Firmex and Mergermarket recently published a report entitled Mid-Market M&A: The Valuation Gap (the Report), which explores valuation challenges that buyers and sellers are facing in mid-market M&A.
According to Mergermarket data, the number and value of American and Canadian mid-market M&A deals (US$10m to $250m in value) slipped year-on-year, with the slump continuing into the beginning of 2016. The valuation gap between buyers and sellers may help to explain why mid-market M&A momentum has stalled, despite high buyside interest.
Some experts contend that the valuation gap is in part due to the prevailing expectations of sellers, which are driven by the widespread publicity received by lucrative M&A deals and attractive valuation multiples for businesses across a broad range of industries. The availability of credit and heightened competition for high quality mid-market businesses has raised valuations for select companies which, in turn, are widely reported in the press. On the other hand, average and less attractive deals receive little press. As groups such as baby-boomers look to sell their businesses, reports of attractive valuation multiples may be an important motivating factor. However, their valuation expectations may not be realistic or applicable to their specific business or circumstances, which may pose difficulties as they negotiate with potential buyers.
The valuation gap is also an issue in highly speculative industries, such as the technology and life sciences industries. While the potential for upside in these sectors is alluring, the inherent risk and speculative nature of these businesses make them difficult to value and often invite closer scrutiny from buyers.
In light of the above, how can buyers and sellers confront the valuation gap and complete a successful M&A transaction? One useful tool is to use an earn-out to tie a portion of the business price to the post-closing performance of the business. Helpful tips for negotiating earn-out provisions have been addressed in a previous post on this blog. Other techniques may also include increasing the proportion of management equity rollover, on the theory that the interests of management and the buyer will be better aligned, and spreading out buyer-side risk by bringing on co-investors.
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