Article written by:
Wade Kozich, CPA, CM&AA, CEPA
Senior Director, GBQ Transaction Advisory Services
Liaison to Footprint Capital
In reviewing our 2018 results, GBQ’s Transaction Advisory Services (TAS) group participated in 136 transactions including:
- Assurance and Tax Diligence and Tax Structuring (41)
- Capital Markets including those completed jointly with Footprint Capital (16)
- ESOP Feasibility Studies and ESOP formations (16)
- Purchase Price Allocations, Pre-Transaction Valuations, and Fairness Opinions (63)
While we worked on 136 transactions, we looked at hundreds of other deals when considering all that we review on the buy-side.
Our TAS Team consists of 13 core professionals in various disciplines. Chris Dean and Kaz Unalan lead our tax structuring and tax diligence efforts. Both Partners within GBQ’s tax group, Kaz also leads our succession planning efforts. Tom Powers and Ben Forquer drive our assurance due diligence and quality of earnings efforts. Both are Partners in GBQ’s assurance group.
Footprint Capital, led by Josh Curtis, brought on John Meine from GBQ’s valuation group as a senior analyst. Greg Hicks leads our buy-side search activities, while Steve Lundregan focuses on assisting clients with sale readiness and strategic planning. Finally, I spend the majority of my time working on deals jointly with Footprint. Click here to learn more about Footprint.
Our valuation group members are Brian Bornino, Joe Borowski, Kelly Noll and Craig Hickey. All of these team members are considered national experts in the ESOP world.
The TAS team served as speakers at various events and participated in a number of panels and workshops throughout the year, as well as routinely participated in AMAA, ACG, ESOP and OSCPA conferences.
We have a strong team that covers most financial aspects of deals including buy- and sell-side investment banking, deal origination, assurance and tax diligence, tax structuring, valuation issues, ESOP formations and liquidity planning, all located in one office here in Columbus, Ohio.
Developments and trends we are seeing in the deal world
The M&A climate
The M&A market continues to be very robust; our deal activity is higher than ever. Strong economic indicators, combined with low interest rates, decreased tax rates and reduced government regulations all continue to support a robust M&A market environment.
Another contributing factor is the ever-increasing influence of private equity (PE) in driving the whole M&A market. Most people have no idea how many companies are owned at least in part by PE. It is a staggering number both in terms of numbers and dollars invested. They are extremely active and highly skilled both on the Buy and Sell side. We are seeing PE invest heavily in industries that we had not seen in the past like physician practices as an example.
Baby Boomers looking for liquidity before the next downturn
There seems to be growing concern about when the next recession will occur even though the chance of a recession in 2019 is still only 20% and most key economic indicators are still very strong. There is an increasing number of aging business owners who want to do something prior to the next recession. They have seen the “face of the devil” and do not want to see it again. The truth is, no one knows when the next recession is coming, but we do know from history that they can come on fast and unexpectedly. Personally, I predict that the next recession, when it comes, will be shorter and much milder than the last one. Still, the pain of the last one lingers.
More companies are looking to acquire to meet strategic objectives
Organic growth has been hard to come by for many companies making acquisitions — the only way those companies can achieve their growth objectives. In addition, companies are making acquisitions to add strong people, expand geographically, and add to their intellectual property. It simply turbo charges strategic plans.
Also, it is a proven fact that companies that have acquisition strategies are more valuable than ones that do not. This pertains to public and private companies alike. For many of the same reasons, we are seeing much smaller companies attempting to enter the acquisition game.
Strategic buyers who are backed by private equity seem to be the best organized and motivated of buyers from our experience.
It’s still a strong seller’s market
It continues to be a seller’s market even though multiples seem to have moderated slightly. The competition for deals is tougher than ever. The number of private equity firms has risen well above 7,000. Also, the number of family offices that are functioning in part as PE is increasing, as well as the number of independent sponsors (PE without their own fund). Of course, the strategic buyers are very active, have huge resources and have increased the amount they are willing to pay for companies. Strategic buyers are probably now on a par with PE as far as the prices they are willing to pay. We are also seeing more seller concessions on deal terms other than just price than we have seen in the past.
As an observation, the private markets for companies have become so efficient that strong companies are getting multiples not all that different than public companies when you consider how those multiples are calculated.
Leverage multiples are also increasing
Along with higher prices, we are seeing higher leverage multiples both in terms of senior debt, and especially, the amount of mezzanine debt being used. This is especially true when the equity investors in a deal are trying to increase their ownership percentage for the same amount of equity dollars contributed. Of course, as with prices, leverage multiples vary a lot with size and quality of the underlying company.
Cross border deals are becoming increasingly common
On certain kinds of deals like software and technology, probably now over 50% of buyers of U.S. companies are foreign. Of course, the highest prices are usually obtained through running an investment banking process, but strategic buyers are very good and organized about trying to go directly to companies in their industries and do what we call “proprietary” deals; meaning they are the only one talking to the target company.
The rise of the family office in the deal world
There have been a strong number of privately held companies being sold over the last six or seven years for large amounts (in excess of $100 million), and many of them are forming their own private equity teams. What is changing is that these groups are getting much more sophisticated and hiring their own staff with strong M&A backgrounds or subcontracting some of that out to groups that specialize in M&A.
There are a few notable differences with family offices as compared to traditional PE. One is that they have a tendency to value the culture of a target organization more than PE might. Those cultural differences may translate into them valuing certain characteristics of a company like religious inclinations, political inclinations, stances on the environment, or a host of other preferences that the heads of the family office highly value. Another thing that is notable is that they typically do not have limits on holding periods for their acquired companies because they don’t have fund mandates like typical PE. In other words, they are much more inclined to buy and hold indefinitely as long as it makes economic sense to do so.
On the tax structuring side, we are seeing more complexity and sophistication
It is common for a Seller to want to defer tax on equity they reinvest upon a sale to private equity. Most of the deals where we have served as the sell-side advisor have been in the $5 to $30 million range, and most of those owners who have sold to a PE buyer have rolled some equity in this manner. The tax deferral on the rolled equity can amount to hundreds of thousands or millions of dollars of savings and it is not obvious or always easy to accomplish. It takes a fairly sophisticated tax group to get this piece right.
State and local taxes also continue to rear their head in deals. Both buyers and sellers underestimate how sales tax, use tax, unclaimed funds, property tax and other indirect type tax issues can sneak up and add additional complexity and potential liabilities to deals. We have had at least one deal blow up because of potential exposure in this area. In some cases, we have needed to set aside special reserves at closing to fund potential costs related to these issues.
Traditionally, small deals were almost always done as asset deals. Now, a good number of the deals we are involved with are stock deals with 338 (h) (10) or 336 (e) elections. This is being done primarily for the purpose of making the deal simpler and getting to a close faster, especially, where a number of contracts would need to be transferred with an asset deal. These elections allow for a stock purchase from a legal perspective to be deemed an asset purchase for tax purposes only. Attorneys for buyers seem to be getting more and more comfortable with the risks associated with a stock deal and covering their risks with adjustments to reps and warranties provisions and required escrows. Having a strong M&A attorney really can make a big difference in situations like these.
We are seeing more ESOP deals
While ESOPs still make up only a small percentage of all companies sold, we are seeing more companies looking at ESOPs and at least doing a feasibility study of doing an ESOP transaction. Click here to learn more about ESOPs. As mentioned above, we participated in 16 ESOP formations in 2018 and consulted on many more, as well as valuing over 100 ESOP companies. Our ESOP leaders are considered experts on a national level and are frequent speakers at ESOP conferences.
Every deal is unique
One thing you find in the deal world is that every deal is different. While there are many trends and common themes, each one must be examined on its own merits and the only way to really learn deals is to do them. Each year, our TAS group becomes 100+ deals smarter.