Bain & Company aptly coined the term “Capital Superabundance” to describe a flush dealmaking environment in which the availability of financial capital is at record highs while the weighted average cost of capital for companies is experiencing record lows. What follows are some thoughts on how this environment of so-called “Capital Superabundance” is affecting American middle market M&A and its three major participants: private equity and corporate buyers, investment bankers, and exit-ready or “exit-curious” private companies.
To begin, have a look at the charts below to see how real the era of “Capital Superabundance” is:
Economics 101 teaches that when demand rises faster than supply, prices in the affected markets tend to rise.
The chart below details U.S. leveraged buyout purchase prices as a multiple of EBITDA for the past 20 years. Source: Capital IQ.
These macro charts provide the framing for a discussion about the most meaningful effects of Capital Superabundance on its participants in middle market M&A.
Top three effects of Capital Superabundance on private equity investors and corporate buyers:
- A respected and highly memorable brand has become a major advantage. Capital Superabundance is rewarding organizations with differentiated brands aligned to credible value creation strategies. A well-known examples of a memorable brand is Audax, one of the most effective buy-and-build private equity strategies in America. Other respected middle market brands include Danaher. Their now-famous “Danaher Business System” is the cornerstone of both their operational success and corporate M&A marketing story.
- “Business Development” has gone from an afterthought to top of the strategic agenda. BD excellence has become just as strategic to private equity and corporate development teams as sales and marketing excellence is inside companies. Private equity firms are investing in BD excellence through dedicated BD headcount and a series of enabling solutions. This includes CRM systems, deal networks and niche data and analytical services. The refrains so often heard in the 90s: “we know everyone we need to know”, or “all our deals are proprietary,” are heard less and less these days.
- Revenue-oriented value creation. It is often easier to cut costs than to find sustainable methods to drive revenue growth. Capital Superabundance’s upward pressure on purchase price multiples is rendering cost reductions insufficient. Buyers have responded to this reality with increased expertise around buy-and-build value creation models. These approaches play to buyers’ transaction expertise and utilize the increasingly popular “operating partner” model.
Top three effects of Capital Superabundance on investment bankers:
- The “personal Rolodex” approach to winning clients and creating great client outcomes is ancient history. A proliferation in the number and variety of middle market buyers has caused the modern middle market investment banker to rethink how they create, maintain and activate their “Rolodex”. Investment bankers are incorporating modern data services to discover buyers, research real-time buyer intent and engage buyers more intelligently. These “21st century investment bankers” are running circles around those who still think contact management is MS Excel + Outlook. Those who know how to dynamically discover the best set of buyers in a data-driven, deal-specific setting have the upper hand in driving great outcomes and meeting the expectations of an increasingly informed entrepreneur.
- Capital superabundance has made investment banking economic for sub-10M EBITDA opportunities. Historically, it was hard to find high quality investment bankers for businesses in this portion of the middle market. But with an increasing number of transaction-ready buyers in the lower middle market, the economics of investment banking have changed. Combining Capital Superabundance with some of the regulatory changes that have eliminated or relaxed broker dealer capital and oversight requirements for the execution of private M&A, establishing one’s own “micro-boutique” investment bank becomes easier than ever. The growth in these micro-boutiques also confirms that.
- The brand of an investment bank is more important than ever. Today’s entrepreneurs are able to search the internet to find and research different investment banks. Sell-side investment bankers must focus on developing a brand and a competitive differentiation to build a sustainable niche. Investment banks are taking a page out of the modern marketer’s playbook. They are leveraging well-established content marketing strategies to disseminate their expertise, clarify areas of focus, and create an inbound funnel of prospective clients. Similar to PE, sector and transaction specialist bankers are outflanking generalists with more memorable and more focused brands.
Top three effects of Capital Superabundance on middle market companies:
- It’s the most attractive and sustained seller’s market in at least half a century. Multiples are at record highs for businesses across nearly every sector.
- Middle market companies have unusually high amounts of strategic choice and freedom. M&A or LBOs are not the only way to achieve liquidity. A sufficiently cash-generative business might be able to generate more liquidity than it does with a 100% debt-only transaction. Royalty-based financing has emerged as another genuine alternative. Private equity isn’t the only option if you want to stay independent. Capital Superabundance has created a new set of choices for entrepreneurs running middle market businesses. They shouldn’t assume conventional approaches are the only way to realize their liquidity goals.
- M&A educational information is more widely available for entrepreneurs than ever. Free and affordable solutions for entrepreneurs such as BizEquity’s software-powered valuation tool, Axial’s online deal network and The Salability Score are examples of online solutions that educate and serve private companies that are considering a financing or exit event. These solutions give middle market entrepreneurs access to education on the transaction / valuation process and high quality recommendations to vetted investment bankers and capital partners.
No one knows if Capital Superabundance is a brief blip or if this status quo is the new long-term norm. However, today’s middle market participants must acknowledge it and take advantage of it by taking certain actions.
For private equity investors and corporate development teams that are committing to a more memorable and more focused brand, start slow and follow these tips. For firms that are looking for innovative ways to source deals, Boston Consulting Group is now recommending that going digital is worth considering. Investment bankers should be aware that sourcing the best deals is just as important as making yourself stand out to CEOs and knowing what not to do when dealing with investors. As for CEOs and business owners running middle market private companies that are riding the wave of Capital Superabundance, finding the best timing for a sale and getting ready for a transaction takes time and intentional preparation.