M&A: Is this a buyer’s or seller’s market?

Opinion piece written in late January, 2023

Strategic Corporate Finance Partner, Chand Chudasama, shares his thoughts on whether the current market is in the hands of buyers or sellers.

There is no doubt that buying, selling and raising equity in the lower-mid market feels different right now to the largely ups (but also a few downs) of 2020-2022 in the world of transactions.

For nearly 30 months, in most sectors, we have experienced a seller’s market. Valuations have polarised, but businesses who scored median (i.e. were in the middle on a scale of best to worst in their category) or above on four critical components hit bullish, premium, valuations whilst those that didn’t hit all four marks suffered.

These components, in my view, were:

1. Sound financial fundamentals (across all three statements)
2. Very good management teams (i.e. the management teams staying in a sale situation, not the ones leaving)
3. Fundamentally attractive markets and segmented position (the businesses’ customers are numerous, happy, attractive and surrounded by potential customers who can be described similarly)
4. Real growth capabilities (the business is showing in real time the ability to continuously sell to these attractive customers at an interesting growth rate and have the operations and supply chain to match)

On balance, from the 100 or so businesses I saw from the UK, Europe and US this annually, I would say about

• 1/3 of companies hit and exceeded the median point for all four markers and had bullish valuations as buyers who struggled in at least one category needed to acquire their way to solve the problem,
• 1/3 hit the mark on some but not all of these criteria and either delayed a transaction or tried and were let down on valuation, and
• 1/3 made some progress on all four categories but ultimately fell short to median standards and suffered a significant loss of equity value.

Nonetheless, I would still categorise the majority of the last 30 months as a sellers’ market. About a third of businesses I met were good, and they could command a valuation premium to historical comparables.

Looking back on last year, being on the sell side was fantastic. Yet, on the buy side it was phenomenally irritating! Deals became more complicated as downside protections were created, deals took longer, and due diligence providers were stretched.

As we stand today, as a department, we are working on 18 live transactions across the four partners and wider team. My sense is that, unlike the last 30 months, it is neither a sellers nor a buyers’ market as everyone has calmed down and become more rational. This means it is now a little irritating when on the sell-side. This is because deals were potentially more lucrative last year and the year before, and as business owners see and remember what peers achieved they will feel some frustration, naturally resulting in more good businesses deciding to wait to go to market. This delay is a sensible outcome as being median or above on the four factors above shouldn’t really qualify for a significant premium that could be classed as bullish. This should create a major incentive for business owners to invest in building their capabilities so they can return to market with a truly justified premium based on their own business capabilities and fundamentals, rather than one that just existed because valuations were ‘generally’ high.

There are obvious external factors creating risk and uncertainty that is driving the current change in negotiating power. My reflection on this is that it is not only sad that these external events are happening, but it is also sad that it takes such events to bring rationality back to the purchase and sale of unquoted equities.

There are, of course, sector based variances where one side has more power than the other. Not to mention that where one or more of the above factors is markedly below or above median expectations then power also shifts. Overall however, and unusually, I think this is currently neither a buyers nor a sellers’ market. It is instead a rational market.

I write this knowing that in 12 weeks this could be very out of date. However, as far as I can see, if you are minded to sell or raise equity one day soon, in order to maximise value, this is the best window of opportunity since the start of COVID to invest in your own businesses rather than drawing excess profits – this is simply because the challenges of the next few years have been disclosed to us; labour, energy, supply chain etc. Investing in solutions to these that mean your business is above median on all four markers has never been more rationale, and will likely lead to increasing valuations.

However, most businesses either won’t do this, can’t do this, or will misjudge where median is and fall short. This is an opportunity for the rest. If you do plan to acquire or invest, then it would be wise to double the search efforts and relationship building as there are an increasing number of decent businesses that could be better, but at least now have realistic valuations rather than a premium. This offers, once again, the old words of synergy and arbitrage, but at a more practical level acquisitions and growth capital offer the ability to expand the responsibility of high potential managers (something salary rises alone cannot buy), access more attractive customers and markets and accelerate valuation growth at an optimum time.

I suspect commentary on green shoots is not far away and it may shift to be a sellers’ market once again, but those sellers who make the right value creation decisions now will be far better placed than the rest of the pack.

Or of course, I could have only a narrow window of experience across a small sample of clients and contacts and therefore be very wrong, in which case please ignore all of the above.