Lower-middle-market deal-making remains strong

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Record unemployment claimsHistoric weekly job losses. Words like “recession” and “depression” used to describe economic forecasts. It’s hard to read business news and see any glimmer of hope. However, if you weed through that noise, you can see that the outlook for lower-middle-market businesses (LMM), defined as those with less than $100 million in annual revenues, is actually one of growth and opportunity.

What does this mean for your business? It means that many of you have unprecedented opportunity available to you, despite what you are reading and hearing.

Collectively, my colleagues and I have met with over 150 private equity and family office investors over the past three weeks, and all are actively seeking new investments in strong LMM businesses. They want to move now, and they’re willing to pay higher valuations to lock them in today. I’m finding that private equity investors are sitting on piles of cash and are more eager than ever to put that cash to work, allowing it to reap the benefits of economic recovery.

Below are LMM deal-making trends we are seeing today:

1. Essential businesses equal growth opportunities

Businesses deemed “essential” by state and local governments are viewed by investors as recession-resistant. They have recurring revenue and consistent demand, two things investors love. This includes industries such as:

• Home services: HVAC, plumbing, electrical, roofing, pest control, landscaping, waste management, etc. With everyone home these days, people need their houses to be fully functioning. Anyone who lives in the South in the summer knows they’ll pay anything to have the AC working.

• Direct-to-consumer retail: Consumers are buying everything, from groceries to toilet paper, direct online, and this habit will likely be one that continues after the mandated lockdowns.

• IT software and services: App development, help desk support, cybersecurity, financial technology, telecom/unified communications and all things related to virtual technology will thrive and convert into long-term contracts going forward. People are learning to work remotely but need ongoing support to do it efficiently and securely.

• Education and training: Online learning has become essential, and record unemployment means many consumers will use that time to improve skills to be more marketable as employment rebounds.

2. The hardest-hit industries will eventually rebound

Deal-making for food and beverage, entertainment and recreation has, obviously, come to a halt. Real estate investment in the developments that house these hospitality businesses are equally impacted due to slowing rent cash flows and no access to credit. Many investors have communicated to us that once consumers come out of lockdown, they will start hospitality spending again. We’re all daydreaming of the vacations we’ll take once this is over, and investors are counting on that.

3. Credit is tight

Credit underwriting is difficult during a pandemic, and with capital markets fluctuating like a roller coaster, many lenders are putting money on hold. LMM deals are smaller and not as reliant on debt to close. Investors have cash on their balance sheets and can quickly write checks for the full amount. We have several clients who will be closing deals in the next 30-60 days because the investors are flush with cash and ready to close.

4. Deal-making certainly looks different

5. Pricing risk is hard

Valuations remain strong for LMM essential businesses because the associated risk is much lower. These businesses will still take advantage of historic highs in valuation. Those not essential will be tougher to price, as long-term uncertainty with COVID-19 makes it difficult to value growth potential.

6. Start now

It takes anywhere from 30-90 days to go to market. Preparation of financial and marketing materials takes time, and we all have nothing but time right now. Businesses should take this time to get their internal “house” in order and prepare.

So, yes, it’s tough out there for the big enterprises. Investors see that and are coming down the chain to focus on the LMM. They understand the growth potential is much higher with the LMM, and they want to move now. If yours is an essential business, you should think hard about moving forward with a deal today. There won’t be another chance like this anytime soon — don’t find yourself looking back in a few years with regret.

Article originally published April 20th, 2020, in the Orlando Business Journal: OBJ – Lower-middle-market deal-making remains strong