Merger and acquisition in the middle market is flat in 2013, according to a first-quarter research report, which attributes the finding to a stalled economy, challenges in Washington around tax and estate issues, hesitation by business owners to relinquish, and the gradual recovery in the debt market.

The report comes from that Babson College Middle-Market/Small Business Mergers & Acquisitions Survey conducted by the business school’s MBA students in the first quarter of 2013.

The survey, directed by Babson College Professor Kevin J. Mulvaney in collaboration with members of the Association for Corporate Growth (ACG) and Exit Planning Exchange (XPX), assesses and defines current trends that impact buyers and sellers of businesses.

The survey population included leading national middle-market investment banks, large business brokerage firms, advisory professionals, and commercial bankers.

“The M&A environment for both small and mid-sized business exits or recapitalizations is stable and may improve in the coming years,” commented Mulvaney. “It is a very good time for entrepreneur owners to begin planning for their capital event.”

Among the survey’s key findings:

Middle-market volume is strong; but small business M&A activity grows more slowly.

• The volume of middle-market deals is steady and a majority of respondents project a continuation of the current level through the rest of the year. Only 20 percent of respondents foresee volume increases as the year unfolds.

• Services industry sector remains the strongest with increased activity reported in e-commerce, health and medical services, and aerospace and related industries.

• The small business arena is growing more slowly (an average of 0.5 times increase in EBITDA valuation over 2012) with no expected rise this year in valuations.

• The environment for M&A activity is about the same as a year ago, but Babson authors project an increase in the number of private equity buyers in the next 18 months because of increased debt availability on more acceptable terms.

• Underperforming or weak companies are not viable deals and receive lowball offers and very little interest from financial buyers. The market is willing to pay a premium for revenue growth potential and predictable EBITDA performance.

Buyers demand high “seller assistance” for smaller companies

• The percentage of seller assistance (earn outs, deferred money, etc.) continues to be high. The smaller the company (on a $1-100MM survey scale) the higher the demands for seller assistance from the buyer.

• Good news for sellers—the deferred component of the purchase price has dropped from an average of 30 percent down to 20 percent. The survey also found that sellers are beginning to dig in their heels demanding a larger component of cash upfront.

Timeframe to complete deals lengthens

• Due diligence by buyers who have concerns about a sluggish economy and perceived challenges to building revenue will increase deal-making timeframes by a month (formerly 6-9 months). Strategic buyers are also organizing more outside expertise than ever before to prepare their due diligence reports.

• Sellers need patience and must be prepared with information and the ability to respond quickly to buyer requests to increase chances of closing deals within six months. Like buyers, seller success is dependent on acquiring the right legal and deal-making expertise.

• It is still a seller’s market for quality companies. Whether selling or restructuring capital, sellers must develop a knowledgeable game plan to evaluate options and potential deal partners.

Financing for Buyers continues to grow and terms are more acceptable

• More financial lenders are making loans with terms that represent a fair balance between what the lender and borrower feel is acceptable.

• The Babson survey projects an increase in the number of opportunities for every type of middle-market financing. This is good news for private equity buyers when balancing leverage versus equity contributions for new M&A deals.

• For smaller deals, there has been a strong rebound in SBA loans especially from community banks, that will help contribute to the growth of small business deals moving forward.

• Surprisingly, the survey found an increase in the percentage of equity needed by qualified buyers of small businesses. This had been a minimum of 20 percent, but some experts see an increase to a minimum of 25 percent. The increased equity demands from lenders may have contributed to the slow growth of small business sales.

Source: Babson College