The M&A market ended 2019 in good shape and professionals who work in the field expect dealmaking to remain strong in the new year.
A seller’s market should prevail in 2020 as buyers — particularly a growing number of private equity firms investing in the region — pursue the fewer good companies that are selling, according to participants in a recent roundtable hosted by MiBiz.
Participating in the discussion with this reporter and MiBiz Editor Joe Boomgaard were:
- Elisa Berger, vice president in the M&A practice at Charter Capital Partners
- Jordan Hoyer, a partner and general counsel at public relations and investor relations firm Lambert & Co.
- Remos Lenio, a partner at Tillerman & Co. LLC, a Grand Rapids-based investment banking and merchant banking firm
- Matt Miller, managing director of BlueWater Partners LLC, a Grand Rapids-based investment banking and consulting firm
- Pete Roth, a partner who focuses on M&A at Grand Rapids-based law firm Varnum LLP, which sponsored the roundtable
- Kurtis Trevan, CEO of Grand Rapids-based Gun Lake Investments, the economic development entity for the Match-e-be-nash-she-wish Band of Pottawatomi Indians, or Gun Lake Tribe.
Here are some highlights from what they had to say.
What’s the state of the M&A market now, and what do you see ahead for 2020?
Lenio: There’s still a lot of money chasing a lot of deals. There’s probably more money than I’ve seen in years. The two trends that are almost frightening to my partner and I are the fact that we are seeing more firms moving down market. The guys with the big money don’t see the opportunity, so they’re coming down into the small end of the market. And the second thing is there’s more new funds popping up, there’s more new money out there chasing deals than ever before. It’s keeping pricing pretty steady, so you’ve got to look long and hard to find attractive deals, and there’s a lot of competition for them.
Trevan: We see a tension that exists in the market that’s really unique in that valuations continue to be high and continue to move higher year over year, while at the same time there’s a lot of money that is sitting. I think the money is sitting because there’s this fear of the ‘what if.’ Obviously, everybody reads the headlines, and the headlines, for instance, (are on) tariffs and labor, and how long can this economy continue to buzz along for. So if we place capital today, what are we missing out on tomorrow?
Berger: There’s still so much out there, and new funds are popping up. Every time we go to market, it seems like we’re finding new private equity firms that didn’t exist a year ago. From a busy-ness standpoint, Charter is going to have another very strong year. We have a lot in the pipeline, and that doesn’t seem to be slowing down, at least in the lower middle market.
We don’t know what’s going to happen, but a recession could put a fear into the market a little bit, and we’re sensing that in terms of a little bit deeper dives on our companies, a little more conservatism in terms of debt placement. But other than that, it’s been pretty solid and … I don’t think it’s going to slow down in 2020.
Roth: We’ve seen the mix of deals change a little bit. Deals aren’t slowing down, but we have seen some distressed stuff. As the economy cycles through, if we head into a recession, I don’t think deals will slow down. There’s all the money out there that Remos talked about, but they might be chasing different deals where the mix could be about good-value money, which you’re going to have to be more diligent about. You have to be careful doing those sorts of deals.
Miller: We are seeing that some people are shying away from the highest bidders because they’re having experience where there’s so much competition and prices will be up so much. … But at the end of the day in diligence, they’re finding problems that destroy their valuation, and end up wanting to revisit valuations. We’re hearing more sellers think about that, and not about how they actually want to execute on process, as well as how they think about and evaluate individual buyers.
Hoyer: We are in the PR and marketing space and the competition has been really tremendous for our pipeline. Interestingly as well, the private equity firms that are going down market and in our sandbox, they haven’t been there before. So that’s an interesting observation this last year that we’ve noticed. I don’t know, forecasting into 2020, if that’s going to remain, if it’s going to become more aggressive. I can’t say for sure, but definitely (we expect) very high valuations. The competition’s been huge.
What are buyers buying today?
Berger: Talent is one now.
Hoyer: For our purposes, talent acquisition is huge. Geographic expansion and capacity also.
Miller: A client actually acquired a tool and die shop just to get the talent, especially because the particular talent pool in that industry is really drying up. Historically about 15 to 20 percent of our M&A work has been on the buy side, and right now it’s quite a bit more than that. It’s probably half of what we’re doing. Our clients are looking for growth, they’re looking for diversification, and looking for new capabilities right now.
Lenio: They’re buying anything they can get their hands on. Some of these funds are actually (at a point where) they’ve got to get the money out or give it back. Those are the real fun guys to deal with because they need a little extra here and they are willing to pay it because they want to close. There’s quite a few of those, and some of these new funds want a deal just to show they’ve got the chops to do it.
There’s still a lot of irrational deals getting done that will make the bankruptcy guys rich in five years. There’s new lending institutions popping up almost as fast as private and credit equity funds, and then the newest one, these asset-light financers come in. ‘What do you got? We’ll lend it.’ It’s interesting to see how people adapt to service a market need that nobody knew existed until times got really good. In five years, they’ll all disappear again and we’ll go back to conservative bank lending.
What’s all this doing to valuations that we’ve heard the last few years have been so high?
Roth: A few years ago, you could put a less-than-perfect business out there and get a premium valuation. Now, I think you put a less-than-perfect business out there, or one in a non-sexy space, they’re going to get a reasonable single-digit multiple. If you put a great business, it’s got proprietary I.P. and all that out there, then you can still get double digits. It’s a little higher than average, but I don’t think it’s particularly all that crazy right now.
Berger: There’s a difference between those really great companies coming to market. They’re getting those high valuations, and even higher than historically; but we’re seeing a difference with the less-than-perfect businesses. They’re not getting that bump from the market anymore that we’ve seen.
Is that because buyers are worried about what the economy will do in the next year or so?
Berger: I would say that they’re just being a little more conservative. We were not sure what it’s going to do, so if you’re project-based and you don’t have management in place and there’s some warts on the business, they’re going to be a lot more critical. That will lead to lower valuations, no matter how much diligence you do up front. You have got to prepare your client to be realistic.
Trevan: As a buyer … especially being West Michigan-focused, and thinking through the types of ownership that we have in West Michigan, which is a lot of founders, a lot of second-generation (owners), and especially in the Baby Boomer generation, you have companies that have grown through the brute force of the owner and perhaps the personal or the family relationships that they have. Which has been great. But they’re lacking the management teams or the structures that make them attractive to an outside buyer.
Lenio: There’s actually become two types of sellers, too. As buyers, we look at smaller companies, sub-$20 million in revenue, and there are those that want maximum dollars and they go to strategic buyers, and there are those that are more concerned with their legacy and they’ll take a lower price just to keep the business where it is and going. We’ve seen discounts at 50 percent of the market just because we’ll keep them where they are.
What’s driving the influx of outside capital looking at West Michigan companies?
Berger: The availability of well-run, profitable companies that are privately held with generation two or three owners that are looking to get out while the market is good. That’s what we’ve been seeing happen. There does seem to be a conglomerate of a lot of really good middle market companies here still. We’ve had no trouble going country-wide for buyers.
Miller: It comes down to supply and demand. Too much capital, too few deals. Over a long time, Michigan and West Michigan was under the radar, and over the last several years that’s changed. They’re finding a lot of well-run, family- and founder-owned businesses that I think tend to be less highly leveraged and more conservatively managed than businesses elsewhere. It’s the good companies and it’s the good quality of life here. People come here and they find they like it, and it’s a nice place to do business.
Berger: The debt aversion is great to think about. I’ve not sold a highly leveraged company in West Michigan. I’m sure they exist, but not privately held, not family owned, and that’s very attractive.
Roth: Middle market private equity has kind of really dropped, so they’re not locked into a geography. You’ll see smaller to middle market private equity funds from other parts of (the country) nowhere near the Midwest that are looking at deals here because they just figured out they can do deals wherever.
Lenio: The infrastructure here has grown tremendously too over the last 10 years … which means there’s a bigger network out there and more people have people to call in the market, so they’re coming into the market.
Trevan: One of the concerns I have with the long term, and I don’t know that it’ll affect me in my lifetime, but I think of the next generation: This community has been so strong through cycles and we’ve seen such growth because there’s been a lifeblood in these companies that are born and raised here. As you take capital from around the country, it concerns me to think what happens in the next 10 to 30 years. Are those companies going to remain West Michigan companies? Are those going to be the platforms that the private equity or other outside investors use to grow? I’ve had some conversations over the past year with others in this space about the importance of being able to pool that capital here to ensure those companies continue to stay here.
Does that issue come up with sellers, where they would rather have a local buyer who’s going to be part of the community rather than outside money?
Lenio: We’ve got tremendous discounts on purchase pricing because of that. When we tell them we’ll stay there, we have no time frame on our sale, they love us. We don’t have to flip in five years and give our money back to our investors. Our investors say, ‘No, my grandkids are still going to be in the business. We’ll hold onto it.’ We’ve seen that through $50 million transactions. There is a lot of concern with community responsibility.
We like to think we’re unique here, but we’re not. There’s just as many small businesses owned by Boomers in all the other markets. In fact, there’s probably more. When you look at Detroit, Cleveland, Chicago: Those are huge industrial places and they have probably a higher number of small businesses where the Boomers are thinking about selling. But they too are concerned about community reinvestment, the community involvement, and does the community continue to grow.
Miller: Most of our clients, if they have their way, would prefer a call from a local partner, buyer or investor that had a long-term investment horizon. But at the end of the day, price does matter, and it does seem like we’re hearing more about it as private equity proliferated and it’s higher profile and some have become more used to it. I think people have gotten more comfortable.
Berger: We’re not having sellers turn down significant money, but we’re rarely selling to the very, very top there because of some of the softer reasons you mentioned.
How active are family offices in this market right now?
Trevan: This is anecdotal specifically to GLI, but probably 80 percent of our deal flow is proprietary, knowing some advisers or bankers who spend a lot of time on that. Those are by far the best deals that we see, but it’s also the longest time frames to move forward. Anecdotally, we hear similar conversations from some family offices that we have relationships with. I think there’s an open mind. It’s trying to wait for quality and wait for the right time. We’ve not run into other family offices on opportunity discussions that we have built ourselves.
Miller: It’s a trend we’re seeing with more and more family offices entering the M&A market. I agree that it tends to be a longer cycle, a longer process. Because it’s not brand new but it’s still new-ish, it seems like they don’t have the same kind of business development process that a PE fund has. It’s a little looser. It’s not as well organized. It seems like that’s evolving though. Family offices are seeing this as a new opportunity, and maybe still trying to figure out the best way for them to approach it.
Do family offices hold more sway with sellers of a family-owned business because that conversation is taking place family to family?
Trevan: It’s a common bond. It’s a conversation point.
Roth: You’ve run a business that you’ve built, created a legacy, so talking to somebody about their legacy when you’ve had your own legacy I think resonates. You’re talking about not needing to flip it in five years, and to be able to say, ‘We can hold this indefinitely. We might hold it indefinitely.’ Especially if they have a next generation involved: Maybe you have the patriarch or matriarch, and then you’ve got the 30-year-old who’s driving it and he or she is looking to do this for 40 years. I think that sells.
Trevan: Whenever we’ve had a conversation with another family office about acquiring an asset that they have, we know there’s a common bond that we think is almost instantly developed. This is where we start the conversations and starting with what are your long-term goals. We think it resonates better because it’s not that private equity coming in where you know you have a defined time.
Lenio: There’s an awareness with members of the family office to understand who they’re talking to. I was in a situation about eight months ago where we had three private equity funds come in to look at a deal (and they were from) Connecticut, New York, and St. Louis. They all dressed like PE guys: They had the $500 suit on, they had the Rolex watches, the suspenders. When they left, the guy that we were backing with the investment goes, ‘I’m not dealing with any of those guys.’ What’s the reason? He says, ‘Those guys’ shoes cost more than my first tractor.’ There’s just this lack of awareness on the part of some of the PE guys. They all came in thinking they’ve got to impress Wall Street. Well, the guy from Wisconsin doesn’t give a shit about Wall Street.
What are some of the more interesting deal terms you’ve heard in the last year?
Trevan: I just see more sellers wanting full, 100-percent buyouts. Their expectation is that they don’t need to provide seller notes or earn outs at all. I’ve seen anecdotally some trends in that direction. I don’t think that’s necessarily deserved.
Roth: For us, it’s been speed and just process. It’s not necessarily a deal term. It’s a process term of the bankers driving deals very quickly, sometimes in a matter of weeks from start to finish in the extreme example. People who are worried about re-trading and whether some of the new funds can follow through, they have real aggressive processes from the bids and then from when you bid to when you close. Buyers are trying to distinguish themselves by saying, ‘We can get it done.’ Then in those instances, where it’s a quality company, they might not be picking on every little thing, they might not fight over every little deal term.
What’s a prediction for the M&A market in 2020? What will we be talking about a year from now?
Lenio: I think it’ll still be a good year. It’ll be strong. I think everybody will be pretty happy. I think the year after could be when people start questioning their wisdom.
Trevan: I believe the economy still remains strong throughout 2020, and interest rates are relatively stable, and I think that’s just going to continue to fuel deal activity to edge up slightly over 2019.
Berger: I think there will be a consistent number of deals taking place. They may look different and we may start to see some more distressed deals, but from where we sit, the kind of deals we do, we’re still in a seller’s market.
Roth: The year looks a lot like last year. There’ll be winners and losers, and it will be spotty up and down, but I think in the aggregate, it’s a strong year. There’s just too much money out there chasing deals.
Miller: We think that volume will be down slightly again, but valuations will hold up for the same reasons we’ve been talking about. There’s so much capital. But one of the challenges is there really is a shrinking number of good or great companies, and I think that’s what’s driving volume down primarily. Buyers, investors are having to work a lot harder here in West Michigan.
What could throw a wrench into the market in 2020?
Trevan: I think if the trade wars escalate, it (could be) a real threat in the model. I don’t know how to define that. Today, there’s a lot of noise and posturing, but if the U.S. enters into a substantial trade war around the world, then for me, it causes a lot of concern. If that’s where the trend is going, who knows where it stops. Let’s not buy into that trend. Today, to us, it’s a lot of noise. We pay attention to it. But that’s one of our concerns of what could derail this.
Miller: Business investment has been slowing, and consumers have been really powering the economy. If that changes, then that’s an economic consideration that certainly we talk a lot about. (Corporate) confidence has been downwards, it’s been dropping the last few quarters. We talked about the auto industry. There’s also structuring changes in the auto industry with autonomous vehicles and electric vehicles. A lot of companies in the supply chain need to be thinking hard and strategically about the future of business and where that’s going to be.
Lenio: On the flip side of it, for us as well, some of the U.S. economy has continued to hold steady. We saw a peak (after the tax reform law) and it feels like things have moderated, but there’s still a road that I think everybody is relatively happy with at a time that there’s major economies around the world that are experiencing a slowdown in their growth. If we can see the U.S. is sustaining its growth long enough to see growth pick up around the rest of the world, that puts us back into an extremely bullish mode.