William Fink, Chief Lending Officer and Head of Credit Management, TD Bank | October 31, 2016 | Middle Market Growth
The U.S. middle market continues to see lower deal activity in 2016, down 30 percent from a year earlier, according to a Thompson Reuters analysis. The same study found that 70 percent of participating commercial banks have allocated up to 10 percent more capital to the middle-market segment in 2016, even as commercial and industrial middle-market loan issuance is also projected to be lower.
Despite the prevalence of available capital, the remaining uncertainty over Brexit’s impact, worries over the upcoming presidential election and concerns about long-term stability in corporate profits are halting lending and merger-and-acquisition activity. These qualms are likely to dissipate in the coming months, however, and middle-market companies should take advantage of the continued favorable rate environment to grow or make strategic moves to align with other organizations.
Set Up Your Company for M&A Success
Traditionally, there are six primary reasons why companies consider M&A: to gain access to a new market; to acquire expert talent; to block a competitor from increasing market share or entrée to a market; to grow revenue; to expand physical locations and deepen market penetration; and to obtain an asset like technology, a patent or product/service. Strategic and financial buyers, direct and indirect competitors, publicly traded companies, and private equity firms may all be interested in taking advantage of the continuing economic uncertainty to acquire assets cheaper than during times when more robust bidding may take place. Companies in the pharmaceutical, telecoms, software service, and grocery and beverage wholesale businesses currently may experience a more robust M&A market.
Outlining the strategic reasons for a sale or acquisition is the first step. A financing partner will do an independent evaluation of opportunities, risks and challenges, so it is critical for company leaders to succinctly state their rationale and provide backup documentation. A bank is unlikely to underwrite an M&A that could negatively impact the borrower’s market position, so company management needs to be clear on the strategy—just saying XYZ Company is a “good get” won’t suffice.
Find a Knowledgeable Financial Partner
M&A transactions involve much more than setting a sales price and merging the books, particularly if companies with overseas operations or dissimilar industries are merging. An experienced financial institution will look at multiple factors when evaluating a deal, including:
• The management team’s experience in the industry
• The proposed capital structure
• All sources of debt
• Normalized and sustained revenue, gross margin(s) and EBITDA
• Valuation of the company that includes analyzing discounted cash flow, comparative ratios and identifying comparable competitors
• The flexibility of the overhead structure and ability to weather economic fluctuations
• Any foreign currency risk if products or services are provided internationally
Don’t Derail the Deal
Because deals involve so many players, they have a higher likelihood of going bad. Most often they go south because the borrower did not fully identify or disclose their expenses and liabilities; other factors include labor unions, foreign entities or government contracts that limit scalability or have influence over the sale/purchase; too much exposure in a risky market; or management not being able to prove ability to adjust fixed and variable overhead.
Despite the softness in the economy and slowdown in borrowing, 2016 is still a great time to complete a deal. More banks have excess liquidity to lend and interest rates remain historically low. Middle-market executives with vision and ambition could find that taking a calculated now risk with a well-executed acquisition could reap rewards in market share, profits and enhanced competitive position in the future.