M &A Roundtable: The “New Economy” Fallout On Middle-Market M&A

Huge sale prices for Internet and emerging companies, no bigger and less profitable than traditional “old economy” mainstays of the middle market, have created a two-tiered marketplace that is challenging m&a intermediaries. Some dealmakers are expanding their focus and their resources to handle technology-related deals. Traditional roles in deal networking, structuring, valuation, and financing arrangements are more important than ever. M&A: Some huge prices have been paid for Internet and tech stocks that are no bigger than the companies you are dealing with and don’t have as good a track record. Has this affected your business in any way? Has it raised your clients’ pricing expectations? Or are you still going with tried-and-true valuations and multiples? Hubert: I amazed, in looking at the list of companies that are filing for an IPO, how many have revenues of $1 million or less and are losing $10 million or $20 million per year but up until early spring have been able to complete a successful public offering, some with unbelievably large valuations even after recent corrections. I think that demonstrates a situation in which there essentially are two markets right now – there is tech, or to be more accurate, Internet, and there is everybody else. For the companies that I would characterize as venture capital deals with nominal revenues, large losses, and at an early stage in their development, I think their only option is to do an IPO. But there are other technology-related companies that may not have the opportunity to go public. They are either not the flavor of the month for Wall Street or they don’t have the management sophistication or the time to hire underwriters and obtain strong institutional investment in their business. For these companies it becomes more attractive for them to partner with companies that are about to go into registration, are already in registration, or recently have gone public. In these situations, they are obtaining very strong valuations. If they are willing to take a very volatile and high-flying stock as collateral for their business they can get a very, very high price. So, there seems to be some differentiation from that standpoint. But again, technology-related businesses have a right to be aggressive until the markets fundamentally change their valuation methodology. As for non-technology businesses, the market is still providing strong value relative to historical levels, just not at the extreme level of some of the technology plays. Deutsch: I heard a wonderful expression recently: the “not-com.” We tend to cater to “not-coms” rather than “dot-coms.” These are the low- to medium-technology, niche-leading companies with good and growing levels of cash flow, and strong and long-tenured management teams. We think the 130,000 companies in our target range of $20 million to $200 million in sales that are so-called “old economy” companies haven’t gone away. There is, on the other hand, a brand-new set of enterprises that, some believe, have much greater growth potential, much greater scalability, and a much greater chance of becoming large, global enterprises than certain of the old economy companies. As a result, there are different methods of valuing, approaching, and financing merger transactions for the “old economy” versus the “new economy.” While we tend to focus on “not-coms,” we think the Internet has changed all of the rules. It really is quite revolutionary along the lines of railroads, electric power, the automobile, the telegraph and radio. But in our view, except for a relatively small group of so-called portals and pipes and tools companies, we tend not to be a big fan of many of the new Internet-only enterprises. That said, we love “bricks-and-clicks”: the best of the old economy with an Internet twist. We think that’s where companies are creating the greatest corporate values today. Novak: There is a great distinction between the old economy and the new economy, the latter being the Internet, some telecommunications companies – even the very small local and regional ones – as well as high-technology and perhaps even biotechnology firms. A recent study of CFOs mostly from the old economy found that about 80% of those surveyed used discounted cash flow to evaluate acquisitions; 70% also used a multiple of EBIT-DA; and roughly 60% also used earnings per share or return on investment. None of those metrics applies in many of the new economy companies, which may use multiples of revenues or more specific industry metrics like price per subscriber or price per hits on their web site or something along those lines. So, you really do have two different sets of metrics in the two areas. Ainsworth: As investment bankers, the work we are doing today has a tendency to be a lot more subjective because of the differences between the old and the new economies. With the older businesses, a lot of the valuation work is done on financial models. We are looking at the numbers for a standard objective analysis. As today’s valuation work moves to the subjective side, we are spending more time managing expectations, which has increased human dynamics more than ever before. If there is a steel company and the typical multiple in the industry is six times EBIT-DA or cash flow, a good banker can perhaps move it up to seven or maybe 7-1/2. But he is not going to get 15. When working in technology, values are a lot more subjective; we have a lot more freedom and fewer guidelines in pricing a transaction. This is the biggest shift I have seen; it’s in the valuation techniques. It is very different from the way that we were all educated. A lot of our time as bankers seems to be spent in the human dynamics and relationships because we are trying to manage expectations. On any given day, your client may read The Wall Street Journal and think his company is worth $2 billion. I spend more time trying to explain the valuation process than I do the numbers. Today, there may not even be numbers to analyze. Cromwell: I think we were facing a two-tiered market with the bigger valuations that were happening in the Internet/tech sector through the first quarter. But if you stripped away what was going on in these “hot” sectors and looked at the S&P and other industry averages, you found in a lot of industries that the valuations in the public sector were going down. So, managing client expectations involves making sure that your client understands that his valuation is going to be driven by his specific industry sector and not the broad averages or what he is seeing in selected deals by dot-coms. With so much attention focused on dot-coms, I think we find ourselves having to work a little bit harder on the non-Internet deals. Many major industrial companies and other companies are looking for deals that will put them into the Internet sector. So, when you’ve got a regular not-com client, you have to work just a little bit harder to sell that business. There are a couple of other areas on which the Internet has had an impact. If our client companies have an Internet component, we are trying to draw that out to enhance their valuation. That component should be more than just a web site, and ideally should include actual sales. We try to accent these Internet elements as much as possible to help show the extra growth potential for the company. At the same time we are careful about companies that are trying to instantly have the appearance of Internet companies when there is really nothing there. Recently, we were looking at a travel agency that had just put up a web site and was trying to position itself, all of a sudden, as an Internet travel company. But there really was not much magic there that was going to make this travel agency become a big Internet company. One interesting professional aspect of the Internet for boutique firms is that it is easier now to learn more about prospective buyers and prospective sellers on the Internet. Almost all companies, including private companies, are putting up a lot more web sites. It is easier to learn about companies and deals, which allows us to compete effectively with the larger firms, which typically have had more resources. We can also use selective e-mail to contact prospective buyers, including financial buyers. But we are also finding that you’ve got to be on the phone very rapidly to make the necessary follow-up calls. Some of the financial buyers that we talk to are getting 30 to 40 to 50 business plans a day via e-mail and they often are responding more quickly and positively to people that they know. One person told us that his first cut on the daily flood of e-mail is to instantly erase all e-mails from everybody he’s never heard from before. Novak: We have a web site and we’ve done quite a bit in terms of information sharing among the firms in our M&A International Worldwide network. In fact, one of our firms even manages a site for matching buyers and sellers. Ainsworth: But it cuts both ways. One of the dangers is that it can lessen our value as investment bankers because everybody has access to all this knowledge. Clients think they already know valuations and can structure their own deals. However, for many clients, the value of their investment banker is still their underwriting knowledge. So, our role has changed a lot. We used to sell a client on the fundamentals and capital market knowledge. Today, I find myself selling issues that have nothing to do with investment banking because, frankly, potential clients think they already know my business. Deutsch: Relationships are still absolutely essential. A corporate sale is a seemingly simple yet deceivingly complicated process. Our clients need to devote their full attention to the day-to-day management and growth of their business, especially if theirs is a technology-oriented company. They need a banker with the right skills and the right relationships. One who can guide them through the process and orchestrate their interaction with acquirers. And, one who can properly structure the transaction. M&A: Are you getting involved more often, either on the buy or sell side, with the Internet and tech-related companies? Is this a growth area for your businesses? Hubert: We’ve always been on the sell side of the deal business, which has allowed us to push for the best possible value while also concentrating on the strategic relationship that a buyer can bring to our client. There are some great businesses in this area right now that have tremendous upside and it clearly is a growth area. However, as technology incorporates its way into virtually every business practice, every deal we will do, even for any traditional business, will have technology playing an important role in salability and valuation. Ainsworth: We’ve expanded our technology group. We’ve recruited bankers with technology backgrounds because the key is to understand and value the marketability of clients’ technology. We need to see if the company can survive more than 12 months. Sometimes the hardest part is picking clients with survival rates that are longer than a year. So, we really need that extra expertise. Novak: We have, as well. Mitch Frankel, at our firm, has quite a background and leads our efforts in telecommunications, technology, and the Internet. As a result we’ve had buy side, sell side, and financing assignments coming to us, although we have not necessarily actively searched them out. There is just so much activity in the marketplace that if you have reputation and expertise, the market finds a way to you. Deutsch: One new way that we have begun to approach technology is to partner up with other firms. For example, we have just met with C.E. Unterberg Towbin, one of the premier technology investment banking firms, to discuss how we might work together on certain assignments. Cromwell: We are working more on the sell side with Internet-related companies. But it is interesting that we are finding an m&a component to our traditional capital-raising projects. Every time we put together our prospective investor call lists, they include not just the financial institutions and the venture funds but also a number of corporate strategic investors. In the past, a manufacturing company that wanted to, for example, increase distribution overseas might look for a corporate partner to buy 20%, 30%, 40% of the company and help them expand. With Internet companies today, the investor call list for a capital-raising project includes the corporate partner that is bringing not only the money but also extra important business elements to these very, very early-stage companies. The Internet company obviously gets the required capital but it also leaves open the options of still doing an eventual sale or IPO. The corporate buyer, who wants a chance to review the business before it perhaps buys the whole company, has an opportunity to get some Internet capability or some technology in the meantime. Deutsch: While we might not work with just any e-tailer, we might be eager to work with a new client in the logistics business. We love companies, for example, that are in the business of selling shovels and dungarees to gold miners. We may not back the gold miner, but we’ll back the shovel and dungaree maker. For example, we recently raised private equity for a leading microwave antennae maker. We would have been far choosier in agreeing to raise capital for any one of a number of makers of radio transmission equipment, whose technology is far riskier. M&A: There have been some unique deal structures and formats on major deals recently. Are there any major structure innovations in the mid-market? Ainsworth: Investors are creating capital structures that maximize returns in the shortest time possible. Investors were used to a five-to-seven-year return. Today, they want a 12-to-36-months turnaround. Equity sponsors are changing the capital structure to compensate for a shorter investment cycle. Investors are being more creative, placing larger percentages into convertible or redeemable securities. We see simpler capital structures in the middle market. The capital structures of some technology companies look like Fortune 500 corporations. Investors have to consider multiple tranches of investments, and address risk in a shortened cycle. Hubert: The 1999 tax law that disallowed installment sales by S corporations that were selling assets that kept their books on an accrual basis had a major impact on deal structuring options for many sellers. While there is legislation in Congress to retroactively wipe out that law, we have had to improvise with deal structures and purchase price allocations in order to complete several deals. Other than tax issues, most buyers want to invest in management and want management to have a hook into the deal. As a result, they are willing to be pretty creative with how it gets done with supercharged equity and large preferred debt pieces, equity that is earned through performance and tenure hurdles, options, or other incentive arrangements. But management has to have some skin in the deal for them to be comfortable. That is usually a requisite on almost every deal we do. Deutsch: To the degree that management’s expectation regarding value exceeds that of the buyer, there is inevitably some form of contingent future payment. Ainsworth: We’ve seen unrealistic expectations in raising capital for young companies. About 50% of our capital-raising assignments eventually end up with the sale of the company instead. In the technology sector, management teams are creative but lack operating track records. The due diligence process highlights management’s lack of operating skills and inexperience. Management’s realization of the true cost of capital often leads to a partial or total sale. Deutsch: The opposite of that is true, as well. More companies than ever before that begin a corporate sale process end up being recapitalized. Frankly, we think that’s why firms, like ours, that do both m&a and finance are better at corporate sales than the “one-trick ponies.” M&A: What is your take on pricing trends in this highly tiered market? Are the multiples rising or other benchmarks rising? Are the aggregate prices rising, falling, or staying level? Novak: In the old economy – the stable, mainstream manufacturing and distribution companies – we’ve tended to see relatively stable multiples in the last year or two. In terms of multiples of EBIT-DA, they have run five to six, and a little bit north of six for financial buyers. They’ve run about six to seven to eight or more for large corporate strategic buyers, depending on the cost savings and synergies. The key issue that people tend to overlook is exactly what the appropriate EBIT is to which you apply a multiple. We get more and more into issues, especially in a good economy, as to whether it should be the EBIT in the last historical year or the current-year EBIT. People accept the fact that at a privately held company, or even a corporate subsidiary or division, the number is going to be an adjusted EBIT-DA. But how far and how deep do you go and how creative are you in adjusting it? There is a question of using things like owner add-backs, non-operating items, and non-recurring operating items in making adjustments. And then you fold in some of the more obvious consolidation or acquisition benefits. That is where we’ve seen more aggressiveness in people in rebuilding the EBIT-DA number to which they apply the multiple. Deutsch: A rising tide does not necessarily raise all ships. The Dow and the Nasdaq can move in opposite directions. Our client may be in an industry that’s in or out of favor. It can be the best or the worst in that industry. For any given transaction, for any given company, there is typically a wide range of possible outcomes. From an investment banking point of view, our challenge is to manage the transaction to achieve the best possible outcomes. Generally, middle-market pricing is flat to up. Hubert: Stability certainly rules the world. I think that in the last couple of months I’ve actually seen some clients, especially those somewhat involved with technology, become rather conservative with respect to the potential purchase price for their business. I think they recognize that there is an awful lot of froth in the market right now. And the volatility over the last year has scared a lot of sellers about accepting any kind of equity in return. Some people are willing to take less for a more secure price with a cash component. They recognize that it is going to affect overall value, but they are willing to give up some upside in order to have some security. It is interesting to see some reality based on the fact that they recognize that a lot of stock prices are completely out of whack. Ainsworth: Buyers are becoming more conservative. They are less willing to pay big premiums for acquisitions. Buyers are now stepping back and rethinking the impact of the acquisition on their businesses. How much can they pay? What if things go wrong, how disastrous will it be? Last year, management did not believe anything could go wrong. Deutsch: Back to the notion of acting as an advocate for your client and trying to manage the transaction to success. There’s also “spin.” Good investment bankers can manage an acquirer’s perception of its client. One can take a company, for example, that owns a group of specialized magazines and portray them as Internet “content.” One can take an education company, as it’s developing its Internet strategy, and develop a cogent argument that it has far greater scalability if it can demonstrate its ability to accelerate distribution of its product over the Internet. M&A: Do you find that consolidation plays are slowing down? Conversely, are there markets in which they are still going strong and are there any newly emerging areas for consolidation projects? Cromwell: Probably the biggest area for consolidation is going to be the Internet arena. Two types of consolidation are happening there. One involves acquisitions by the larger companies that figure they can get technology from buying up bright, emerging, earlier-stage Internet companies. There is also a fair amount of consolidation going on with the smaller or intermediate size Internet companies that need to merge, either to survive or to prosper. Deutsch: I think it is quite clear that many promoters who were responsible for the so-called roll-up phenomenon have gone away. However, those acquisition professionals who for decades have pursued good old-fashioned consolidation strategies and build-ups, still do a fine job of acquiring and capitalizing an appropriate platform company then carefully integrating new acquisitions. There is an enormous difference between overly promoted roll-ups and good old-fashioned industry consolidations. Of course, there are greater and lesser degrees of consolidation in certain industries. Clearly, there is increased activity in telecom, Internet service providers, certain business services, certain financial services, and computer software companies, among others. M&a activity has been slower in specialty chemicals, staffing services, and office products distribution. Whether these industries have increasing or decreasing consolidation activity also has had much to do with who has been the driving consolidator in that industry and whether that firm is more or less active today. Novak: Those firms that have had solid strategies continue to consolidate their industries, and it was not just the roll-up people that were driving the consolidation. Customers and competitors have also been drivers, and those factors are still there. People may be a little more careful today, but it depends on which industry segment you are talking about. We do a lot of work in distribution. There are about 31 segments in that industry and only 10 of them would be considered mature from a consolidation view. There are still 21 segments that most experts would consider to be relatively unconsolidated or only moderately consolidated. They continue to roll along. David’s term “bricks-and-clicks” applies to what is happening in distribution. You have the bricks-and-mortar distributors from the old economy and their consolidation. And then you have the “clicks” – the so-called e-commerce “distributors” in the new economy – and their consolidation. You also see those two merging, where the e-commerce people need to link up with the bricks-and-mortar people for fulfillment and the bricks-and-mortar people need to link up with the e-commerce people because they are concerned about the direction that the market is going in. Ainsworth: The major investment banks are allocating their resources to developing technology sectors. The basic industries are not as well serviced as they once were, resulting in underexposure. The lack of exposure can lead to undervaluation. A low valuation along with a good management team create an appealing consolidation target for competitors. We haven’t seen as many “buy and build” strategies. Private equity funds haven’t achieved the level of returns they once did. What we have seen is an increased investment from international companies that see good value in the basic industry market. The consolidation is driven more by companies buying competitors verses private equity funds buying companies. Hubert: A lot of the slowdown has been in the public market. The quality private equity groups that have been consolidating for a long time are still building and creating value. The big change has been in their exit strategy. Right now, I would characterize the private equity market as a large feeding chain. While it is probably not possible for them to take their portfolio entity public, they are still achieving nice gains by selling the entities to the next-size tier of private equity buyers. A successful consolidation play by a $100 million to $250 million fund looks very attractive to a $400 million to $750 million fund, and so on. This phenomenon has created a wonderful opportunity for all of these firms to continue their activities until the public markets turn and embrace consolidation plays again at some point two or three years or five years from now, as they always do. M&A: Turnaround acquisitions are becoming more popular. Do you get involved in them, representing either buyers or sellers? Cromwell: We still prefer to work with healthier companies without problems that require major turnaround efforts. But most of us at this Roundtable know that each of our middle-market companies typically have some “issues” involved with them, just by virtue of being in the middle market. We have worked with some troubled companies and some turnarounds but we are not focusing our business in that arena. One main reason is that there is not much of a change in strategy by the many financial buyers that we know very well. There are some firms that can call on a cadre of executives to do the turnaround. You are either in the turnaround business with the cadre of executives or you are not. Those investors who are not in the turnaround business would prefer to sit on boards and act more like financial and strategic advisers. I don’t see those folks now changing to look at more turnaround situations because they then would be forced to visit that troubled plant in the Midwest on a regular, extended basis to make sure it turns around. As a result, we find that we ideally want to work with a healthy a company, although we are not afraid to take on one that has a few problems, because that often is the nature of the business in the middle market. Deutsch: We’ve always had a certain amount of “challenged company” deal flow. Some have acute problems that are quite solvable. And then there are those with total organ failure. We are often approached by distressed companies that want to merge with another company in their industry on the theory that they’ve got satisfactory gross margins and their only problem is excessive corporate overhead, which makes them unprofitable. If they only merged with their competitor, everything would be fine. Quite often this is not the case and there are really other issues to address. We often advise these companies not to sell but instead to avail themselves of a product we developed called a “strategic action plan.” In many cases, these companies’ best course of action is not to hire us for an arduous, multi-month sale process but to engage in a concentrated exercise of strategic planning. We drag them into the woods for 30 days and help them. And once they have, to some degree, repaired themselves – perhaps in one year or two they might consider a more effective corporate sale. Ainsworth: We provide a number of different services at our firm. We invest, buy, and sell. Banks had built up large portfolios of bad debt in the early 1980s; our firm invested in a lot more “turnarounds.” But the capital structure was very different then. Banks had overleveraged many businesses. We saw a lot of overleveraged balance sheets. Banks became attractive partners for us. This allowed investors like us to step in and put just enough equity in to restructure a deal. In some cases, we offer to guarantee part of the bank debt in lieu of providing equity. The deal restructuring enhances the appeal of the company for an eventual sale. In today’s market, many turnarounds need a large amount of equity, with the possibility of more to follow, and with the hope that management will turn around the company. One of the reasons I don’t see turnarounds being big business is because of a different risk profile today than in the ’80s. Hubert: The biggest challenge of the turnaround is management. In most situations the buyer is bringing in somebody from the outside to manage the business, and the typical turnaround situation takes a few years to reach fruition. Because of the time required to complete a turnaround and the huge incentives offered by well-funded start-ups, qualified executives with successful track records are now gravitating toward businesses with greater upside potential and a shorter payoff period. The inability to attract qualified management to these situations has affected the viability of most turnaround efforts. Novak: We have found little interest in turnarounds when we work on behalf of public, strategic buyers interested in middle-market acquisitions even though we’ve actually seen some deals where, all things considered, the sellers have relatively good values despite being turnarounds or underperformers. Public acquirers may shy away because of their own stock prices and the way that the stock market is so unforgiving when you miss expectations. When we sit in meetings with the top executives, they may have a turnaround plan for the seller, but they are so concerned that if they miss it by a quarter or two, it is going to hammer the stock price. So, they decide to pass up the opportunity. M&A: A lot of m&a drivers, such as deregulation, globalization, technology, and the repeal of Glass-Steagall, have had visible effects on large companies. Is there any fallout on middle-market companies? Novak: Our experience in many of the industries we serve is that those same drivers are still around. There may not be the exit strategy of rolling up and going public but you still have larger competitors to deal with and perhaps to sell to. And the middle-market companies increasingly see that their competition is becoming larger, multinational, and well-financed companies. You still have customers who want to deal with fewer suppliers who are still driving consolidation trends. I recently got a call from a business owner that I’ve known for 15 years and who has thought from time to time about selling his business. He said it’s now time. Customers keep wanting him to build a new plant or get involved overseas and he just doesn’t want to take that risk. He doesn’t want to do what needs to be done to meet those objectives, so he wants to sell. We still see all of those drivers in the middle market. Ainsworth: Globalization will have a big impact on middle-market companies. Middle-market companies feel the same competitive pressures as large caps but lack sophisticated management and access to capital. I see it being more difficult for middle-market companies under competitive pressure of globalization. Surviving companies will need to create strategies to compete and have access to capital. Large-cap companies have an advantage in both areas. Deutsch: There’s a trickle-down effect. When “Big Co.” does another deal, that generates more opportunities for middle-market m&a because Big Co. will likely sell a number of small subsidiaries that it doesn’t like, doesn’t want, or that don’t fit. Every time a larger transaction is completed, it generates additional m&a opportunities downstream. Hubert: A lot of middle-market owners recognize that they need to sell because they don’t have the resources to make the necessary investment as their customers grow and start requiring that their suppliers grow with them. As the OEMs push a lot of the costs of their growth on their suppliers, middle-market owners find that they can’t survive. For them to thrive and prosper, they really have no alternative but to take a look at a strategic sale in many situations. Deutsch: Now that many banks are also in the securities and m&a business, they are also “stirring the pot” by suggesting to their borrowers that they consider acquisition or divestiture ideas. That’s a relatively new deal driver. Ainsworth: The latest rounds of mergers and acquisitions have created banks with big lending and underwriting capabilities. Banks that were once happy to lend $25 to $50 million are now looking to lend or underwrite $100 to $500 million. This has created a large void in middle-market banking. Companies like Trenwith are actually the beneficiaries of those large mergers. It has allowed us to fill the void. M&A: What is happening in financing markets right now as far as availability of funding and pricing of money is concerned? Are there any new sources of lending or other types of financing? Cromwell: We see more specialization of funds. A lot of them have to specialize to raise money for a new fund. They are specializing by industry and also specializing by what stage of the deal they want to invest in. At the same time, some firms are stressing that they are more flexible as to what they want to do. For example, some of the LBO funds are looking a lot more at technology deals these days. They often will have criteria for revenues and EBIT-DA but will bend them a little bit when looking at specific deals. Also, they are much more willing to look at public companies and do deals by either taking control positions or taking companies private. Finally, some of the equity funds are willing to invest at earlier stages of a company’s growth, particularly those companies related to the Internet. They realize that if they wait for the maturation point, they are going to miss out altogether because the company may be public or sold already by then. The message we keep getting from a lot of the sources of capital is “show us deals.” With so much private equity raised in the recent past, I think they all are hungry and they go looking for deals. Two final financing developments I would note are that a few of the larger funds are teaming up with some smaller funds so they can go after some deal flow outside of their norms. And there is also the very interesting trend in which corporations are becoming sources of capital. Deutsch: In terms of debt financing, we continue to observe a bit more marketing than actual lending. We have found that lenders, in general, are becoming more cautious about availability at closing. Cash flow lenders, in particular, are getting a bit more choosy. We think the lesson here is that our clients and their advisers must not only understand where cash flow dollars come from but also where asset-based dollars come from. We’ve also observed more self-bridging of transactions. Firms such as Three Cities Research have been known to pay 100% cash at closing and refinance as a second step. There is also greater use of recap structures as distinguished from complete change-of-control transactions, so there is need for fewer total dollars of new financing. Hubert: I think there is a very, very competitive debt environment right now. Here’s one example. One buyer in a deal we handled recently was a Nasdaq company, an old-line firm with a $100 million market cap. We asked them if they needed some introductions to arrange their debt financing and the CFO turned to me and said, “Well, unless they can beat LIBOR and 65 basis points, I don’t think so.” That startled me. Deutsch: Did they have a pre-existing relationship with this financing institution? Hubert: They must have. Deutsch: In the final analysis, relationships are critical in this credit market and in financing in general. Relationships still trump “beauty contests” in the credit markets. Ainsworth: We are often retained when a potential client does not have a relationship with an existing lender. My feelings are that the credit market has tightened. Given the fact that banks have much more flexibility in the structure of a deal today by spreading their risk across a bigger portion of the capital structure, it can give an illusion that credit is a little looser. I think in reality, lenders are just covering a bigger part of the capital structure. M&A: Are lenders still drawing a line on limits of their financing? They would say they would lend up to, say, four times to five times EBIT-DA or cash flow and that was it. Is that still the case? Ainsworth: The short answer is yes. The longer answer is that lenders have cut back on the advance rates. But as previously discussed, lenders have spread their risk across a larger part of the capital structure. As an example, you might see a bank loan money as follows: First tranche, in subordinated debt. Second tranche, in redeemable preferred. Third tranche, in convertible preferred. Although we don’t see lenders going over four times, lenders have moved down the capital structure, allowing maximum flexibility on advance rates. Deutsch: I wish the range were tighter. The range is still anywhere from a low of maybe three times cash flow to the high of four to 4-1/2 times cash flow. Another phenomenon is that some lenders are outsmarting themselves in their evolution toward one-stop shopping. Frankly, they are confusing their customers. We’re surprised that certain private equity firms have called on us to assist them in financing buyouts when we think they are perfectly capable of doing it themselves. What has happened is that many banks have confused the marketplace about what they do exactly. And, therefore, the private equity firms in some cases view the banks as less predictable. M&A: With all of the dynamism just described, are you actively recruiting professionals for your firms and what type of people are you looking for? Cromwell: We have always had specialists within our firm. Right now we’ve got 16 senior people with 20 or more years of experience at major Wall Street firms. Some of our key specialties include health care, media, telecom, real estate, technology, financial institutions, and consumer goods. However, we still feel that there is a good role for generalists at Bentley since we have many deals that fall outside of these industries. We offer our clients a lot of senior-level attention. There has been mention of how the larger firms are ratcheting up the sizes of the deals that they do. We get referrals from a number of the major Wall Street firms and we know that a number of those firms have $500,000 or $1 million fee minimums. So, for boutique firms like ours, there is still a lot of room for us to make a good business on fees that fall below the amounts required by some of the major firms. We promise our clients the benefit that they will receive senior-level attention, and so we are looking for more senior-level people. My typical criteria are somebody who has been in the business for eight or more years at a major Wall Street firm and has his or her own contacts, both at companies and with other deal sources that can refer business. We are looking for people who can work not only with their own business leads but, because we are on the referral list for four major Wall Street firms that send us deals, work on the referral businesses as well. Ainsworth: We have 18 professionals. We believe the growth of our firm is in younger bankers who can contribute to growth and client relationship. Investment banking is a service business, and a lot of our clients are young. In 70% of the meetings, I’m the oldest person there. I see younger bankers being key to developing business relationships. Our older bankers are spending a lot of time calling on Wall Street firms, which is where we got our start. A lot of the business relationships used to be developed at the country club or on the golf course. Today, less business is done at the country club. It’s a different mind-set, which requires a different banker. So, we are looking for professionals who understand technology, the new economy, and the importance of client relationships. Bankers who have the vision and drive to help build our firm. Novak: We are a firm of 10 professionals in a middle-market m&a boutique. The right people are most important for us, and we are always quietly looking for them. What drives us first is finding people who are compatible with our culture, with the people we already have, with our core values of how we like to conduct ourselves and do business. If they fit, we then look at their level, breadth, and depth of experience to see if they fit in the practice areas where we are very active or where we want to be active. From a specialization standpoint, manufacturing and distribution have been our bread and butter for years, distribution in particular in the last five or six years. But in the last 18 months, we’ve brought on experienced people who have done a lot of financial structuring in the m&a middle market. And we’ve brought on people who have expertise in technology, telecommunications, and the Internet. We’ve also developed a relationship with people who we can bring in when we have an underperforming opportunity. This allows us to take a look at a company with someone who is a seasoned operating executive and, first, decide whether we should get involved at all and, second, how we can best present this from an operating perspective as opposed to a purely financial point of view. Deutsch: We have an all-points bulletin out for a number of good, smart bankers who also think like businesspeople. They should have financial skills, business strategy skills, and writing skills and also be good, nice people who are compatible with our boutique-style of operation. We have two sets of people in our organization. We have day-to-day professionals and we also have an “advisory board.” We are adding to our advisory board, which includes a number of very well regarded ex-CEOs of some very prominent corporations and a general partner of one of the Wall Street firms. Because we all work so hard and so closely together, our professionals must be compatible with one another and with our culture. We have a current opening for at least one additional terrific, smart, solid, mid-level banker and at least one more solid, smart senior banker working off our platform. We will also hire a couple of new analysts this year out of college – we think that our training program is superb. Hubert: We tend to look for entrepreneurs – people who have run their own businesses. They are articulate, they know dealmaking, they can make decisions, and, most importantly, they can communicate very effectively with other business owners. We think that we can teach them the deal business because they already have the basic business skills, such as negotiation skills, financial skills, and operational skills. As our business grows, we are also recruiting a number of younger bankers and analysts to add input from a new generation that really has had the benefit of growing up in the technological age. I’m on the younger end of our partnership scale, but a lot of our older partners have only a limited understanding about technology. They certainly can’t speak to it on a credible basis, but they have great dealmaking and people skills. That balance has really worked well for us.