Consumers have a lot on their minds these days: The price of everything keeps going up. The Federal Reserve keeps raising interest rates. Will there be a recession in 2023? If so, how long will it last, and how deep might it be?
Companies that sell products to consumers, either online or in stores, have many of the same concerns. And owners who are considering selling their businesses have an additional worry: Is there still a M&A market for their company, are the consumer and e-commerce buyers active in 2023? And what kind of price can they expect in such a foreboding economic environment?
First, the good news
In fact, the market for middle market consumer retailers has changed, but it’s still strong by historical standards. Valuations also remain strong. M&A volume was down in 2022, but that followed the prior year’s record-breaking pace. In 2023, we are expecting to see a healthy climate in middle market M&A.
Consumer products continues to be a category that is very popular among investors, both strategic and private equity, so we don't see the category going out of favor in a recession. One of the most positive indicators is on the buy side.
In 2019-2020, there were more acquisitions by strategic investors. Now there's more activity by private equity. And PE groups still have a large appetite for companies. In fact, according to several estimates, PE has $2-3 trillion of “dry powder” capital looking for a home. Moreover, they need to spend it soon.
Typically, PE groups are required to invest their capital during an investment period, usually in the first 24 to 36 months of receiving it—regardless of the economic environment, whether it’s objectively favorable or not. And a lot of this dry powder has been acquired recently. Seemingly every time we talk to a PE group they are in a new fund raise. A lot of this money is institutional, from pension funds, large endowments, and universities, who are allocating a larger percentage of their portfolios to alternative investments, which would include PE and hedge funds.
More selective investors
So, there is money out there. However, that doesn’t mean these investors are throwing their money around blindly. Investors being selective over which Investments they are making.
A year or two ago, when money was cheaper, buyers could afford a mistake here and there. Now, not so much. They are doing more dissecting into the business prior to making an offer. In 2021, we saw nearly all companies receive letters of intent. Now, some prospective deals don't even get to the LOI phase.
With higher interest rates, if companies need debt as part of the deal, it will cost the investor more money to finance the deal. That puts more pressure on valuations and requires that investors have a higher conviction in the opportunities they select. As a result, they might get a little more stringent around their investment parameters, such as the level of revenue and profitability they will demand than they have had in the past. Deals are still getting done, it's certainly not going to kill middle market M&A, but investors are getting more selective.
Here's an example. In 2021, a PE group might have considered companies with profit margins below 15%; now they want 20% or 30%. Two years ago, a three-year operating history would have been acceptable; now they want five. Maybe they would have considered a company with offshore labor and contractors; now they want 100% U.S. employees.
There is also less “style drift” among investors. Many PE groups prefer or specialize in certain types of stores, such as baby products, clothing, or sporting goods. In 2021, a PE investor might have considered buying a company that was “close enough” to their wheelhouse. Now many investors are not willing to vary from their investment thesis. It must be exactly what they're comfortable with.
Standing out in today’s market
So what kinds of companies stand out in this market environment?
Companies that have established their own brand identity, as opposed to being mere distributors of others’ products, are most attractive. Stores with their own unique brand image and product selection are generally considered less risky from an investment perspective than a company that must compete solely on price. A brand creates a “moat” around the business from competitors, and that makes it more valuable.
Having a strong management team in place is also incredibly important to private equity. PE firms don't want to run the business or have to put in a whole new management team to do it.
If you are concerned about how a recession and higher interest rates could impact performance of your business, you might be advised to sell, while you still can. Buyers are looking for 15%+ Profit and 15%+ Year over Year Growth. If you have that, good time to sell. If you’re below that key performance indicator, waiting 24 months and focusing on scaling your branded products and EBIDTA profit of your portfolio may be a smart move and make for a bigger payoff in the end. But if you’re at or nearing retirement age, what should you do? That’s where the services of a good investment banker come in.
We believe there is a buyer for every company, an investor who just has to have your company. The trick is finding them and putting them together. It's really about matchmaking and finding the right buyer that needs your company as part of their portfolio. We can help.
If you’re considering selling your company, please give us a call. FOCUS Investment Banking’s Consumer Group leverages years of industry specific transaction experience backed by a strong research organization. Our bankers can confidently advise on mergers, acquisitions and raising capital for growing businesses across the consumer industry. Our team also includes strategic advisors who are former consumer CEOs with experience scaling and exiting businesses. We leverage this experience to help best articulate our client’s value proposition to the marketplace and achieve successful exits.