In a post-pandemic and inflationary world, macroeconomic shifts need to be accounted for in deal terms. BMO Harris Bank Director - Corporate Advisory John Chalus says one part of the equation has to do with the power dynamic within an industry, particularly a company's pricing power.
"It's the difference between a price taker and a price maker," Chalus says. "Some companies are order takers, price takers, and others hold the power within their relationship and they're able to raise prices."
It's an economic environment in which price increases are expected. When evaluating a company for a purchase, having that type of pricing power, not being a victim to the market, can be a positive differentiator.
"We've had companies that have struggled because the market dictates their pricing," he says. "And so you're in this, it's almost like an oscillator where you have an inventory that's either diminishing in value or growing in value depending on how quickly you can turn it. These are all things we're looking at, I think it's all things that buyers in general are looking at and obviously it's desirable to have a company that can pass along price increases if necessary."
Another issue is dealing with anomalies in a company's trailing 12 or 24 months. Tecum Capital Partner Matt Harnett says accounting for that can be tricky.
"If we just look at our portfolio, we have 34 companies and revenues are up 20 to 30 percent," he says. "Not everyone is that good. So, what's going on in the market? Is there extra capital? Is there inflation? Is it dollar revenue today worth less than the dollar revenue last year? So, we're really grappling with a lot of things."
There's also conversation regarding the stickiness of the recent price increases. While everyone's accepting these increases right now, it's having a knock-on effect. Cost for a shipping container of goods, for example, has gone up significantly, and companies are essentially forced to pay that increase in cost. Shipping companies are certainly benefiting from that right now. But other companies that are paying that increase are then adding five percent to their customers' bills to cover the shipping.
For Harnett, determining how these increases will play out, means trying to analyze where revenue growth came from — whether it's a specific customer, specific contract, a price increase, new customers.
"So, really digging down into where is that revenue growth coming from and is it going to be here in two or three years because otherwise you're buying at the tippy top of a market that's not truly efficient from a supply chain perspective," Harnett says. "I think that'll readjust. Not to be negative, but I think there will be some kind of readjustment. Maybe we have two or three good years here but if you're buying on just a true increase or inflationary-type snapshot in time, you're going to be disappointed in two or three years."
On the other hand, he says, if it's a great company that's adding new customers, adding new SKUs, then that's revenue that is likely to stick. But if companies are growing on one-time price increases, those holding that business for five or six years are likely to see it swing the other way.
"It's cyclical is the way we look at it," he says. "But we still got to do deals. So, you have to just find that middle ground of where can you get a fair deal for the seller and still leave some margin of error for yourself because it is really hard to price a deal right now."
Chalus and Harnett spoke at the Chicago Smart Business Dealmakers Conference about the economic factors that are affecting deals and how buyers and sellers can adjust. Hit play to catch that segment of the discussion.