Toronto-based Birch Hill Equity Partners is the largest mid-market PE shop in Canada. The firm is currently investing its third fund, Birch Hill Equity Partners III, an $850 million vehicle raised in 2006. It focuses on all areas of the market except real estate and natural resources and it has an average investment hold period of about six years. Stephen Dent, a partner with the firm, spoke to M&A Report about dealmaking in Canada and how the U.S. market woes have affected the region.

Mergers & Acquisitions: What is the dealmaking environment in Canada like these days?

Dent: Things have become very quiet. The lack of financing in the U.S. is trickling into Canada. We never got to the levels of leverage you would see in the U.S., but it was more available than it is today and it was driving deal flow here too. When leverage was still readily available you were seeing a lot more going private transactions in the Canadian Trust Market. Those types of deals have disappeared now.

At Birch Hill we are ticking along. Luckily we never used a lot of leverage and we generally do management-friendly deals, which are mostly proprietary. The real issue we face is that many entrepreneurs who were talking with investment banks last year still think they can get 10 times for their business. It will take some time before their expectations adjust to normal levels. That being said we are on track to see as many if not more deals that last year.

Mergers & Acquisitions: How do you find proprietary deal flow?

Dent: Out of our latest fund we have done eight transactions and only one was an auction. Canada has a really small business community and we tend to find our deals through our contacts. We tend to be management friendly, which is why our hold period is so long. We also don't over lever as opposed to the financial engineering approach. We track over 300 companies in Canada and when they are ready to sell they already know us and hopefully want to deal with us.

Mergers & Acquisitions: In the U.S., the larger players are having a tougher time in this market than the middle market firms, although lending is not readily available to any private equity firms now. Is that true in Canada?

Dent: I do think it's true to some extent. But our lending market is set up differently here. In the times that we have gone up against U.S. private equity firms looking at Canadian companies, they seemed to be using leverage much more aggressively than we were. In Canada there are five banks that lend so we don't use the marginal lender. They just don't do business here. That's part of the reason we never saw such high leverage levels.

Mergers & Acquisitions: When leverage was more available do you think valuations were inflated?

Dent: Absolutely, and it was driven by the leverage. Instead of 6x financing total, firms were going 6x leverage. The floor for transactions was 8x. There were a lot of things in the double digits, which had been unprecedented in my experience. Not a lot of people put recession pricing into their buyout models.

Mergers & Acquisitions: Would you say that now is a good time for private equity firms in places like Canada to try to do deals in the U.S. given the week U.S. dollar?

Dent: With the currency swing, you do see many private equity firms looking for positions in U.S. companies. Everyone is using this opportunity to move into the States in some way.

At Birch Hill, we are not looking to complete buyout transactions in the U.S., but a number of our portfolio companies are being viewed a valuable strategics again and are moving into the States. For years, U.S. private equity firms were out-bidding them. Without the leverage available and valuations coming down, strategics can do deals again. In the last year we have done 12 follow-on deals for our portfolio companies.

Mergers & Acquisitions: Many people think the best deals happen in these slower environments. Do you think that will hold true in Canada?

Dent: Yes, especially for companies in distress. That type of deal flow will expand. There are more and more catalysts helping make that happen, but at Birch Hill we don't look to do that type of investing. We only invest in profitable companies. And since no one has to sell, it may make it harder for us in this environment.

Mergers & Acquisitions: Are there any sectors in Canada that are particularly interesting these days?

Dent: There's been a lot of value created around the energy sands in Alberta. It's been a big source of capital investment for a lot of different industries for many years and it will continue to be for the 15 or so years.