Toughing Out Harsher Climes To Do Mid-Market Deals

It’s harder to complete mid-sized transactions in 2001. Financing is tight, a soft economy has dampened buying ardor, and sellers are adjusting very slowly to the reality of reduced offering prices. Tougher negotiations are common and structural engineering – such as increased use of contingent payments – often is needed to get a deal to the finish line. M&A: How have tight financing conditions affected m&a in the middle market? This would include anything from a company’s plans to acquire or companies putting themselves up for sale because of financing problems. Hurley: It is hard to separate the miserable debt financing conditions from the slowing economy because lenders have pulled back in reaction to the slumping markets. But we have seen it have an impact on prices and deal structures for almost a year. With the exception of health care, multiples went down across the board in 2000, as compared with 1999. Buyers have been more cautious, but in many cases the lenders are just not interested. Lately, we have been seeing some of the lenders convincing buyout funds to accept capital call provisions in their loan terms. If they want the deal, they swallow hard and say OK. Deutsch: Tighter financing has, without a doubt, changed things. It has meant less certainty of closure in transactions. It has meant lower purchase prices. It has meant transactions taking longer. Tightening credit has not only affected deal financing but the business prospects of companies themselves. Acquirers are reassessing their own business and corporate development strategies, as are sellers who are being held to earn-out commitments and who, therefore, must reassess their own ability to achieve those earn-outs. Sellers are in a bit of a funk right now. Many are choosing not to sell, after a period over the past couple of years in which many offered their companies for sale, primarily because it was a “seller’s market.” Molner: The tight credit market is clearly affecting m&a activity. That isn’t exclusively limited to middle-market companies, but it is across the board. We work with companies that typically have enterprise values of $25 million to $500 million. Among the substantial, private companies that we are working with, we’ve seen debt coverage ratios tightening. For example, senior debt to EBIT-DA coverage ratios are now on the order of 1.5 to two times, which was substantially higher a year ago. The types of companies that we are working with tend to be well-managed, market-leading private businesses where the owners are under no duress to sell. Therefore, it is a simple decision for them to defer the sale and wait for market conditions to improve. We also manage private equity funds, so we play both sides of the market. We have invested over $1.5 billion in more than 50 private equity transactions during the past 10 years. We also manage a $400 million mezzanine fund, which is looking to make investments of $5 million to $20 million in middle-market companies. We are seeing that the targeted returns for this type of financing are going up in light of tight senior bank markets, scarcity of mezzanine capital, and the fact that the high-yield market hasn’t been available to these types of middle-market companies for a long time. With this capital market environment, there are a lot of opportunities to put mezzanine and private equity capital to work. Robertson: In the private company sector, there are many good companies where the seller has a price in his mind. But we are in a market where buyers frequently can’t meet that seller’s price expectation. So the private-market activity is going to be generally limited to distressed and strategically important situations right now. The public sector is obviously affected by the decline in the stock market, and you are seeing that a lot of public companies are coming under pressure. So you are probably going to see more takeover proposals from financial buyers at relatively low levels. We are also going to see more proxy fights. We recently signed up for three advisory assignments in connection with proxy fights that are about to take place. I think this is indicative of the types of things you are going to see in this market. Braun: I think that we started seeing some tightening in October of 1999, or about a year-and-a-half ago. But that is providing an opportunity for some of our acquiring clients to come into the market. Some of them have been sitting on the sidelines because of the high multiples that were paid over the past 24 to 36 months. They are starting to recognize that the gap is not quite as wide as it used to be between sellers and buyers. So some people are coming off of the bench. But we also have seen that the due diligence process is becoming much more thorough and elongated by the people who are bringing the capital to the table. The process is being slowed, and the longer that you allow that to go on, the more likelihood that some deals are going to cave. We are starting to see some of that happen as well. A positive note is that a lot of our privately held clients are not highly leveraged, so this offers a good opportunity, and they are coming off of the bench. The tight market has not affected them nearly as much as some other companies. Males: From a pure technology perspective, it is clear that the telecom industry has suffered a severe closedown in the availability of funding that is in turn going to have an enormous effect on the whole technology industry. Financing is available only for the few really good companies with good business cases right now. So this has caused others to re-focus on real business fundamentals and sustainable business plans. Mid-market public companies face what we call the “abandonment issue,” or lack of analyst coverage of their stocks. It is better to be the 30th analyst covering Microsoft than it is to be the first analyst on a $30 million public company. That is going to drive a lot of m&a activity aimed at small public companies, as people become more liquid. Whe-ther you consider an IPO a financing event or an exit event, the IPO market has disappeared for the smaller company that lacks a large capitalization. Goldenberg: Some of the private equity groups, even though they have a lot of money, seem to be reducing the number of transactions that they are willing to do. They prefer to continue to fund the growth of some of the companies that they already have in their portfolios, since the normal exit strategies, particularly the IPO, are very difficult right now. We have also seen companies pulled from the market because the valuations that they were being offered did not come anywhere close to what their expectations were. We have also seen situations where companies are being forced to come to market because of problems with their banking relationships, that is, the banks have said you’ve got to do something. The only way they can figure out how to do something is to put themselves on the market, whether they want to or not. Of course, we have seen a number of private bottom-fishers starting to emerge from their caves and look for acquisition opportunities where they can get the business for a very good price. Cromwell: Moving down the capital structure, we are seeing the mezzanine people still looking for deals. And in the equity arena, there are two kinds of players right now. The first, and probably the larger group, has done a number of deals in the dot-com arena. They are licking their wounds and figuring out where to put their money back into their current internal holdings. Those problem situations mean that they do not have as much time to go out looking to finance new m&a activities. Those funds that avoided the dot-com arena are still out looking for a lot of deals, and we think those funding sources are good places to raise money for m&a deals. We bring in equity speakers every week to our group meetings and they raise, first and foremost, the issue of bank debt as one of the key problems for getting deals done in the current environment. As a result, they are getting backup bank arrangements to make sure that the bank component is in place on their deals. Brady: If a financial buyer believes that the total debt-to-EBIT-DA ratio in a leveraged transaction that is available today is somewhere in the three to 3.5 to 4 times cash flow range, the implication is that the buyer would have to be willing to provide 50% of the capital structure in equity just to get to a six to eight times cash flow multiple. The impact of that is that the buyer either will make the purchase with half equity, in which case the business has to have very strong growth in order to make his return targets. Otherwise, the buyer has to reduce its return targets or pay a lower purchase price. In terms of the seller, I think that access to capital is a very big deal. The abandonment issue for smaller companies was mentioned earlier and has an impact. The average actively managed mutual fund is substantially larger than it was five years ago, yet a portfolio manager can only follow so many names. This means that the average position in a given company must be even larger, so it is hard for a company with a $100 million public float or a $200 million public float to get any real sponsorship. If a small-cap company has debt that it has built up to levels that today appear to be unacceptable, but maybe didn’t appear to be unacceptable two years ago, it can’t finance its business plans because it can’t sell stock. These companies have seen their P/E multiple contract because they have been abandoned. They don’t have any other choice but to take a look at being bought by a strategic acquirer. M&A: How about the confidence level of the owners or CEOs? Has the current combination of a slowing economy and tight financing affected their confidence in doing acquisitions? Braun: It has increased their confidence in doing divestitures. We are seeing a fair amount of what I call corporate indigestion. The CEOs are a little spooked right now and they are concerned about maintaining their top-line revenues. They are concerned about their debt ratios. What we are seeing is a lot of discussion around what pieces they could divest that are going to make them more attractive to analysts if they are public companies and are more acceptable to their debt partners if they are private companies. The CEOs that we are dealing with seem a little bit more interested in selling off pieces than they are in being aggressive in making acquisitions. Deutsch: There are clearly different reactions among buyers and sellers. We think that the economy and the capital markets are having a sort of polarizing effect on sellers. Some are clearly less confident about their own business prospects, and they are effectively running to the exits. Those that are a lot more confident won’t be bullied into selling for a lesser value, and they are clearly on the sidelines. From a buyer’s point of view, I think it is safe to say that all buyers are hesitating and are a bit more thoughtful right now. They are rethinking business strategy, developing new strategies, rethinking purchase prices, and rethinking existing capital structures. Existing capital structures that were acceptable to the banks that lent into the acquisition of their platform companies, say, a year ago, don’t look so appropriate now. Their banks aren’t so sanguine about the very same capital structure with the very same company one year later. Buyers also are rethinking their target’s projections and growth rates. And this isn’t just a knee-jerk reaction to tougher market conditions and an excuse to reduce purchase price multiples. Savvy acquirers know that some of the targets in their sight are really less valuable and that their prospects for growth are less bright. In terms of deal structure, these acquirers are offering less cash at closing and more consideration in the form of earn-outs. Hurley: Most CEOs are focused internally to tighten and strengthen base businesses. Only real bargains are of buy-side interest, and most sellers have adopted a wait-and-see attitude. M&A: Does this mean that a lot of these people who had planned to exit and retire are being asked to stay on in these turbulent times? Deutsch: Any buyer who now faces additional economic risk and capital markets risk is probably much more concerned about operating stability and, therefore, wants the seller to “stick around” for a period of time. Males: I would question that from the technology perspective because you still have the question of make versus buy. In fact, the aggressive buyer strategically needs to make acquisitions and is being aggressive in using its cash. There have been a recent number of technology transactions that had large cash components to bridge that conceptual gap between what exactly a target is worth versus the uncertainty of today. It works where the seller is nervous about sustainability. Deutsch: That same acquirer isn’t just sitting on a pile of cash that they would like to utilize. They also view their own common stock – deflated in value – as a currency they do not wish to use. Brady: We are seeing more and more earn-outs in these deals because buyers are skeptical. They have financing constraints and they are nervous about their own businesses. The earn-outs that we are seeing today are a lot more complicated and much more heavily negotiated. Molner: I think we are seeing those more complex proposals from acquirers. But we are also seeing that they are not of interest to really exceptional private companies. At the end of the day, a strong, well-positioned privately held middle-market company owner always evaluates sales or recap alternative versus the attractiveness of retaining the business. So while the acquirers get creative in structuring acquisition proposals, company owners and entrepreneurs re-focus on managing the business. Hurley: I think that most of the folks who wanted out took advantage of the cycle before it started to lose steam. There are some people, I think, who will have a much better appreciation for striking while the iron is hot. M&A: Can you put some quantitative measurements on the pricing? What are some of the multiples being commonly offered and what types of companies match those particular multiples? Robertson: As a practical matter, the multiples should come down. But if the seller isn’t willing to sell at the multiple that is dictated by the financing that is available, he just sits on it. So you end up with most of the activity involving distressed companies with troubled bottom lines. It is very hard to put your hands around what the real multiple of EBIT-DA is because in an environment like this, the true sustainable EBIT-DA is more difficult to measure. Molner: It also depends on the perspective from which you look at the multiple. Our firm just closed a deal valued in excess of $550 million that involved one of the largest food product companies in Latin America – Mavesa SA, a company whose ADRs were listed on the NYSE. From the buyer’s perspective, we had a sense of what they think they are paying. From the perspective of the seller, our client’s perspective, the multiple was somewhere in the seven to eight times EBIT-DA range. But there were certainly operational cost savings and revenue enhancement strategies that any acquirer factors into what it thinks it are paying for a business. As such, the buyer would claim the acquisition multiple was less than 7 to 8 times cash flow. It’s misleading when you just throw out the multiple as a proxy for a valuation range because both sides are invariably looking at it differently. Deutsch: The fact of the matter is that multiples aren’t always the relevant thing. For example, what is the total value of a transaction with a significant earn-out that is structured to the advantage of the seller? The seller’s “second bite at the apple” may provide for significant additional consideration. Scharfstein: When you look at the question of multiples, one of the dynamic changes that we are seeing is buyers asking to look at forward earnings as opposed to historical earnings. In the past, the seller was always fighting to be paid for the forward-looking earnings of the company and the buyer wanted to look at the past. Now it is flipped as companies try to deal with a flat-to-declining economy. Robertson: In the present environment, most of the deals we are talking about are strategic deals, which are going to continue to get done. The pricing really is determined by the ROI achieved by the buyer who may be factoring in things that are not visible to the public. That camouflages the real multiple. Most sophisticated strategic buyers use a discounted cash flow analysis to determine the ultimate purchase price. Hurley: From the seller’s point of view, the long-term values have gone up dramatically over the last four or five years. If a company is ready to sell and it is being realistic, it should look at the deal in terms of where the dollar value was value four or five years ago. It has been a terrific run in terms of profit growth. It is a much more efficient market. There are many more people who are willing to bid on companies and have $6 million or $7 million dollars in operating profit. The multiple isn’t as important as whether they can get the price. The family that can sell these days at $35 million at a 5.5 times EDIT-DA multiple will move forward even though the multiple is down from 7 times EBIT-DA 30 months ago when the profits were half of what they are now because the price of $22 million just didn’t result in enough money to satisfy the shareholders. Cromwell: Sometimes it is not just a question of the multiples but whether the bidders are just completely evaporating. We had a deal in the telecom arena done about a year ago. Most of the negotiating was done, and we sitting with five or six bidders. Then the first one got cold feet, but we were quickly able to jump to the second one. More recently, we had another telecom deal that we thought was equally attractive, but in the recent demise in the telecomm arena, no price was good enough and the two potential buyers just plain disappeared. That brings us back to the earlier issue of the confidence level. Some buyers are, in fact, focusing much more on their own internal problems first. If they are solving internal problems, no price is a good price from the buyer’s point of view if the potential acquisition involves adding more problems to solve. And unless they have a very strong need to sell, the sellers are extremely reluctant to sell. Robertson: We’ve been in an environment where the question is which was going to evaporate first – the seller’s earnings or the buyer’s financing? We started seeing the economic slowdown late in the third quarter in terms of the people we were working with. But we actually have started to see a pickup in the market. There are different motivations on the parts of sellers and buyers, but at least the activity level seems to be picking up. Males: In the technology industry we still don’t have earnings. What you actually have is a period of education in which the technology companies must tell the public market that they will be profitable in “X” period of time. So when they go after the buyer the whole focus is of the buyer is, “When are you going to be profitable?” The buyer can not tolerate and the stock market will not accept any dilution of that story. Deutsch: One silver lining in the cloud of diminished purchase prices is that the new treatment of goodwill may allow those strategic buyers who view acquisitions primarily through the lens of earnings per share to pay more than they were able to pay last year and still find the acquisition accretive to EPS. M&A: What does this shift in positions mean for the deal flow in general? Brady: Our deal flow, in terms of transaction opportunities, is very strong. But there is a threefold trick to getting the deal done. One is the expectations on both sides of the transaction. Two is the financing. And, three, is whether the seller’s earnings will hold together until the deal closes. So it is not so much the deal flow or opportunity to do deals. Getting them done is the challenge. Males: In terms of some stats, in technology there were 27 transactions in the fourth quarter of last year. In the first quarter this year there were six in the U.S. Over the first three quarters of 2000 there were 144 transactions, averaging almost 50 a quarter. Europe is in the same boat – 16 transactions in the fourth quarter of last year and three in the first quarter this year. To put it bluntly, strong flow is rubbish when compared with closure rates. Goldenberg: I have been talking to some of our affiliates and intermediaries that we know reasonably well and the picture is all over the place. One chap who does a lot of lower middle-market deals has said that his deal flow is down 50%. Others are seeing relatively level deal flow but a change in the composition – to more search work and fewer sell-side assignments. We have also noticed that there is still a fair flow of potential cross-border deals. Also, some U.S. buyers are strongly interested in making very targeted acquisitions in Europe that fit into their international expansion plans. Deutsch: We find that we are doing a lot more pre-transaction thinking, a lot more hand-holding, and a lot more pre-deal evaluation work. I think the decline in the volume of transactions may be most pronounced in deals above $100 million. If you look back historically, the pace of private corporate sales and divestitures tends to be relatively constant year in and year out, whether the market is up or down. What changes is the pace of somewhat-larger stock-for-stock transactions that seem to be more affected by the tenor of the economy and the value of their publicly traded common shares. Cromwell: Compared with a year ago, we’ve got about the same number of active investment banking prospects and about the same percentage are in the m&a area as compared with the financing side. But the composition of our client project list is much more moving toward the old economy. For both old and new economy companies, I definitely agree with the idea of doing the due diligence before the deal and making sure that a seller understands the valuation levels he will be facing. Scharfstein: Our backlog and our deal flow are as strong as ever but we are saying “no” a lot more often to potential sellers where the gap between what is realistic in the market and the seller’s expectations are has widened. We actually see more deals hitting the table and more deals being made available to us, but it is a far more difficult task to make sure that the seller’s expectations are in line with what is realistic in today’s market. M&A: What are some of the innovative deal structures, innovative methodologies, or heroic efforts that have had to be used to bring the deal to closing? Molner: Acquirers are showing creativity in presenting deal structures that do everything but put up a lot of cash at closing. It depends on how strong the client company is as to whether those are going to be interesting proposals to the seller. We are trying to be extremely selective in terms of the clients that we decide to work with. It is hard for a substantial private company to consider selling the business, relinquishing control of the company, and then not walking away with a meaningful portion of cash at closing. That means that it is harder to get the deals done. We are seeing all types of structures, but we’re not necessarily recommending these highly structured transactions and our clients are not typically going for them. Deutsch: In terms of financing structure, we have seen a couple of things. One is increased use, or at least consideration, of sale-leaseback techniques and equipment financing techniques, specifically to finance that extra bit of “stretch” that the acquirer or senior lender might have provided a year ago but won’t provide today. Second, we have seen a rekindled interest in asset-based lending. We have transactions that might have been financed by cash flow lenders in the past. Now we see a new cadre of lenders beneath the banks, so-called “second lien” lenders, that are inserting themselves into transactions that wouldn’t have required them a year or two ago. Hurley: Particularly with owners who are not retiring, there are more recapitalizations, more tax-deferred rollovers, and more sales of partial interests so that there will be a second bite at the apple. More is happening in the way sellers think like buyers so that they become more reasonable and increase the likelihood of the transaction getting done, as opposed to everybody just walking away unhappy. Deutsch: We haven’t seen it just yet, but we will encourage more clients to consider tax-free merger transactions and tax-free stock-for-stock transactions. M&A: What about stock as a currency? Are your sellers willing to take stock? Are your buyers willing to offer stock at these reduced levels if they have it available? Brady: I’ve looked at our numbers on this and through the first 12 weeks of this year, 64% of our transactions were purely cash, which is a reversion to our historical mean. It was 66% in 1999. Last year, however, 44% of our sellers took either stock or stock and cash combined. Last year, especially early, we saw an unusually high number of stock deals. Scharfstein: Well over 80% of our transactions are cash transactions. Buyers are less willing to part with their stock if they have good solid companies and they believe that their stock is unrealistically depressed. We recently had a buyer walk away from a transaction because he thought that his stock was undervalued at $40 a share. Now that it is at $15, I am not sure that he has the same view of the transaction. Molner: In today’s volatile capital markets, I don’t think that buyers are taking comfort in the fact that stock is off 40%. I don’t think anyone can look at a security and tell an owner of a company that they are confident that it has bottomed out. So to make a stock transaction work, you had better have a cushion. You had better be getting a lot more stock than the value of your cash proposal. Or you have to carefully advise sellers on the risk of taking the sort of a security that often will have tie-up provisions and other restrictive issues. Deutsch: I think that it is the sellers who are driving this issue. We take it as a given that with their common shares at historic lows, buyers are generally more reluctant to offer stock. It’s less a matter of the acquirer’s willingness to offer stock than it is a matter of what the seller is willing to accept. Scharfstein: Buyers who are willing to work with stock as a currency are now more willing to offer features like price protection on the shares. In the past we might have fought tooth and nail when we sought price protections for sellers. It’s less of an issue now for those buyers who believe that their stocks are truly undervalued. In smaller transactions, the protection is typically structured as a contractual obligation that terminates at the end of the lockup period. It protects a stock’s value when the sellers don’t have the freedom to sell the stock. The buyer takes on the obligation to make up the value difference if, in fact, stock prices drop below certain levels. Molner: I think stock deals are lose-lose propositions. Acqui-rers are reluctant to use their shares because in many cases the stock is trading at low levels, making any acquisition paid for with shares more expensive. At the same time, sellers are discounting the value of the stock they receive because of the risk of holding often illiquid or restrictive securities. So it is a tough structure to make work, particularly in the sort of market we have now. M&A: What about the distressed companies? What kinds of companies are they? Is their supply increasing and are there more bargain hunters going after them? Males: There are plenty of technology companies that trade way below cash right now. The definition of distressed, or walking dead, from our perspective, is when the company is not following through on profitability. There has been a reemergence of large private equity players who are buying assets at relatively cheap prices and who, no doubt, will do well in the long term, especially when they are private individuals rather than funds that have timing issues. The individual can hold that asset in perpetuity, do what has to be done with it, and take the benefit from it in the long term. Molner: On the technology side, we are seeing a number of shotgun weddings. For example, two competitive local exchange companies (CLECs) in a region are both addressing issues about whether they have enough traffic to support their network infrastructure investment and are deciding that there are really compelling reasons for two strategically weak companies to combine. We have worked on a couple of these situations recently and I think there is going to be a lot more of them. I don’t see the private equity firms coming in with fresh capital to save the wreckage of partially funded telecom build-outs. Deutsch: There are clear distinctions among kinds of troubled companies. Some companies have lost their way, or perhaps never found their way – in the case of many dot-coms. They had a “revenue model” but never quite had revenue. This version of “trouble’ is different than what companies have always suffered from – acute problems related to production, acute problems related to loss of a key customer, acute problems related to an ownership transition. Much of this “trouble” is perfectly remediable, and many of these companies remain interest-ing to acquirers who have the capabilities to address those problems. Males: I don’t think that we had many discussions last year in technology asset purchases where the buyer was concerned with lowering the cost basis of the company. But all the conversations now center on, “if we buy the technology assets, how do we take $10 million, $20 million, $30 million out of the expenses of this business?” You are going to see a lot more of those types of tactical approaches. Goldenberg: We’ve seen several troubled non-tech companies in the last several weeks. One is a distribution company that was under pressure by its bank and had pre-debt positive cash flow but negative cash flow after debt service. The business had an established client base and probably, with the proper ownership, would do well. We saw another one that was a niche manufacturer in the food industry. There were some clearly identifiable buyers for this business. Unfortunately, we didn’t get the assignment. It went to a turnaround firm that claimed it could move it in 60 days. We don’t do deals that quickly. Hurley: I think it depends in part on how tough the bank regulators are going to be. If you are a privately held company and four or five times cash flow is less than your senior debt, you are not going to do anything unless your bank forces you to. If you are a buyer, you want to see something cleansed through the bankruptcy process because it gets visibility and then a judge decides who is going to end up with the property at the end of the day. Otherwise, why go near things that have too much trouble around them already? There is no reason for most intermediaries to pursue those kinds of projects. Let the specialists have their field day. If you are a principal or you have a strategic interest you may hang around to see if it falls into your lap. M&A: What has all of this meant for your firms’ individual businesses and growth plans? Have you been getting the larger transactions that were predicted to go to middle-market intermediaries as a result of bulge-bracket mergers? Deutsch: If you’re part of a major firm “cartel” you are in a game of market share. If you cater to the Fortune 1000, your business increases and decreases with the state of the economy. Our business continues to grow. In fact, a significant percentage of our referrals comes to us from the largest firms on the Street. Most major firms have migrated up market as their minimum fees have gravitated toward $2 million. We find that they are delighted to work with firms that do high-quality work in the middle market. I don’t think that our kind of middle-market company and its CEO will ever stop wanting good, trusted counsel, structuring advice, senior attention, and the sorts of things that firms like ours provide for them. It’s a matter of the right tool for the job. If the client is General Motors, we’re no substitute for the largest Wall Street firms in terms of global capital-raising. On the other hand, The Street’s largest firms are no substitute for us in terms of providing the kind of guidance and transaction management that middle-market companies require. Robertson: I think it is a function of what the client perceives is required and what he perceives we can do. If it is primarily analysis, judgment, and advice, he focuses on the quality of the people we offer and the kind of experience that is represented at this table. We’ve been through the war, we’ve been in the trenches. If it is a transaction that is going to require bridging or financial muscle, the client is going to use the larger bracket firms that are capable of bringing those assets to the deal. Who gets the work is a function of what the assignment is likely to entail. Molner: I don’t think that there is a news bulletin here. For a long period of time, the bulge-bracket firms haven’t been able to afford, or haven’t had an interest in coming down and working on, transactions that are less than a couple hundred million dollars – unless it’s a divestiture for a larger client or work for leading private equity sponsors. Over the last year-and-one-half we have advised on more than a half-dozen transactions in the range of $500 million or more. Occasionally, we will see a bulge-bracket firm on these deals, but judging by the teams that they send, it is not an important piece of business for them. It is much tougher competing with people around this table for that type of business. We sometimes wonder to ourselves if we are out of our water on a deal. If so, we ought to get out of the way and let the big firms do it. But if we come across an opportunity to work with a private or closely held company valued from $200 million to $500 million, and it’s in an industry we understand, we can assemble a project team that will compare favorably to bulge-bracket firms. Deutsch: Competition in our market is increasing. I’m sure that many bankers who now find themselves shrunken out of major firms in this down market will establish many new middle-market investment ban-king boutiques. The problem is that most of these new firms won’t ever develop the infrastructure, systems, and quality control that firms like ours have taken years to establish. They’re going to find that it’s not so easy. Molner: The whole mentality of the larger firms – and I came out of one of them many years ago – is league tables. They really have no interest in a deal that doesn’t get them in one of the top spots on that table. For everyone here, that is really irrelevant. We all want to work with high-quality companies where we view the probability of the transaction closing as very high and to deal with people that we respect and enjoy working with. That is not what drives the people who lead the top m&a firms. Scharfstein: When the entrepreneurial business owner makes his decision as to which firm he is going to choose to represent him in what may well be the largest financial deal of his life he wants the firm he hires to give him senior-level attention and staff the assignment with the right people with the proper experience. One of the major issues for the entrepreneur is his desire to deal with professionals who are culturally similar. He must feel comfortable with these representatives, how they view the business, and how they understand the entrepreneur’s passion for his business. Our firms are very often able to convey that understanding and make a cultural connection with the owner and his business. Comfort is one of the major factors that is involved in a transaction. Brady: The New York firm mergers and the regionals that have been sold to commercial banking firms have resulted in dislocation and layoffs. I have heard countless stories of clients that are halfway through a project when their deal team leaves for one reason or another. It is devastating to the client. So the investment banking mergers among our competitors have contributed to our business being as strong as it has been in the last couple of years. Cromwell: Bentley is on the referral list for four major Wall Street firms, and we have not seen a decline in the minimum fee requirements for them to take on a new assignment. In fact, when I look at them over the past few years, they have been rising each year. This is a benefit to us since more deals will fall below their higher fee thresholds and be outsourced to Bentley. When things get tougher, these large firms don’t necessarily lower the fee minimums. I think that they typically cut back on the number of people at the firm. There is still plenty of room for business for the people here for such reasons as client services, senior-level attention, and the chance to do deals that can be meaningful on an individual level. I find it personally interesting to work with these kinds of people on very direct levels. From our vantage point, I see no decline in the fee minimums. M&A: Has the tax hassle in Washington impacted the deals market? Hurley: I think it is always interesting to talk about taxes because many businesses would never be sold if Uncle Sam wasn’t standing behind the Grim Reaper. But I don’t think it is going to make any difference over the next two or three years unless death taxes are eliminated. Deutsch: Not the current tax situation. But certain other regulatory issues have had an impact, such as the repeal of the 1999 Tax Act, which jeopardized the ability of many small companies to sell assets and benefit from installment sale treatment, and modification of the Hart-Scott-Rodino reporting levels from $15 million to $50 million and the easing of reporting on many $50 million to $200 million transactions. Molner: Many major issues that drive the decision to sell the company go way in front of tax considerations. It is something that people look at and evaluate at an appropriate time. But the outlook for the business, the preferences for the shareholder group and management team, the competitive landscape, all the things that we naturally think about, drive a transaction. Taxes are a structural issue that people find ways to incorporate. M&A Roundtable Participants Mark G. Brady Managing Director William Blair & Co. David M. Braun President Virtual Strategies Inc. Oliver D. Cromwell Senior Managing Director Bentley Associates David N. Deutsch President David N. Deutsch & Co. Arthur P. Goldenberg President FINCOM Inc. T. Patrick Hurley Jr. Director of M&A Fleet M&A Advisors Edwin W.A. Males Managing Director Broadview International John P. Molner Partner Brown Brothers Harriman W. Gregory Robertson President TM Capital Corp. Alan J. Scharfstein President DAK Group Ltd.