Insights

  • M&A Trends for the Rest of 2022 and into 2023
    POSTED 8.31.22 M&A

    Inflation, a rise in interest rates, and global unrest and uncertainty represent some serious headwinds for the economy right now. But the consensus, from my sources in the M&A world is that dealmaking for the lower middle market has not faltered and will not falter going into the next year.

    Granted there has been a decrease in the pace of M&A activity when you compare 2022 to 2021, but that’s not a far comparison, as last year we saw record-breaking deal-making thanks to pent-up demand for deals as we emerged from the pandemic.

    As PricewaterhouseCoopers put it in their Deals 2022 midyear outlook report:

    “Just like a car that slows from 100 mph to 60 mph is still moving fast, so was the first half of 2022. The 2021 deal volume was not a sustainable annual average, and that context is important.” 

    There are several factors contributing to this continued run of impressive M&A activity.

    There is a massive amount of capital out there, with $800B to $900B in dry powder available to be exercised by PE firms and Strategic Buyers.

    Prices are leveling off. Unlike in 2021, with its frenzied rush of acquisitions, there are not as many Buyers pursuing a given target. That means more reasonable pricing for Buyers. Fewer bidding wars.

    There has been extra scrutiny focused on publicly-held companies, with the federal and some state governments taking closer looks at so-called megadeals in terms of antitrust issues. But this is not an issue for privately held like the majority of lower middle market firms.

    Rising interest rates, inflationary pressure, and consumer spending variability are impacting transactions – but not stopping them.

    Supply chain issues have actually caused many companies to react by acquiring suppliers, cutting out the middle-man to source materials directly. For example, in consumer goods, companies are acquiring distribution centers so they have control over that part of their supply chain at least.

    While volatility does inhibit IPO volume, PricewaterCoopers maintains in their report that “alternative sources of capital or transactions may be more likely, including PE suitors.”

    You also have to look to owners and founders of lower middle market companies. Many feel cornered by these ongoing macroeconomic trends. They feel like we’re headed to a similar fate as 2008/09, and they don’t want to be caught up in that cycle as a protracted recession could prevent them exiting for three to five years. So they have an incentive to get a deal done in the next 12 months.

    This is particularly the case in places like California and New York locations. These folks want sell, retire (or move on to other ventures), and they’re ready to escape to places with lower taxes and lower cost of living.

    These Sellers willing to take a discount if they can get out sooner rather than letter.

    It’s also worth noting that conditions that you would think would slow down deal-making…are actually doing the opposite. As the Deals 2022 midyear outlook report notes:

    “Some of the same forces creating market uncertainty – the lingering pandemic and geopolitical turmoil – also are driving dealmaking imperatives. Whether a company needs to transform its capabilities, supply chains or go-to-market approach, the market is impatient and one of the fastest ways to accelerate transformation is through M&A.”

    Certain market sectors are doing particularly well in these times.

    Technology companies are sitting pretty, buoyed by very favorable market fundamentals. Businesses need to keep pace with innovation and the ongoing worldwide digital transformation. There is always some new tech needed to stay competitive.

    And that means M&A deals for companies offering software, cloud solutions, analytics, and cybersecurity will continue at full steam.

    In the consumer goods market, they are faced with the fact that some people are not buying as much due to inflation. However, we have a strong market, which means plenty of people spending money out there.

    And industrial and manufacturing companies are also streamlining in the face of supply chain issues. With recent experience, they are getting better at making contingency plans for future supply chain interference, which means commodity shortages are less of an issue. Plus, they are increasingly turning to onshore manufacturing.

    All this said, deal-makers must be cautious. There are a lot of unknowns out there. The situation is volatile and changing constantly. But I contend that it will be more expensive – in terms of lost opportunity – to hunker down instead of continuing to move forward on deals. But deal-makers do have to work smarter in this climate.

    As Cascadia Capital put it in Summer 2022 Quarterly Newsletter:

    “Though the astronomic prices are gone, buyer scrutiny is more intense than ever. We have entered a ‘show me’ world where buyers are demanding concrete proof. They need to see it before believing it; once they do see it, they are willing to value and pay for it.”

    One way to eliminate Buyer and Seller risk in an M&A deal – especially now but in any market conditions – is with Representations and Warranty (R&W) insurance. This product is tailormade to facilitate fast acquisitions too.

    This coverage:

    Transfers risk of breaches of any Seller Reps and Warranties to the insurance company.

    It protects Buyers if a post-closing breach occurs. They won’t be subject to covering that loss entirely themselves or having to pursue the Seller for a clawback.

    When this coverage is made part of the deal early on, there is no need for the intense negotiations over reps and warranties because, if there is a breach, the insurer pays the damages.

    This speeds up the process – not to mention saves on legal fees, about 20% savings on the negotiations part of the deal.

    The target company keeps more money in their pocket rather than in escrow. This is especially compelling for owners and founders seeking a quick exit.

    Buyers savvy enough to offer the idea of R&W at the opening of negotiations, routinely finds the target company will gladly pay for the coverage.

    As a boutique broker with long-time experience with R&W insurance, I’m happy to chat with you about how this unique coverage could be part of your next deal.

    Please contact me, Patrick Stroth, for more information on TLPE and other M&A insurance options.

  • Chris Parisi | Why M&A Isn’t About the Numbers
    POSTED 8.24.22 M&A, M&A Masters Podcast

    M&A is never just about chasing numbers….
    It’s about the people who trust you with their business…
    A business that represents generations of hard work—and a family’s legacy.
    My guest Chris Parisi knows this well. At Carl Marks Advisors, which has been around since 1925, Chris secures clean exits for lower middle market business owners.
    In this episode, Chris shares some of Carl Marks Advisors’ storied history and reveals how he fights for the best outcomes for his clients.
    Read More >

  • TLPE Insurance and Non-Disclosure Policies
    POSTED 8.17.22 M&A

    Transaction Liability Private Enterprise insurance (TLPE) is taking the lower middle market M&A world by storm. 

    Unlike traditional R&W insurance, TLPE is a Sell-Side policy where the Seller, rather than the Buyer, is the policyholder. The policy is triggered when the Buyer makes a claim against the Seller. Instead of going after the Seller directly, the Buyer simply collects from the insurer. 

    Sellers benefit from this insurance as well, with TLPE effectively reducing escrow levels in deals from 10% to 1% of the purchase price. (The cost of TLPE is only $10,000 to $20,000 per $1M in Limits.) You can check out a great case study of TLPE coverage being used by a Strategic Buyer here.

    But there is a downside to TLPE…

    TLPE, like all Sell-Side transaction liability policies, has an inherent weakness.

    If the Seller does not disclose something to the Buyer intentionally, that known item is excluded and not covered by the TLPE policy.

    This is the polar opposite of Buy-Side policies, where if the Seller commits fraud or intentionally doesn’t disclose an issue, the Buyer is still covered because they are the policyholder.

    This key difference has made some Buyers suspicious, and reluctant to go with Sell-Side policies that might exclude Seller breaches. Let’s say, TLPE insurance isn’t the first choice of many to cover their transactions. They’d prefer to keep a chunk of the Seller’s proceeds in escrow.

    But understandably, Sellers have been all over TLPE coverage because it offers protection, reduces the amount held in escrow, is easy to qualify for, and has a low cost.

    Enter a new insurance product to save the day…

    The Nondisclosure Policy, as its creator, CFC Underwriting, puts it “covers the Buyer for loss as a result of a breach of Seller’s representation caused by the Seller’s nondisclosure of known matters.”

    As you can see, this new coverage fills the whole left by TLPE quite nicely.

    The cost is a $10,000 premium per $1M limit, plus a $500 policy fee. And if the Seller gets a TLPE, the Buyer can then seek a Buy-Side Nondisclosure Policy.

    Then, in the event that the Seller does not disclose a bad thing in their history intentionally, the policy pays. There is no deductible.

    To be clear, unlike other Representations and Warranty-type policies, the Nondisclosure coverage states that if the Buyer suffers a breach and the TLPE coverage excludes it because it was prior knowledge of the Seller… the insurer will pay. However, the Buyer must give subrogation rights to the insurer, so they can then go after the Seller.

    A breach could be something as simple as out of date license or permit. Or a past indiscretion that seemed minor at the time and was felt to be a nothing issue not worth bringing up… and then it blows up big time. Of course, an innocent Seller has nothing to worry about and there’s no risk to them.

    The Nondisclosure Policy helps both parties with these claims.

    Please understand that this specialized coverage does not insure intentional fraud, simply issues not disclosed intentionally by the Seller. 

    No insurance company will willingly insure against fraud. It’s a moral hazard. However, the Buyer isn’t committing fraud, they are suffering from fraud. Buyers get protection from fraud with a traditional R&W policy. Insurers are willing to do this because diligence is so thorough it’s hard for Seller to hide something. 

    However, in a Sell-Side TLPE policy, much less diligence is done. If a Seller chooses to withhold key information, the Underwriters might not catch it. That’s why they don’t pay these claims. And then the Buyer is out of luck.

    Again, that’s where the Nondisclosure Policy kicks in. And it’s important to note that the Seller must have TLPE insurance in place before the Buyer can seek this other coverage to protect themselves.

    It’s cheap and the Policy Limit can go to $20M, with a six-year policy period.

    When you have TLPE coverage in the deal, it’s a good idea to throw in a Nondisclosure Policy as well. Policies can be issued within 24 hours of submission…in conjunction with the TLPE Policy.

    As far as who pays, this is negotiable. But for many Sellers, it’s worth footing the bill to dissuade the Buyer from holding back a portion of their proceeds in escrow. The Buyers have the leverage here.

    I understand TLPE inside and out. As this new insurance product has rolled out, it is becoming a go-to for many of the smaller deals out there and something I’ve been specializing in.

    Please contact me, Patrick Stroth, for more information on TLPE and other M&A insurance options.

     

  • Sean Frank | An Expert Investor on Cloud-Based Infrastructure
    POSTED 8.10.22 M&A Masters Podcast

    Cloud-based infrastructure is one of the most rapidly expanding industries today…
    And this episode’s guest, Sean Frank, is an expert on it.

    As the founder of Cloud Equity Group, Sean invests in lower middle market companies in the web hosting and cloud-based infrastructure sectors.

    Read More >

  • Current Trends in M&A Add-Ons
    POSTED 8.3.22 M&A

    Globally, M&A activity so far has declined 23% in 2022 compared to 2021. Yes, that is a significant drop. But, as I wrote in a previous article, you must consider that 2021 was a historic record-breaking year of deal-making. So, in a sense, 2022 has been somewhat of a return to normal.

    That said, while worldwide M&A activity has declined, what we’ve seen in the U.S. is little or no decline in deal-making. It’s essentially “flat.”

    This is largely because of the increasingly common practice of purchasing “add-ons” instead of platform companies.
    Read More >