Q&A … With Bill Conway

Q: We saw some pretty robust M&A activity in 2018-19, and a lot of that even carried into the pandemic, then it boomed again in 2021. But conditions have deteriorated a bit economically throughout the first half of the year; how has that affected transaction volume and interest?

A: Volume was down in Q1, due somewhat to a hangover effect from 2021, and the elevated transaction volume. Many market participants stopped and caught their breath in Q1. There were a fair amount of deals that didn’t get done in 2021 that rolled over and were closed in Q1 2022, but to date, Q2 feels like deal flow has increased from Q1 as the market participants are back at it. M&A volume is the result of supply and demand, supply of capital looking to be deployed into the M&A marketplace, creating demand for companies to buy. Capital availability remains strong, and I would expect the volume of deals in Q2 to be significantly above Q1.

Q: What about various headwinds facing the economy, from inflation to higher interest rates or other factors? What’s been the impact on transactions, or seller interest?

A: There are a lot of headwinds facing us, but there have always been headwinds of one sort or another. Inflation reared its ugly head this year, we  have continued human-capital challenges, supply-chain issues and interest rates moving substantially for the first time in a while. That all created more uncertainty in the market. It’s not that we can’t navigate through challenges, but when money gets more expensive, it changes the underlying economics of how a buyer evaluates a transaction.

Q: You mentioned the supply-and-demand factor in deal availability. What’s happening there?

A: We are seeing a supply of capital trying to find a home, creating stronger demand for sellers to enter the market, resulting in higher valuations. There have been, and continue to be,  premium valuations associated with very squeaky-clean, well-run A-quality companies.

Q: We’re guessing that a lot of companies don’t fit that model. What’s the outlook for them?

A: Sellers that are viewed as less-than A-quality companies, those that have a little more white hair, more customer concentration, more management challenges, and on and on, that’s where we’re seeing a little pullback. Buyers are no longer placing premium valuations on those companies, largely driven by higher interest costs, inflation, and other market headwinds.

Q: Any sense among buyers that, if 2021 produced peak activity, that they’re getting in the game too late?

A: We continue to have discussions with a  number of potential sellers who are thinking about selling in the next 12, 24 or 36 months who are asking, “Have we missed the market?” Or they are debating, “The company is generating $10 million EBITDA now, on my way to $14 million in three years, but if the M&A market is valuing the company at 10x today and the market valuation in three years may be at 8x, am I  better off selling now or making the investments and taking the risks to generate higher EBITDA and a higher valuation at a future date?”

Q: So how is that math working out?

A: The math is the simple part, given it is just math. The more challenging decision for business owners to rationalize is does the incremental investment justify and the additional risk justify a potential moderately higher valuation? These are tough decisions to make, but our job is to present business owners with strategic options, and let them make educated decisions.

Q: Any shift in where the buyer interest is coming from, or conditions that sellers might be inclined to sell into?

A: Intriguingly, we are seeing a lot more interest among sellers who want potential alternatives to private-equity buyers. Some business owners are more focused on preserving the legacy and ensuring a future for those who helped build the business, rather than becoming a “bolt-on” acquisition to a private-equity portfolio company, where the customer lists are absorbed and the employees are transitioned. Buyers who articulate a longer-term strategy and a desire to back current management and provide the resources to facilitate growth are well received by potential sellers. 

Q: Shifting a bit to seller demographics here. Baby Boomer owners continue to push past traditional retirement ages of 65 or 66—the last of that cohort is less than a decade away from that threshold. For those on the leading edge, is there any sense that if they haven’t sold now, they’re behind the curve?

A: Not really. Business owners are focused on being fairly rewarded for the enterprise they have built and ensuring its future. Some owners enjoy the challenges of running and growing a business. Many boomers have worked to position themselves in more strategic roles, entrusting others with the day-to-day operational roles. Others are more actively involved in grooming a successor, or establishing a sustainable vertical product line in order to place the company in a position of strength to enter the M&A market at a future date. The market is generally going to reward sellers for well-run, quality companies.

Q: Within that older cohort, in particular, is there an increased sense of urgency to get something in the works?

A: It is not a secret that we have been in a very frothy market from a valuation perspective. If business owners have not been enticed to pursue a sale in the recent market, it could be the result of incredible growth or other unique dynamics. We are continuously asked how sellers can be compensated for future growth potential in combination with how much longer the strong current M&A market will last. While there is no crystal ball, at the first sign of any headwinds, or as the headwinds get stronger as we have experienced recently, we are beginning to field inquiries around “Is now the time? Are things going to improve or get worse?” It will be interesting to see how things play out if the economic headwinds we are facing now get stronger. Are we going to have a recession or are we in one? How high will interest rates go? What will the labor market look like? And how tired, if you will, are those founders and CEOs? All of these factors dictate the timing to enter the market.

Q: That’s a tough choice for people who have invested, in many cases, their working lives into an enterprise. The emotional part has to be a hurdle in this process.

A: Transaction emotions are the most challenging aspect of a transaction to manage, considering the M&A process can be a roller-coaster ride. It becomes a question of what you really want. Going back to the example of $10 million EBITDA vs. $14 million projected EBITDA in the next three years. That’s a big delta, but a lot can happen in three years, not to mention securing and managing the required investment  to achieve the $14 million EBITDA. Owners have to decide whether the risk is worth it, and if not, pull the ripcord. Those questions are more common this year and likely will continue. No question, 2021 was incredible year from an M&A perspective, but when we hit that first speed bump in Q1 with higher interest rates, inflation, the war in Ukraine, and other geopolitical pressures, the focus should have shifted to what impact this was going to have. If this question is not ruminating in the minds and strategy sessions of boards and executive leadership teams, it should be.

Q: Are the signals to a seller that the time is now changing at all?

A: Once sellers get the business to a point where it’s on a glide path and continues to grow with those operating the business, taking advantage of favorable M&A market dynamics in an efficient, timely manner is paramount. Once the emotional decision to pursue a transaction is made, time is of the essence. 

Q: And are the time frame changing for deal completion?

A: Once a decision is made to explore the market, a transaction can generally be completed in five to seven months. There are a lot of variables that affect the timing, including the availability of information, holidays, access to transaction advisers, amongst others.

Q: What kinds of things get in the way of that, for those sellers?

A: If you’re going through a major transition, investing in an alternative market or product line, it can be difficult to convince a buyer of the vision and to fund it, prior to it being validated by the marketplace. Getting systems in place, grooming management, creating KPIs, and establishing consistent financial reporting are a few examples of tasks that need to be taken into consideration in transitioning a business to craft a soft landing for all involved.  

Q: So in general, what shapes that soft landing?

A: At the end of the day, it really depends on who the buyer is and what the seller wants. Some sellers want every last nickel and then go stick their toes in the sand; others truly want to take care of and preserve the legacy of the business and take care of those who helped get to this point. It can be difficult to command both a premium valuation and preserve operational integrity post-closing, given buyers often want to do things their way. A strategic buyer is not as likely to care about the management depth or the staff if they are going to be transitioned. Private equity will be asking ‘Who are we buying? Who’s going to run this, and what are they capable of?’ Our job is to present the best strategic options; we do not get to vote on the merits of selling a business.

Q: Any other thoughts?

A: All of that said, strategic buyers or large corporations continue to be very active in the marketplace. They have tremendous amounts of cash available—$1.7 or $1.8 trillion, by the last estimate. Corporations continue to represent two-thirds of all M&A volume. The question is ‘Do I build this out under the current umbrella, or do I let someone else bootstrap and validate an opportunity, then step in and buy it?’ Corporations have opportunities to build around synergies that financial buyers just don’t have, thus benefiting selling business owners.