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Conditions Ripening for Mid-market Rebound

Mid-market perspectives blog: Growth enterprise services

Posted February 5, 2014

A handful of megadeals captured the headlines in 2013, but just as important for the mergers and acquisitions outlook is the fact that buyers and sellers in the middle market seem to be perking up. Over the past 12 months, mid-market M&A transactions valued at less than $500 million are up 14 percent, according to Thomson Financial.

In polling conducted during a recent webcast hosted by Deloitte Financial Advisory Services LLP, nearly half of the participants said it was likely their company would be making strategic acquisitions within the next 12 months. Further, in response to a fall survey by Deloitte Growth Enterprise Services, 51 percent of mid-market executives said that M&A was important to their company's growth strategy.

A confluence of factors is fueling the renewed interest in partnering up. Confidence is improving in the market after the S&P 500's 26 percent climb over the past 12 months. The performance of the equity markets is encouraging corporations and private equity firms — both flush with cash — to hunt for takeover targets or to divest non-core businesses. Organic growth has been tough to come by of late, and that's causing companies to create growth through acquisitions. Finally, the increase in middle market loan volume indicates that companies are enjoying improved access to debt markets with quite favorable terms.

Added up, those drivers explain why many of the midsized companies my corporate finance colleagues meet with indicate they are thinking about doing a deal; however, my colleagues also tell me that potential buyers are analyzing potential deals much more closely. The downturn instilled a new level of deal discipline, and just because overall conditions seem to be picking up, it doesn't mean that companies are going to return to the free-spending days of 2006 and 2007.

Specifically, both buyers and sellers are going to greater lengths from a deal-structuring standpoint to secure their desired multiples. It's not uncommon for management earnouts (where part of the ultimate purchase price is paid out post-close and only after the target company hits certain financial goals) to represent a significant portion — exceeding 20 percent, in some cases — of the overall consideration. Companies are negotiating much more heavily around working capital adjustments to protect themselves from uncertainties such as the economy or regulatory issues. In addition, escrows are creeping higher and termination "drop dead" closing dates are moving up to reduce companies' potential exposure.

Companies that are considering the purchase or sale of a business have plenty of flexibility at the negotiating table, but deals are still subject to plenty of risk. It's important to understand the complexities involved in any deal before negotiations begin in earnest. Proper due diligence is paramount. Those who are looking to break into an unfamiliar geography or business segment need to be especially diligent when sizing up deals. Conditions may be ripening for a rebound in M&A activity in the months ahead, but it still pays to approach every transaction like it's your first.  

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