M&A Insights

As we plunge into this long overdue and pent up recession, a fact remains that is worth mentioning. Per Fortune, there exists $2.4 trillion of unspent private equity capital in the market, the highest total ever recorded. For those who don’t know, private equity funds have a contractual mandate to deploy committed capital, generally in 5-7 years from the start of the fund, or they will lose out on their investor commitments.

Despite the recent brutal economic climate, and with so much continued uncertainty, we are still receiving calls from investors asking for deals and reiterating that they’re open for business. For example, we recently spoke with a software-focused private equity contact of ours, talking about paying lofty revenue multiples, even when the S&P went down nearly 10% in that day, and ~25% in the last few weeks. Other inquiries include specialty debt/finance providers who are alternative lenders to that of traditional banks, and offer cash flow-based to growth technology companies who are naturally asset light.

While without a doubt, groups will exercise more caution and less exuberance, the fact remains they need to deploy this capital, or they lose out on such commitments. Specifically those who’s portfolio of companies have been less affected, will have less of a reason to slow down on evaluating new investments or acquisitions. So, if a business is performing well (>$10mm revenue, >20% growth, >15% profitability, strong recurring rev, low churn, low customer concentration, in recession resistant industries), many options still exist, and we expect company values to generally hold up, on the expectation that the broader economy will rebound upon a flattening/declining of the curve for Coronavirus, as this is a public health crises damaging the economy, not an economic one, like the last recession. Further we expect more demand for “safer bets” with companies in industries less affected (healthcare, insurance, IT), or perhaps even benefiting for this climate (think Zoom, Peleton, Slack), which may drive values back to where they were a month ago or higher.

For those industries related to travel, events, oil/gas, etc.., they’re likely already too heavily impacted, whether their financials reflect it or not, and may be placed in the “value” or “distressed acquisition” camp, with a valuation to match, or just lack of interest. Whereas for other industries, it remains to be seen how much of an impact there will be, which depend on customer retention, mission critical nature of their product/service, and some continued growth, etc.. Perhaps stating the obvious, yet to receive a growth-type valuation (revenue multiple or high single digit – low teens EBITDA), companies are still expected to perform well, even through a situation like this one.

Timing the market is nearly impossible and how long the current state will persist, yet with this record amount of capital in the market that needs to be deployed, there’s inherent urgency for funds to transact with the many strong performers out there weathering this storm, and who can still generate solid returns funds are seeking.  This in turn may not hamper activity and values as much as one would expect, yet its important to know who are the value investors vs. the growth oriented folks.

HRC is happy to speak with you regarding your business, provide feedback on valuation, the desired transaction you are seeking, options in the marketplace, and how we can be instrumental in accomplishing your strategic objectives.

Despite the overwhelming number of investors/acquirers approaching companies these days, we feel it makes sense to call out an investment option that not a lot of funds employ, and many entrepreneurs may not know about.

Minority liquidity or a minority recapitalization is an equity investment by a private equity firm, where the use of proceeds is liquidity to shareholders vs. the monies staying in the business for growth. Not a lot of funds make these types of investments, as it disincentivizes owner operators to continue creating value with the same rigor as before, when the vast majority of their wealth was tied up in the company. Firms that make these investments pursue high growth, profitable companies, who do not want or arguably need a capital infusion into the business, therefore this may be the only way for the investor to get into such an attractive business.

Companies find this type of investment attractive as it allows shareholders to diversify their holdings by selling a minority of their equity, often 25-49%, at a favorable valuation, while retaining control of their business, and focusing on a larger exit 3-5 years down the line. In the interim, it gives owner/operators an ability to hedge against a downturn that can wipe out equity value (please note if a growth company becomes flat or down growth wise, valuations can be reduced by a material amount, as a whole category of growth-focused investors/acquirers will no longer be interested, and there may only be “value” type folks interested, which as their name suggests aren’t paying premium valuations).

In addition to owner operators covering their downside, companies bring on a private equity institution which will not invest unless they feel they can make 2-3x their money in 3-5 years, so they support growth and value creation in areas incremental to the current operations such as with finance, accounting, acquisitions, strategic direction, and preparing the company for an ideally much larger exit down the line.

We at HRC have not only been part of PE groups who make such minority liquidity investments, but have developed a robust network of firms where this is a standard practice, and can share more particulars as well as assess the fit for such firms and your company. Feel free to respond herein, to schedule a call to discuss.

You hear more and more about the importance of ROI-based selling, to demonstrate to customers the potential tangible value of your product and service, especially as we may be heading into a recession where expenses tighten up. This is no different in investment banking, where the ability to demonstrate value, in relation to fees, is critical in customers’ decision-making process.

In three M&A transactions where HRC represented sellers, ran processes, and negotiated multiple acquisition offers, the end results equated to ROIs between 3x, to as high as 28x. The ROI here is calculated by taking the value increase (final sale price minus the initial acquisition offer) divided by the sum of all HRC’s fees for the transaction (retainers, success fees, etc.).

While the 28x may be viewed as an outlier, HRC is seeing more consistency around an expected ROI between 3-5x, due to the ability to bring in highly strategic acquirers where there’s existing relationships, run a tight competitive process, and negotiate a market transaction.

This type of ROI potential is often prevalent in situations where a seller is negotiating an acquisition with one buyer without current investment banking representation. In two of the three cases noted above, including the 28x case, this was the current situation before HRC was engaged.

We welcome discussing any M&A or capital raise opportunities you may be exploring and how we may be helpful.

About: Harbor Ridge Capital is a leading M&A boutique, with a focus on technology verticals, including software, IT/Cloud services, marketing technology, and healthcare IT, in the $5-50mm revenue or value range. The group has developed extensive expertise in these industries over a 20-year period, as well as fostered relationships with the most active strategic acquirers and private equity investors. Learn more at www.harborridgecap.com.

The Principal of Harbor Ridge Capital is a registered representative of, and Securities and Investment Banking services are offered through, Ashland Securities, LLC, Member FINRA, SIPC. Harbor Ridge Capital and Ashland Securities are separate and unaffiliated entities. This email/information does not constitute an offer, invitation or recommendation to buy, sell, subscribe for or issue any securities.