Slow M&A deal flow in 2022 has trickled into 2023 as more people are standing on the sidelines concerned about rising interest rates and the perpetual threat of a recession. Though deal flow as picked up in recent months, Gregory Taber, managing partner at Provariant Equity Partners, says he's noticed that smaller deals have been more active, largely because of the add on acquisition strategy the private equity firms are trying to deploy. Strategics have a lot of cash on the balance sheet and looking to do roll ups. The founder or family-owned business market has been not great, but is getting stronger.
"A lot of families, entrepreneurs, have lived through COVID, lived through supply chain issues, lived through a lot of headaches and they realize this is the new normal," Taber said during the Columbus Smart Business Dealmakers Conference. "Where those sellers were holding out for top dollar in past markets are saying maybe now's the time to sell. And I might not get top dollar, but I'd be able to get out with a good multiple and take some risk off the table and have a partner going forward. We've seen some of that kind of be a little bit more resilient in terms of the deal flow."
Generally, multiples have come down a little bit and valuations could be considered more reasonable, but, he says, buyers are still likely to be uncomfortable.
"It's just the nature of the market these days," he says. "You've got to put a healthy multiple out there to get a deal done or else, obviously, the deal is not going to get done."
Deal structures in this environment are getting more creative. Earnouts have been a consistent response, but he says there have been more seller notes and more structure.
"I think a lot of buyers like us are a little bit less concerned about the leverage, a little bit more focused on making sure that the company is well capitalized, protected, has the ability to do the growth initiatives that it needs to do," he says. "And if leverage multiples change, if the environment changes, you can always recapitalize and refinance later. And so I think a lot of buyers are putting extra equity in to be to be secure knowing that one, two years down the road, if the company performs OK, and the market changes, you're going to be able to do some things with that, or execute an add-on strategy where you can do a little bit more without worrying about financing those."
Additionally, as the availability of credit has changed, where a lot of buyers were using unitranche and doing all senior deals, that seems to have fallen by the wayside.
"We definitely had to look harder in terms of finding partners that could be creative," he says. "It's really easy to say no these days on a deal. There's a lot of reasons to not do a deal. And it's always easier to say no. And so finding the financing partner that's going to go shoulder to shoulder with you and go through the diligence and understand the business, I think that's where you're looking for long-term partners. And that's why we believe in mezzanine and always have. But there's a lot of senior lenders out there that are sitting on the sidelines because of the difficulty of getting a deal done today."
While some buyers are accustomed to longer-term earn outs or structures, using them can be difficult when partnering with a founder whose motivation is in conflict with the shareholders. Taber says his earnouts and structures have been shorter in terms of proving out some of the add backs and some of the uniqueness that's been going on in the market. But as this market picks back up, the competitiveness of buyers is going to minimize these approaches.
Taber says another approach he's taken in this market is to enhance the equity incentive packages for management teams.
"And that's perhaps another way to bridge the valuation gap and allow the management team to put their money where their mouth is and allow the in-going equity to be a little bit protected and create some structure around an equity incentive package that allows a win-win where you're not on opposite sides of the table, so to speak," he says. "But everybody wins when you have you have good equity incentive plans in place."
Ultimately, Taber says it's great time to be a buyer.
"This is where a creative dealmaker can get a deal done and really be happy six to 12 months from now," he says. "And when deal flow picks up and everybody's busy, it's going to be harder to stand out. You can stand out when you're creative and have ideas and do things where you can add value, be creative with a structure and get a seller what he or she needs or wants. That's really where you can make a good deal."