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Private Equity Firms - Why Are They Selling?

 

John Kielich, CPA - Managing Director for Kolb+Co. M&A Advisers   email | bio 
LeAnne Foster, CPA - Senior Associate for Kolb+Co. M&A Advisers   email
August 2011

Over the past several weeks we have been meeting with a number of Private Equity Firms and discussing the current Merger & Acquisition (M&A) market. They are in a unique position of seeing the market from both the buyer's and seller's shoes at any given point providing them with a great perspective on opportunities and indicators in the market. There are some consistent themes that have resonated through these discussions which have grabbed our attention.

The firms that we have met with generally focus on the lower middle market which are companies with a minimum revenue of $10 million and EBITDA (earnings before interest, taxes, depreciation and amortization) of at least $1 million. This is usually the threshold for considering new platform acquisitions, however, they will consider smaller companies for add-on transactions. These firms are from throughout the US and are generally looking to invest in your typical Midwest company. The funds these firms have to invest range from under $20 million to over $600 million, representing a very good cross section of the Private Equity world. Without exception, the firms expressed surprise and dismay at the lack of good companies for sale. Deal flow, while not lackluster, is surprisingly weak.

The lack of quality companies on the market has caused a number of the firms to take advantage of the favorable market and sell some of their portfolio companies sooner than originally planned. Why are they selling? It is a seller's market in the opinion of the Private Equity Firms and here are the reasons why.

First, an unprecedented amount of cash needs to be invested both by Private Equity Firms and synergistic buyers. There is anywhere from $1.5 trillion to over $2 trillion of cash available for investment. Idle cash right now is a curse because it is earning so little. Synergistic buyers need to find growth and the Private Equity Firms need to deploy their funds to earn an adequate return for their investors.

Second, banks are coming back into the M&A market. We were given examples of banks leveraging transactions at over five times EBITDA with minimal covenants and at very favorable rates. Banks are in need of making loans to earn an adequate return for their shareholders. This combination of increased leverage and low rates leads to higher multiples. This is another reason the Private Equity Firms are not shy about putting their own companies up for sale.

Finally, every discussion that occurs leads to a mention of the current favorable tax rates. While there is no certainty that the capital gains tax rate will increase beginning on January 1, 2013, the smart money is betting on taxes going up. Washington keeps spending and revenue is needed. Favorable tax rates combined with attractive pricing is advantageous to sellers.

The people that work for Private Equity Firms are smart people. If they think it is a good time to sell maybe you should as well.