I’ve been an investment banker since 1995. Over this period, a handful of trends have defined the sale of a private business – market-clearing auctions, the emergence of the adjusted EBITDA multiple as the primary valuation benchmark, and the widespread use of outsourced financial due diligence.
All of these developments reflected and contributed to what has been a period of elevated valuations, but it is not like any of them were on tablets handed down from a mountaintop.
They all were at a different place 30 years ago:
Processes were more targeted, often in arbitrary ways. The universe of financial buyers and their portfolio companies was a fraction of what it is today. Sellers and their bankers relied even more on established relationships. It was harder to get to know someone outside of your geography or personal orbit. Also, and maybe most practically, it was hard to have a hundred buyers when that meant sending out a hundred FedEx packets.
By the mid-90s, the market had already evolved away from price/earnings ratios to cash flow-based metrics, but there was more reliance on modeling before expressing even a preliminary view of value. The typical buyer would have frozen like a deer in headlights if a sell-side banker sent over a teaser and said, “We think you need to be at eight times to get a meeting.”
Financial due diligence
Unless specific concerns emerged, buyers tended to rely on their own and their accountants’ review of financial statements and operating data. Quality of earnings has been a phenomenon of the past 15 years, with sellers and their advisors embracing preemptive financial due diligence about 10 years ago.
What has changed in the past generation is changing again.
This is not the case for every business. A pallet manufacturer will be marketed, valued, and sold pretty much as it was back in the day. But a subset of industries are and will continue to see a different kind of process. These industries are characterized by extraordinary projected growth, lofty valuation expectations, and some complexity susceptible to deeper analysis. The more a business embodies these characteristics, the more the process of selling it is likely to change.
These trends are already underway. The only questions
are who pays for the additional work.
For instance, companies operating in outsourced residential services, cyber security, behavioral health, precision medical devices, branded direct-to-consumer products, and other markets are already seeing the building blocks of contemporary M&A changing in interrelated ways.
More targeted auctions
If you want to sell a business for 15 times, it takes a buyer with the capacity to confirm the case for stellar long-term growth. As will be noted below, this often costs money. Processes need to funnel down to the cluster of buyers that like and know the industry but also are able and willing to pony up for consultants and other external resources.
More sophisticated analytics
I don’t mean to suggest that EBITDA multiples will be replaced as the lingua franca of M&A, but for many of these highly valued businesses, buyers are already doing more ground-up confirmatory analysis.
More external due diligence
This has come in two waves. The first is the greater use of external consultants to supplement the buyer, their counsel, and accountant in traditional and emerging areas of due diligence – tax, IT, cyber security, employee benefits, intellectual property, and real estate.
At least one leading investment bank has established a transaction advisory services group to provide some of these services to its M&A clients. It is not new for accounting firms to reach into M&A, but this goes the other way. It is an interesting move to capture more of the total “advisory spend,” not to mention getting at more fee-based as opposed to success-based revenue.
The other wave involves an array of business models taking advantage of artificial intelligence, behavioral science, and advanced analytics to provide a much denser view of a given company’s value proposition. Two quick examples help make the point.
Think of the relative simplicity of modeling the spending habits of a Macy’s shopper or a Budweiser drinker in 1990 compared to their internet-shopping/craft-beer swigging counterparts today. One intriguing response is Theta, a firm founded by two business school professors from the University of Pennsylvania and Emory University, that provides “predictive customer value analytics” – a ground-up view of valuation – to acquirers of consumer-facing businesses.
Next think about all of the industry rollups that have gone awry because of improper fit. New Orchard, based in Nashville, provides a SAS offering, the Journey Strategic Platform, that amounts to “quality of culture & operations” analysis – “quantifying, profiling and improving the existing behaviors within a business.”
These trends are already underway. The only questions are who pays for the additional work (seller or buyer) – and when (pre- or post-exclusivity).
Based on my experiences as a sell-side banker, I think of two things. First, the selling client is not looking for additional out-of-pocket expense. Second, over the next few years, more and more of our energy will go into managing complex interactions with buyers undertaking these activities, as opposed to the rote administration of a marketing funnel.
About the Author
Andy Greenberg is CEO of Greenberg Variations Capital, a mergers & acquisitions advisory firm based in suburban Philadelphia devoted to one-off or targeted transactions. He is also the Founder of GF Data© (now an ACG Company), the leading provider of information on private transactions in the $10 million to $500 million valuation range. For more information, visit www.greenbergvariations.com or www.gfdata.com.
© 2023 Private Equity Professional | February 14, 2023