How wide is your moat?

When buying a business, one of the qualities buyers look for is barriers to entry. The harder it is for someone to get started in your business or take away your customers, the bigger the barrier.

When investing in businesses, Warren Buffet talks a lot about moats. “In business, I look for an economic castle protected by unbreachable moats,” he says. “If you have an economic castle, people are going to come and want to take that castle away from you. You better have a strong moat.”

Buyers see long-term value in wide moats. The better the moat, the greater confidence the buyer has that your cash flows won’t fall to competition over time.

For example, after 9/11, businesses became nearly unsalable overnight. Then again in 2008, the Great Recession hit and businesses were suddenly worth much less, if they were even saleable at all.

But roll forward to today, and despite all the hurdles in business and the wider global community, M&A continues at a fevered pace. Last year the total value of global M&A transactions was $5.8 trillion, 48% higher than 2018, the previous record high.

So what’s different today? Why are people using the word “super-charged” to describe this market when the last two upheavals tanked M&A activity and reduced multiples overnight. We can point to two main drivers:

Supply and demand. We have more buyers looking for business acquisitions than we have sellers. Not only that, we have more money set aside for investment than we’ve ever seen before in our country. Cash and cash equivalents in the S&P 500 increased 11% year-over-year, to about $3.78 trillion, according to S&P Global Market Intelligence.

Likewise, private equity capital raising hit a new record in 2021 with at least $733 billion gathered, based on preliminary data from Private Equity International’s Fundraising Report 2021. Meanwhile, PitchBook’s 2021 annual breakdown shows private equity deal-making surpassed $1 trillion in value in 2021, an increase of more than 50% over the last record set in 2019.

The outcome of all that cash chasing deals: Buyers were up against powerful competition, and multiples climbed upward. According to GF Data, a company that collects data on privately held M&A transactions between $10 million to $250 million, multiples for Q3 2021 hit the highest level they’ve seen in their 16-year history.

Strong lending. Companies aren’t using debt the way they used to. Many have paid off their long-term debt and are operating from cash reserves rather than a line of credit. That’s good for business but bad for lenders. In response, lenders have gotten more aggressive in pursuing new loans and encouraging growth through expansion or acquisition.

Interest rates are still the lowest we’ll likely see in our lifetimes. Money is cheap and available, and lenders are funding a larger portion of each transaction. So even though valuations are high, buyers can still meet those prices with a smaller percentage of equity in the deal.

All in all, it’s good news for sellers. We can’t predict how long these strong value trends will last. The industry is setting up for another record year in 2022, but economists are pointing to some headwinds in the years ahead.