Dealmaking remains red hot in Central Ohio, despite the fact that PE fundraising is expected to fall below 2019 totals this year, according to PitchBook’s 2020 Private Equity Outlook.
The report also predicts venture capital to private equity buyouts will continue to proliferate and that there will be continued expansion in growth equity deals.
“There are enough deals already committed to go through the first six months of next year without a problem,” says Ice Miller LLP Partner Rob Ouellette. “A potential recession keeps me up at night with when it’s going to happen, but our backlog of work headed into next year is the highest it’s ever been. I haven’t seen any indication — and I’m looking — but I haven’t seen any signs of weakness in the M&A market.”
Scot Crow, general corporate, M&A and private equity practice group chair at Dickinson Wright PLLC, is also seeing high deal activity, with a lot of transactions in the pipeline. He expects the first half of 2020 to be busy because of the amount of PE dollars that still need to be put to use.
“There’s a lot of competition for the same type of deals, depending on fund size,” Crow says. “In the mid-market space, trying to find companies that fit their EBIDTA profile is getting harder and harder to do, particularly in each of their service sets. It’s caused a buildup of cash. The funds have to deploy the capital at some point, or they’ll lose the ability to deploy it at all.”
Smart Business Dealmakers spoke with Ouellette, Crow and Steve Bennett, Central Ohio regional president of U.S. Bank, about what they forecast for the 2020 dealmaking climate.
How do you see deal valuation trends manifesting?
Crow: It’s more of a seller’s market right now, which you can see from the multiples that are higher than what I would call normal, at least in the mid-market space.
When you get above midmarket, you see some of the multiples coming down. That’s because some deals that have been tracked at those multiples haven’t panned out as expected. In other words, they didn’t hit their earnings marks.
It’s harder and harder to find deals that fit the profile that the buyer is looking for, so a lot of them are competing for the same acquisitions. It’s not a function of there not being that many people willing to sell; it’s just that there’s a plethora of buyers right now. There’s a ton of cash out there that’s available, and that makes it a pretty good market when there’s an oversupply of buyers.
What changes are you seeing with deal structures or terms?
Ouellette: With banks staying disciplined, equity funds are putting more equity in than they would have in the past to make up the difference, or the owners of businesses are rolling over more equity than they would have in the past, which are all signs of continuing optimism. People are putting more equity at risk.
What I see different this time than I did, let’s say 10 years ago, is that the banks are continuing to act disciplined. For example, a deal five years ago would take 20 percent equity to do, and the banks would loan at 3.5 times EBIDTA to fund the transaction. Multiples have gone up, but the bank’s not stretching very much on the senior (debt), so where is the rest of the money coming from?
They put more equity into the deal. Those equity funds will put, instead of 20 percent, 35 percent of equity into the transaction. That’s healthy, I think, for the economy. When the next recession hits, the smart money is it won’t be as bad as the last one was because there’s more equity in deals. There’s more of a safety net to run these businesses.
Bennett: I do see from some acquisitions that the seller is putting more money in, as either subordinate debt or investing back in the company that’s acquiring them, via equity. I’ve seen that on two or three deals now, where the sellers are willing to come along for the ride and not totally get out.
Let’s say it’s a $10 million acquisition, I’ll take $8 million now. And then I will take the other $2 million and put it in as capital in the new company and continue to invest alongside.
Crow: I play a lot in the health care M&A space, and there’s less debt being used in a transaction. The buyers are tending not to lever out the business as far; there’s more equity coming in.
Also, the use of reps and warranties insurance has increased dramatically in the last 24 months. The reason for that is it solves the common issue of “I don’t want to sue my partner,” because most deals require some sort of rollover equity. Sellers are getting some cash, and they’re required to roll some of their purchase price back in the form of equity into the buyer, which means if you sue under an indemnification plan, you’re immediately at odds with your partner. Reps and warranties insurance solves for that issue.
What do you anticipate as far as the availability of capital?
Bennett: On our side (the bank’s), there is a lot of availability of capital, and when I talk to the PE firms and also some of the family funds here in town, they still have a lot of money to deploy. With interest rates being low, they don’t have too many places to put their money, except in good companies that have good management.
Ouellette: Prices go up naturally — supply and demand. So, if you have a well-run business that’s up for sale, with more equity out there, you’ll get a higher price for it. But that higher price is being financed with equity dollars, rather than debt dollars, which is a good thing.