It Figures Podcast: S4:E15 – Current Trends in Mergers and Acquisitions

Speaker 1:

From Carr, Riggs, and Ingram, this is It Figures, the CRI podcast, an accounting, advisory and industry focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.

Jeff Silver:

All right. Well, welcome to this week’s It Figures Podcast. I’m Jeff Silver. I’m a partner at CRI in CRI’s TAS practice. Today we’ve got Marc Berry and Jeff Hawkins, both partners in our TAS practice. Guys, you want to introduce yourselves here? Why don’t we go with Mr. Hawkins first?

Jeff Hawkins:

Yeah. Thanks, Jeff. Glad to be on the episode and hope to share some knowledge. As mentioned, I’m a TAS partner out of our Atlanta office, and I’m a 100% dedicated TAS partner. We focus on quality of earnings, general consulting, working capital consulting as part of what we’re doing. We also have valuation underneath our service line as well. It’s not something I personally do, but again, it’s something we offer. And then also, we have tax consulting as well, also not something I work on, but it is part of our team.

Jeff Silver:

Excellent, excellent. Marc.

Marc Berry:

Yeah. Marc Berry, also a TAS partner housed in the Houston office, rolling up on about 20 years of diligent experience, and look forward to talking about some TAS work here.

Jeff Silver:

Excellent. Well, Marc, you don’t look like you’ve done this a day over 19 years, man.

Marc Berry:

I appreciate that.

Jeff Silver:

Well, so let’s get into it. We’re going to talk about the current trends in the market right now. As we all know, it’s been a very interesting three and a half years for the world. We’ve seen pandemics, we’ve seen inflation. We’ve seen bank failures. It’s definitely been challenging times, but there’s also been a significant amount of transaction activity that’s going on. Really, I guess I would kind of phrase it as a roller coaster ride. Jeff, can you give some perspective on some of the changes you’ve seen across the last three and a half years as we kind of lead up to today?

Jeff Hawkins:

Yeah, sure. So COVID really was a disruptor in a lot of ways. And the transaction world was not able to be hidden from it. So what happened is when COVID first happened, a lot of private equity groups, they own multiple sets of companies and what that prevented them from doing was getting a lot of PPP loan money. So what those guys had to do is really kind of batten down the hatches and start managing their portfolio companies really closely to make sure they got through this unknown time period. So between that and kind of banks unsure what was going on, deal flow in 2020 was almost nonexistent.

And in this space what really happens is when private equity raises money, that’s not when those guys get paid. They get paid when they utilize the money. And so they had multiple months, eight, nine, 12 months to make up of deal flow. And so what essentially started happening is in late ’20, early ’21, really the waterfall kind of happened. Right? I mean, the dam burst and everything that was kind of pent-up really kind of flowed through. So then the other thing that happened in this space is there’s a lot of FOMO, and so people … If my buddy’s acquiring a bunch of car washes, our group has to acquire a bunch of car washes. Right?

So part of that, everybody trying to make up the deal flow, and then again, the FOMO factor of people trying to make sure that your buddy at the other firm doesn’t surpass you really caused an all time high of deal flow in ’21 and in ’22. So those two years are all time highs, really. Fast forward to Q one, ’23, it was all time low in the last decade of deal flow. We’ve seen things start to pick up a little bit here recently. But really, so as you mentioned, roller coaster really is the right kind of terminology for this. And really, what we’ve seen as a result is people are digging way deeper on diligence today than they were a few years ago when it was really just: Can you get to the finish line the fastest? That’s no longer the sentiment anymore.

Jeff Silver:

No, that makes sense. That makes sense. Yeah, that roller coaster ride has contributed to a lot of changing of perspectives. And Marc, next question for you is that Jeff just talked about how basically we’ve gone up, we skyrocketed, and now we’re plummeted and deal flow is the lowest in a decade. Right? So in your opinion right now, what are the biggest challenges that sellers are facing?

Jeff Hawkins:

Yeah. I think a good story around how quickly they were able to come out of the downturn of COVID. A lot of industries literally shut down for a long period of time for months on end. And I think the data and the story tells two things. One is: How quickly can you rebound? How well of a management team did you have in place? How well are you able to mitigate risk and disruptions in your business? Some things you can’t control. Right? Supply chain, those types of things you just couldn’t control. But how well can you float until supply chain opens back up?

The other piece is just data. How good is your accounting data, sales data, and is it baking the story that we’re seeing and kind of that rebound effect similar to what Jeff was talking about from deal flow, but also the rebound effect of operations and how well your business was able to rebound once the pipeline opened back up. I participated in diligence during the ’08 crash. And I would say the COVID crash was somewhat similar, obviously different issues, but it’s reminiscent of the ’08 Q four crash with the real estate and the banking issues.

Jeff Silver:

Sure, sure. And I think one of the biggest differences today probably versus ’08 is the amount of what we call dry powder that’s sitting on the sidelines. And you read articles about that all the time about how much capital is just sitting there waiting to be deployed. And yeah, that is definitely a difference for 2008. And so I guess conversely, Marc, we just talked about the sellers, what challenge … With all this dry powder sitting on the sidelines, what would you say is the biggest challenge for the buyers?

Marc Berry:

Piggybacking off what Jeff Hawkins just talked about with the private equity model is you’ve got to employ capital to start realizing a return. And so from a buy side standpoint, I do think at least talking to our private equity clients, they are digging a little deeper than they have in the last 24 months on deals. And I think a lot of that not only relates to understanding the business and also the rebound effect in the operations, but also the model, the investment model for that with the cost of capital continuing to rise with the fed rates going up every so often. It changes their deal model every single time that interest rate rises.

And so I think a lot of their risk or a lot of their analysis is coming more in their investment model. What’s our debt to equity ratio that we need to throw into this deal, one, to get it closed, but then our ability possibly in a year or two to refinance to pull cash back out, lever it up slightly more to assist in our returns? And then it gives us more capital to invest in two years when we refinance each of our deals. So I think that their view is really internal looking in how are we going to invest. What’s our investment model looking like with the cost of capital that we are currently facing.

Jeff Silver:

Got it. Now being in transaction advisory services, all of us we’re all very, very in tune with the idea of equality of earning study is, and going through a financial due diligence process. Jeff and Marc, Marc, you commented on this a little bit. But Jeff, can you describe in a little bit more detail how the diligence process has evolved say from ’21 and ’22 at the height of the deal flow to now? What are some more specific examples of the changes of how both buyers and sellers are approaching the diligence process?

Jeff Hawkins:

Yeah, sure. So I think probably the most prominent example would be when we’re doing a sell side engagement because the buyer comes in and they’ll maybe have multiple people look at our work product. During the height of everything, we were rarely getting questions on our work product. We would maybe have a phone call, and maybe 30 minutes to an hour, they would even have things they wanted to follow up with us on and they would never follow up with us on it because what it became was is less about the diligence process and more about who can offer the most and close the quickest. So when there’s a lot of people at the table, it becomes a bidding war sometimes. Right? And so that’s really what we saw happen.

Well, now it’s not a bidding war so much. Again, now you have more time to dig in and so people are. But plus, there’s more risk out there. I mean, Jeff, me and you worked on a job particularly where they had ramped up their inventory about 50% in the last six months. Well, that could mean a million different things. Right? Well, what it ended up meaning was because of supply chain issues, they overbought. Now the buyer has to content with, “Well, what do we do with this excess inventory. Is it saleable? Do we even want it? Do we pay for it as part of the transaction?” So things that have arisen now with the economy slowing down some, they didn’t exist a few years ago. People couldn’t get enough inventory a few years ago. Now people have too much in general, so that’s a big risk for a buyer’s perspective is …

And again, with how quickly that all changed too, that’s another thing that’s risky. There’s no real consistent results from ’20, ’21, ’22, and now ’23 is even maybe more back to normal, but there’s banking issues and lending issues. So the last three years have had different challenges that making it now more risky for buyers. The other thing I’ve thought about too a lot is: Well, if people were bidding against each other to buy these companies just like in residential real estate, how many buyers overpaid for companies the last few years? Right? And people probably have already realized that. And so now on the next deal, they’re going to dig in harder. Right? So that’s really what we’ve seen from change on the diligence side.

Jeff Silver:

Would you say that based on these changes that there’s more potential for a deal to die before it gets to the finish line?

Jeff Hawkins:

Yeah, 100%, because again, in the last two years it was just hey, we’ve got to get there. Right? And if we’re not digging as deep on diligence, maybe we don’t find that issue that kills the deal because we’re too blinded by just trying to get there and be the person that closes on the deal.

Jeff Silver:

Understood. Marc, anything you want to add to that?

Marc Berry:

That’s what I was going to say. I think we all can agree that in the last six months, we’re seeing buyers walk away, where in 2022 and 2021, we didn’t see any buyers walking away from a deal. They just figured out how to get it done, get it past their investment committee, I think more along the lines of just having the deploy capital and that was the mindset. And now we’ve had a couple deals in the 11th hour get squashed, and just they’re more willing to walk away now than they had been the last 24 months.

Jeff Silver:

Sure, sure. Now when we talk about deals and we talk about working with both buyers and sellers, there’s definitely the detailed technical aspect to our jobs, but there’s also the psychology part of our job. I think we all put on the psychologist hat as we’re working through this. And obviously, as the deal market is changed and especially as a result, valuations have changed because if you’re doing that FOMO phase, it’s just buy, buy, buy, fear of missing out. Everyone’s just going to, whatever it is, okay, I’ll pay for it because I may not get the next deal. Right? And so valuations have come, so you’re looking at sellers that say, “Well, a year ago I could’ve got a seven or eight multiple. Why are you telling me it’s five or six now? Well, that means my EBITDA’s got to be higher then, guys. I’m sorry. It’s got to be higher. That’s the only way this is going to work.”

Well, you know what, doesn’t always work out like that. Where I’m going with this is that with every deal, there’s a war story. There’s a war story that comes out. And as we know, everybody loves war stories. So Marc, can you give us an example or maybe a short story of a unique challenge you’ve come across recently in one of your due diligence experiences or deals that you’ve worked on?

Marc Berry:

Sure. We started a deal, an LOI was drafted, negotiated, agreed upon in September of last year. Right? This was right before we saw a downturn in the market more related to the cost of capital increasing. Right? And so purchase price, everything was based off of pre-crash, so to speak, in the economy. And as we went through diligence and the buyer was respectful, went through the process, was willing to honor the deal to some extent with a few caveats. And this buyer had closed three other deals where we did diligence prior. This was going to be another bolt on acquisition for this platform. And just some of the buyer’s, excuse me, the seller’s mentality was I’m not going to negotiate off of this price that I negotiated back when the market was at a high. And we found a few operational issues, a few accounting adjustments that affected earnings and brought them to seller’s attention and the seller just would not negotiate and was dead set.

And that’s just because we all have … Every seller has a friend who sold at an all time high, and everyone’s … Entrepreneurs are competitive by nature and so they’re not going to be outdone by their buddy who sold the same type of business. And that’s the most recent war story that I have. That deal died and it did just because the seller was somewhat unrealistic with the economic changes and now he’s going to face it as being the owner of that business, and his sales have started to slow. And his cashflow is going to go down. And it’s funny because our buyer client, the deal points that they were trying to negotiate had nothing to do with the operations. It had to do with the building leases and some of the terms around related parties. That was part of the deal. Anyway, that’s one of my … The buyer walked away and walked away really after full-fledged diligence was done, APA was drafted, and they were just trying to finalize the last few deal points when it came to leases and whatnot.

Jeff Silver:

Got it. Jeff, what about you?

Jeff Hawkins:

Yeah, I’ve got a pretty good one. It’s actually not that recent, it’s a little over a year now. But one of the things that I always like to talk to people about in this space is, this is very relational. It’s all about relationships and trust. And so the story I’ve got is basically that we were working with the buyer and this was a large acquisition. It was almost $100 million. And so they had already had our quality of earnings procedure was done, the tax planning, the tax diligence was done. Environmental diligence was done. The legal diligence was just about done. And again, we were almost ready to issue our Q of E. Everything had checked the boxes on every single one of those pieces of diligence.

And then about a week before closing, the seller calls our buyer and basically says, “Hey, I’ve been having something on my conscience. We had an employee pass away on one of the job sites,” so he was a contractor. And they had an employee passed away about three months prior, but that was within the diligence period. And so we had asked about it, legal had asked about it. The buyer had asked about it. And really, it never came up. Right? We even do, for certain contractors, we even do a quick OSHA search to just see if there’s any claims filed against them. Nothing. But in this scenario it was because the claim hadn’t been fully investigated and filed yet, so there was really no way to find this. But again, he called the buyer and just said, “Look, this has been on my conscious. I’ve got to tell you that this happened.”

Financially, it really didn’t impact them at all. When the OSHA investigation finished, there was a $10,000 fine. And again, not to diminish what happened, but financially, it was not an impact. And if anything, it could’ve just been handled within escrow. Right? Or we’re going to put something in the purchase agreement. But again, our buyer walked away literally not even the 11th hour, at 11:59 after almost half a million dollars of diligence and six months of time had been put in, walked away because they no longer felt like they could trust the seller. Right? And so they even asked our opinion on that like, “Is this something that you guys would expect to see or be comfortable with if you saw in your experience?” No, not at all.

Because again, it’s not something that should’ve been hidden. Right? And so that’s kind of a good war story, but again, the message with this is it’s very much about relationships. And if you’re not honest, and that goes for us too as the CPAs. Right? I mean, honesty is keying in these transactions because if something like this comes up at the last minute, it will kill a deal, even again with a $500,000 worth and six months worth of time put into it, deal can still die.

Marc Berry:

Both of these war stories, and I can’t speak for Jeff’s deal, and Jeff, maybe you can elaborate a little bit more, but a lot of times the sellers are rolling equity. They’re going to become business partners with a buyer.

Jeff Hawkins:

That’s exactly [inaudible 00:20:53]. Yep.

Marc Berry:

And my example, that was the case. And the buyer asked us our opinion as well, and the short answer is: Is this someone that you want to be in business with as a business partner if they’re unwilling to look at X, Y, and Z or negotiate X, Y, and Z. Same thing with your deal, Jeff, if that seller is looking to roll equity, it’s not a good start if you begin by lying to your new business partner or hiding something from your new business partner. Sometimes it’s just inexperience and nervousness of maybe the seller, but at the end of the day, I think buyers look at that and say, “Can we be business partners with this person for the next five to seven years?”

Jeff Silver:

No, makes sense. It makes sense. We’ve covered a lot here, guys. We’ve talked about the roller coaster ride, the changes, the additional layers of scrutiny that we’re all kind of seeing now during the diligence process. I think kind of to wrap this up, I mean, we’re all regular attendees of the ACG events where there’s a lot of … There’s always deal makers there, a lot of buyers, a lot of sellers there. Jeff, I know you just this week attended the Mid South event up in Louisville. Just wanted to get your take. What’s the temperature right now for the M and A market?

Jeff Hawkins:

Sure. Yeah, you’re actually looking at a fantastic Louisville hotel right here. So yeah, actually, as we said, deal flow is at a 10-year low. It’s a little misleading though because that’s more the upper middle market I think, lower middle market and smaller add on type deals have kind of still been chugging along, but again, at a much slower clip. But this week, that’s obviously when we had 24 meetings, that’s one of the things we always ask everybody is, “What does the deal flow look like? What do you foresee?” Finally, for the first time this year, we’re hearing people with positive sentiments about we’re a little bit more comfortable with what the Fed’s going to do, little bit more comfortable with the banking crisis that’s kind of resolved itself, because again, that’s what a lot of this is, is confidence.

As Marc said, they can kind of rework deals, that versus equity, to kind of make up for the rising cost of capital. But again, a lot of it is confidence in the market. The stock market’s actually been going up lately too. This stuff is actually really closely tied to it. Again, it’s just all about the confidence level of these people investing. So yeah, we heard from multiple private equity groups that they’re bullish on the rest of the year and I think that’s a good sign. And we’ve seen that from our deal flow proposal activity here recently as well.

Jeff Silver:

Marc, anything you want to add to that?

Marc Berry:

No. I think also from a sell side standpoint, we’re seeing a lot of inquiries from our investment banking clients, the ones that we work with regularly. More deals are being prepared to go to market, which I think is also a good sign that we have willing sellers, understanding the current economy and the market that we’re in, that they’re still willing to work on getting deals out in the market I think is also a positive sign. And I also think it’s indicative of what Jeff just said, that we know that there’s buyers that want to deploy capital. And so I think it’s a positive sign for the last six months of 2023 in the deal market.

Jeff Silver:

Great. Agree. And it also feels like with recent reports out there with inflation softening, and maybe interest rates, they decided not to increase interest rates this time around. Maybe there’s an end to that. And obviously, we talked a lot about cost of capital, and obviously interest rates driving that cost of capital increase if that starts to tame itself, then hopefully that will also encourage more transaction activity as well. So gentlemen, always a pleasure. Appreciate all the great insights you’ve provided today. For everyone else out there, please check out the podcast. You can go to cricpa.com. Also check out our social media posts. Our transaction advisory service is very active. And thank you, everybody, and you guys have a great day.

Speaker 1:

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