It is one of the benefits or curses of having been in this business for so long – I have SEEN SOME THINGS.  Business cycles impact profitability and hiring, but they also impact the behavior of certain types of buyers.  If you are a business owner, you may notice that private equity groups or financial buyers may be reaching out to you directly and more frequently now than they had been in the last couple of years.  

Of course, you have probably been getting some level of correspondence from groups that are interested in purchasing your business. 

Why now? Is private equity interest in the lower middle market on the rise?  Here are a couple of things going on:

When deals get more difficult to do in the middle-market, private equity moves down stream to the lower-middle-market.  

Firms that previously were only interested in businesses with more than $10 million in EBITDA will start poking at businesses with around $7 million in EBITDA.  The thought is there is less competition for the smaller lower-middle-market assets and there is potentially more return available (albeit with some risk).  In addition, the lower-middle-market companies are owned by the baby boomers and generally speaking, the same ones that are going to be sold right about now.  Lastly, PE firms like to take advantage of something known as “size arbitrage.”  They have the capital to put several small companies together to create a larger company, which tends to sell for a higher multiple.

Rising interest rates are pushing them into transactions that require less debt.

Those larger deals, as I mentioned above, trade at higher multiples – which is generally supported by higher levels of debt.  Larger transactions can have 5, 6, or 7 times EBITDA of debt (or more!), while in the lower-middle-market, debt financing at those levels is rare.  When debt is more expensive and you still need to place your private equity capital, the lower-middle-market can start to look attractive.  

Lastly, when times are tough, they move closer to the business and away from auctions.

PE firms hate auctions.  PE firms ❤️  proprietary deals.  They will try to direct source a transaction whenever they can because an auction forces them to pay a very full price.  When transactions become more scarce, valuations remain high and PE firms must compete for every deal so they start to double down on going direct to the business owner.  

Direct to the business owner used to take the form of a bunch of college kids smiling and dialing business owners and hoping that someone answered the phones or sending hundreds of unsolicited emails.  A fair amount of this still goes on, but since the stakes have increased, so have the tactics of outreach. 

Now a days, I hear terms like “big data” and “artificial intelligence” as it relates to sourcing information about businesses that fit a particular profile or investment thesis that a private equity group likes.  I’m not sure that this is entirely different than the college kid model, other than it might have a more sophisticated front-end, but the end result is the same – business owners are receiving direct contacts by private equity or financial buyers with the hopes that they catch them at a weak moment and want to sell their business.  Don’t be surprised if the number of outreach emails or phone calls you receive double or triple in the next year.  

Unfortunately for business owners, the price to pay for forgoing an auction is greater than ever because valuations remain so high.  PE firms understand the arbitrage of the proprietary deal, which is why they are willing to throw so much capital at getting one.  I suggest that you collect all the letters and emails you receive about buying your business in an email folder or manila folder and hand them over to your investment banker who runs your auction process.  It’s too bad you won’t be able to see the sad looks on their PE faces when they realize that you have an advisor and they won’t be able to buy your company for a discount.  If they really ARE interested, they will happily participate in the sale process.