The active mergers and acquisitions market shows no signs of slowing down for the foreseeable future.
According to local dealmakers and their advisers, the M&A market fundamentals remain solid for buyers to keep scouring the market for new growth opportunities, strategic partners and the right technology.
Similarly, the executives say they believe the strength of the overall economy will continue to drive the current seller’s market, given the amount of dry powder that still needs to be deployed both by well-capitalized private equity firms and even strategic buyers with flush balance sheets.
When they take into account the building volume of deals driven largely by aging baby boomers looking to realize a return for their years of investment in their businesses, the corporate executives and transaction advisers say they’re bullish about what the future holds for their companies and for the transaction environment in general.
MiBiz invited representatives of the winners and finalists in the M&A Deals and Dealmakers of the Year Awards for a roundtable discussion on the deal environment, the dealmaking process, best practices for buyers and sellers and their outlook for the current market.
Participating in the conversation were:
- Chas Chandler, partner at Birmingham-based Amherst Partners LLC, the adviser to KL Outdoor in its sale to New Water Capital
- Dustin Daniels, partner and mergers and acquisitions practice leader at Grand Rapids-based Miller Johnson Snell & Cummiskey PLC
- Jeff Johnson, managing director of Blackford Capital, whose founder, Martin Stein, won the Dealmaker of the Year Award in the corporate executive category
- Rich Sorota, CEO of Ranir LLC, a maker of oral care products
- Daniel Terpsma, executive vice president of regional and commercial banking at Chemical Financial Corp.
Here are some highlights of the discussion.
From a 30,000-foot-level, what’s the outlook for M&A right now?
Chandler: You basically have too much money chasing too few goods. It’s very, very simple economics. That’s positive for sellers. When you talk about entrepreneurs, many sellers will sell when it’s right for them, not necessarily when it’s good to sell. If you look at private equity, there were guys who had very little in their portfolio because they sold everything. I call them unemotional sellers. They’re going to trade for the benefit of their investors. The entrepreneur doesn’t think that way, so we can sit there and say, ‘This is the best market we’ve seen in the last X number of years,’ which is true, but that may not impact them if they have other issues going on with their families, the business itself. People like me can talk until you’re blue in the face saying, ‘It’s time to sell,’ but if you’re not ready, it’s not going to happen.
Johnson: I think that’s exactly right. We continue to see valuations at a pretty high level. What’s I guess interesting to us is that from a buyer standpoint, I think we’ve had to be a little bit more critical and selective in that there are a lot of businesses or properties that I think in other markets probably would not come to market. I think to a certain extent there are a lot of sellers that recognize that we’re in a pretty overheated marketplace, and there’s been a lot of activity. Some businesses that I think just from an evolution standpoint are still pretty immature and still need a lot of work and whatnot, I think if anything they’re probably trying to come to market sooner than they otherwise should because they feel the market is there. While we’re seeing just as many potential opportunities, ones that we’re really excited about and we want to run really hard at, it’s lower than in prior years.
Daniels: Overall we still have a really strong market for sellers. I think that you can get into industries, and there’s some that are stronger than others. Health care is really hot. Technology or companies that have a technology spin to it I think are really hot. Commodities in general — things there are not as bad as they were maybe six months ago, but businesses tied to commodities aren’t doing as well. I think you see some options there, some distressed deals in that area. I think everyone knows auto deals are not an ideal time right now to be in, especially for private equity.
As advisers, are you working more on the buy side or the sell side these days?
Chandler: Most of what we do is sell side engagements; we do some buy side, and it’s been a great market for all of us doing transactional work in the last seven or eight years. I don’t think we’d want to see 2009 again, because in our world we work with two kinds of clients: people that want to do something and the people that have to do something. In 2009 I think we represented 13 companies and not one of them had positive EBITDA. Those aren’t fun transactions. Those clients were very happy, because we got them (off) personal guarantees. That was a big deal to them at that time. These markets are a lot more fun, meeting the goals and objectives of clients who want to do something, and have worked hard to get there.
Daniels: Both buy side and sell side is probably like 50-50, maybe a little more buy side right now. In sell-side engagements, we usually represent closely-held family-owned businesses who are exiting. We do a few corporate divestitures, but that’s not the majority of what we do on the sell side. I think one thing that makes us maybe unique is our buy side’s pretty diversified. We represent large corporate companies, West Michigan-based, Michigan-based, even a few international, and we represent a fair number of private equity.
Is there anything in the current political environment and the resulting uncertainty that’s shaping deal flow?
Daniels: It doesn’t seem like it. My sense is that people aren’t paying a lot of attention to it right now.
Chandler: I think probably after Trump got elected, there was discussion of do I close the deal in ’16 or ’17 for tax reasons. You saw that. Maybe there might have been some paralysis around that.
How has the promise of corporate tax reform and going to a 15 percent corporate tax rate affected the M&A market?
Chandler: You can’t bank on that (to get enacted).
Daniels: When that discussion has come up a number of times when we’re going through planning, I think the consensus was (that) we have to go solo. I don’t think anybody feels confident anything will get done.
Sorota: We were looking at something where for it to happen it would have been much more desirable; it was a factor, but they ended up going with a different approach. They were modeling that as a potential component that could help them, but I think they also realized the probability of it happening in a meaningful amount of time was low. They were thinking about it, and they modeled it. I think maybe people model as an option, but I think people realize you can’t control the time with that.
Turning to something that has happened: The Fed raised interest rates twice this year, and there’s a potential for more coming up. Does that start to affect your deals at all?
Chandler: I think the biggest issue is availability of credit, not the cost of credit, within reason. One thing that’ll shut down M&A activity is if the banks aren’t lending.
Terpsma: There’s always a factor of how much equity, how much senior (debt), and what do you bridge in between. We see mezzanine providers who are more flexible with rates today. There was a time when they needed their 14-15 percent, and I think they’re recognizing now that maybe they would take an 8 or 9 percent pay. … I think the blend works out, and when you think about historic interest rates, they’re still very low. … I don’t see that as having any negative impact on getting deals done.
Daniels: There is a lot of available credit, not only from banks. Until that changes, I would agree.
What role is foreign capital playing in the current M&A market?
Chandler: The Chinese and Europe have been big buyers. We have a transaction right now with a Chinese buyer, and the U.K. has been aggressive as well.
Daniels: From my experience, I haven’t seen foreign buyers dominate or disproportionately represent the buyers. It’s mostly been U.S.-based private equity, etc. The (foreign) buyers I have seen have been strategic. We (work with) a very active European strategic buyer. They’re a great buyer, they’re active, and they have cash. I haven’t seen any influx of money from any particular region that’s not somehow strategic.
Johnson: From our perspective as a private equity buyer, the strategic activity has been about as robust as it’s been in a long time. Of course we’ve been the beneficiary of it because we’ve sold a couple of our businesses to strategics, but on the flip side trying to compete with them is a real challenge. They’ve been a lot more aggressive, and active, and professional, and swift than we’ve seen in years past.
How creative do you need to be these days to get deals to close?
Daniels: I think when you see people try to get creative in the process to win, sometimes that means they just take more risk or maybe they have an advantage because they know the space well, or have another group partner, etc. You just see more risk I think.
Sorota: I think the creativity is an interesting one on both sides. We’ve gone through (competitive bid) processes, and we’ve done things directly, and I think that folks are open to being more creative, to try to create as much value as possible. I think there’s a huge focus on growth, and trying to bring different assets together to try to create more growth. I think the traditional approach, there’s no such thing.
When you have to get creative, what does that mean in terms of deal complexity?
Sorota: From my seat, and my team’s seat, it’s a lot of effort. If you are doing something exclusive (not through a bid process), that can be very beneficial versus going through a fairly expensive process. … Entrepreneurs have to be in the right mindset to do it, and there are different things that are going to trip that mindset and kind of say, ‘Oh, this could be kind of interesting, maybe now is the right time, but I’ve not done this a lot, so maybe I don’t want to go through a very elaborate process. Maybe you can make it simpler for me.’ I do think there is a lot of activity, and I think a lot of folks are looking to try to create as much value as possible. I suspect there’ll continue to be activity.
Daniels: It’s very competitive today, so if we want to get things done, you can’t show up and say, ‘Here’s how you do it, you’ve got to fit within this box.’ I just don’t think you’ll be competitive or get things done when there’s so many options, so much flexibility. I think the creativity in my mind is listening to what your client wants and why, and then how can you basically find the structure to give them what they want and maximize for both sides.
What’s your advice to sellers around going through a competitive bid process or trying to find a partner directly?
Chandler: Here’s where the seller misses it, I think, and that is everybody’s concerned about what a (competitive bid) process is. I would argue that from a legal perspective, they’re going to do the same thing with or without a process. They’re going to find out maybe there’s a little more work putting a memorandum together. Sure. Every buyer’s going to drill into those numbers and into the legal documents in a big way. (Lawyers have) the same amount of work. What a good adviser can do is flush that out to mitigate surprises on the back end.
Daniels: Yeah, I agree. I don’t think there’s any shortcuts to buying or selling a business. Generally speaking, when they go to sell, and they know they’re going to sell, running a process has always provided more value than it cost and you’re going to go through most of the same work anyways.
Chandler: If you build a successful business, getting out of this business is going to be 10 times harder than getting into it, because you’ve been successful, and you deserved that additional elbow grease to get out. When you look back, if you build a business for 20 or 30 or 40 years, you don’t want that last nine months to be a nightmare. Why have a bad memory? Why not look back and say, ‘We did it the right way, from the beginning when we started this business to the time we completed it for the family.’ Why not go through, get the right advisers and get this done the right way?
Terpsma: On the financing side, we’re involved with financing some private equity buyouts, family office buyouts, and I think it’s been interesting to see how many sellers want to sell, but as they get into negotiations they’re not that excited about selling 100 percent. The PE firm makes the case that today with your size, your multiple is six, but we want to grow this business and we’d like your expertise to help us. … Let’s take this business to a higher EBITDA, and we can sell this for an eight multiple. I think a lot of these entrepreneurs A) they get it, and B) they’re not quite ready to golf five days a week. They buy into it, and that’s part of the flexibility on the price.
Daniels: I’ve had a lot of clients over the last few years who’ve had a very positive experience with private equity. I’m a big fan of private equity. If the culture fits … and they’re a good working partner, it’s going to be a big positive.
Johnson: We feel as though that cultural fit and that post-acquisition strategy in terms of the partners working together, more often than not always trumps price and valuation. We have successfully completed a handful of transactions where we know we have not been the high bidder, but fundamentally we felt as though there was a good alignment in terms of culture and that we had a commitment to their employee base, which is more important than you can ever imagine for entrepreneurs as they think about their legacy. To the extent that you can meet that type of alignment, and really convince them that you’re going to grow the equity together, and give them a significant second bite of the apple, it’s a highly effective strategy.
What are some of the common challenges that pop up and delay deals from getting to a close?
Johnson: I don’t know if there’s any one common area. I think it is really deal specific. Every company has its own path and its own set of issues. From time to time, we’ll see areas having to do with real estate and environmental that maybe aren’t scrubbed as carefully as others. You have to remember a lot of these entrepreneurs, they’ve spent their life and blood and sweat growing a business. They’re new to the transaction business, and they don’t scrutinize quality of earnings like a private equity buyer. A lot of it is not intentional — like they’re trying to hide something or sweep something under the carpet — it’s just that they’re going through (a new) process to begin with.
Chandler: A lot of it’s financial. You said, ‘Hey, I’ve got $5 million of EBITDA’ as a seller. And then the buyer comes in and does a quality of earnings review. They say, ‘You said you have $5 million, do you really have $5 million?’ They won’t tell you if you got $6 million, but they’ll tell you if you have less than $5 million. The issue is if you have $4 million, then you have a conversation. That sometimes comes in within the 30 days before closing. Then life gets interesting.
Daniels: Every transaction has unique issues. The biggest one I see is net working capital type disputes, and just conversations around that. In addition to that, (another area) is unique liabilities within their debt — what are debt-like items? If you want to look at post-closing disputes, I would say some of those revolve around that. I’m involved in three of them right now.
Chandler: Yeah, clients will say, ‘What’s the big deal about working capital? It just is what it is.’ It seems to be a dogfight in every deal.
Daniels: Yeah, and I would say buyer and seller beware, so people who aren’t familiar with going through that, the traps and how it all works, you can really get sideways on those.
Do family-owned businesses come with any unique considerations for buyers?
Johnson: One of the big challenges there is fundamentally a lot of these businesses don’t have what I would call a professional CFO. Oftentimes, it’s a family member who’s counting the checks, and while they’re very good spirited and want to do the right thing, they just don’t have the sophistication around setting the right reserves, setting the right accounting policies. Oftentimes that doesn’t happen until you close the transaction. Then as you set up the net working capital adjustment, you realize that there’s a lot of accounting policies that have not been (set up). It’s a discussion, and kind of a walk which you go through.
Have there been any significant changes to how you handle M&A transactions in recent years?
Chandler: There’s been more procedures or processes that are now taken on by sellers that they never would have considered five years ago. What more and more sellers are doing — which they’ve been doing in Europe for decades — is sell-side quality of earnings. Before you even launch a process, companies will pay to have an accounting firm look at their numbers, and vet them as if they were how buyers would see them. Then you can mitigate those surprises, and quite frankly, buyers like that because there’s nothing worse for a buyer to go all the way through, spend all that money with attorneys and what have you, to have the deal blow up because of emotion. If you can convince someone to spend some money up front, to vet those numbers in advance, that’s big.
Johnson: That’s a big change in the industry over the last few years. Virtually all the accounting firms are doing it now. To a certain extent, I think it’s money very, very well spent, because not only do you kind of avoid any of the pitfalls learning about it after the fact, but it speeds up your process tremendously. Because it’s a very laborious task to go through and pull all these, and to the extent that you can do that up front in advance of a process — that’s not to say that the buyer won’t hire their own firm to do that, but having two accounting firms speak the same language and going through that similar exercise will literally save you weeks upon end in terms of the process.
That sounds like a best practice that’s emerging. What else do you recommend from a best practices standpoint for companies thinking about buying or selling?
Chandler: The other one that’s been instituted a lot in the last 24 months is reps and warranty insurance. You’ll see it on the bigger deals, but statistically you’ll see where the indemnification caps have come down dramatically because of that. Also they did a study between the companies that had reps and warranty insurance and those that didn’t, and (the companies with it) traded about a half turn higher.
Daniels: I’d say almost all my deals that are over $50 million are reps and warranty insured. It just makes transactions easier between financial buyers and sellers.
Chandler: You can afford it, the premiums are worth it. A lot of sellers who were grousing about that initially — about the cost and everything — but afterward they’re really happy because they just have more money and less risk, and it’s psychological. The resistance to the seller is always cost, but I think between ourselves in our industry and the better lawyers who understand the products, they’re able to convince the client that it’s a good tool.
How about from the company side: What do you recommend as best practices?
Johnson: One recommendation we always give family business owners or entrepreneurs is to hire a good adviser and a market-based lawyer, because more often than not we see that families tend to kind of rely on counsel that has been working with them on their family issues, as opposed to transaction-based counsel. While it sounds somewhat counterintuitive that we would prefer the other side to be stronger in terms of their representation, for us it just makes the process go so much smoother. … If you have advisers that don’t know what is market based, and try to kind of shoot for the moon just because they feel like they can, it inevitably either slows the process down or you never get to the point you want to. You just end up wasting a lot of time, and we’d rather give up on some of the economics and terms to have a process that’s quick and efficient.
Sorota: Where we’ve (experienced that), it just is terribly frustrating and slow. It’s really not good for either party, so you’re right, you’d rather actually have folks that know what they’re doing, so it’s more predictable versus stuff just not getting done.
Daniels: Then you’re really just getting on negotiating business issues. When you have counselors that aren’t experienced, you’re dealing with irrational feedback. When you’re dealing with people who are taking irrational positions and just don’t make sense, the job’s not as enjoyable as it could be in that situation.
What sectors are you watching for deal flow, including some that might not be on everyone’s radars?
Chandler: A sector that people are not focusing on is industrials. Just look at Caterpillar. Caterpillar’s stock has doubled in the last 12 months, and who would have thought of that? Now, they were impacted by energy, (but) they’ve come back roaring. … They’re starting to see volume increases, because energy’s come back. A lot of the other sectors, infrastructure’s gotten better. Ag is still having some challenges.
Daniels: I think anything tech, if it’s good tech, seems to be a growth sector in general.
Sorota: I think anything linked to the direct-to-consumer (business). What’s going on, I’ve never seen anything like it in my life, and I think it’s just going to keep happening. (You think about) shipping to people’s homes, you think about how many people are having stuff shipped to their house today versus even five years ago. There’s a whole industry around that. There’s just so much change going on in the way consumers operate and what they use and technology. It’s huge.
Is anyone really concerned about where things are headed for the economy right now given the length of the recovery we’re in?
Daniels: I don’t think so. I’m a believer that sometimes the harder the downturn, the longer the recovery. We had a pretty severe downturn, and we’ve been in it for a long time. It feels like we’ve been in the seventh inning for years. I think people always stress test their models, but if you’re in private equity and you’re going to have that mindset, then you might as well get out of it for a while, and then get back in it when it does happens.
Johnson: There’s been a huge private equity fundraising cycle over the last 24 months, and because of that the availability of excess capital has never been stronger. Until that weakens, I think that will continue to push the deal market forward.
Chandler: One thing that I always kind of look at is what are businesses doing with capex. How do they feel about the growth? Are they willing to build a new plant … or are we somewhat cautious about that?
Terpsma: We do see companies when they fund their capex that much of it is from internal cash flow because they’re doing so well. We’re seeing many people, because they’ve got their own balance sheets in good shape, they’re self-funding.
Given the demographics of this country currently, the wave of boomer retirements is not going to stop any time soon. However, as they hold on to their companies and avoid taking the next step, does that pose any unique challenges?
Chandler: The number of times you’re saying, ‘What is this guy waiting for at 75 years old?’ — you wouldn’t have seen that a number of years ago. Maybe retirement isn’t all that it’s cracked up to be. They like working.
Terpsma: We see these guys sell, but maybe not all. They want to sell 75 percent, and then part of the negotiation is, ‘What’s left for me to do?’ Ideally, I’d like to do these three things, but not these 12 (that) have to do with compliance and administrative things. If this PE firm or a family office can say, ‘We’ll take that off your plate. You do the three things you want to do, and we’ll give you 10 weeks vacation, and we’ll let you work 25 hours a week, but we value the expertise.’ I think that can turn a deal.
Chandler: I’m right up there with you — I’m a big fan of private equity. It gets a bad rap because everybody wants to focus on the negative. Have there been some blips? Sure, but it’s not like strategics have a clean bill of health either. You’ve got to do your homework and spend your time. We’re big on that because then the client will make better decisions. I think private equity has helped drive better values, but it gives sellers more options.
Daniels: If it wasn’t for private equity, these baby boomers wouldn’t have as many options for exits. I look at the baby boomers and the older business owners, and I think every situation is unique with when they want to get out. The market will get a handle on them. I don’t see that being a big concern — whether they are sold outside or they get passed on to the next generation. I do think for advisers like me, that’s a good thing. n