This episode was originally published on August 29, 2018.
In an era when few companies go IPO and there are even fewer unicorns, M&A is more popular than ever, says Mihir Jobalia, a veteran of KPMG’s Silicon Valley operation.
In fact, among VC-backed companies in the last 10 to 15 years, he estimates that more than 90% exit through M&A. And business in the last few years has been especially good.
We dive deep into what makes the current environment so appealing to M&A, who the big players are, and best practices for companies hoping to exit with this strategy.
Check out the interview to find out…
Patrick Stroth: Hello there, I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders, and their investors. Today I’m joined by Mihir Jobalia, Managing Director of KPMG’s corporate finance technology practice here in Silicon Valley, where he serves as an advisor to technology clients with a focus on both M&A and private capital raises.
Mihir, thanks for joining us today.
Mihir Jobalia: Patrick, thank you. Thank you for having me. I appreciate the opportunity to speak with you.
Patrick Stroth: Well, to give everybody here a little context. Your background is extensive educationally in chemical engineering. Why don’t you tell us how you got from chemical engineering to this point in your career, where you’re advising on major M&A transactions in the tech sector.
Mihir Jobalia: Yeah, great. So, my background … I’m an engineer by training. I have an undergraduate and a graduate degree in chemical engineering. Worked as an engineer for a few years and then I got bored and went back to business school at the University of Chicago, and majored in finance accounting and strategy. And then coming out of business school I went into investment banking. And have been an investment banker now for about 20 years. I spent my entire career working with tech companies on raising capital and advising companies on M&A.
And have worked with companies, both public and private companies, on raising capital and have advised companies on both mergers and acquisitions. But I think the engineering background does come in helpful because I have an understanding of what the companies do in terms of their products as well as the technical know-how that the founders have, or the teams have. And also understanding the markets, understanding the end markets of where these products go.
And so it’s good to have a technical background, especially working with technology companies. And Silicon Valley is a great place to be. So in our business it’s good to be at the epicenter of where things happen. I mean you have a number of large companies here who are very active in M&A … companies like Google, Oracle, Facebook, Microsoft, etc. But you also have a fantastic ecosystem here in Silicon Valley where 60% of the venture capital dollars on the planet get invested in the Silicon Valley, San Francisco Bay Area.
So there are a lot of new companies that get created here. There’s a lot of technical talent, managerial talent capital available. And so there’s a very good ecosystem for companies that get created or [inaudible 00:03:13]. I’ve seen a lot of these companies become very large companies. So that’s a quick background on myself and type of transactions I’ve worked on, Patrick.
Patrick Stroth: Give us some perspective for KPMG in general and your team in particular, here. In terms of number of deals that you guys have worked in the last, I don’t know, 12 or 18 months.
Mihir Jobalia: Yeah, I shared with you a little bit of background on our practice. We are the most active advisor globally in the middle market. So KPMG is a firm … in the last five years we have closed 2000-plus deals, which makes us the most active firm globally. So year in and year out we’re doing about 400-plus deals a year, all in the middle market. So what does that mean? M&A deals generally between 25 million to 5 hundred million in enterprise value. We also do private placements, generally 15 million and up in capital. And we are very active in the market. So our clients tend to be venture-backed companies, private equity-backed companies, founder-owned companies, and smart [inaudible 00:04:19] public companies. If you look at … just in tech for example, this is kind of where I focus, a bulk of the transactions, 80+% of the transactions in deck are below $250 million.
So I think that there’s a lot of companies where they raise some capital and ultimately the outcome is either M&A or there is additional capital. That’s … the market that we play in is actually the most active part of the market.
Patrick Stroth: Yeah. You and I spoke awhile back where the billion dollar deals get the headlines, then a few years ago it was a deal that would be a billion or two billion. Now, there are deals in the 50s and $30 billion range that are the ones that make the headlines, but far more frequently you’ve got just a great array of transactions down that people don’t hear about, but they’re in the $100 million to $250 million M&A deals.
Mihir Jobalia: Yeah, I think you’re right. So, I think if you look at venture-backed companies over the last, call it 10 or 15 years, if you look at the data for ultimately what happens to these companies, 90+% of these companies exit through M&A. And you hear of the occasional IPO which gets a lot of press, and for all the right reasons. But the bar to go public has become much higher. The size requirement from public institutional investors to have a company go public has become much higher. So it takes … Back in 1990-2000 timeframe companies would get to 5 to 6 million in quarterly revenues and file an S-1 for a $25, $30 million IPO. Today, in today’s world, the average revenues for a company before they file an S-1 is about $130 million. So for a company to go from zero to $130 million, it generally takes more than 10 years, and that’s with good growth. So a lot of investors who have come in early in those companies generally get end of life by the time even a company does go public. And the reality is, an IPO is really a financing event, it’s really not a liquidity event for shareholders and management.
So I think we have been in a very strong M&A market, and that kind of continues. We’ve had a nine-year bull run in M&A, and the market continues to be very active.
Patrick Stroth: You don’t see any slowdown in it?
Mihir Jobalia: We had a little bit of a slowdown last year. Just to put some numbers, just so that your listeners understand where we have been … so the low point in the market was 2009 in terms of global M&A activity. In 2009, we had $2.4 trillion of M&A. Last year we had $3.4 trillion of M&A. The peak of the market was in 2015, where we had 4.5 trillion of M&A. So in terms of the market we’ve a had a very strong market over a nine-year period now. This year, just in the first quarter, we had over a trillion dollars of M&A activity, and we will likely cross 2016 numbers this year, so it will be just shy of 2015. But we are in a very, very strong M&A market. If you ask me as to why are we in a very strong market, fundamentally we have a very strong economy. You look at all the public market indices, they’ve all done extremely well. So you have public companies that are very … they’re using their balance sheet, they’re using their stock.
We are still in a record-low interest rate environment, so you have public companies who are generating a lot of cash, and they’re not collecting a lot of interest on their cash that they have on their balance sheets, so you have also investor activism, where public investors are … they want to see management put the capital to use, or giving it back to shareholders. So you have sort of an environment where public companies are being asked more about growth, and they’re certainly being very active in the market. Now on top of that, private equity firms are sitting on a record amount of cash. If you look over the last … even five years, private equity firms have raised so much capital, they’re putting that capital to work in terms of acquiring companies, and also doing a number of add-on acquisitions. So private equity firms are being super active in this market. In fact, last year, of all the acquisitions done by private equity firms, about two-thirds of those acquisitions were add-ons to their portfolio companies, and this year we are on track to see private equity firms being … having a record year in terms of new investment. So I think it is a very … there are a lot of macro factors which are driving this M&A market, but it certainly doesn’t seem to be slowing down any time soon.
Patrick Stroth: Well I think the facts you mentioned, they’re all right now sustainable, and that’s unlike some of the past bubble periods where, I just can remember when we used to write D&O policies for companies going IPO, a lot of times the drive during the dotcom era for going public was, you wanted to do it to show your relevance in the marketplace. You weren’t doing it for any other reason than, there was a hint of vanity, but it was, “Well, other people are doing it, I have to do it to keep pace.” And that’s not a sustainable model, whereas these factors are coming in because you’ve got capital coming from a lot of different areas. And, particularly where you’ve got large funds that are holding on to portfolio companies for a period of time, and as you mentioned before, they may not go public. And so what are you going to do with these … you know, they’re profitable investments, they are good, but they’re not going to deliver the return that you’re looking for. So sometimes it’s time to spin those off and look for other opportunities. Well, if you’re spinning them off, that means somebody has to buy them.
Mihir Jobalia: Yeah, I think … let me bifurcate the discussion by saying, look, there are companies that will come out of this where … there will be some phenomenal public companies that will come out of this timeframe. You have a number of great companies that are being created that are currently private, I mean companies like an Uber, or an Airbnb, or a Houzz, or there are a number of companies which are … they are changing the incumbent market, where, whether it’s taxicabs, or you have the real estate market, or you have the home remodeling market, or construction, there’s a number of markets which are getting completely turned on their heads, so you’re going to see some amazing companies that will come out of this, but let me just give you a stat which will kind of illustrate the point. We have a 160-plus unicorns, where these companies have raised capital at north of a billion dollars of valuation. In the last 10 years, if you look at private companies, only 55 private companies have been sold for north of a billion dollars, and so that’s about five-and-a-half transactions a year of north of a billion dollars. So if you look at these companies of a 160-plus unicorns, and there are only five-and-a-half transactions a year, of north of a billion dollars of private companies, you technically have inventory for over the next 30 years.
So a lot of these companies are predicated on going public, and some of them absolutely will, because they’re so big nobody can buy them, like an Uber or an Airbnb, for example, they’re just so big, the valuations are so large, that they pretty much have to go public, but there are a lot of these companies which are not going to go public, and I think there’s going to be, for the companies that perform, there’s certainly going to be some nice exits through M&A, but you … investors are also being very cautious on saying a company needs to have a path to being profitable. So investors want to certainly see growth, but also want to have some financial discipline. And I think that’s probably the biggest change, is you’re seeing companies are much bigger, but also have a lot more financial discipline in this market than companies that you saw in the ‘99-2000 timeframe.
Patrick Stroth: Yeah that was one thing that was absolutely a characteristic of the dotcom era, was increased burn rates, and they weren’t deploying the capital very efficiently. And I completely agree with you there. Another reason for sustainability for successful companies. For your advisory services, one of our technology clients out there, if they’re building, at what point would they be considering an M&A transaction where they’d seek out an advisor like you?
Mihir Jobalia: I think for us, we generally want to see companies where they have 10 million or so in trailing revenues, we generally … that’s the point where we generally get engaged with clients in terms of helping them on M&A and/or private placements. Have we taken companies which are slightly smaller than that? Yes, but not too much smaller. But I think that’s kind of the bare minimum in terms of the types of companies that we get engaged with. I think it’s more … more than the revenue, it’s more about A, what are the team like, is it an all-star team? B, how big is the market? If you have a big market it forgives a lot of sins. C, is this a company that has a proven product or services, in terms of have they throughout the business model been able to sell the products into customers who have bought and have kicked the tires, and ultimately deployed the product? And four, ultimately what is the business model, and the financial model? Is it a one-time sale, or is there any sort of recurring revenues? I think we kind of dig into all of those things. There’s no one factor, but you look at a company from all these sort of lens and have a point of view as to, is this a company that ultimately is going to be attractive to buyers and/or investors? Because we take on transactions that we can close.
Patrick Stroth: Okay. Well, and you do a high number of them. Is there any key from your experience, what separates a successful M&A transaction from an unsuccessful one, whether you’re advising on the buy side or the sell side?
Mihir Jobalia: Yeah. What I would say is that first of all, companies that are thinking about potentially having an exit, they start preparing for an exit several years in advance of an exit. And so it’s very much a thoughtful process of, okay, who are the most likely buyers in the space, or around our space, and do we know them? Do we know … do we have visibility into the C-level executives at those companies where they know us, and do we have the right partnerships, do we have revenue-sharing partnerships with the right companies? And so … because it’s much easier for a company to see some revenue fraction over time where there’s a relationship built between a seller and a buyer, versus PowerPoint slides on what the synergies are. So I think the powerful companies actually think about who the right buyers are and start building those relationships much in advance of a transaction, generally at least two or so years prior to a transaction, they start thinking about biz dev, or dev type relationships with the right sort of companies in the ecosystem.
Number two, also getting a right alignment with your investors. I think there are a lot of times where you have investors who have certain expectations of value from a company, and you want to make sure you’re aligned with your investors and keeping them informed in terms of where the company is going and how you can benefit from being part of a larger strategic, or having another sort of private equity firm who can be involved in the company. So I think getting … I would say two things. Number one, building visibility with the right sort of strategics in the ecosystem can be very helpful from a business standpoint, but also building the right relationships, and building trust. And number two, getting alignment with your investor base.
Patrick Stroth: I think both of those are absolutely critical. And I think also because when you think mergers and acquisitions, people on the outside think, well company A is buying company B, and it’s actually people, where it is the executive management team or core dev team of company A has a relationship or an understanding with the owners, founders, or the all-stars of their target company, and they have to think about working together, or those types of issues, rather than just the dollars and cents, and make sure it’s the right fit. Is that probably … what would you say would be your number one piece of advice that you would share with owners and founders out there that are thinking … you know, they’re on the back nine of their career, or they’re emerging and they’re at a point where they’re not going to be able to grow much more, and maybe have to start looking at a strategic partnership or something, what would your advice be to them?
Mihir Jobalia: I think … so number one I think you think about more growth than profitability. Companies, lot of private equity firms that we talked to, they’re interested in the rule of forty, so they look at a company and say, “Is the company growing at 20+% in revenue” … so let me explain the rule of forty. The rule of forty is investors, private equity firms want to see companies that have revenue, growth, plus the EBITDA margin added up to north of forty. So if a company is growing revenues at 20%, and has 20% EBITDA margin, that’s great, that’s the rule of forty. If a company is growing revenues at 40% and has 0% EBITDA margin, that’s fine, because you’re basically deploying all that EBITDA back into the company and growing revenues. If you have a business which is flat, so essentially 0% revenue growth, but you have 40% EBITDA margin, that’s fine, too, because you are a business where you are generating a significant amount of cash, and it’s a slow-growth or a no-growth market. So … and you want to see one of these two. But if you have a company which is growing at 0%, and has 0% EBITDA margin, that’s not going to be very attractive to private equity investors.
Now strategics are generally looking for a build versus buy kind of model where does it give them time-to-market, and also from a private company standpoint, if you think about, if we raise more capital, it’s going to take more stake dilution. And then we are also taking on operating risk to grow the business. And then with new capital comes a different perspective on ultimate time to an exit, because when a new investor comes in, and even if they are coming in in a minority role, they generally want to make three times their money in three years. So the ultimate price for an exit goes up quite dramatically, and the number of buyers shrinks. So I think you have … as a CEO, or a CFO, or an owner of a company, you have to be thinking about, is this the right type of business which requires an institutional investor? And all companies don’t necessarily fit the mold of an institutional investor. Remember, institutional investors are looking for companies that can go through hyper growth and ultimately have a good exit. And some businesses are well suited for that, others are not.
So I think you just have to find the right type of investor who can fit, who can match your ultimate objectives. But if you’re … to your question, if you’re in the back nine of your company, you want to … you’re to look at, is this a company where with a different balance sheet you can run the company differently? Is it a M&A strategy, because private equity firms want to acquire a company, but they don’t want to run the company just as-is, there’s a plan around how are we growing … going to grow the company faster? Is it a … is there enough market opportunity where with a new management team, a new owner can grow the business faster. And if there’s an opportunity like that, with organic growth and/or inorganic growth with acquisitions, to scale the company and get much bigger, ultimately improving margin, then there is a story there in terms of bringing in a … the right type of investor. But I think you’re … kind of think about what are the key things that you would … of how you would run the business differently with this strategic investor, or a buyer, and/or a private equity firm, to get interest.
Patrick Stroth: Well, and I would think that … yeah, that’s helpful. And I think engaging an advisor like you, would be step number one in organizing that process, and finding what are the goals, what are the fits. And because you’ve been involved with so many deals, you, I’m sure, have a lot more options available for them to think about than they could come up with themselves. Obviously. And so I think the value that’s brought there, in addition to, you would then also throughout the course of your services, you hold their hand and walk them all the way through the process. So it’s not just the overall strategy, it’s actually execution, correct?
Mihir Jobalia: Yeah. I would say, that having good advisors is critical to getting a good outcome. And I think it’s having good accountants, having good lawyers, having good bankers. Because you need to have good accountants to have your numbers in the … to be shown in the right way, whether they’re audited numbers or reviewed numbers. You need to have good counsel, so having a good lawyer, or a law firm, is going to be very helpful as you go through an M&A process, because there’s a lot of things that will come up during an M&A process where it’s important to have good counsel. And number three, having a banker or an M&A advisor to help you through the process is going to be really critical because A, generally you’re kind of heads-down focused on running the business, you want to have an advisor who has reach into strategics in the U.S., outside the U.S., private equity firms, what are the portfolio companies of the private equity firms, and then run a process to maximize value, valuation and terms. Because it … you want to make sure you are getting in front of the right parties to be able to tell the story to get the interest.
There are so many instances I can tell you over the last even 12 months, where when we talked to companies who thought company A, B, and C would be the right buyers, and ultimately there was a company completely out of left field who ended up being the buyer and ultimately was willing to pay the highest value for the business. So I would certainly, so certainly having advisors really helps getting a good outcome for the process. Also, at times these discussions and negotiations do get … do have some friction, so then it’s also good to have a buffer, whether it’s your law firm and/or your banker involved in having those hard discussions with your potential buyer, that you ultimately have to work with them. So that would be my advice in terms of getting your numbers in order before you even start a process, but then also making sure you have good lawyers and bankers to help you through the process, and they certainly should be able to deliver significant value for you in the process.
Patrick Stroth: Well, I couldn’t have said that any better myself. The only other add-on I would say to that is, because of your experience in this community, and it’s a tight community here in Silicon Valley, you can, for your clients, particularly on the sell side, you can parse out and segregate from really good active buyers and others that may just want to kick the tires and may not necessarily have the best intentions out there, and you know the good, the really good players in the community, versus others that may offer higher valuations but then the terms are not as favorable.
Mihir Jobalia: Yep. Yep, you got it.
Patrick Stroth: Yeah. Well, I’m sure-
Mihir Jobalia: I have to run, so I apologize if I may have to cut it short by a minute or two, but I have a client call that I need to take, but I really-
Patrick Stroth: I completely-
Mihir Jobalia: For setting this up, this has been certainly very helpful, and if there’s anything I can do to help, please let me know.
Patrick Stroth: Absolutely, thank you very much. Mihir, real quick, just how can our listeners reach you?
Mihir Jobalia: Yeah, they can reach me by email. It’s mjobalia, so m, j, o, b, a, l, i, a @ kpmg.com. I will repeat. M, j, o, b, a, l, i, a @ kpmg.com, or my phone 408-367-2850.
Patrick Stroth: Mihir Jobalia, of KPMG, thank you very much.
Mihir Jobalia: Thank you, take care.