The M&A market in 2027: valuations, deal activity & outlook

Transcript

Richard: Do you think the founders are looking to exit because they’ve lost confidence in the future, or they don’t have the ability to carry on, or they feel they just need funding from somewhere else and, as a result of that, they’ll have a diluted control over their business?

Ricky: Yeah, I think that’s, like, in terms of the people we’re working with, I guess, you know, entrepreneurs don’t tend to start a business with the sole purpose of selling it. A lot of the people that we work with started a business because they didn’t want to work for anyone else. And, you know, they win a few contracts, they have to hire some people to service those contracts and then, you know, 10, 20, 30 years later, all of a sudden they’ve got a business that’s doing 2 or 3 million EBITDA. And, actually, you know, manage a management team that are kind of largely running the business independent of them, or they may still be quite hands on, and they get to a period in their life where, you know, the business itself is their biggest asset, um, and they want to, they want to turn that into cash, that they can, they can live off or pass down to the next generation.So, yeah, we’re largely talking to founders that, you know, been through COVID, the Ukraine war disrupting supply chains, you know, a number of black swan events in the last 2 or 3 years. and they’ve perhaps been putting off the decision to go to market because of those things. And actually, you know, they can’t, they can’t really put that, that decision off any, any longer as Doug alluded to, you know, there is a lot of capital in the business chasing, chasing good, good, good deal, and and transactions are still taking place, albeit the lead times are slightly longer.So, so, you know, it’s down to us to find the right partners for those entrepreneurs to hand their business over to, or indeed, you know, help them find, help their management teams find the right funding partner to acquire the business off the founder.

I’d say last, last, probably 12, 18 months, the kind of recurring threat of capital gains tax going up, under the current labour government, has made people think that they may want to sell now, obviously talks of inheritance tax and pension taxes being attacked or have been attacked over the last couple of years making people think about structures and trusts and, you know, family investment companies and various other solutions. But really sort of, you know, getting the business sold in a lower tax environment is quite appealing to a number of founders at the moment. And I believe that’s been what’s holding up deal activity in the graphs that Doug showed us earlier.

What is really driving mid-market valuations?

Richard: Okay, so let’s move on to the other side of the story, which is basically valuation, and judging by the number of enquiries and comments we get. Is it always a difference between what the buyers and sellers, so to speak, how they value a business? How is that changing? Because at the end of the day, you’ve got to have transactions that take place rather than people hope that they will get a price or they will do something. Well, we think largely investors are the guys who are generally in control. Now, I’m not sure whether you agree with that or not, but this seems to be part of discussions that we’re having all the time.

Ricky: Yeah, I mean, for a transaction to take place, you need a willing buyer and a willing seller, right? Everyone knows someone down the pub who sold their business for 12x. So that is often a challenge we have to wrestle with when we’re when we’re 1st engaging with a business owner who wants to sell.

I think it was quite interesting the stat that Doug showed earlier, where kind of the kind of peak of multiples in the lower mid-market was at around 7.8 and had sort of flattened off around the 6x over the last couple of years. I think that’s, you know, certainly analogous of what we see in the market.

Um, I guess, you know, what’s driving the activity and valuations? You know, it’s availability of capital, but actually, it’s the ability to create value once that capital’s been deployed. I guess at its simplest form the valuation is, you know, a sustainable profit number multiplied by an appropriate deal multiple.

What makes a business attractive to buyers?

Ricky: So buyers, we believe that are sort of focusing on two questions, really, how robust is the earnings of the business and how much confidence can they place in the fact that that profitability is going to grow going forward?

And businesses that can demonstrate that they’ve got historic growth that’s going to be sustainable, healthy, profit margins, kind of recurring and predictable revenue lines, limited amounts of customer concentration, um, exposures to, you know, attractive underlying market dynamics are still generating really strong interest and definitely generating really strong valuations.

I guess the other point in the sort of strategic relevance to the buyer, or the investor, you know, most competitive process tend to involve businesses that really move the dial for a buyer, perhaps by, you know, introducing new capability, access to a difficult to access customer base, scale, as Doug alluded to earlier scale drives valuation, drives, drives multiple, so being able to add scale, with little risk, would certainly command a premium valuation.

I guess in contrast, businesses with less predictable earnings, you know, material concentration, less differentiated value propositions, can be still transact but buyers are likely to be a lot more cautious, both around valuation that they place on the business and also deal structure.

So we’re seeing quite a lot of situations where a deferred consideration element or an earn out or a sort of vender rolling up into a PE backed consolidator is used to kind of bridge that valuation gap.

So I guess, you know, capital remains available, but it’s following quality and predictability rather than being deployed a bit more discriminatively in order to simply achieve multiple arbitrage in the platform.

Does competitive tension really matter?

Richard: Now, I’ve got one sort of final question, which is, when you’re looking a lot for these transactions, any any of them competitive? Not always, the buy side is actually competing, or is it basically, these are, this is the sell side, the companies, trying to find a buyer, and quite frankly, there’s probably one person or one company that might be interested. So they’re not in a particularly strong negotiating position, which is totally different, if you have several companies, several investors looking for the same company.

Ricky: Yeah, yeah, I guess, um… Depends how I niche the business is really. I mean, for a lot of the processes that we, that we run, you know, typically there are a number of buyers. You know, you can, you can, even if the business has been approached off market by a, by a trade acquirer that’s sort of found them outside of a process, the kind of threat of running a wider process can drive competitive tension, even with a, even with a single buyer.

Um, I think the market tends to, to, to drive the valuation. Okay, both the buyer and the seller will tend to know where other comparable transactions in the sector have traded at. So, having a single buyer doesn’t necessarily mean that you’re leaving value on the table and, in fact, not running a process could indeed buy you a bit more good will down the road when you’re starting to negotiate things like debt items, free cash, network and capital adjustments, etc.

So whilst, you know, getting a premium valuation in terms of the headline number is part of the equation. you know, keeping your powder dry and and actually being able to get some winds in terms of the bridge between the Enterprise value and the equity value, can really be quite valuable further down the line.

Earn-outs: bridging the gap between buyers and sellers

Doug: I think maybe thanks, Richard. I think my, what I’d be interested in, Ricky’s view on, is just earnouts, and to what extent are you seeing those, those being used more or less or the same to bridge those expectations that you, you know, inevitably find between buy and seller valuation?

Ricky: Yeah, absolutely. Yeah, we do see that. We do see that quite a lot in transactions, particularly with a trade buy, because it acts as a, it sort of has 2 a dual purpose, I guess.

So firstly, it will help bridge that gap between the seller’s valuation aspiration and what the buyer’s prepared to pay. Also, it acts as a good retention mechanism. And if you are working with a, an ANA managed business and you want to make sure that they’re kind of hanging around for 12 to 18 months to affect an orderly handover of key client contracts or even just to keep the keep the ship running whilst the buyer figures out what they actually acquir and keeping them honest with an element of deferred consideration that may be contingent on, you know, keeping keeping the numbers where they ought to be is, is, yeah, is a tool that is being used.

Obviously, you know, when we’re acting on the sale side, we make sure that there are provisions within the sale and purchase agreement, which mean that the buyer can’t act, you know, unscrupulously to chip away at the overall value, by not paying the, earnout.

But obviously, you know, we want to make sure that the ability to integrate and deliver some of the synergies that the buyer wanted to achieve are there, you know, sometimes deferred consideration and earnout mechanisms can come frustrate an integration process.

So we have seen instances where whilst there’s a bit of uncertainty during the deal negotiations and the SPN reflects a sort of earnout model. you can you can effectively accelerate the payment of that deferred consideration once everyone’s got comfortable with each other so that the buyer can actually push on with the integration exercise.

So having that flexibility in the legal docs is quite important.

Doug: Yeah, makes sense. Thank you.

Will 2027 be a stronger year for M&A?

Richard: Do you have another question, Doug? Doug: Oh, no, that’s me. thank you. fine, fine. Richard: I have got one final question for both of you because we’re coming up to the end of 2026. People are starting looking through all sorts of 2027 and looking to the future. So, do you think 2027 is going to be a busy year in the acquisitions market? And do you think there’s a possibility that some of the activity might increase from domestic purchasers, as opposed to, as Doug was saying, there’s been quite a lot of activity from overseas? But basically, a lot of IP has been taken from this country at relatively low prices recently. Are you looking to 2027 as being quite a dynamic year, or do you think there’s gonna be a change in any trends? Like, maybe you start off, and then Ricky can comment.

Doug: Well, I, yeah, I mean, I’m happy to come, and I think Ricky will have a far better view on this than me, but I suppose the things that we hear, when we’re talking to customers, are, I think the 1st thing to say is that it’s been an incredibly volatile period for the last 5 or 6 years. So the one thing that has been normal in the market has been this volatility.

And I think people, and certainly we, as, you know, business owners ourselves, have just had to get used to that. You know, you’ve really just got to get used to the fact that you’re operating in an environment where there are shocks and those shocks are relatively frequent.

And in terms of, I guess, if I think about that in a wider context about, you know, Do I want to engage in M&A activity? I suppose that maybe in some other environments, you’d wait for things to calm down, you’d wait for some certainty. And the certainty now is the uncertainty. So you’ve just got to get on and do stuff.

And I think, again, you know, the, the, you know, Ricky alluded to this, the kind of, the tax drivers as well, you know, just, you know, whilst there’s lots of uncertainty going on, and a lot of that is relating to, you know, you, when you look through the tax lens, it’s okay, what’s going to happen here? what’s going to happen to CGT? Is it going to be equalised with income tax and so on? I can see that sort of acting as quite a big driver to be able to say, well, I don’t want to take that risk and I’m getting to a certain stage in my life. age, health or whatever, I’m gonna push the button now.

And and, you know, so so I kind of think irrespective of the macro and interest rates and all that kind of stuff. I actually do think next year will be quite a healthy year in my in my opinion.

Richard: Thank you.

AI and the changing M&A landscape

Ricky: Yeah, I echo Doug’s, comments, so I think, I think, you know, as, as, as Doug alluded to, in his earlier, presentation, sort of press around deal volumes and deal activities is quite negative, but actually, if you look at what’s actually happening in terms of deal executions and valuations is that the market’s held up, I think that will continue into next year, albeit the, you know, the on-going threat of AI may mean that technology businesses, software businesses, and IT managed services businesses are still sort of perhaps trading at a slightly lower valuation than they were a couple of years ago.

And that’s sort of shift towards old economy type businesses, business services, people businesses, industrial businesses, they continue.

I guess, a lot of the clients that I’m working with have AI and technology is more of a headwind than a threat. Actually, those that are adopting those technologies to deliver their service more efficiently, more quickly in order to keep client satisfaction up and keep margins robust will trade at a better rate than those that seeing it as a headwind and maybe not adopting it as quickly because they think it’s gonna, you know steal jobs of their employees, et cetera.

Yeah, we’re quite positive about about 2027. I think there’s still a lot of dry powder amongst the private equity community. I think the debt fund providing an additional source of liquidity versus versus sort of traditional bank lenders and a lower cost of capital to doing a straight PE deal.

But I think we’re seeing a lot more appetite to do sort of leverage buyouts where management may have, you know, 30 to 50% of the of the equity and actually they’re using a debt product or a best debt product to fund the buyout of the, of the same 50 to 60% founder shareholder and perhaps leaving them with some stub equity or a, or a vendor loan note to, to, to bridge difference between what they can achieve from a, a, debt perspective and the total EV of the business.

So, yeah, I think the market will find solutions. If, if, if the, if the trade buyer isn’t there, then the management team potentially step up and then obviously private equity continues to deploy capital. So, yeah, my view is that the, the 2027 will be just as strong as 2026.

Richard: Thanks, Ricky. That’s been a really useful perspective, particularly around the difference between headline market sentiment and what’s actually happening at transactional level. So thank you. And to our viewers, please don’t forget to like and subscribe to our channel. We appreciate your time, and we look forward to seeing you at the next forum. Thank you and goodbye.