Darrell Austin is one of many dealmakers with ties to Citicorp. The multinational investment bank and financial services corporation’s office in Cleveland was the home base for Austin, Stewart Kohl, Joe Carreras, John Kirby and Jim Petras, among others. All of whom built their resumes on making deals.
“There was a group of us that gravitated to leveraged financing because we liked doing deals and wanted to be entrepreneurial,” says Austin, principal at Austin Capital Partners. “You wanted to understand the secret sauce of making money through acquisitions. I was no different. When you can see the effect in business school of leverage on your return on equity, it gets your attention. I joined that group.”
Austin has spent more than 30 years working on middle-market transactions as a lender, financial adviser and a principal.
“A lot of the early deals in those days were asset plays, undervalued assets that you could get liquidity on pretty readily,” Austin says. “There was a lot more low-hanging fruit. But we also liked the cash flow deals and tried to understand the risk inherent in a deal and get paid for it too.”
In this week’s Dealmaker Q&A, Austin talks about M&A in the middle-market sector, as well as the effect that rising purchase prices have had on M&A players who used to be a lot busier.
What’s unique about doing deals in the middle-market sector?
They are mostly family-owned companies and working with families has distinct characteristics. You get into the issues about the size of the business, whether it has critical mass and how you can build a team with it. I always try to draw a distinction.
Companies that are so reliant on one person, it becomes very difficult to grow that business. It’s a little more hands on because often, you have to build certain areas of the business that an owner neglected, like accounting and financial reporting, internal systems — things of that nature. It’s about your ability to be patient, work with the seller and structure a deal.
A lot of them wouldn’t necessarily understand why you would need escrow money or need to have potential indemnity provisions or a management transition. Even things like noncompetes can be kind of sticky with smaller companies. Most of these people have only done one thing their entire life.
What factors tend to make a deal more difficult to complete?
It’s disclosure, honesty and forthrightness. It gets back to basic business ethics. There is always some risk inherent in a business and often, companies try to gloss over some of these issues. It can be very problematic in a closing where all of a sudden, things come out that hadn’t been disclosed. Then it becomes a pricing issue. We would never go into a transaction looking to deal creep, as they used to call it.
By deal creep, I mean there are groups out there that will offer whatever the seller wants to hear and then at the 11thhour, start negotiating down the price. We try not to do that. But if you’re not getting full disclosure on a number of issues, it lends itself to that. The deal could fall apart. You could have a lot of dry hole costs, transaction costs that both the seller and the prospective buyer have to eat. That can be very problematic.
How has the private equity market changed?
Prices have gone up so significantly because interest rates are so low. It used to be a fairly small community of players. Today you have a lot of large family offices and larger PE groups are dipping down into the lower end of the market and they are overcapitalizing the deals with lower returns because in the case of family offices, they are not getting significant returns in the market and from banks.
So they’re willing to accept lower rates on buyouts, which we’re not prepared to do. These smaller companies can be very volatile. If the market drops and you’re highly leveraged, you’re going to have a problem. There is so much capital that has been accumulated from successful entrepreneurs.
If I made a couple hundred million or a billion dollars, I’d be doing the same thing. I’d say, here’s a great little company. I’ll pay seven to 10 times EBITDA and I’ll overcapitalize it and I’ll be willing to accept a 5 to 7 percent return for a few years and take a longer term perspective to get it paid down. For our group and groups like ours, we don’t make these investments to get our investors 5 to 7 percent returns. We want to get paid for the risk we’re taking.
How to reach: Austin Capital Partners, www.austincapitalpartners.com