Exciting Financial Buyers About Mid-Market Targets

Whether you’ve just hung out your shingle as a mid-market m&a intermediary or you’re a veteran dealmaker, a lot of your pitches will go to private equity groups. These buyers, by some accounts, are on the buy side in more than 60% of mid-market deals. And what this large category of buyers wants to see in a target company and when they want to see it is critical information for m&a intermediaries. The ability to move a transaction toward a successful close will be smoothed by dealmakers’ understanding of what the party on the other side of the table is looking for at each stage of the transaction. Overall, one investment banker says, intermediaries sometimes get lost in the financial aspects of a deal. “Presenting deals to private equity sources is a marketing process. The intermediary needs to understand what makes investors tick. You want to present the deal in a way that is going to ring investors’ bells,” says Burt Alimansky, a Managing Director at Alimansky Capital Group in New York. Do the financials have to be audited financials? Does the intermediary have to supply industry comps as part of his or her presentation to financial buyers? How does the adviser’s role change from working on the sell side to working for a buy-side client? Mergers & Acquisitions posed these and other questions to dealmakers on both sides of the deal to determine what experienced advisers consider the best practices in hawking client companies to financial buyers. For the purposes of this story, we are defining the mid-market as deals valued between $20 million and $500 million. Unless otherwise noted, the relationship being discussed is a sell-side mandate with exclusivity for a certain period. As a cautionary note, intermediaries should realize that the balance between financial buyers and strategic buyers isn’t static. The large slice of the action that financial buyers currently account for reverses the trend in mid-market deals several years ago. “Ninety percent of the buyers 20 years ago were strategic. Now the percentages have nearly flipped,” says Jack Lowden, President of private equity firm Newcastle Partners in Greenwich, Conn. He points to the speed and flexibility that private equity firms bring to deals as one of the prime reasons for their ascendancy. Moreover, financial buyers with investor money to put to work are more willing to do deals than super-cautious corporate buyers, experts say. However, intermediaries note that strategic buyers are still the best audience for some pitches because they often have a key advantage over their financial competitors: They often can pay more if they can extract synergies from the deal. Get Used to Hearing “No” Mid-market m&a intermediaries point out that financial buyers are not hesitant to reject proposed deals that don’t meet their standards. “If you really look at how private equity groups work, they are in the business of saying no to investment opportunities,” notes Alimansky. The average financial buyer, he says, looks at 500 to 3,000 proposals a year and may reject them all or vote thumbs-up on no more than five. Mark S. Kuehn., a Partner at the law firm of Gibbons, Del Deo, Dolan, Griffinger & Vecchione in Newark, N.J., makes the same point in saying that a top mid-market banker stresses that his most important decisions, and the ones that most directly affect his bottom line, are his choices about which deals to pursue. But this situation need not make the m&a intermediary feel like a struggling actor who is striking out at auditions. In fact, if negative decisions on his pitches come quickly, it can almost be a positive because he can then move on and refer the original deal elsewhere. But the high rejection rate does raise the question of how broadly the m&a intermediary should cast his net. While some mid-market bankers say that only inexperienced dealmakers make their pitches shotgun style, some recipients of these proposals, such as private equity buyers, say that intermediaries should err on the side of making their pitches to the broadest possible financial buyer audience. “The deals I cry over are the ones I don’t see,” says John Camp, a Managing Director at Lincolnshire Management, a private equity firm based in New York. Another private equity manager cautions that the intermediary can’t know all the factors that will influence a group’s evaluation of a proposal. While it makes sense to target a leveraged buyout firm that specializes in food deals if you’re trying to move a food company, there may be a number of other interested parties as well. “If you’re representing the spin-off of a division of General Motors, obviously it’s not a fit for us, but our viewpoint is that we would rather hear from people than not. It’s our job to figure out if we’re interested,” says Joe Linnen, a Managing Director at Jordan Co., a firm with a diverse portfolio. It’s hard for an intermediary to know what will constitute a particular private equity firm’s sweet spot, Linnen says. While a seller’s agent can look at past purchases to get some idea of a fund’s interests, he has no way of knowing how his deal will fit into some of the other deals the fund may be considering. Alan Gelband, a Principal at Alan B. Gelband & Co. in New York, raises the point that many LBO firms have become strategically oriented. “Some of these funds might own five companies in a given space. A lot of them are doing build-ups. It’s kind of the flavor of the month to buy a platform and build on it,” he notes. As a result, he adds, many potential financial buyers will know more about a given industry than the mid-market m&a intermediary will be able to learn when securing the assignment. Know the Client In addition to knowing why the owners are selling, Gelband says it’s important for him that the potential target’s numbers “make sense” and are “specific numbers.” “I don’t want to just hear that the company is making a lot of money.” The New York-based dealmaker notes that if the numbers don’t show profitability and growth potential, a buyer won’t be able to get financing, and everyone involved will just be wasting their time. He cites a case in which a letter of intent was signed but was based in inaccurate numbers. “If you make a mistake on the numbers, it will cost you more to discover it at the end than at the beginning.” What PEs Want to Know “I want to hear about the unique characteristics of the company that are going to get me excited,” says Peter Petrillo, a Managing Director at Wafra Partners in New York. If the best thing a company has going for it is a record of steady growth, then the adviser should emphasize that some reason has to be highlighted for the target to be an attractive acquisition. The mid-market dealmaker thus walks a fine line – balancing the need for openness with the understandable tendency to make the best of the client company’s prospects. “You want to highlight the opportunity, but you also need to be even-handed,” says Linnen. Camp says that depth and continuity of management count for a lot. “We want to know if management will reinvest, if they want to stay on. That says a lot about the faith they have in the company.” It isn’t necessarily a deal breaker if management wants to walk away, he adds, but if that is the case, his firm probably would try to build in additional protection for itself in the form of performance clauses or other deal terms. In the management area, some financial buyers are willing to exercise more hands-on control than others who may be more financially oriented. One fund that gets directly involved is Greenwich, Conn.-based Gridiron Capital, where Managing Director Tom Burger says that his firm’s philosophy is working side by side with management teams. “For us, the acquisition is only the first stage. We’re really focused on working with management teams.” However, Gelband notes that depth of management and its continuity are often key factors in mid-market deals because even though a lot of private equity firms say they want to work with management, many of them really don’t want to have to roll up their sleeves and help run the business. A nuance of the relationship between private equity firms and advisers is the difference in pitching deals to large financial buyers and small ones. At a large firm, Alimansky says there is an extensive staff of business development personnel who vet incoming deals. In pitching to a small company that has fewer people, the LBO firm will expect more analytical work by the investment banker. So the size of the information packet delivered will differ depending on the target. But regardless of the size of the private equity buyer, players on both sides of the relationship agree on several points: The view of a number of private equity professionals is that audited financials are nice, but not a deal breaker if they aren’t on hand. They’re handy but not essential in the early contacts between parties. Their role will also change according to the size of the deal and the type of company involved. Linnen says that four or five years worth of historical financial data often is sufficient, depending on the situation. If the relationship does progress to its final stages, and audited financials are being furnished, intermediaries need not concern themselves if they aren’t supplied by a Big Four accounting firm. “If they use a respected regional firm, that’s good enough for us,” says one dealmaker. Noting that many business owners are reluctant to divulge financials, Camp says that as a principal, he often can persuade sellers to part with more information than the intermediary can. But as long as the initial presentation by the adviser is accurate, he can use that as a jumping-off point in his discussions with management. Lowden says that advisers frequently don’t understand the seller’s hot buttons and that private equity people can do a better job of ferreting them out. The financial buyer also may be in a better position to determine whether the owner is truly a seller out to make the deal. To Auction or Not to Auction Usually the investment banker and the seller will determine whether to conduct the sale via an auction. One of the clear advantages of an auction is that it’s often better to have a number of potential buyers bid up the sale price than to approach potential purchasers one at a time. Kuehn says that the bigger the deal, the more likely it is that it will end up as an auction. “For a $10 million deal, you can get a proprietary discussion, but once you get up to $100 million, the likelihood of having an auction is greatly increased.” He notes that if you can bring a deal that large to a private equity buyer without an auction, it normally is an advantage. “There are too many PE groups chasing too few deals. A quality deal is hard to find.” But even for the sellers, auctions have their negatives, and they may not be right for every company. Petrillo says they are more time-intensive, in part because they require meetings with multiple potential buyers as well as public dissemination of company information. Buyers don’t love them because they spur price competition and tend to homogenize the sale process. “When you get above $30 or $40 million deals, you have a well-scripted, orchestrated process,” Petrillo says. Competition tends to remove the inefficiencies in the process, and for mid-market dealmakers, inefficiencies often translate into opportunities. “Some of these larger though still mid-market investment banks do their job too well,” notes one private equity source. “By the time these bankers present a deal,” he adds, “all the kinks have been ironed out but the cost to the LBO buyer is that the sale likely will command a higher multiple.” Relationships Matter As in so many other areas of business, relationships can dictate how the intermediary approaches the private equity prospect. “What I require from somebody bringing me a deal depends on the length of my relationship with them. If I’ve been doing business with someone for years, I’m more willing to trust their judgment,” Lowden says. Alimansky adds that while “relationships will get you in the door, it’s arrogant to assume that they can substitute for doing your homework.” In the mating game between private equity groups and m&a intermediaries, Ian Caulfield-Smith, a Principal at Toronto-based Business Transition Advisory, says that intermediaries should keep in mind that every step in the process should be aimed at winnowing down the number of potential buyers out there. The reward comes when the private equity group’s interest has been whetted enough so they start asking for information about the target. That’s the beginning of what is a “win-win” for both sides of the budding transaction. Copyright 2005 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com