It’s a seller’s market, and large strategic buyers are being very aggressive — in some cases, short-cutting due diligence processes.
“They’re less concerned with all the financial numbers,” says Wade Kozich, who has worked with middle-market business owners for more than 40 years. “They’re looking more at revenues, production capabilities and performance measurements, with the knowledge that they will be able to, post-deal, probably engineer the company to comply with their financial requirements.”
Not only are values high, but the terms of deals are changing.
Kozich recently worked with a seller, a C corporation valued at around $15 million. The buyer was willing to do a pure stock deal, which was more advantageous to seller, in order to win the deal.
“These strategic buyers, they’re under a lot of pressure to grow,” he notes. “They’re looking for competitive advantages, and so I think they’re going somewhat out-of-the-norm or out-of-market to get deals done.”
Strategic buyers can move quickly through due diligence or even lessen the amount of due diligence, Kozich says. When a very large buyer buys a smaller company — a meat-and-potatoes, blue-collar business — they typically know the industry extremely well and know what to expect in terms of numbers.
“Their strategic reasons for making an acquisition are a lot of times beyond the numbers you see on the page,” he says. “They might be looking to gain geographic territory. They might be looking for a competitive advantage to get into certain customers. For example, if your client has a relationship with, let’s say, the big-box retailers, and they’re looking to get into a certain big box retailer and specifically in a geographic area, that might be a very strong reason for them to buy a company.”
In the minds of many strategic buyers, the synergies they’re gaining outweigh whatever they’re giving away in terms of price or terms, Kozich says. In addition, an environmental issue, for example, that would concern a financial buyer may be a problem a strategic buyer has already dealt with in 15 different plants.
While this behavior isn’t unusual in a seller’s market, Kozich feels the change has been more dramatic in the deals he’s worked on.
“Where a financial buyer would come in and do a lot of quality of earnings, a lot of due diligence work, really kick the tires hard, the strategic buyers are coming in and the financial diligence is pretty light,” he says. “It’s not real sophisticated. If they’re buying a manufacturing company, for example, they’re more concerned with the condition of the plant and the customers they’re serving, and maybe the volume that’s going out.”
Financial buyers are also shifting their strategies, because they’re subject to the same market conditions.
“If you went back five or 10 years ago, the number of private equity firms willing to take a minority position was pretty low,” Kozich says. “Now, I wouldn’t say it’s a majority, but there’s a lot more out there who are willing to take minority positions.”
And just like strategic buyers, financial buyers are getting more creative and moving up or down market to find deals.
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Pushing the limits
Kozich is starting to wonder, especially on some private deals, about the high values. However, the cost of money is definitely contributing to these high prices.
He says when you only earn two or three points on bonds or secure investments, and you can borrow at low interest rates, the price of everything — like investment real estate, which is at a premium — will increase.
“I don’t want to go so far as to say things are overblown or being overpriced, but I think the limits are being pushed,” Kozich says.
At the same time, everyone is wondering when the shoe is going to drop.
No one knows if the next recession will be in six months, 12 months or 24 months, but Kozich hasn’t talked to anybody that thinks it will be more than two years before there’s some kind of decline.
“It’s like a forest fire, right?” he says. “Nothing cleans stuff up like a good old recession because recessions bring everybody back to reality. They bring everybody back to nuts-and-bolts thinking,” he says.
Frankly, Kozich says, professional buyers should want a recession because just like the stock market, you look to buy when the market is at the bottom.
“You can still make good investments when the market is at the high, but it’s easier when it’s down,” he says.
Timing a transaction isn’t easy, so he recommends sellers look at three things to make informed decisions:
- Where are you personally? Are you 40, 50, 60 or 70 years old? Are you burned out? Are you invigorated?
- Where is the company is in its cycle? Is it on its way up or down? You don’t want to sell on the way down.
- Where is the M&A market? Right now, it favors sellers.
Even in this seller’s market, some deals don’t go through. That’s often because the sell side has unreasonable expectations and poor advice, Kozich says.
“People, they hear things,” he says, “whether it’s at a country club or in a locker room or over dinner, from some friend or whatnot, and they think that all applies to their situation — when it’s out of context. It’s not reasonable. It’s not realistic.”
That’s why Kozich always tells his clients, who are 75 percent on the sell side, to try to be objective. If you’re 70 years old and you want to wait to sell two or three more years, another recession could hit in the meantime.
“Now, you’ve got to wait another five years and your business just went down 50 percent in value,” he says.
It’s also critical to prepare by having good investment banking and legal advisers who know the M&A space.
“They’ll coach you very quickly on how to prepare, what to expect, how to maximize value, how to get through a deal with as little pain as possible,” Kozich says. “Because transitions are not easy. They’re very difficult. They’re very time consuming, but they’re very worthwhile.”