You’ve no doubt heard of the best-selling book from author Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable.
In it, Taleb denotes “black swan” events as those that are unexpected or unpredictable. Examples include the 9/11 terrorist attacks, World War I, the rise of the internet, and the fall of the Soviet Union.
However, despite the worldwide, devastating impact on society, economies, entire industries, healthcare infrastructure, and more, the COVID-19 pandemic is not a black swan.
Taleb himself says so, noting that many experts, including Bill Gates, who has closely studied and funded epidemic research, have long said a global pandemic like this happening was a matter of when, not if. Taleb says this is actually a “white swan.”
This is not a black swan, despite the tumultuous times we’ve had in the face of this crisis, including economic downturns, widespread unemployment, travel bans, and more. We won’t go into the details here as to how this might have been prevented or who holds the blame, if anyone.
We’re concerned with the results and what happens moving forward.
As far as COVID-19, as countries see decreasing cases and are exiting government-mandated lockdowns, we can now see we are at the beginning of the end.
Economic activity is set to return, as people go back to work and those businesses that survived, large and small, start up again.
As I wrote previously, expect M&A activity to resume, but in a different form due to impacts of this crisis. We’ll see:
This strong M&A market is also a result of previously existing conditions, such as:
This is a recipe for PE firms to come in and find low-cost but high-quality gems to invest in and turn a profit, in many cases, faster than pre-COVID-19. Private Equity has the capital, resources, and expertise to take on the challenge of many struggling companies out there right now.
This is not to say that the economy will not experience a downturn due to the pandemic. Its impact will be felt in many sectors for a long time, including companies, investors, and consumers.
But there is opportunity. And this is very different than the 2008 Crash, at which time M&A activity slowed considerably for the most part.
As Sander Zagzebski, partner with Greenspoon Marder LLP, put it in a recent article for C-Suite Quarterly:
“Shrewd dealmakers will sense opportunities by purchasing discounted debt and providing debtor-in-possession financing packages. Smaller debtors may seek to take advantage of the new Subchapter V Small Business Debtor Reorganization provisions, which as drafted provide a more streamlined process for debtors with less than $2.725M in debt. As part of the recently passed CARES Act, that limit was increased to $7.5M for the next year.”
Sander likens this opportunity to that which a select few savvy investors took advantage of in the 2008 crisis.
“While capital market and traditional M&A transactions slowed significantly during the financial crisis, distressed investors became presented with numerous attractive options. Howard Marks and Bruce Karsh at Oaktree Capital were later lauded by The New York Times for their timely $6B bet on corporate debt during the height of the financial crisis, as was Leonard Green & Partners for its timely $425M minority investment in Whole Foods.”
“Overshadowed in the media by high-profile, pre-crisis bets on the overheated real estate market by the investors profiled in Michael Lewis’ 2010 book The Big Short and others, these blood-in-the-streets bets at the bottom of the market later proved to be enormously profitable.”
There are similar prospective valuable deals out there now… for those that can recognize them.
As Sander writes:
“Many investors are starting to view the world today as Karsh viewed it in 2008 and are seeking those unique buying opportunities.”
Still, there is plenty of uncertainty surrounding deal-making, as future impacts of the ongoing pandemic are unknown. Watch for Representations and Warranty (R&W) Insurance, which had already been enjoying a renaissance amongst lower middle market deals, to be a strong presence in deals going forward.
To discuss R&W coverage with a broker with hands-on experience with this product, I invite you to contact me, Patrick Stroth, at firstname.lastname@example.org.
Many people are concerned about the state of M&A when we get on the other side of the COVID-19 pandemic. Understandable. But as I pointed out in my previous article, “No Significant Drop in M&A Activity During This Recession,” I don’t believe M&A activity will be going south, post-crisis due to:
Now, a new report from Deloitte has shed some new light on the situation and reconfirmed my insights.
In “Opportunities for Private Equity Post-COVID-19” they discuss how in these uncertain times and ongoing economic crisis, the organizations ideally positioned to help out the economy and business, and even countries get back on their feet, are PE firms.
They have plenty of cash, and they are willing to go the Island of Misfit Toys, so to speak, and find gems to invest in. They have the patience to get in at a low cost and turn a company around.
PE firms are unlike other investors in that right now, they have the capital, resources, and occupational experience to turn struggling companies into high flyers. That’s simply what PE firms do in good times… and have a unique advantage in these bad times to keep working their magic.
A lot has been said in the poplar press about how PE firms swoop in on broken down companies then turn around and sell them for 10 times more. The perception is that they pulled a fast one or took advantage.
I think this misconception goes back to the movie Pretty Woman and other depictions in pop culture. In that movie, Richard Gere plays an investment banker who buys companies and sells them off in parts after loading them with debt… in the process ruining peoples’ lives.
Contrary to popular opinion, that’s NOT what PE’s do. They’re closer to house-flippers. They’re turnaround specialists. They do the good work of creating value where there was none before.
In this crisis, I believe PE firms will be the heroes and instrumental to a broader economic turnaround. They do good work, and it’s needed now more than ever. And nobody else is going to do it, with Strategic Buyers biding their time and holding on to their cash.
Companies struggling right now, and there are a lot of them, should not expect a government bailout. Most companies, even if they secure some of those funds, will not get what they need to move forward.
Another issue is that employees are getting laid off and collecting more in unemployment and other benefits… and that employers are concerned they won’t be able to get their experienced people back.
These are certainly uncertain times, and I think the attitude you should have moving forward is one espoused by Warren Buffett:
“Be fearful when others are greedy and greedy when others are fearful.”
We can also base this assumption of the rise in M&A activity tied to PE firms by looking to the past, specifically to the economic crisis of 2007 and 2008.
Back then, PE firms, along with other investors, sat on the sidelines. There were many opportunities that were not taken advantage of.
They’ve learned their lesson, and this time they will be aggressive in going after the low hanging fruit. PE firms are generally well ahead of public opinion on these sorts of things. The smart money gets in early, which, in this case, gives them a nice window in the next two years to get some great deals.
Lower middle market companies, those most at risk and vulnerable in this downturn, in particular will see lots of activity. These smaller businesses are easiest to make a quick investment in, without many other suitors.
For investors buying distressed assets, Representations and Warranty (R&W) insurance becomes more important than ever. This coverage makes deals clear, smoother, and more affordable.
For Sellers, not having the burden of a large escrow is a key benefit when they need cash to do other things.
For Buyers, R&W insurance is a “back stop” for risk. If they are buying assets, they won’t get a remedy otherwise if there is an issue post-closing and the escrow is not enough to cover the loss. With R&W coverage you get certainty of collection if there is a breach.
The great news is that R&W policies are now at the most favorable pricing they’ve ever been, and deal sizes as low as $15 million are eligible.
If you’d like to discuss coverage, pricing, or market conditions, please contact me, Patrick Stroth, at email@example.com.
When it comes to M&A, lower middle market companies often get overlooked and overcharged by big institutions. But Cascadia Capital is an investment bank that specializes in working with this underserved market.
Chairman and CEO Michael Butler explains how they help “stage the house” for a company about to go to market, including the financial, legal, and operational aspects, among others.
We also talk about Michael’s unique take on the current financial crisis, including the key differences between what’s happening today and what happened in the Great Recession of 2008 and 2009. He says he’s optimistic about a quick turnaround… including a significant increase in M&A activity this summer.
We go into depth on the reason for that pickup, as well as…
Patrick Stroth: Hello there. I’m Patrick. 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 Michael Butler, Chairman and CEO of the investment banking firm Cascadia Capital based in Seattle.
Cascadia Capital is a team of transparent, client-focused, trusted advisors with deep expertise in a broad range of industries. Michael came to my attention following an article he posted in response to the coronavirus pandemic just a week ago, with the title “Opportunity Does Not Go Away, It Only Changes Form.” We’ll link to this in our show notes. Michael, thanks for joining me today. Welcome to the show.
Michael Butler: Thank you, Patrick. Thank you for having me.
Patrick: Before we get into Cascadia Capital and the article you posted, let’s give our clients a little bit of context. Tell us how you got to this part in your career.
Michael: Sure, Patrick. I’m a Seattle native. I went to the University of Washington, then went out to Philadelphia to get my MBA at the Wharton School. And then after that, went up to Wall Street and worked on Wall Street for eighteen years with Lehman Brothers and Morgan Stanley. And then in 1999, with two small kids in New York City and a wife who didn’t want to raise a family in the city, moved back to Seattle and co-founded Cascadia Capital.
Again, that was in the middle of 1999. All was good for about a year, year-and-a-half and then we hit the internet bubble burst. So not good timing on my part, but I think you’ve got to make the leap at some point, and I did so in 1999.
Patrick: Well, at least now you and I can both say that we’ve gone through three… Now, this is our third real big shock to the economy because we had the dot com issue there, then follow that with the banking crisis in 2008/2009, and the one that we’re going through here.
Michael: Yeah, I agree, we’ve seen a few. I think it makes it easier. You know, you’ve seen this movie before. And if you’ve seen the movie, you kind of know what’s coming next. You kind of have an idea of how the movie is going to end, and it enables you to be proactive and look at the opportunities rather than just focusing on the challenges. And that’s what we’re trying to do here.
Patrick: Yeah, I completely agree. I mean, that’s the thing is that, unlike some other people in the society right now, if you’ve gone through this, you know, the lights will go on. And so you have to have that in your mindset that this isn’t Armageddon and we’ve got a long way to go.
Now, tell me about Cascadia Capital. I always like finding out how you came up with the name. And then talk about what the focus is because you’re not agnostic being a generalist. You guys are very specific on a couple of specific areas.
Michael: Sure. So Kevin Cable and I co-founded Cascadia in 1999. We couldn’t decide whether to call it Cable and Butler or Butler and Cable. I bought a house on Cascadia Avenue in Seattle, Washington. And Cascadia is kind of the name for the region that encompasses Vancouver, BC, Portland, Seattle, and Boise.
And so I said to Kevin, look, maybe it’s a good omen that I moved to Cascadia Avenue. Why don’t we just call the firm Cascadia Capital? We thought that was a great idea. And that’s how we came up with the name. It was no brilliant thinking. We didn’t hire a, you know, marketing firm. It was kind of a coincidence of me moving to Cascadia Avenue and that being a name that just got to describe this region that we live in.
Patrick: It’s also helpful nobody took the name ahead of you.
Michael: Absolutely. Yeah, sometimes you got to be a little bit lucky. What Kevin and I originally tried to do was focus the firm exclusively on the Northwest. You know, our thesis was the Northwest was going to become a great region, and we were focused on the Cascadia region. That plan worked well for about fifteen months until the internet bubble burst.
And then we quickly realized we had to broaden our footprint and we became a national firm over the years. We also determined that the day of a generalist was going away and that you had to have domain expertise and really understand the industries you worked in to add value to your clients. So those were a couple of the big lessons we learned from the internet bubble burst.
Patrick: And your commitment, in terms of the sector of the industry that you’re looking at, in terms of size, is lower middle market, the middle market?
Michael: Yes, our client base tends to be at least 75% non-institutionally backed. So entrepreneur-owned businesses, family-owned businesses that typically have an enterprise value of between 50 to 500 million. I would say our sweet spot is 75 to 200 million. Again, we’ll do deals bigger than that and smaller than that, but that’s really the sweet spot for the companies we work with.
Patrick: I think that sector is a great sector and some people may think it’s on the larger side, some think it’s on the smaller side. I sincerely believe that that lower middle market, under $70 million transaction volume, is a vast and underserved market. And so the more people who find out about specialists such as Cascadia, I think it’s nothing but helpful because, unfortunately, a lot of these organizations, if they’re not doing M&A all the time, they’re not aware of organizations like yours.
And they make the mistake of defaulting to the big institutions and the brand names. And what ends up happening is they get underserved. They get overlooked. And they also get overcharged. And a lot of times, there are solutions for the middle and lower middle market that are out there that the big institutions just don’t provide.
And it’s in the interest of the lower middle market members to really find out the specialists like yourself because you’ve got solutions that are beyond the bandwidth of the larger organizations that would alternatively just go ahead and pull out some stuff off the shelf canned product for them because they just don’t have the bandwidth to handle that one service.
Michael: I completely agree, Patrick, what we found is, there’s a different set of circumstances that impact lower middle market companies compared to larger companies, you know, typically they don’t have the infrastructure that a larger company will have. They might not have the CFO or the processes or procedures.
So when we work with a company, a lot of times it takes months and months to get them ready to go to market because we have to help them think through their infrastructure and their people and their processes to kind of get them ready to be able to go to market. That takes a lot of patience.
It takes experience. Having done it before, I think the larger firms just don’t have a business model that allows them to spend that amount of time with a company.
Patrick: Give us a couple examples of what you did with clients like that where you literally have a face to house before it went on the market.
Michael: Yeah, exactly. So what we try to do is put together a team to help a company. And that means bringing in the proper accounting firm, it means bringing in at least a temporary CFO, if they don’t have a CFO that is up for the task. And it also means bringing in a good law firm.
So it’s going through the various contracts that they have with suppliers or customers to make sure that those contracts are in a form that will be acceptable to a buyer. It’s making sure that they have the right checks and balances in their financial function. And robust books that can withstand the diligence process don’t need to go through.
It means making sure that their strategy, their operations, and their financials all tick and tie, right, that the financial model reflects the operational model that reflects the strategic direction of the company. And so after you’ve done this, you know, the number of times we’ve done it, you kind of know where to look for issues. And once we find those issues, you know, we know who to bring in or how to help them solve the problem.
Patrick: That avoids surprises during the diligence phase or during the negotiations, doesn’t it?
Michael: Exactly. What we tell our clients is, you want to take as much time as needed to get ready to go to market. Because if you go into the market and you’re in diligence and the buyer finds a problem, they’re then going to look for the next problem, right? It lessens their confidence in the company being a clean company, so to speak.
So we spent a lot of time making sure clients can withstand the diligence process. The other thing we find, Patrick, with our client base is a lot of them have not done the personal financial planning that they need to do to minimize taxes or to maximize, after tax, proceeds.
And so we also recommend that they work with, you know, a financial advisor or personal attorney to make sure that their own personal house is in shape. So that when they go through this process, they can maximize the after tax return to them. And that might mean gifting shares to their children, it might mean setting up trusts. And that all takes time to do.
Patrick: That’s nice because you’re caring about the people, not just making sure the deal gets done and then that’s, the owner or founder, that’s their business. We’re not going to touch that. I mean, that could be everything.
Michael: Yes, it absolutely can be. The amount that an owner of a business can save by having the right tax structure in place is immense. And these clients become our friends. We realize that, in many instances, this is somebody’s life’s work. Or it’s several generations of their life’s work.
And we take that pretty seriously. And so we make sure that we spend the time to get to know them, understand the objectives, and make sure that they’re well-positioned to maximize the returns for what for many is the biggest financial decision of their life.
Patrick: I always think of M&A, ever since I got into it a few years back, was I always thought about the people aspect myself, just as you do, where it’s not company A buying company B or merging with company B. It is one group of people deciding to trust and combine forces with another group of people.
And in an ideal situation, the new whole is greater than the sum of its parts. That’s where it’s “win win win” out there, and it comes down to trust when it comes down to people.
Michael: It always does. Every time.
Patrick: Yeah. With this, you mentioned the financial impact for owners. As an insurance person, we always look also just on how can we reduce mitigate risk which is very, very boring. But it can be the key to having a successfully executed deal.
And that’s where we ensure the transaction itself through rep and warranty insurance. A product’s been out there for years then very, very popular recently. If you could–good, better, and different–share with us any experiences you’ve had with rep and warranty on your deals.
Michael: So we look at reps and warranties as the new quality of earnings. So about three, four years ago, buyers demanded quality of earnings reports, which are basically a Good Housekeeping Seal of Approval from an accounting firm around a company’s finances, and they become just part of the transaction.
Almost every deal we work on has a quality of earnings. And what it does is it gives the buyer comfort in the seller’s numbers. And it’s a risk mitigation strategy for the buyer. And it’s something that every seller needs to do. We think rep and warranty insurance is on the same trend. We think really every deal is going to have rep and warranty insurance, the cost-benefit is immense.
The cost is really minimal. When you think about the benefits that the insurance provides, it means less money has to go into escrow. That means more goes to the seller on day one, it allows the buyer to have comfort in case something goes wrong because they have the insurance.
And so it’s going to become, in our view, standard for every deal we work on. It makes so much sense. It just makes too much sense not to become the case and it, you know, again, from a cost-benefit analysis it’s, in our opinion, a no-brainer.
Patrick: Now as we record this, we’re hopefully, you know, who knows from week-to-week, but we’re hopefully on the downside of the shelter-in-place environment with COVID-19. And that we are, you know, with the term of your article there, you know, there’s going to be an end to this and we’re going to go forward.
Just to put this in a little bit of context for folks, in your article, you talk about the comparison contrast between the great banking recession of 2009 and the current environment we’re in right now, and you have a unique take on it. So if you could summarize to share that with us. I appreciate that.
Michael: Yeah, there are similarities, but there are a lot of dissimilarities. The Great Recession of 2008 and 2009 was due to financial weakness in the mortgage market, in the high yield market, and so there was instability in the financial system, which caused the recession.
The situation today is different. The government essentially put a healthy economy on hold. And it was a choice the government made, not because of any underlying financial weakness, but because of a health issue. So our view is that there’s an underlying strength in the economy that will begin to show once we get through the quarantine, and even in the last week, we’re starting to see what we call some green shoots.
Deals are moving along a little bit better than they were three weeks ago. We’re starting to see companies looking to potentially come to market in the next four to eight weeks. We have a couple new deals that are in market and received good bids. So I think there’s some green shoots.
The biggest difference I see between 2008 and 2009 and the situation we’re in today is this feels like a movie that’s on fast forward, everything seems to be happening so much quicker today than it did in 2008/2009 or in 2001 through 2003 when we had the internet bubble burst, you know, it took time for those downturns to kind of cycle through.
And today, what we’re seeing is, the things we saw that took six to twelve months to happen, and the last two downturns are happening and, you know, six weeks in this downturn, and it just feels like it’s on fast forward. So we’re going to move through this one, in our view, a lot more quickly than we did the last two.
Patrick: Well, that’s the type of message, that optimistic message for a quick turnaround that we all want to hear and it’s not, you know, Pollyanna. This is fairly realistic, but, Michael, back, we spoke about what’s going to happen, when this does end, and it will. And you characterize the coming period as “July is the new January.” Tell us what you mean by that?
Michael: Yeah, so I didn’t coin that. I can’t take credit. We are hearing that in the marketplace from investors and buyers. And there’s a view among investors and buyers that by the time July rolls around, things will begin to be back to normal, and then activity will peak and pick up.
Typically, what you see each year is just kind of a rush to look at new deals in January because the period from Thanksgiving to year-end tends to be very slow. People put down their pencils, they don’t really look at new deals. So you get a lot of pent-up demand in January because people haven’t really done much the prior six to seven weeks.
And I think the view is by July, the deal market will open up and buyers and investors will have pent-up demand because they haven’t done a lot of deals over the preceding two to three months. So the thing we keep hearing from, again, investors and buyers is that July will be the new January, meaning there’ll be a lot of activity, a lot of pent-up demand. And you’ll start to see the log jam break.
Patrick: And you’re open for business and ready for anything that’s coming. Even now, you’re not gonna wait till July.
Michael: No. So, you know, there’s a lot of things you can do. Right now, you can help companies think through strategy. You can help them think through operations. We have a couple of companies that were looking to go to market in March, and we advised them not to go to market, and now they’re looking to be buyers.
They’re saying, look, this might be a great opportunity for me to buy some of my struggling competitors, integrate them, and go to market, you know, in a year with a business that’s one-and-a-half times as big then as it currently is now. And so there’s a lot you could be doing during this downturn to prep and get ready for the expected upturn.
Patrick: Very, very helpful. Michael, how can our listeners find you?
Michael: So I’m available on my cell which is (917) 865-0962. And the email which is firstname.lastname@example.org.
Patrick: Michael, it’s been very informative. And I really appreciate the optimistic tone we have here just because I’m getting a little tired of seeing all the COVID-19 warning emails I’m getting from all the law firms. So every now and then it’s nice to have a nice, sunny, happy report.
Michael: Well, I can say I’m a realistic optimist. Let’s hope I’m right.
Patrick: You and me both. Thank you very much.
Michael: Thank you very much, Patrick.