Consolidation is inevitable in maturing industries. As an M&A advisor working with owners of private wholesale distribution, manufacturing and industrial service companies, one of the questions I am often asked is whether it is better from a valuation perspective to sell early in a consolidation phase, or hold off. It depends of course, but generally earlier is better, all else being equal.
I’ll explain why, but first I want to point out that industry consolidation isn’t always at the top of a seller’s list of sale timing considerations. More important factors may be:
What is your exit time frame?
Next year or two? Three to five years? Five or more years? The answer is often driven by your financial needs and that of your partners. Obviously, as with any investment, the shorter the holding period, the more conservative one should be with respect to anticipated returns. Maybe today’s value isn’t quite what you think it can be in a few years – but eliminating risk may be worth a lower price tag.
For sellers who want to stay and manage the acquired/merged business or serve in a strategic (e.g. corporate development) role, that tail of income is above and beyond the sale consideration. Sellers who want to buy a boat and sail to the Bahamas had better have a strong executive team in place to lock in value. If not, their company will likely be passed on by the buyer for another acquisition with stronger leadership, and they may lose out on that strategic premium.
Is your company performing well?
Last I checked, cash flow was still king when it comes to acquisition values. If your business is performing well relative to industry peers and further improvement is likely, now may be your best opportunity to maximize value in a sale or recapitalization. If not, you’ll have to decide if and how you and your leadership team are going to improve performance and by when. And, by the way, what is your track record of achieving past projections?
Is the macro-environment favorable?
Does the economic outlook portend for several more years of strong economic growth, or is there increasing uncertainty or signs of an imminent slow down?
If the former is the case, perhaps you have time to continue to grow revenue and profit margins to increase value and better position your business for a future sale. If a downturn is likely, are you prepared financially and mentally to wait it out and try achieving liquidity several years from now? If that’s not appealing, maybe now’s the time to take some or all of your chips off the table.
Conditions can change quickly for all sorts of reasons and you can be stuck, not just with a reduced valuation, but with closed private capital markets altogether. M&A came to a sudden halt in early 2020 and late 2022, and remember what happened in the wake of The Great Recession.
Why earlier is usually better.
To make my answer more tangible, consider the example of independent industrial distributors, where national or global players are executing acquisition-based growth strategies. Driving consolidation may be mergers and product line expansions by upstream manufacturers (suppliers) and vendor reduction programs and consolidation among downstream customers.
- If I’m an aspiring consolidator/acquirer, I’m willing to pay a nice premium for my first acquisition in a particular market – to attract the best of the options available and to secure that foothold ahead of my competitors. I may want to make a statement with regard to the quality of organization I intend to build. Hence, there is more of a strategic component in the valuation of platform acquisitions, whereas later add-on acquisitions may be more about simply adding market coverage and earnings.
- Further, the first couple of acquisition targets are likely to have more to say (and be credited for) relative to the manufacturers they are aligned with. As the map fills in, later acquisitions may be forced to discard certain lines and replace them with others to conform to the acquiring organization – which destroys value. Count on acquirers considering the lost profits, risk and costs of making those transitions when assessing the value of an acquisition.
- Early on, there are likely to be more strategic acquirers available. As the market consolidates further, the number of viable strategic match-ups will decline, which may favor the remaining buyers and reduce the likelihood of a strategic premium for sellers. Eventually, the only option for the last few independents standing may be to sell to pure financial buyers – such as their management teams or private investors, or private equity groups if the independent is large and profitable enough and positioned for strong future growth. For some owners this is perfectly acceptable, for others it is not.
- Then there is the expectation that consolidators will have competitive advantages over independent operators – such as access to and influence with best-in-class suppliers, ability to attract and retain talent, proprietary products and solutions, investments in technology and online platforms, buying power, lower admin costs, access to growth capital, financial stability, etc. To the extent true (which sometimes it’s not true because there are also competitive disadvantages) the market share and value of the remaining independents will gradually deteriorate.
- Disintermediation is a constant threat to wholesale distributors, as manufacturers seek to expand their profit margins. This can take the form of direct salespeople serving large accounts or entire geographies, and online platforms. As industries mature, distribution’s market share tends to decrease as direct relationships increase, although this varies by segment.
Another attractive aspect of being one of the first few acquisitions in a roll-up is your team’s ability to shape culture and strategic direction. You have less influence as a late addition to a well established platform.
Going to market early in a consolidation phase is likely to produce a stronger valuation than waiting around, all else being equal. However, when evaluating their exit options, company owners should carefully consider shareholder needs, business performance and market conditions, in addition to what stage of maturity their industry is in.
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Al Statz is the founder and president of Exit Strategies Group, a leading lower middle market M&A advisory and business valuation firm. For further information on this topic or to discuss a potential business sale, merger or acquisition, confidentially, contact Al at 707-781-8580 or firstname.lastname@example.org.