Small business M&A trends: what’s driving the market?

The market for small- to medium-size business transactions has been healthy this year, especially among accounting, legal and insurance firms. Additionally, there has been a number of deals done in the IT and software sectors and also in the medical technology and retail areas throughout the course of the year.

Much of this activity has been driven by firms with a desire to grow their market share, especially in the accounting sector. In particular, a number of businesses have sought to reposition their firm among the ranks of the second-tier accounting businesses. Acquiring another firm has allowed them to increase staff numbers and turnover to achieve the scale required to realise this goal.

In the software sector, businesses have been buying firms that have a particular piece of technology to give the enterprise a competitive advantage. For example, Xero recently bought Canadian tech company Hubdoc for $94 million, the latter being integrated into the former to achieve greater market share. Additionally, we are seeing firms make acquisitions to enter new markets.

Exit and entry strategies

In the past many transactions, especially in the accounting and advice spheres, were driven by partners wishing to exit the business they founded by selling it to younger partners. But this trend is starting to abate.

This is because new technologies such as cloud computing have transformed accounting and advice. So, rather than buy an established firm, some younger accountants have set up their own enterprise. This allows them to start off with new technology backing the business, rather than having to address any legacy issues as a result of older technology being in place in the target firm.

Foreign buyers drive higher multiples

There’s a wide variety of multiples on which businesses are trading presently, with the industry and type of business being sold some of the main variables that determine the sale price.

For example, let’s say the business for sale operates in the real estate sector. The sale price will be determined by the quality of the rent roll, the location of the clientele, how many landlords they have and the firm’s tenure at its existing location.

In general, at the lower end of the range, a typical multiple will be two times earnings before interest and tax (EBIT). The higher end of the range a typical multiple will be seven times earnings, assuming the deal is between local firms. Overseas buyers may be prepared to offer double digit multiples. But single figure multiples tend to be the norm when it comes to small- to medium-sized firms.

Contract term trends

Most sale contracts include performance criteria the business needs to meet for the sellers to achieve the full sale price. Clawback provisions will usually apply if the firm doesn’t meet the criteria subsequent to the sale. It’s common for the acquirers to pay around 80 per cent of the business’s value initially, with the vendors receiving the remaining 20 per cent after certain hurdles have been met.

Overall, the market is displaying a healthy level of activity and, unforeseen events notwithstanding, this is likely to continue into 2020.

The information contained herein is of a general nature only and is not intended to be relied upon nor is it a substitute for appropriate professional advice. Whilst all care has been taken in the preparation of the material, it is not guaranteed to be accurate. Individual circumstances are different and as such require specific examination. Asparq cannot accept liability for any loss or damage of any kind arising out of the use of or reliance upon all or any part of this material. Additional information may be made available upon request.

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