Bad and negative market news over the past year has been substantial. Layoffs. Aggressive interest rate hikes. Inflation. Stock market selloffs. Tightening credit. Recessionary fears. Ukraine. Silicon Valley Bank and Signature Bank collapses.
All of this is enough to make your average business owner, and their various advisors, feel the markets are closed for opportunity. However, when you dig deeper into the specific elements of each situation, it becomes clear to us that opportunity has not gone away, only changed form. Depending on which side of the current M&A and capital market supply/demand equation you are on, there are different yet substantial opportunities that remain for middle market CEOs in this current market.
On the Sellside, we have seen that “A” companies – those that have demonstrated continued growth , are profitable, led by deep and experienced management teams, and have no material business issues (i.e. customer concentration, low margins, extensive and unsustainable COVID bumps, etc.) – are continuing to get strong interest and valuations in the market. There remain pockets of industries where these “A” companies are prevalent including food, industrials, transportation/logistics, specialty physician practices, and even sub-verticals within the otherwise battered tech industry. In a very counter-intuitive fashion to the main market news, we are even seeing these “A” companies experience headier interest and valuations than in the past, given that performance through this market stands out with materially fewer companies now being chased by ever-increasing amounts of private equity and strategic buyers.
If your business is not currently an “A” company or in an industry that continues to generally perform well, then opportunities still abound in a different form. We are seeing a substantial number of middle market companies turn their lens toward acquiring smaller or weaker competitors, which can now be executed at potentially lower valuations than the past few years. Additionally, this can be a ripe time to recapitalize inactive shareholders, either exchanging passive or unaligned owners for a value-added and more growth-minded investors, or consolidating and increasing active shareholders’ ownership.
Finally, while the credit markets have generally tightened and become more selective, we still see solid pockets of debt and structured equity capital available to middle market business owners. Tapping this capital often requires a change in mindset for CEOs and CFOs, shifting a 10+ year focus on the lowest cost of capital to an optimized capital structure that can execute growth, recapitalization and/or acquisition opportunities employing more flexible – and more expensive – capital. The trade-offs are not always worth it and require extensive diligence and cost-benefit analysis, but we are seeing more business owners embrace expensive debt with a “cheap equity” mindset from an overall shareholder value basis.
In conclusion, for all of you in the LA middle market community including business owners and those advising business owners, this can be an important time to revisit your strategic alternatives to avoid missing out on opportunities that may not be immediately evident. That said, proceed with caution, ensuring you understand your valuation in this current market to avoid “chasing rainbows” or the distraction of a failed process. Be true and circumspect on whether you fit within the “A” company category, and if you are not able to consider optimizing a sale transaction at this time, then reassess your cap table and acquisition opportunities, if that option is available and of interest.
It is also a perfectly appropriate strategic move to do nothing in this market. That said, we believe you should end up at that conclusion only after fully considering all options currently available, which will ensure you avoid missing any key opportunities to build material shareholder value through this market cycle.