End-to-End Insight and Expertise Along the M&A Lifecycle
End-to-End Insight and Expertise Along the M&A Lifecycle
Stout’s Jamie Spaman and Jeff Zellner featured in PitchBook’s Q3 2022 PE Breakdown Report.
This Q&A was published as part of PitchBook's Q3 2022 PE Breakdown Report sponsored by Stout.
Given all the volatility this year, what are your thoughts heading into Q4?
Zellner: I am cautiously optimistic. While the public market has been volatile, the M&A market has remained strong. There’s still a considerable amount of capital ready to be invested in the private equity space, so I think there will continue to be deals over the final quarter of the year and moving into 2023. The state of the economy at the end of the year will certainly drive people’s investment strategy going forward.
Spaman: Much of this year’s volatility has settled down, and the market has held together better than initial expectations, given current events. From a valuation perspective, areas that were a little gray earlier in the year due to factors such as geopolitical conditions or supply chain disruptions have started to clear up. The private market tends to move a little less drastically than the public markets, so private company valuations have not been hit quite so hard. And earnings and revenues have generally held up well, so valuations are holding up, too.
On the buy and sell sides, what trends are you watching most closely in PE?
Zellner: On both sides, I’ve found that some processes are taking a little longer than they have in the past. Given the overall multiples and expectations of price, there’s potentially a gap between buyers and sellers. Sellers are still in the mindset of last year’s significant demand and high prices. But buyers are more timid given macroeconomic factors, leading to a gap in expectations and, subsequently, valuations. That said, multiples are still high across the board—although the question remains if multiples are going to remain as high as they have been over the last 12 to 18 months.
Spaman: There’s cautiousness as people approach deals; it’s not quite the frenzy from 2021 and earlier this year. It’s taking longer for people to pull the trigger on deals, as they are paying closer attention to valuations, entry points, and other relevant data. Deals are happening, though the “buy it now before you lose it” sentiment is fading.
How have your PE client concerns evolved—if at all—throughout the year thus far?
Zellner: Private equity is being more diligent in what constitutes a good underwritable earnings base. Sellers and their advisors have been aggressive in proposing run-rate and pro forma adjustments to increase adjusted EBITDA. As a result, buyers need to understand what qualifies as a legitimate or sustainable level of earnings going forward. Depending on industry, aspects such as customer pricing and input costs—such as freight, material, and labor—can mean that there’s a lot of potential noise due to the environment of the last year or two. Those could have driven earnings higher than what they might be in the future. So, buyers really need to evaluate whether that is something that requires the same multiple evaluation on that earnings base, or if it needs to be cut down to get to a more reasonable go-forward earnings prediction.
Spaman: Over the last couple of years, investment firms have had record amounts of money that needed to be put to work, and they needed to move fast on opportunities that would quickly pop up and then go away. Now, there is a more measured, diligent approach. Firms still have plenty of capital that they need to put to work, and lending is still open and fairly affordable. But they’re paying a little closer attention to the earnings capacity of companies and making sure they have recovered from supply chain shock or other disruptive events.
What can companies do to better prepare pre-sale, sale, and post-sale efforts?
Zellner: On the pre-sale side, they should be getting experts involved as early as possible. We see a continued focus on sell-side quality of earnings engagements. Getting professionals involved early in the process is only going to help accelerate the sales process and add value to the company contemplating the sale.
As far as the sale process, make sure you give yourself enough time for due diligence. Don’t rush through an engagement because it’s a super competitive process.
Post-sale, people must think through how to integrate and ensure quality financial reporting. Many companies may purchase entities only to realize that the companies are more complex and messier than originally thought. Assessing companies prior to the deal will allow them to hit the ground running and avoid a headache post-deal, which can then be followed up with a successful integration.
Spaman: For larger deals, getting valuation advisors involved pre-sale to ballpark some of the future accounting treatment and issues is always a good idea. Post-sale, integrating add-on acquisitions or prepping the reporting systems of a platform company are also important. From a private equity standpoint, you need good reporting to implement strategy and make key decisions. If you have to wait for that to get sorted out after the deal, it can result in lost time. Getting the right people involved early can save you six or nine months foreach acquisition, and this will pay off.
What are some of the mistakes you’ve seen companies make during the M&A lifecycle?
Zellner: We’re in an environment wherein the amount of data being provided over the course of a sales process is more than ever before. But the timeline to complete diligence is probably the shortest that we’ve ever had. Processing a massive amount of data under a crunched timeline requires a robust process. Certainly, if you have the internal expertise, that’s great. But many companies need to leverage external experts to help them evaluate that data in a short amount of time.
It can also be beneficial to use the same company throughout the process, from due diligence to purchase price allocation. There can be a synergy in the knowledge transfer between teams and the ability to share information, which allows forgetting the purchase price allocation up and running quickly. That’s one less thing that the new buyer or company needs to worry about post-closing. In the first 100 days, you have all kinds of important items to check off the list. If you can easily transition work from the diligence group to the valuation group, it’s one less thing to worry about.
Spaman: One mistake that companies will make is trying to do everything on their own by leveraging internal resources. Unfortunately, this can lead to an unsuccessful deal or lower returns in doing the deal because they did not have the specific expertise or the right amount of resources to get through the information. The result is that they end up doing a deal that they either should not have done or they see much lower returns because of delays or missteps. So, there can be many mistakes if you do not have the right people and processes in place.