Record deal valuations have been insufficient to keep financial sponsors on the sidelines of the ongoing M&A boom, say panelists at today’s Rising Stars of Private Equity SPEAK. Instead, dealmakers are coping with higher multiples by sourcing deals before they become competitive auctions, structuring deals with contingent payouts, and pitching founders on non-price advantages like partner networks.
Specialist private equity firm Motive Partners hasn’t slowed down capital deployment in response to market conditions, vice president Miguel Tejeda told the panel this morning. The firm instead finds deals on attractive terms by tapping its network of financial technology industry participants to source potential transactions before they come to market, even scouring geographies outside of major city innovation hubs.
“Sourcing differentiation is the biggest driver,” Tejeda said. “Being vertically focused, you can be differentiated; it’s about network and strategy. As a proportion of deals, we source a number from our network or in what we call an advantage deal, where we go outside of a sale process.”
It’s an approach that resonates with limited partners as well, said Karen Nes, growth assets investment analyst for Australian pension fund Aware Super. The group manages $125 billion in assets.
“We’ve tended to favor sector specialists, and that holds true today,” Nes said. “GPs can have lower loss ratios, and be more knowledgeable about the business. We look for managers with a unique sourcing relationship with a sector.”
The relationships specialist PE firms can bring to potential portfolio companies is a selling point to founders, and can differentiate a buyer from others in a process, notes Encore Consumer Capital co-founder Robert Brown. “We like to work with people who care who their partners are,” Brown said.
Private equity firms can also “blend down” multiples by acquiring accretive, lower multiple add-ons for a platform, Tejeda said. The buy and build strategy takes on added importance in a high valuation environment.
“We like blending down entry multiples with M&A,” Tejeda explained. “A lot of assets you have to pay up for, but we spend time pre-acquisition identifying more reasonable acquisition companies: ideally peripheral products to what the core customer [consumes], with a sticky customer base you can cross sell into, and can blend the entry multiple down in the first 6 months to a year.”
Earnouts also provide an attractive structural path to bridge the bid-ask gap, though the market’s appetite for risk might mitigate the effectiveness of the tool, the panelists noted.