During the first half of 2008 the small to mid-sized corporate M & A market was relatively unaffected by the problems caused by the unwinding of the 'Sub Prime' mess hitting the financial markets and the onset of the dramatic fall in the value of FTSE 100 companies (down 35% from its peak in 2007). However, as the lack of confidence in the economy in general and funders in particular continued, it was no longer immune. The almost complete lack of IPO's on both the main market and AIM led to a reduced number of mid-size buyers. Consequently, this significantly reduced the total number of transactions being completed.
The onset of the current stagnation in the SME market was masked to an extent by the mini boom in activity leading up to the change in CGT regime on 5 April 2008.This undoubtedly led to some SME owners activating or bringing forward disposals during the last quarter of 2007 and the first in 2008 During the summer of 2008 there was still evidence of transactions being completed with leveraged debt funding and VC backing, although with hindsight, deals were starting to dry up.
With the unwinding of the financial markets during September and October 2008 the 'back to school' activity, which is normally seen in the autumn, just wasn't there. UK banks were in survival mode. Restoring their capital adequacy ratios and balance sheets has been the order of the day since then.
The recession has now moved from the financial sector to the whole economy. Businesses have had to cope with declining trade, sterling's weakness against the dollar and euro and in some case the withdrawal of credit insurance. There has been much publicised government aid to struggling businesses, however this has focused on keeping companies afloat.
There has been no support for the M & A funding market despite initial talk of a government backed venture capital fund.
There has been pressure on transaction prices, mainly due to the EBIT (Earnings Before Interest & Tax) multiples that banks are prepared to lend coming down significantly. Before the credit crunch last summer it was common for banks to lend up to 4 - 5 x EBIT on a leveraged transaction with a debt to equity ratio of 70/30. There has been a seismic shift to somewhere in the order of 2 - 2.5 in the current market. There is a close analogy with the housing market where though interest rates are at an all time low the borrowing hurdles have increased considerably and those that don't have to sell (and be prepared to accept anything up to 25% less than at the peak of the market) will not do so,
For nervous buyers or sellers embarking on a transaction, advisers are finding it difficult to say whether it's a fundable transaction and, equally importantly, whether there will be stability of earnings, of both the buyer and seller, leading up to completion (this is often a critical factor).
However, there are still many reasons why entrepreneurs should still maintain their M & A intentions. Owners of SME's will always want to retire, or possibly be forced to through health or family issues; companies will need to find ways of solving growth or logistics issues and though we could face another 18 months of uncertainty in the funding market, the pent up demand will require satisfying in due course.
The key question is: have we been living in a false utopia over the last few years and where will the equilibrium be struck between price, terms of payment and funding instruments?
As Sir Brian Pitman, former chairman of Lloyds TSB said recently, "we have had an illusion of prosperity, based on greed, and now we are going to have to correct that because it was an illusion, it was not the real world".
The question for all of us watching the M & A market is: When and how will we determine what the 'real world' for the next 10 years looks like?
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