Your Vendors  

It’s worth the time and effort at the end of each year to review all your key vendors. Review how much business you're doing with each one. Are your price and terms favorable? What is your working relationship with them? Is your relationship mutually beneficial? If you're satisfied with your vendors, let them know and work to create a better relationship with them. Often it will surprise them to learn their customer has an interest in them.  

During this process and discussion, you can explore establishing performance indicators for each vendor and develop even more effective evaluation processes and procedures to review and rate your vendors. 

It is our hope that 2021 has been a very good and successful year for you and your business

$3.1 Trillion Available for Business Owners Considering Exit or Sale

2021 may be a good time for business owners who have been considering selling or exiting their business to sell. 

There is a record level of capital available (“dry-powder in private equity jargon”) to acquire your business. Our research and conversations with many senior private equity partners reveals that private equity fundraising has been so successful that 2021 will likely be a record year.  

Through July of this year $550 billion in new funding has been raised for acquiring businesses. Private equity funding available to acquire businesses has been increasing consistently over the last several years. One summary report stated that the funds available for acquiring businesses reached a record level this year of US $3.1 trillion.  

The consensus of the private equity executives with whom we spoke is that they are aggressively seeking and making acquisitions this year. This is good news for business owners who have been waiting to sell. Private equity firms have capital ready complete acquisitions and low interest rates will also help in getting acquisitions completed. When many private equity firms are seeking acquisitions, it is good news for sellers who will be able to get higher prices for their businesses.  It is likely that the hunt for good companies to buy will continue to be very competitive. Private equity firms are actively seeking platform acquisitions and bolt-on or strategic acquisitions for their current portfolio of companies. 

The price for businesses, typically a multiple of EBITDA, has also been increasing from 5.5 times at the end of 2018 to 6.9 times through Q2 2021. This means that now may be the time for business owners to maximize the value of their business and get a higher sale price for it.  

Many business owners are concerned that an increase in the capital gains tax this year could have a negative impact on the proceeds of the sale of their business. There are proposals to double the capital gains taxes on proceeds of over $1 million. This will be a key deal structure issue to be negotiated with buyers. We also expect tax law uncertainty to stimulate more deal activity as PE firms and business owners look to lock in gains prior to any increases in capital gains taxes. 

For the balance of 2021 we believe private equity firms will be aggressively pursuing acquisitions. However, good acquisition targets will not be easy to find and there will be strong competition for the best companies. Business owners now considering an exit, sale, or transition now have a good range of options including strategic buyers, family offices, and private equity firms. 

We expect 2021 to be a very robust M&A market for privately held businesses. If you are considering selling your business, now may be the time to act. Don’t hesitate to reach out to us if you have questions.

Good News for U.S. Business Owners: Over $350 billion of debt funding is now available at low rates.

Through the first half of this year private debt fundraising has been increasing at a very rapid rate. Recent reports and our conversations with executives of large lenders reveal over $70 billion has been raised already in 2021 and is ready to be deployed (loaned out). This is due to low interest rates, decreased default rates, and the desire by investors to see alternative investment vehicles, rather than equities, bonds, etc. Direct lending continues to be robust, and billions are available for loans to businesses.   

It’s also interesting to note that many lending sources already have large amounts available for distressed debt and special situations funding. However, the deployment of this funding is lagging right now as right there are not a lot of good opportunities to deploy funds due to the lack of current financial distress in the market. 

When the COVID pandemic hit, many private debt funds experienced their worst quarter in the last decade. However, many have rebounded with the U.S. economy coming back, improving liquid credit markets, and surprising maintaining lower default rates.  

It is worth repeating that private debt fundraising for the first half of 2021 is reported to reach over $70 billion. There are over 80 funds actively raising funds and are currently on pace to raise more than average of the last five-years. If interest rates remain low, default activity does not suddenly rise, and investors continue to see debt investments as attractive, we will experience continued growth in private debt fundraising. This is good news to U.S. businesses who will find loans available to fund their capital expenditure and growth needs with low-cost debt. 

How much funding is available?  At year-end last year, there was $355.1 billion dollars in debt fund available to be loaned out. We forecast the total amount private debt funds available to reach $500 billion by year end.

$270 Billion in Venture Capital Funding Available for Early-Stage Businesses and Startups

The first half of 2021 has been a surprisingly good year for venture capital fundraising.  US and international venture capital funds have raised over $88 billion since January 1, 2021.  At this current level of venture capital fundraising, the 2021 fundraising total could surpass the record $130 billion raised in calendar year 2018.  Our analysis reveals that the last twelve (12) months rolling average of venture capital fundraising is on pace to be near or at the all-time high for a twelve-month period.   

This is due to many factors, such as investors seeking new investment opportunities in Agtech, biotechnology, energy, Fintech, logistics, medical devices and technologies, social media, transportation, etc. 

Our research has found that there are over 420 active venture capital funds.  The median fund size in the first half this year increased to over $70 million.  This is at least 25% higher than 2020.  Although it’s always changing, we believe that the average funding available for investing by large funds through July of this year to be around $200 to $220 million.  This is an increase of over 35% from last year.  

Many of the senior partners of venture capital funds with whom we work, have portrayed the first six months of 2021 as one of the busiest periods of their investing careers.  We have seen investing and deal making, liquidity events, and fundraising at a rate that is higher than in 2019 – before the pandemic began. 

New venture capital firms are having some trouble getting traction in the industry.  However, established funds that have raised three (3) to five (5) funds are successfully raising additional funding.  We estimate that the established venture capital funds have raised over %70 total new venture capital funding.  Some venture capital leaders have told us this is the best year thus far they have ever seen. 

It is good news for business owners of startup and early-stage companies seeking venture capital investment.  There is a record level of venture capital funding now available (“dry-powder in venture capital jargon”) for attractive emerging early-stage businesses.  The current amount of venture capital funding is at an all-time high of $278.3 billion.  

Additionally, venture capital funds have experienced a very robust exit market the last 24 months with a record level of distributions of over $130 billion.   

If the recent performance of venture capital exits continues and fundraising remains at the pace for the first six months of 2021, we should see a record amount of capital invested by venture capital firms in 2021. 

If your business is ready to seek venture capital funding, now may be the time to reach out to the appropriate venture capital firms who are active within your industry niche.

Business Exit, Succession, and Transition Planning – Pitfalls of Procrastination

               On a cold, gray day in February, I received a phone call from a friend whose family owned a large privately held business that was embroiled in a difficult and acrimonious transition.  Due to confidentiality, I am changing the type of business and the owner’s name. 

               John was calling to discuss the latest heated fights and problems among his siblings who were equal shareholders of his family-owned business.  His father had built a successful manufacturing business that produced high quality parts for large automotive manufacturing companies.  The company supplied a wide variety of unique component parts to GM, Fiat Chrysler, Ford, and others.  The business was a tier two supplier in the automotive world.  The company had a long history of profitability and strong sales for over twenty years.  Each year, the company generated around $3 to $4 million in profit for the family. 

               The business was managed by John’s father and mother.  Both worked full time in the business, with his father focusing on sales and manufacturing and his mother handling the accounting, human resources duties, and everything else.

               As John’s father got older, he attempted to bring all his children into the business.  Unfortunately, John had no passion for the manufacturing industry and instead became a successful dentist with a large network of dental offices in Michigan, Ohio, and Indiana.  John’s two sisters did not last long in the business and left as soon as they were married to raise their families.  John’s youngest brother, Tim, stayed working in the business in the engineering and sales departments, like his father, and clearly had the desire and capability to run the business.

               About two years ago, John’s father had a severe stroke and required extensive home care.  John’s mother spent most of her time at home taking care of him.  It was not long before the company began to struggle, missing product deliveries, paying suppliers late, and missing bid submission deadlines.  The company’s large, long-established customer base quickly eroded.

               John told me he met with his mother and father, pleading with them to come up with an immediate transition plan that would allow his brother to take over the business.  Unfortunately, John’s father was in no condition to provide any guidance and his mother wanted all her children to have an equal share of the business.  She told John they had a will that would leave John and each of his siblings with an equal share of the business.  She said it would be up to him, Tim, and sisters to determine how to move forward.

               John’s father soon died, and his mother did not live long afterward.  John and his siblings were now faced with a daunting task: how to proceed with the transition of the business. 

               Unfortunately, with John’s parents deceased, he and his siblings each now owned 25% of the business, which became a major contentious issue.  Tim approached John with a plan to keep the business in the family and build it into a much larger and more successful business. 

               John sent me a copy of his brother’s business plan.  It was a robust plan for recapturing the lost customers and expanding over the next two years.  I sent a redacted version to a senior level colleague in one of the big three automotive companies.  His reaction was positive and believed the plan was achievable and potentially successful.

               John and Tim called a family meeting to discuss the next steps following the death of their parents.  John took the lead in presenting his brother’s plan to keep the business in the family and continue to operate it and make it grow over the next several years. 

               Unfortunately, John’s two sisters and their spouses were adamant that the business be immediately sold.  They wanted their share of the money out of the business as soon as possible and did not want to wait.  According to John, over the next two hours a heated debate ensued.  They left the meeting in two camps:  John and Tim wanted to continue to run the business and make it more successful and their sisters wanted to cash out and would not budge on their desire to sell immediately.

               Over the next several months, the arguments and fights among John and his siblings continued. Tim became so tired of the arguing and fighting and was unable to get either of his sisters to sell all or part of her shares to him. Finally, he quit working at the company. 

               Sales continued to decline, profits fell, loan payments could not be made, and the company defaulted on its bank loans.  John and Tim attempted again to get their sisters to agree to some type of sale, but nothing changed.  The company was forced into bankruptcy.  The process was long and costly, and when it was finally settled, John and his siblings were left with nothing. 

This unfortunate saga could have been avoided with the proper planning when John’s father and mother were still healthy and running the company.

Business succession within the same family diminishes with each future generation.

               However, over the thirty years in which I have worked in mergers and acquisitions for buyers and sellers, I know how hard it can be for a business to be successfully transitioned to the next generation.  Although there is no real hard data collected on the transition success of a family business from one generation to another, most of the data I have seen states that less than one third of family businesses are successfully transitioned into a second generation.  Additionally, less than 12% survive and are viable into a third generation, and only about 3% are owned and operated by the same family in the fourth generation and beyond.

                  As you can see, the fact that John’s family business did not have a successful transition plan in place happens frequently, regardless of the owner’s good intentions and hopes for their family.

               For this reason, this is the first of a series of blog posts that will provide insight and best practices on business exits, successions, and transitions for business owners.  Although the focus of this series of posts will be from the privately held business owner’s perspective, the content, suggestions, and recommendations still apply and will be helpful to many CEOs and boards of directors of public companies. 

               As the Founder and CEO of a long-established upper middle market M&A firm, I have worked with a vast number of business owners who have faced many of the issues that each of you will face as you provide the leadership and make key decisions for your business and its transition to another owner.

               John’s family business did not face any uniquely unusual challenges. Most family businesses struggle with governance, leadership transitions, and survival.  Although I will review in later posts some family business transition success stories, the instances of smooth continuity, harmony, and longevity are unfortunately, often the exception rather than the norm.

               John’s parents, like most successful and active business owners, were good at planning and managing their business, but they had not invested their time or energy in preparing for their succession as owners or ensuring the future continuity of their business.

               It is also important to note how valuable family-owned businesses are to the U.S. and global economy.  Several recent research studies show that family businesses comprise an estimated 80% of companies worldwide and are the largest source of long-term employment in most countries.  In the United States, they employ 60% of workers and create over 70% of new jobs.  

               These are not just small or medium-sized businesses.  In one-third of S&P 500 companies, 40% of the largest firms in France and Germany, and more than 60% of large corporations in East Asia and Latin America, family members own a significant share of the equity and can influence key decisions, particularly election of the chairman and the CEO.

               The bankruptcy of John’s family company could have been avoided if his parents had taken the time to position the company for success after they were no longer running it.  Their mistake was similar to many business owners in that they were working hard in their business but did not give priority to thinking about a long-term succession plan.

               There is a clear course of action they could have taken to ensure their business would survive into the next generation.  As we look at the overall family situation and what occurred, Tim was the only one of their children who had an interest and the potential capability to take over the business from them.

               Their mother’s desire that each of the children receive an equal share of the money from the business is an admirable maternal objective and not one that prevents a smooth transition to Tim.  There are many business transition strategies that could have been implemented to allow Tim to become the majority owner, while still paying his siblings for their shares. 

               One potential transition plan they could have employed is a leveraged recapitalization of the business.  If they had worked with their company’s existing bank to re-capitalize the company with additional bank debt, there most likely would have been sufficient cash for Tim to immediately purchase his sisters’ shares of the business and purchase some of John’s shares.  John and his two sisters would then receive cash for their shares in the business and Tim would thereby own all of the business after paying his siblings a fair market value for what they had inherited.  Tim would be the new majority owner and have sufficient time to implement his new business plan, increase the businesses sales and profits, and keep the business going.

               When I described this deal structure to John, he said he would have been willing to wait for a longer time to liquidate his shares or even be a joint owner with Tim.  He said he wished that he had contacted me earlier, while his father was still in good health.

               Leveraged recapitalization is one of the first options I would explore for John’s family business.  However, if the bank would not loan the company the full amount required to purchase the siblings’ shares, there are other options we could consider.  For example, Tim could offer to buy a portion of his sisters’ shares up front and then buy the rest later.  If they were adamant that they wanted to liquidate immediately, he could pay them as much as possible from the bank recapitalization loan and ask them to accept a short-term loan for the balance.  This often occurs in the sale of a business where the seller cannot come up with the total purchase price.  The seller gives the buyer a short-term loan to complete the sale.  This is usually a five-year term loan that is similar to selling a home on a land contract and is often called seller paper.  As you can see, there are plenty of better options than bankruptcy.

               If John’s parents had agreed to allow Tim to buy the company, they could have easily executed this transition.  The first step John’s parents would take is to have a professional business valuation completed to determine the fair market value of the business.  This would ensure John’s mother that each of her children would know the value of their 25% share of the business.  Each child would receive their fair share of the business as she desired.  This professional valuation would be used by Tim to get the bank to agree to a leveraged recapitalization.  Once the bank is confident of the valuation of a business and its future plans for success, they will be more likely to make a loan to complete the share buyout.

               I have found that it’s prudent to be very candid with the bank’s leadership as to the purpose of the loan.  Most banks will be reticent at first to give you the loan because the funds loaned will be leaving the company and paid out to shareholders.  However, once they understand that the business will be increasing sales and profits, they will become comfortable with the leveraged re-capitalized deal structure.

               There are other exit and transition options that John’s family could have considered that would not have resulted in the demise of the company and sending it into bankruptcy.  The primary transition plan covered in this blog post is the leveraged recapitalization.  During my thirty years of experience as a senior level investment banker focusing on mergers and acquisitions, we have implemented a wide variety of exit and transition plans for business owners.

               In future posts I will discuss other exit and transition options, such as steps to prepare for a successful transition of the business to the next generation, getting your business ready to sell, understanding the value drivers of your business and how to maximize them, finding a premium buyer who will pay a premium price, getting private equity firms interested in buying your business, identifying potential strategic buyers, and other related topics.

               In 2021, I will be launching a podcast that will focus on all the key issues business owners face in deciding the future of their business and making a successful exit and transition out of their business.  My guests will be second and third generation business owners, current CEOs who have managed large privately held businesses for the family owners, professionals who help assist private business owners, and other interesting guests. More details regarding the podcast will be provided in upcoming posts.

               For more information about my background and the services we provide to owners, please visit our website at www.mfsib.com. 

               I would appreciate hearing from you and your comments on this post.