Q1-2019 continued to face many of the same broad headwinds as previous quarters. Brexit and USA–China trade uncertainty persisted, as well as growth slowdowns in most major developed countries. This reality has led the US Federal Reserve and the Bank of Canada to adopt a more dovish outlook on the economy, waiting to increase rates further until some uncertainty has been removed from the markets. However, even though optimism has tempered, there is no need for panic.
These conditions have had an effect on the M&A market, with transaction volume dropping from 513 in Q4-2018 to 322 in Q1-2019. For many larger deals, potential buyers are taking a "wait and see" approach to understand how these macro issues resolve before continuing on the recent record-breaking pace. We believe that although larger deals may be hampered by these macro economic factors, a potential slowdown will not have a proportionate effect on the volume of mid-market transactions. This sentiment paired with the fact that there is still a large amount of equity and debt capital to be deployed means mid-market deal volume could remain robust going forward.
Something that may result from decreased economic growth is a reduction in the transaction multiples being paid for private business. While ultimately equity dry powder will need to be deployed or returned to investors, we expect that average transaction multiples may decline from current high levels due to decrease in forecast target company performance. It appears as if investors are listening to the current mantra of Howard Marks and are deciding to "move forward, but with caution." To help mitigate this current and future risk, the financial and tax diligence completed for deals of all different sizes has increased. Vendors should be prepared for this increased burden, and should consider professional advice in advance of going to market to expedite the deal process and reduce closing risk.
Q1 2019 Transaction Highlight
Q1-2019's highlighted transaction is a US Private Equity Firm's acquisition of a software company specializing in the development of solutions for motor vehicles, providing software to clients throughout North America. Due to the vendor's preference for an expedited transaction, BDO was brought in mid process to prepare a Quality of Earnings (QoE) report and Working Capital (WC) analysis and to provide vendor assistance throughout the diligence phase. The BDO-prepared QoE was distributed to a limited number of parties prior to their LOI submission. This resulted in a standardized set of facts amongst all parties and all but eliminated the potential buyers' ability to re-trade subsequent to the letter of intent ("LOI") submissions. With the QoE and WC prepared for the purchasers, the time required for financial diligence was significantly reduced with the transaction being closed in under 60 days from LOI acceptance to signing. The purchaser hired their own diligence firm to review the QoE and WC analysis, but this review was significantly more condensed and targeted than a full scope review.
This deal highlights the role of diligence in modern transactions as companies are not comfortable relying on audited financial statements, but are looking for additional operational and financial diligence as systemic risk increases. A report by Merrilcorp on the future of due diligence ranks continued preparedness as the #2 factor affecting the future of M&A markets, with 25% of North American deal makers ranking this as their most important factor. We expect this trend will continue and grow in 2019 and beyond.
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