2018 Year-End Trends and The Way Forward in 2019

By December 30, 2018 Insights

Year-End Trends and The Way Forward

Having supported a range of clients; helped them seize opportunities, mitigate challenges and improve their business and financial strategy over the past year, Auctus Capital Partners is familiar with the many issues facing corporate America and decision-makers across the lower middle market.

In our last post, we shared the trends that financial advisors needed to be aware of in 2019. But what about tends impacting our clients? As we close out 2018 and wait for the ball to drop on 2019, it’s time for our business “year in review” and “year ahead” predictions:

1. M&A will continue to be the greatest driver of corporate growth: Mergers and Acquisitions (M&A) is responsible for the largest percentage of growth, by far, for lower middle market companies. In fact, every year, a quarter of all middle market companies acquire all or part of a business and about one in twenty sell (or divest all or part of) their organizations. Buyers seek growth by acquiring market share, expanding geographic reach, increasing industry expertise or investing in capabilities, technology, talent and new assets. Seller rationale can be tied to wealth maximization or a need to monetize business, as well as the desire to sell off ancillary divisions to focus on core business units.

The intention is unique to every organization, but it is based on the idea of creating more value and synergy — which has become a commonplace strategy today. In the first half of 2018 alone, M&A transactions reached US $2.1 trillion (a 36% year-over-year increase) with new synergies and hundreds of billions in investment capital earmarked for lower middle market companies.

2. Industry convergence will lead M&A strategy: In 2019, companies will be highly motivated to use M&A as a catalyst for equity value creation, with greater industry convergence expected to be a theme across the largest mega deals as well as lower middle market transactions.

In fact, industry convergence and sector consolidation may have the greatest impact on strategy, targeting, and deal activity in the year ahead. The trend will show greater blurring of lines between companies willing to move outside of the space in which they traditionally operate to new, complementary sectors; with the emphasis on traditional customer-based expansion across markets or growing and diversifying their products and services — rather than technology acquisition, which commonly dictated critical aspect of M&A strategy.

3. Traditional business loans must evolve to survive: While US corporate lending has benefited from relaxed credit standards, lower middle market executives are not satisfied with bankers churning out loans with no added value. Even when credit markets are active, which is not always the case, the interest expense and principal amortization associated with debt financing can create a heavy burden on the cash flow of a growing organization. This will be supplanted by equity investors who can provide invaluable board level perspective and insights to help successfully manage growth and pursue expansions, which can be as valuable as the capital itself.

4. Navigating tax reform — the opportunities and challenges — will not come easy: Tax reform under President Trump brought corporate tax down from 35% to 21% in 2018. Amid other tax benefits US companies acknowledged throughout the year, the impact of reform continues to create unique opportunities for M&A. For example, tax reform provides additional capital to facilitate transactions and supports divestments, as companies look to unload less profitable or non-core business entities, assets that can be sold at a lower price point as a result of reduced capital gains tax.

As we move into 2019, however, navigating tax realities will not be a simple endeavor, especially as the lower middle market settles into the new equilibrium and the greater possibility of a downturn in the coming years. Companies across all sectors should adjust their long-term risk appetite and focus on strengthening their balance sheets in the New Year.

5. Raising interest rates are teeing up private capital in many forms: There’s no question about it, the availability of affordable credit supported the larger (and more aggressive) transactions in 2018, kept borrowing costs low and fueled deal activity to new heights. Looking ahead, however, companies will turn a flourishing private capital industry as the US increases rates more aggressively, with three increases expected in 2019.

While private equity has more cash than ever to invest — and will drive the big ticket deals of 2019— we must remember that term “private equity” doesn’t tell the full story. For companies seeking credit, these funds have become an important alternative to banks but are not the only options. As activity migrates from the banking industry and public markets to private capital, all strategic alternatives should be evaluated. For example, growth equity can be an effective tool when the owners want to remain investors but also want to realize a portion of their investment. In addition, it can be an effective vehicle for providing liquidity to certain shareholders, while allowing other equity owners to remain invested in the company.

Looking back, 2018 was another notable year for large deals with the trends that will continue into 2019. However, we are in the midst of a revolution; moving towards true value-added financial advisory, serving both the CEO and CFO, speaking directly to everyone working within the organization, and advising on what to do to transform business — not just the transaction. As investment bankers, strategic advisors and business counselors, our role has never been more important.