The 2017 tax reform act includes major changes that will affect private equity transactions and portfolio companies both negatively and positively. Provisions include a limitation on the deductibility of interest expense and use of NOLs, a reduced corporate tax rate, elimination of the corporate AMT, full expensing of capital expenditures and a lengthening of the carried interest holding period. How this will affect individual deals and companies will be very case specific. The article The Impact of Tax Reform on Private Equity and M&A Transactions from McDermott Will & Emery provides a good summary of the new rules with a few examples of the potential impact.
According to Pitchbook’s US PE Breakdown for 3Q 2017, private equity buyers are continuing to target add-on acquisitions. Add-on acquisitions made up 64% of US buyout activity through the 3rd quarter of 2017, on par with last year, and up from 56% in 2010. This trend is driven by the high-priced M&A environment. Transaction multiples year-to-date have remained at 10.5 times EBITDA and have increased every year since 2012. Such high valuations make it harder for PE buyers to find attractive new platform investments. Instead, they are focusing on add-on deals that are generally smaller-sized (and therefore typically trade at lower multiples), have the potential of yielding higher returns as they are tucked into the platform, and give a jolt to growth rates. As a result, owners of private companies can continue to expect PE buyers to remain competitive on pricing with strategic buyers.
M&A transactions do not always close – even after a letter of intent is agreed. There are a myriad of deal-breaker issues that arise during the due diligence process such as mismatched cultures, onerous terms or conditions, or a valuation that has vastly changed from the indication of interest. Gary Miller, in an Axial blog, discusses tips that should reduce the likelihood of a failed deal, such as developing a binding and detailed letter of intent and establishing deal-breakers early in the process. To read the article please click here: When Should You Walk Away from a Deal?
Meghan Daniels, on Axial’s blog, describes three practical ways that M&A advisors can add value for CEOs selling their businesses – pointing out gaps in the management team; proposing ways to quickly enhance cash flow; and presenting financial information in an effective way.
In a survey cited in the article, most sellers reported their advisor added “significant” value to their processes, advising that starting the process two years or more in advance of the intended sale helps to reap the benefits. Read the article: 3 Reasons An M&A Advisor Is Worth The Cost
The performance of many acquired businesses post-closing falls short of expectations. There are many reasons for this, ranging from buyers paying too high a price to poor integration of the acquired business. But one of the most important factors affecting the success of an acquisition is the ability to retain existing customers and boost sales to those customers after the closing. In an article on Axial Forum, Anthony Bahr discusses how to use the due diligence process to maximize the ability to retain customers and thereby improve the prospects for a successful acquisition. See the article here: 5 Guidelines to Preventing Failed Acquisitions.
Thinking beyond objective measures, Prospect Partners shares its thoughts about subjective variables that enter into an investor’s calculations in evaluating a potential investment: management and its vision, market trends, a variety of concentration measures, constraints on capacity, and human resource concerns. Read more here.
George Cole and Hal Greenberg, Managing Partners at Riverside Strategic Capital Fund, write that small business owners should consider private equity as a compelling alternative to bank loans. Traditional bank loans may not serve the needs of small businesses due to high monthly amortization and onerous terms and at times are not even available to small businesses. Many private equity firms will now purchase a minority stake in a business rather than demand majority control or a full buyout. Cole and Greenberg argue that a non-control equity investment can be superior to a traditional bank loan. Their rationale is that a minority investment from a quality private equity firm is about much more than cash – these firms have resources and expertise that can accelerate the growth and efficiency of a business. Their caveat is to do the due diligence – check reputation and track record among other issues – to help ensure that the small business owner will feel comfortable with the private equity firm as a partner. Read the full article here.
According to PitchBook’s most recent “US PE Middle Market Report”, the information technology sector was the second most active target industry for private equity investments in the first quarter of 2017, behind only the business-to-business sector. This was partly due to the slowdown in deal making in other industries and also a result of the higher than average deal size for IT acquisitions. But a more important factor is the successful development of recurring revenue streams in the software-as-a-service sector and impressive financial performance sector-wide, reducing the perceived risk of the industry. Read the full report here: 2017 1Q US PE Middle Market Report.
Tuck School of Business professor, Dr. Sydney Finkelstein, in a recent Wall Street Journal article, identifies commonly made mistakes that companies make when engaging in takeovers: believing that prior transaction experience gives a leg up; following the crowd; misunderstanding the nature – and cost – of synergies; and mishandling the integration.
He gives his insight into managing these in Four Mistakes Companies Make in Mergers—and How to Avoid Them.
Corporate acquirers and megadeals (transactions valued at $5 billion or more) dominated the merger and acquisition market in 2016. According to PitchBook’s 2016 Annual M&A Report, corporate acquirers accounted for $1.7 trillion of the $2.1 trillion total deal value in 2016, or about 80%. Megadeals represented more than 55% of total merger and acquisition value. Corporate acquirers took advantage of high cash reserves, high stock prices, and strategic rationale to outbid private equity investors, especially at the high end of the market. But private equity-backed deals made up almost 29% of completed transactions, an all-time high. So, sponsors haven’t reduced their activity. Rather, they have been pushed down to smaller transaction sizes and increased their focus on add-on acquisitions where they can compete with strategic acquirers. Read the full article here: 2016 PitchBook M&A Report.