SOX-Compliant Private Firms Fetch M&A Price Premiums: Private equity and strategic buyers are willing to pay up to avoid hefty post-closing costs of beefing up financial systems

Despite considerable pain and strain in meeting Sarbanes-Oxley (SOX) requirements for corporate governance and pristine financial systems, the effort is generating a payoff for private companies being sold in the M&A market. Mid-sized SOX-compliant companies are starting to fetch higher purchase prices from buyers – including private equity groups – that are spared the hassle and cost of upgrading their new operations post-closing. The development is somewhat unexpected, according to Cynthia Jamison, a Chicago-based Principal and financial systems expert at Tatum Partners, but is a function of how the M&A market has, somewhat subtly, developed in response to the new law. She told a web cast sponsored by KPMG that SOX-ready mid-sized targets are getting a higher price than peer companies, or less of a liquidity discount that private companies often take. Most of the SOX impact had been expected to fall on public companies that were directly covered by the 2002 law, Jamison told Mergers & Acquisitions in a follow-up interview. But smaller private companies have been brought under the federal law’s umbrella by such factors as the cost of crafting post-closing compliance, increasing buyer demands for reps and warranties on SOX compliance, and lender requirements that target financial systems are up to snuff. “Private equity groups, for example, have found that the cost of taking on companies that are not compliant, integrating them, and bringing them into compliance is so far exceeding what they thought it would be so that they’re now looking for companies that are compliant,” Jamison says. “They place a higher value on those companies because it saves them costs post-closing.” She says the reward for SOX readiness only recently has found its way into purchase prices so it’s too early to manage any quantitative calculations. But she says she senses that owners of prospective private targets have gotten the message and have started to add SOX compliance to their checklists of tasks for exiting the business. Reps and warranties, always a thorny issue in M&A negotiations, represent a key reason why private companies are starting to go the extra mile on their systems. “Buyers may seek indemnifications from the targets if internal controls become an issue,” she notes. “They’re willing to pay a higher price if they don’t have to deal with that post-closing. “If acquirers that are buying private firms find that they have to spend a lot of money or beef up indemnifications post-closing, then that is impacting the private companies. They are not going to want to rep that. But they might say, I’m not going to rep that but how can I get myself further along the line on this spectrum so I can make you happy and I don’t have to rep anything?'” Conventional wisdom was that SOX requirements only would catch public companies, but “now the bankers are interested, the investment bankers are interested, the PE groups are interested, and it’s starting to gain momentum.” Getting an up-front handle on SOX compliance may save financial buyers a lot of trouble down the pike when they exit portfolio companies through IPOs or sales, Jamison says. She notes that both investors buying into IPOs and strategic and financial acquirers will want the properties to be in line with SOX demands. Merging LBO Holdings For Scale and Synergy Private equity groups continue to devise new approaches for leveraging their portfolio holdings for size and scale. In early February, Newtown Square, Pa.-based Graham Partners advanced the art by acquiring two masonry contracting competitors from different owners at the same time and meshing them. Graham bought Design Masonry Inc. and John Ginger Masonry, both based in Southern California, and merged them into a new company, The Masonry Group. In another variation, American Capital Strategies Ltd. merged three of its portfolio companies to form Mirion Technologies Inc., producer of sensors for the radiation measurement and protecting industry. The constituent companies were Global Dosimetry Solutions Inc. and Sensing Technology Corp. of the U.S. and French synOdys Group SA. The trend began to stir in 2004 with a unique cross-group merger of three companies. The deal welded yearbook and class rings producer Jostens Holding Corp., controlled by Kohlberg Kravis Roberts & Co., and two units under the private equity arms of Credit Suisse Group- specialty printer Von Hoffman Corp. and ARCADE Marketing, a producer of samples for fragrances and other consumer products. (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com