According to data from DealStats, a database of private company transactions, the median EBITDA multiple of deals completed in Q3 2020 increased to 5.1x. The full article can be found here. The 5.1x multiple of EBITDA is up significantly from the 3.7x median multiple in Q2 2020. The article notes that deal activity “nearly came to a standstill” in Q2 2020 as the pandemic caused a significant slowdown in the M&A market. It appears that not only has deal activity picked up in Q3, but deal prices have also grown. Taking a deeper dive in to the numbers here, there may be a couple reasons for the jump in multiples in Q3. Let’s start with a simple math equation:
Why a Rise in EBITDA in Q3?
From a strictly mathematical perspective, if a fraction increases, either the numerator has to go up, or the denominator has to go down, or some combination of those things. So, it appears that there are potentially two explanations for the rise in EBITDA multiples in Q3:
- Earnings have declined (EBITDA ↓)
It may be the case here that historical earnings have declined for companies included in the database that sold in Q3. This decline in earnings would not be coupled with a decrease in the selling price and as such, buyers are purchasing companies for a higher amount per dollar of EBITDA (a proxy for cash flow). So, if earnings drop off and deal price remains the same, it makes sense that we would see a rise in multiples. It is likely the case that historical (or trailing twelve months) earnings have declined in Q3 as the impact of the pandemic continues to show up in the historical financial statements of the acquired companies. But, wouldn’t it make sense that if earnings decline, the selling price would also decline resulting in lower (or at least similar) multiples to Q2? Maybe not, which brings us to the next explanation.
- The perception of risk has declined (Selling Price ↑)
If we see a decline in historical earnings, then buyers must be willing to pay more for each dollar of cash flow. This would point to buyers having a changing perception of risk. The lower the risk, the higher the multiple. It may be the case that buyers had gotten over the initial shock of the pandemic and feel that the decline may only be temporary. Or, deals that occurred in Q3 only involved companies that were stronger and better able to weather the pandemic. Or, deals that were completed in Q3 involved businesses that actually saw growth and a decrease in risk given the pandemic’s impact on the specific industry of the target company.
As with anything, it is likely a combination of the factors explored above. Historical earnings likely declined, but purchasers were likely willing to pay more given the perception of risk. Also, deals that made it across the finish line in Q3 likely involved companies that were deemed to be more “pandemic proof,” which may skew multiples higher.
Overall, a great sign for the economy and for many small business owners that deal activity picked up in Q3 and multiples are on the rise. This will be something to monitor as we head into Q4 and into the early part of 2021.
If you are a business owner and are considering a buy-side or sell-side transaction, contact a member of our Business Valuation team today to see how we can help.