Insights

The Rise of Smaller M&A Deals in 2020
POSTED 3.3.20 M&A

We’re not yet to the end of the first quarter, and we already have a solid idea of where M&A activity is headed in 2020.

Deloitte put out a report, The State of the Deal: M&A Trends 2020, based on a survey of 1,000 corporate executives and PE firms that looks back at what happened in 2019 and their views and plans for 2020. And the outlook is good for M&A, although there will be some key changes to keep in mind.

As noted in the report, M&A activity will continue to be very solid this year. Only 4% of those surveyed anticipate a decline in the number of deals. Sixty-three percent forecast an increase in transaction activity. That’s down from 79% last year.

There will probably not be as big an increase compared to the last seven years, a boom time that has seen more than $10 trillion in domestic deals alone since 2013. But that’s to be expected as this level of growth in transactions is hard to sustain.

As Russell Thomson, national managing partner of M&A services for Deloitte & Touche LLP put it in the report:

“We’re fairly long into this M&A boom cycle, so it’s not surprising to see a drop in expectations for larger deals. What we’re seeing in the marketplace is more interest in deals in the sweet spot between $100 million and $500 million. Deals aren’t going away; companies are just being a little more careful about those larger deals.”

So the boom is tapering off a bit, but it’s still a rising trend due to several factors, including…

  • Ample cash reserves in both corporations and PE firms.
  • The strong stock market that closed 2019 at record highs (which helps equity-funded transactions).
  • A belief that tariffs/trade wars aren’t too much of an issue.
  • A conviction that current interest rates will not have an impact on deals (and, in fact, 45% feel the interest rate environment will actually accelerate deals).

But this is the biggest change we can expect in 2020:

Fewer “Megadeals,” More Deals Under $500M

The number of deals over $500M in transaction value will likely come down and be replaced by deals in the $100M – $500M range… and as low as $20M. This is for a variety of reasons.

  1. More corporate divestitures. Companies are looking to offload assets in this lower range. According to Deloitte, 75% of corporate execs expect to have divestitures this year, due to financing needs, change in strategy, and the need to offload technology that doesn’t fit a new business model.
  2. Returns for larger M&A deals have not been as valuable as expected. Firms just aren’t getting enough bang for their buck. According to the survey, 46% of respondents said that less than half of their transactions in the last two years gave them the ROI they were looking for. So look for them to reduce their risk and pursue smaller acquisitions that offer more impressive returns. Smaller targets, acquired at lower prices, are just a lot more efficient, cash-wise. To hedge and improve ROI, companies are looking for smaller targets. This isn’t at the expense of profitability. In fact, you can have a higher return on a $100M acquisition – 40% to 50% – than on a $1B deal.
  3. Strategic Buyers are also increasingly pursuing smaller deals because they have a greater need to acquire new technology as today’s tech is already obsolete. They need technology that is a better fit going forward to stay competitive. 
  4. Buyers can take advantage of more favorable terms when they go after smaller targets, especially those under $100M. 
  5. PE firms like smaller targets because they are increasingly looking for new acquisitions that they can “bolt on” to existing portfolio companies instead of hoping those portfolio companies grow organically.

When they add on new acquisitions, the firms can expect to sell those portfolio companies at a much higher multiple than before. This is why they are getting better returns with smaller targets.

What This Means Moving Forward

Based on this Deloitte survey, it’s clear that M&A activity has slowed a bit but is still going strong, continuing a trend of an unprecedented level of deal-making that started back in 2013.

Also, on the rise: the use of Representations and Warranty (R&W) insurance to transfer indemnity risk away from the Seller to a third party – the insurer. With this coverage now available to sub-$20M deals, look for this insurance to be a part of an increasing number of deals in 2020.

Whether Buyer or Seller, R&W insurance coverage can offer many benefits including smoother negotiations, more cash at closing, and less risk. But it is important to have a broker with extensive experience with R&W insurance and how it can impact a M&A deal. If you’d like to discuss coverage for your next deal, please contact me, Patrick Stroth, at pstroth@rubiconins.com.