The issue of buyer-seller misalignment has been brought up increasingly in conversations with dealmakers. There’s a sense that sellers’ ideas of their company's value increasingly isn't what the market will bear.
Ouroboros Group General Partner Samantha Ory says whether that can be the case depends on the sector as well as the state of the economy.
“Pre-COVID, we saw a pretty even alignment, honestly,” she says. “Maybe a multiple was a point and half off, but for the most part we were seeing alignment. But as COVID went on, investors started to get very competitive and picky on what they were going to invest in, and also sit on their capital in many cases, which created a harder situation between the buyer and the seller in terms of what is your company worth? And then as COVID started to peel off and continue to normalize, you are now seeing the buyers saying, We can't give you credit for some of the stuff that you did in COVID, although it was fantastic, this isn't part of your regular revenue stream.”
As an example, she says in manufacturing, many companies pivoted into producing personal protective equipment, a line that’s since tapered off. While she says some buyers and investors may believe these companies deserve credit for plugging a hole where others were not able to, other buyers would not give credit for something like that, which further drives the gap between the buyer and the seller.
Now, because of the economic conditions, she says the buyer and seller gap is further increasing. In certain sectors where seller prices are rising significantly, buyers are questioning whether some of these companies are worth that value. However, those peaks and valleys may start to level out soon.
“I think you're going to start to see some normalization happen in 2023, probably in Q1 to Q2,” she says. “Things maybe will start to go back to what it looked like in 2019, pre-COVID. But I think it's been a really challenging time, especially for the investor who they're used to a formulaic equation and suddenly they're having to get a little bit more creative and say, Am I allowed to give this to you? Or do I feel like this is too far off? And then you have the problem with the PPP loans — where is this? Can we give you credit for EBITDA for this or not? And in some cases it’s a yes and some cases it's a no. And you're having to build a tremendous amount of trust between you and the seller in order to come to what you deem to be a fair valuation, which is also why a lot of private equity use quality of earnings just to kind of make it super fair, so everyone feels like you're getting a fair valuation. And that's also why bankers have such a big role too, being the buffer in this.”
Buyers who already own a company in a space and are buying in the same sector can synergize and justify a higher multiple.
From a platform perspective, she says she’s seeing knowledgeable buyers going line by line and giving companies credit for certain things and not others, working to identify value or find creative ways to plug a hole.
Structuring is another way to offset issues with price differences between buyer and seller. She says she’s increasingly seen private equity structure earn outs, seller notes or seller rollover so that sellers get a higher payout in the future if they reach certain benchmarks. There have, in some cases, been situations with minority ownership at first and then at a certain point the buyer and the seller switch roles and the buyer takes over the majority of the company once they feel like their downside risk is protected.
“The tricky part about this is that there's no formulaic equation, which I think is what throws off a lot of investors because there used to be and now you really have to know your stuff,” she says. “You have to know what kind of company is this, what are the limitations to the growth and, oh by the way, if you are someone who puts a lot of debt on a company, how can you maintain that EBITDA cushion while also creatively structuring. It really warrants itself to a more savvy investor these days.”
Ory spoke on The Smart Business Dealmakers Podcast about buyer-seller alignment, her firm’s growth from independent sponsor into its first fund, and how the current economic conditions are affecting the M&A landscape.