Insights

  • Richard Parker | An Inside Look at Sell-Side M&A
    POSTED 11.17.22 M&A, M&A Masters Podcast

    The sell-side of M&A brings unique challenges and opportunities. In this episode, I’m joined by Richard Parker of Roy Street Advisors for an inside look at a sell-side firm.
    Read More >

  • 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 >

  • Alistair McBride | How to win your deal-by building trust
    POSTED 7.6.22 M&A Masters Podcast

    You might think of M&A as a zero-sum game…

    But that’s where many business owners go wrong.

    It might surprise you to hear that building trust with the opposing side is the key to securing your clean exit.

    This episode’s guest, Alistair McBride, coaches business owners in the fine art of negotiating M&A deals. 

    Alistair has seen deals succeed when business owners treat their opponents like their ally.

    He calls this “the psychological edge of negotiation.”

    In today’s episode, we discuss how you can use this idea to win over the other side and sell them your vision—so you can both close with maximum value.
    Read More >

  • A Look Back at 2022 Q1 M&A Activity
    POSTED 6.9.22 M&A

    As we exit the first quarter of 2022, all the buzz is around the slowdown in M&A activity.

    It’s true that deal activity in the beginning of 2022 is a drop from Q4 2021, as well as a drop compared with Q3, Q2, and Q1 of 2021 because there was so much pent-up activity as pandemic closures waned.
    Read More >

  • A New Trend in M&A Insurance You Should Know About
    POSTED 4.26.22 M&A

    In this era of sky-high valuations, PE firms seeking inorganic growth are increasingly looking at an alternative to acquiring fully built out platform companies.

    The strategy is to buy a platform that is not fully built out yet and available for a lower price and then “add on” other small companies. Not only are these acquisitions cheaper, but they are also easier to transition into the platform, which helps accelerate growth.

    This trend has also led to increasing adoption of two unique M&A insurance products that have been available for a couple of years but were not widely used until now.

    More on that in a moment. But first, why are valuations so high?

    Well, 2021 was a banner year in M&A, with 8,624 deals with a combined value of $1.2 trillion. That’s 50% above the previous record for deal value in a single year.

    What brought about all those deals? As Pitchbook in the 2021 US PE Breakdown:

    “GPs were motivated by the availability of debt, the wave of sellers coming to market to avoid anticipated tax hikes, and the urge to deploy capital quickly in order to return to the fundraising market. Many industries, if not most, experienced intense competition for deals as a result, and multiples elevated to 2019 levels or higher in 2021.”

    On other words, it’s a seller’s market, with intense competition for target companies pushing prices higher.

    A compelling trend has emerged out of all, says the Pitchbook report:

    “The current deal climate has been particularly conducive for buy-and-build strategies, and add-ons as a proportion of the number of total US buyouts reached an all-time high of 72.8%. During the market dislocation in 2020, firms had turned to add-on dealmaking to continue deploying capital with diminished risk, because add-ons are typically smaller deals and the GP has a firm grasp on its platform.”

    As I’ve written before, PE firms these days use Representations and Warranty (R&W) coverage to protect their deals as a matter of course. It’s become standard. So, it’s no surprise that they’ve sought out similar insurance products when doing add-on acquisitions.

    Add-On Insurance

    For transactions under $20M in deal value, PE firms use Transaction Liability Private Enterprise (TLPE) insurance. For example, I recently brokered TLPE coverage for a deal in which a sports apparel manufacturer bought a high-performance glove wholesaler for under $2M. The process took two days and cost just $20,000.

    By having this TLPE coverage in place, the Seller was able to reduce their holdback from $140,000 to $14,000— matching the policy retention.  The standard retention level for TLPE is  1% of enterprise value or $10,000, whichever is higher. Compared to the usual escrow or holdback of 10% of purchase price, no wonder TLPE is so popular.

    As this manufacturer looks at other add-ons, they will again look to be covered by TLPE insurance, which offers six-year policy periods with a limit that is 100% of enterprise value. TLPE isn’t just for Sellers. Now Buyers can be named as Loss Payee in a TLPE policy which ensures faster collection from covered losses.

    What about strategies where the planned add-ons are expected to be above the $20M TLPE threshold? CFC Underwriting has created an innovative coverage called a Portfolio Policy where an initial portfolio platform is underwritten and insured by CFC consistent with a standard R&W policy.  The Portfolio Policy can grow as companies are added to the platform at a discount.

    Under the Portfolio Policy, R&W coverage is arranged for the PE’s platform investment.   As add-ons are brought in, the Portfolio Policy is amended to add new limits for each new entity brought on board. Each new Limit is independent of the other acquired entity Limits, so there’s no dilution as companies scale.

    The thinking is that the Underwriters who underwrote the original platform acquisition will be familiar enough that it will save time and money on the underwriting process (lower UW fees and discounted premium rates.)

    They can see how the new add-ons fit on the platform and will understand the investment theory of the PE firm making the decision to acquire the add-on. In other words, they are already familiar with the key players and aren’t coming at this fresh.

    With familiarity comes comfort and Underwriters can add new companies to a platform for a fraction of the underwriting fee because they’ve already done most of the legwork. Considering the increasing costs for R&W, a scalable product should be a welcome alternative. Another perk: processing time will be cut down as well, with the underwriting call cut in half at least.

    If a PE firm is going into an acquisition and knows upfront that add-ons will be bought, the Portfolio Policy is the correct route.

    Otherwise, they should go with traditional R&W insurance for the platform. For add-ons they could go with another R&W policy if the enterprise value of the add-on is above $20M. If it is lower than $20M, TLPE is the way to go.

    When seeking out this specialized and relatively new M&A insurance, it’s best to reach out to an insurance broker experienced in this type of coverage

    I’m happy to help. You can contact me here at pstroth@rubiconins.com.

  • Laurin Parthemos | Beyond the Dress Code: The Outgrowth of Culture in an Organization
    POSTED 2.8.22 M&A Masters Podcast

    On this week’s episode of M&A Masters, we sit down with Laurin Parthemos to talk about culture. Laurin is a Principal at Kotter, a company named after Dr. John Kotter, the world’s foremost change expert. Kotter’s approach to merger & acquisition integration focuses on culture and people first.

    Laurin says, “Culture is more and more seen as that differentiator within an industry to say we have a strong culture where people want to work.” 

    Listen as she walks us through:

    • Three ways to acknowledge (and counter) the survive or thrive mindset of change and help an organization move forward 
    • The key to the path forward when integrating organizations with varying cultures—she’ll share a case study of the positive results they achieved (with long-time rival companies) 
    • The monumental shift in the talent pool—what’s behind it 
    • One of the most overlooked things most miss when planning integration and catalysts for forward momentum
    • And much more

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there. I’m Patrick Stroth, trusted authority in executive and transactional liability, and President of Rubicon M&A Insurance Services. Now a proud member of the Liberty Company Insurance Broker Network. 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 Laurin Parthemos, Principal of Kotter. With offices on both coasts, Kotter helps organizations mobilize their people to achieve unimaginable results at unprecedented speeds. And I gotta tell you it for a marketing thing, that’s a lot to unpack in one sentence. So there’s a very efficient intro right there. Laurin, welcome to M&A Masters. Thanks for joining me today.

    Laurin Parthemos: Yeah, thanks so much for having me. 

    Patrick: Now, before we get into Kotter, which is a major consulting firm at the forefront of change. Let’s just start with you. How did you get to this point your career?

    Laurin: Absolutely. So I like to say I kind of grew up in the banking industry. So I started my career off in one of those typical but no longer really exist big training programs, working on the lending side. Transitioned into M&A myself doing fundraising for startups, then working with the tier one investment banks, all their processes and operations and how to actually optimize and be efficient. And really, throughout my entire time, through each and every one of those phases within the industry, I really just found myself scratching my head as to why everything was so KPI focused and why things weren’t working, and really leaning on my previous role. 

    And what I was doing back in my college days, which was being a sailing coach, and really trying to motivate people and teaching people how to continue going, despite obstacles that you’re seeing. And I really realized that that human element in terms of change, and how you’re dealing with the day to day is just missing in so many organizations. And it’s that unpredictable factor that really can make or break an organization. So when I was looking for my next opportunity, I came across Kotter and that light bulb moment happened, where I just realized, oh, my gosh, I’m not the only one who thinks that. 

    And not only is there a whole body of work behind this, but it’s operationalized. And it’s actually out in the industry. And it’s not just theories talking about potential research, but it’s actually happening in the real world. So I’d say the short and sweet is that I just kind of was trying to find my home in terms of people who understood that change isn’t just about financial success metrics, that if you don’t have that integrated body of work underneath it, that takes into consideration all factors, then you’re not gonna be successful.

    Patrick: Well, I think that change is at the core of M&A. Alright, and the objective with a good M&A strategy is it’s it’s a situation where you’ve got, it’s not company A buying company B, and now you’ve got something, okay. It is one group of people agreeing to partner with another group of people with the objective that look, the whole is going to be greater than the sum of its parts. And because we’ve got people at the core of this, okay, that’s changed, people are resistant to change. And so it’s always fascinating to see how you address that. 

    A lot of organizations just, you know, they they muscle through that however they can, and you know, they’ve got that attitude. Well, you know, we’ve gone through this before, and we’ve done it before, we’ll do it again. And you know, suck it up. Let’s go. And it’s just so counterintuitive to what’s really happening out there. And so now we come to Kotter. And it’s Kotter with a K which was formed after Dr. John Carter, Kotter, excuse me. And he’s a leading expert in leading change, not just change itself, but leading it. And so talk about Kotter, the organization and what kind of services it’s about on a macro level.

    Laurin: Yeah, absolutely. So the foundation of our business really was John Kotter’s body of work. He’s a former Harvard Business School professor that was doing extensive research around leadership and what makes organizations successful. And in the 90s, he published an article called Why Transformations Fail. And it was 10 years of research, over 100 organizations studied. And realized that 70% of those organizations actually failed some metric that leadership had established in terms of what does success look like in terms of this transformation. Can be whatever budget win over time. 

    But the ones that were successful had this foundation of what he called the eight accelerators, and essentially these various different pieces and it’s not steps that you can kind of check off like a waterfall method but various different pieces with an ecosystem that when activated, means that you’ll be more successful. And so what we do is actually bring those eight accelerators to life when we partner with organizations, and especially in the M&A field. We work a lot on the post deal integration side. Really, really a function of that’s when people start thinking about culture, it’s not because that’s when we should be brought in.

    Patrick: They’re not running into the obstacles yet. You know, coming together, and then once you’re together, okay, now what? So, yeah.

    Laurin: Yeah, absolutely. So what we like to do and what really sets us apart, I think, is that we partner with organizations. We do not come in as a consulting firm and say, here’s our plan. Here’s what the research we did here’s statistics, plop the plan down, leave and call it a day. We work directly with people from across the organization. So that diagonal cross section there all the way from senior leaders, to those junior people on the ground to come up together with plans that will actually make a change successful. And when you’re thinking about that integration process, worst case scenario, you’re going to have a group of people who just feel a sincere sense of loss when they go through. 

    And these integrations, because realistically speaking, you’re dealing with a body of people. And this isn’t the leadership, but the actual employees on the ground doing the work and making the organization successful, that have just had their futures determined for them. They no longer have control, and they’re no longer able to have any certainty around what’s going on. Because it’s just a flash Band-Aid rip most of the time. And so that if you read our latest book that came out this summer, Change, we talk a lot about that in terms of the survive and thrive mindsets. And announcements like that really activate that survive. 

    So you immediately have a rush of cortisol running through your body. You’re not able to really think strategically anymore as an individual, and you really are just in that fight or flight mode in terms of how do you do things. So we try to not only acknowledge that that is a realistic possibility, but actively counteract it to make sure that people aren’t thrown into that. But come up with ways for your own organization, to move away from that into that thrive mindset where you can actually think creatively and be more future oriented in terms of how you can be successful.

    Patrick: Well it’s interesting, because you talked about the people, again, we’re falling back on this people are at the center of this. But it’s interesting, because there are there are other shows out there where they interview firms that merge together, entrepreneurs that sold their company and merged. And one of the common questions comes up. When did you tell your people? And and a lot of them agonized over that because you know, what was the outcome? Obviously, you’ve got that fight or flight, immediate response, particularly when this process has been going on for months. And then the announcement comes to the to the team, like within days of it happening, or in some cases, hours of it taking effect. 

    So you’ve got that natural thing. The other thing is interesting, I appreciate this is that what Dr. Kotter did was he was looking if integration didn’t go well, well, rather than than looking at the ones that failed, which is easy to do, try to pull out the what was common about the ones that succeeded. Because that’s the formula to move forward rather than, you know, Monday morning quarterbacking, you know, others of those deals. So that’s, that’s a unique thing. And this whole issue now where you guys have and again, we’re still macro, but the science of change, and there’s an awareness there. 

    And I think as more understanding happens, that’s fantastic. And that’s leading, you know, we’re Kotter’s kind of leading, leading the change. You know, the the group on that. One of the things that you and I had spoken about before, and we will get into this a little bit more, but it is a big, you know, kind of California, wishy washy kind of thing is is a topic of culture, and how you know, Kotter, one of the things that you guys look at is, you know, the importance of it. And it’s beyond this whole thing of well, these guys dress, you know, have a dress code these people don’t. It goes way deeper than that to talk about culture a little bit for me.

    Laurin: Absolutely. And I will say that one of the things that is really important is that we don’t deal with culture in the sense that that’s the only thing we care about. But that’s how we differentiate ourselves. Because there’s all we obviously care about business practices, and what are the strategies and processes behind something. But culture should always be tied to that strategic objective. And there should always be that measurement going forward. It’s just as important as how we do the work. It’s not a fun little tier off to the side. So when we think about culture, it’s really the behaviors of that organization. 

    So how are decisions made? How are you communicating with people? If you’re a people manager? What are those practices around actually growing the organization? How do you handle professional development? What are your policies around whether it be feedback or how you’re actually just going about the day? Are you a nine to five, only organization? Do you work outside of those bounds? And it’s just all those tiny little behaviors that then culminate into this larger topic of culture. And it’s not that kind of wishy washy California, as you mentioned earlier, but it’s all those little tiny practices, how much does your vision come to life in your day to day? Or does it not? If it doesn’t, that’s okay. But it’s more of an acknowledgement of how that actually is brought in. And understanding the foundations of that is really what’s important.

    Patrick: And the issue with culture also is, as you and I’m stealing from you from an earlier conversation, but it’s the importance of bringing joy and higher achievement in. This isn’t some esoteric, you know, we’re gonna have a company look, and this is it’s really, you know, performance, this enhances performance.

    Laurin: Absolutely. Culture is not just a piece of paper where someone wrote down, like, we are a technology focused firm, where we love collaborating, and then it gets thrown into a drawer and never spoken of again. Culture, whether it’s defined or not, is how people within your organization actually operate. And that’s the key of success and knowing how does that actually work? And if you change some of these levers, in terms of how do we slowly migrate people into one direction, or maybe quickly in another, in order to pull levers to improve performance for the organization as a whole.

    Patrick: And the thing in there, Kotter’s, not alone in this, you’re just at the front of the line on this, but this culture really is trying, organizations are trying to see if they can quantify it, if they can measure it, and then see if they can harness it as a strategic advantage. And and I think, you know, the dynamic of the workforce now is an unmistakable element of the outgrowth of culture. Let’s just talk about that where we had the scenario in the banking industry.

    Laurin: Absolutely. So you’ll see it easily in the financial services industry, where what used to be that exciting field of investment banking, where you had all the graduates wanting to funnel themselves in and fight for those top tier positions in banks are no longer going towards those at the same rate. They’re going towards FinTech, those various different organizations, that could be startups, they could be larger at this point, starting to get some extra funding and are really expanding. But it’s, the hallmark behind it is really, because the cultures are very different. 

    There’s the thought process behind having to work those long hours for the same amount of pay. And the same amount of incredibly high or the hierarchical demoralizing, what can be seen as demoralizing for this generation, environment, versus one where they can create their own path, and they can start defining things for themselves is much more exciting for these generations. So there’s a huge shift in the talent pool in the younger generations wanting to find something new and culture is really at the heart of it.

    Patrick: But with culture it’s also, it’s not just, you know, retaining talent and keeping people but you’ve got to be aware of it when you’re bringing one force to join another force. And and you’ve got to know the potential clash of cultures there. And you’ve experienced that. Talk about that real quick.

    Laurin: Absolutely. So we had one organization that it was two competitors, who were top in their field. Unfortunately, I can’t give the actual names. And I would love to give actual details, because the details are just 10 times more impactful, but when we anonymize it, you can’t really see that full picture. But two, huge top of the industry, competitors formed into one. Merged together. And as we were going through their integration strategy, and what really needed to come out of it, we realized really early on that if we were going to make a proof point of this integration in terms of how to be successful, we needed to generate wins early on. And I would say that’s fairly typical across the board. 

    You always want to be generating wins to boost morale and create that snowball effect of moving forward. And the way that we were going to do it and be most successful and most impactful was to get the sales teams working together. Because if the sales teams could work together, who were rivals and did not like each other, if we can get them on the same team collaborating and actively working as a unit. Then that makes the proof point for the rest of the organization to say you know what, they can do it, why can’t I. So what we did is after we brought them together, we really allowed them and created a space where they can decide what that collaboration looks like and decide what their path forward is. It’s like I said, it’s not us coming in and detailing out high level plans, it’s working with the organization to create that for them. 

    So what they decided to do is that they were going to sell one product together. And it did not matter what industry you focused on. So they were selling products across a variety of different sub sectors. And they all went back and said, you know, what, by the way, have you seen XYZ in the market? Really exciting. I know, it doesn’t apply to you, but maybe look into it. Might be of some interest. And through that, and all of them deciding, we have a goal of we want to sell X amount of this product, we’re all going to do it together doesn’t matter who does it. Let’s do this as a team. It ended up being by far the largest selling product in that industry.

    Patrick: So you get the results right there. I just, you know, when you go the uber hyper competitive forces, okay, now they’re forced to work together. Okay. If they can work, then everybody else can. But what really struck me about this is not only I mean, it’s easy to see also, because we’re in marketing and sales, we appreciate this. But it’s also the, you didn’t take this universal approach, where okay, we’re going to change everything. Okay, you’re just let’s just get, prioritize a couple things and like you said, get some wins and moving forward. 

    I think that’s what happens is, everybody appreciates that, as they’re bringing on onboarding services and so forth, it’s just get those little wins to move down, let’s get those first downs and move on. We don’t have to have the big long pass because a lot of times that could delay things. And then people are just there again, in that space of they don’t know things are changing. They don’t know how it’s factoring, but they don’t see anything happening. And then you get nervous there. So I really appreciate how you guys can break that down.

    Laurin: Absolutely. I would say one of the most important things that often gets overlooked in terms of these plans is that it’s just saying, okay, we introduced you guys to each other, we’re done. High five or something along those lines. And it’s culture and the people integration isn’t taken into the same level of detail, as you see technology integration, or process integration, which does need to be considered at a high level. And if you think of Roger’s law of diffusion, when you’re regarding innovations. 

    It’s the same principle that you need to start with a group of people who are willing to accept that change, create those early wins and proof points, because as you create and generate those small wins and create momentum, you’re creating that rationale for the people who are more resistant to change and wanting to step back to say, you know what, this group did it, they were successful, I’m bought in. And then when you get those people who are partially resistant to change, you start getting the people who are very resistant to change, and you start making a movement that way. It’s not forcing it, but it’s creating proof points of success around that entire process,

    Patrick: Define or give me a profile of your of Kotter’s ideal client. Where are you looking as the ideal client where you can make these changes?

    Laurin: Absolutely. I think, realistically speaking at Kotter, we consider ourselves generalists, but what we really like to focus on are those calcified industries. The ones who haven’t necessarily changed yet, and are looking for that new generation to be that catalyst to move forward. And that’s really where we’re going to see our most success. I would say, anyone who is in a leadership position, where they are already having these thoughts and feelings around this is I want to change differently. I’ve done this time and time again, without success by going through the traditional methods. Let me try something new. That’s going to be our target audience. Because if we have someone within an organization who is willing to try some of the things that, from a traditionalist standpoint, sound a little off the wall, but are proven time and time again by both research and outcomes from our clients, that they do work.

    Patrick: This doesn’t happen unless you get buy in from the top, obviously. Now, Laurin, you mentioned calcified industries. Give us an example of a few others. You mentioned banking, what besides banking would be calcified?

    Laurin: Absolutely, I would say healthcare as a whole very much in that wanting to transition phase and wanting to accelerate phase but hasn’t necessarily gotten there yet. Very much government entities, still working on how to actually become as efficient as humanly possible within their structures. You’ll see it in higher education who are still very slow moving on various pieces depending on the cycles that they’re in in terms of their semester. You’ll see, and you do see it across the board. And you also see, you’ll see it in manufacturing at times and supply chain. It’s very much, I would say a universal piece for all the ones that aren’t talked about in the news necessarily on a regular basis, I would say the rest of them are still looking to really accelerate.

    Patrick: Talk about the onboarding process, how long it takes and things like that.

    Laurin: Absolutely. So onboarding for us, when we first start working with a client, we take a couple of months to actually do that discovery work. And discovery isn’t just kind of sitting in the background, reading some old documents. Yes, we do do that we need to do that and do our research to see what’s actually happened. But it also can consist of doing culture change surveys, and actually figuring out what that network within your organization looks like. And how ready is your organization with what are the general sentiments in your organization. Going through and doing stakeholder interviews, and not just interviewing leadership, but interviewing various different people within the organization who are doing the work to really understand what that landscape looks like, and then going into an alignment session to really define out what is your big opportunity in terms of this. 

    And that’s not saying it’s going to replace a mission or vision statement, because they do not. They supplement it. Because an opportunity is a window of time, it is a strategically held short term opportunity where you can charge towards that and everything that the organization does, should support that opportunity in terms of achieving it. And that opportunity will then flow into your mission and vision and your strategic objectives that you want to achieve for the 10 year vision, or the 30 year vision depending on what you have. 

    Patrick: Gotcha. Now I appreciate, Rome wasn’t built in a day. So this isn’t, you know, an overnight fix. But matter of weeks, months? Ballpark?

    Laurin: I would say months. It depends on after we go through that discovery phase of a few months, we go through and define custom plans and roadmaps for an organization based off of the level of need. If we’re doing a one off, you’ve purchased an entity, great, you’ve got the target company, you need to integrate it in much shorter timeframe, then building out a conglomerate where someone purchased a ton of various different entities. And now you’re trying to make one holistic unit. So really depends on what landscape we’re dealing with. I’d say about a year timeframe, we really like to work through organizations and do a lot of this work on that shorter end, not because it takes that entire year long necessarily. 

    It depends on the organization again, but more so embedding behaviors, take does take time. So you can have that switch. And if you read anything on habits, you can quickly change but then you can regress back if those behaviors aren’t reinforced. So it’s doing, making sure that that repetition is there and making sure that that reinforcement is there across the board in terms of how you incentivizes there in order to make it as successful as possible.

    Patrick: Gotcha. Well, I think that this is important. And one of the things I just pulled from you is that this isn’t just limited to strategic acquirers where they’re going to make an acquisition here or there. You could literally have this for private or private equity clients where they have multiple, very diverse portfolio companies. And although they don’t work hand in hand, the various portfolios, intermix with each other that often, many PE firms are trying to do that. That’s one of their strategic advantages is seeing how they can take, leverage strengths and to overcome weaknesses among the portfolio companies. We want to get, you know, our culture, not just within the PE firm of the investors, but within the portfolio across the breadth of the portfolio. And so I could see that being something that would be very, very helpful.

    Laurin: Absolutely. It’s something that we’ve been talking to clients about in recent years. And I would say, if you think about venture instead of PE, for example, just making all of those bets and saying not all of them are gonna pan out, we’ll have a couple of successes that are runaway successes to pay for the investments that don’t necessarily work out. But how can you actually structure your portfolio to complement each other? And actually work together as a cohesive unit? Not necessarily from going as formal as a joint venture, creating those agreements, but how can you actually work your portfolio to maximize and create cultures where it is okay to collaborate with each other?

    Patrick: So, I mean, this is great, because it’s not just culture isn’t just micro, here is macro on the other side, and that’s a great place where you can be brought in because you’re proven at that level. You’ve done it at that level as well. Laurin, we’re having this conversation just after first of the year. So we’re all getting used to change on writing 2022 now on the dates instead of 2021. So it’s going to take a little while for people to do it, but we’ll all change and then we’ll be sitting in 2023 but what do you see going forward either with Kotter or macro change M&A? And what do you see for the coming year?

    Laurin: I would say, in general, and this isn’t necessarily for 2022. But it’s been a general progression in recent years that there’s more acceptance around what’s considered the quote unquote, softer side of deals and culture. You’re not as frequently getting that eye roll. When you say culture in a boardroom, as you might have 10, 15 years ago. Where people were like, oh, it’s culture, okay, wonderful. Like, that’s not necessarily happening anymore. And, for example, we were working with a firm and within a year, they actually referenced culture at a 22% increase in that one year timeframe after we started working with them. 

    And directly targeted in their annual report, the reason behind their incredible success during the pandemic, was because the culture that they had fostered beforehand. And culture is more and more seen as that differentiator within an industry to say we have a strong culture where people want to work, and especially when you’re starting to think about the great recession. And as people are leaving organizations, when you’re doing an integration, as we talked about a little bit before doing things to people and activating that survive mindset, you have a more vulnerable employee population who is more quickly going to have that thought bubble of, if I can’t define this for myself, and I no longer have control, why don’t I leave? 

    And it’s already prevalent, but it’s even more so in these target companies. So something to absolutely be aware of, as you’re going through in the next year of how do you really retain the talent and the culture of your target, and integrate some of their best practices and their culture into the acquiring company, and create the best of both.

    Patrick: You mentioned the softer side, the two biggest developments in the last couple years. You’ve got ESG and the awareness of that. And then culture is hand in glove with that. So I agree completely with you is that going forward. Laurin Parthemos it’s been a pleasure having you here. For our audience members who are interested in this, how can our audience members find you and Kotter?

    Laurin: Absolutely. So you can find Kotter on our website at kotterinc.com. I have a lot of resources there and various different articles or background research that we’ve done. You can find me personally at laurin.parthemos@kotterinc.com. I will not go through the trouble of spelling that you can easily look on your podcast page. Check out the show notes. It will be there. And then you can also find me on LinkedIn. I’m more than happy to speak with anyone who’s interested personally.

    Patrick: Well great. Laurin Parthemos of Kotter, thank you so much for being here today.

    Laurin: Thanks for having me. It’s been a pleasure.

    Patrick: Great.

  • Trends to Look Out for in the M&A Insurance Market in 2022
    POSTED 12.28.21 M&A

    If you thought M&A activity would slow in 2022 after the record year in 2021…think again.

    Market watchers see current levels continuing through at least the first half of next year. As you know, an increase in M&A activity equals more demand for R&W insurance.

    And that means you should expect to see many of the same trends driving the use of Representations & Warranty (R&W) and other M&A-related coverage continue as well—if not become even more widespread.

    Here’s a breakdown of what you should be looking out for in the coming year:

    1. The “extra” frees being charged on smaller deals are creeping into all

    For a while now, many insurance brokers have been quietly adding fees onto what are considered small deals (under $50M TV). They typically add fees when they don’t charge commission. Now they are trying to do so on all the deals they cover.

    Premium ranges that used to be standard at 2.5% to 3% of the amount of the policy, so $250,000 to $300,000 for a $10M policy, are now at or above 5%.

    There could be some pushback on this from policyholders as premiums go up. However, many brokers will still be able to “sneak in” fees like this because the overall cost of an M&A transaction is expensive and those fees can get lost in the shuffle, so to speak.

    This is fair warning to keep an eye out.

    2. Increased scarcity for a home for sub-$50M TV deals.

    As I wrote in my article, “Limited Bandwidth for R&W Insurance in 2021”, there are fewer and fewer Underwriters who want to work on deals under $50M in Transaction Value. Simply because there are so many deals above $500M+ out there. With limited time and resources, insurers, of course, will focus on those deals generating higher revenues..

    As Woodruff Sawyer put it in their Private Equity and M&A Looking Ahead to 2022 report:

    “We expect RWI options for deals less than $50 million in enterprise value to be scarce leading into the end of the year. As bandwidth reaches capacity, underwriters will pick and choose only deals they deem highly profitable to pursue. We believe there will be limited to no capacity for small deals or deals with financial issues or a lack of underwriting.”

    But if you don’t hit that desirable threshold, all hope is not lost.

    What you need is a clean deal and solid due diligence. With a simple package like this that Underwriters could process quickly, there could be a receptive audience. You should also find a smaller, boutique firm that specializes in smaller deals and will give you their full attention.

    With an approach like this coverage is scarce but not impossible.

    Why would Underwriters turn away business from smaller deals?

    If the due diligence is lacking, that leads to unanswered questions. As a result, Underwriters have to put exclusions in the policy or limit the coverage. And they don’t like to do that because it makes them look like the “bad guys”—they get the blame when policyholders get upset.

    This type of situation often happens because the insurance broker did not adequately manage expectations.

    Sometimes, Underwriters just need clarification in these types of cases where they might otherwise decline to cover a deal.

    For example, in the case of one company that was buying a film and TV library. The Buyer had not done extensive diligence on who owned all that content, which made the Underwriters very nervous. They were expecting thorough legal diligence on the intellectual property.

    Then the Buyer made several good points. Since they were simply distributors, they were not subject to intellectual property infringement laws —those who produced and planned the use of the content would be on the hook. And not only were they not exposed in that way, but all their contracts had indemnification language, so they were further insulated from IP complaints. On top of that, they had insurance to respond to IP related issues.

    That was shared with the Underwriters and the rest of the underwriting process went smoothly, was completed ahead of schedule and with no limitation on IP.

    It’s the perfect illustration of how packaging makes all the difference.

    3. Rates will continue to be high well into Q1 2022…and beyond

    Premium rates went up from 2020 to 2021…and I see them continuing to rise into 2022, at least into the first half of the year. Demand for R&W insurance is just too high to compel a decrease. And, as I said at the beginning M&A activity is on a tear and will continue.

    4. Watch out for the impact of the shake-up at R&W insurers.

    R&W insurance companies have an Underwriter problem. First, new insurers are entering this lucrative market and poaching whole teams of Underwriters from established carriers. This interruption in talent and staff could slow down processing.

    Also, in some cases one of the larger national brokers is losing experienced brokers, and executives in the wake of a failed merger which would have made them redundant. They’ve seen the writing on the wall and decided to leave and start their own firms, including some Underwriters who want to get in on the brokerage side.

    They have the contacts. They have repeat clients they can bring over. It’s the perfect opportunity.

    5. Expect increased scrutiny from Underwriters with regard to insurance that the target is carrying and cybersecurity.

    R&W insurers and Underwriters are looking to pull other policies in to recover losses to be paid in the event of a breach. The thinking being those losses are actually insured by a company’s traditional commercial insurance policies.

    There is also a focus on cybersecurity. Underwriters want to see that companies have adequate IT and cybersecurity measure in place to protect data.

    As Woodruff Sawyer puts it on their report: “If a deal team does not perform diligence in these key areas, they should expect additional questions and/or exclusionary language related to things like Management Liability, Cyber Liability, and Professional/E&O Liability.”

    6. Claims are steady.

    More R&W insurance claims are being paid these days. But it stands to reason as more claims are being reported…because there are more policies out there. No big concern here. “Roughly 20% of policies result in claims, and about 25% of submitted claims result in a limit loss,” as they mention in the Woodruff Sawyer report, and that is a similar rate to 2020.

    The rate of claims being paid has not changed.

    7. Expect more deals with no indemnity.

    There is an interesting phenomenon that has been occurring.

    The accepted wisdom in M&A Insurance circles for a long time was that R&W policies with no Seller indemnity would be more risky and have more claims. As a result, Underwriters used to favor deals where the Seller indemnity clause was present, and deductible was shared by the parties. They wanted to see both sides have “skin in the game.”

    However, in practice this has not been the case. There is no discernible difference between the two types of deals. So, expect to see more deals be covered with no indemnity needed.

    Here’s how it used to be:

    In the Purchase and Sale Agreement there would be an indemnification clause that the Seller must pay the Buyer’s loss if there was a breach. If there was a R&W policy in place, the policy stepped into the Seller’s shoes to take care of that and pay the loss. Although the Seller would still be on the hook for at least a share of the deductible.

    Today, however, now Sellers want no indemnity and negotiate that the reps and warranties do not survive past closing. They want to sell “as is” – kind of like a used car. To be clear, in these types of “as is/non-indemnity agreement”, the Seller is liable to the Buyer for nothing…ever…nothing is held back. However, the risk is hedged for the Buyer because they have R&W insurance in place.

    8. Concern about COVID is waning.

    As the pandemic winds down, insurers are less concerned about pandemic-related claims.  Although they will continue to ask about COVID in their diligence process.

    9. Prices for targets are not going down.

    From attendees of a recent McGuire Woods Independent Sponsor Conference, the word is that prices for targets are not going down any time soon—despite any pandemic effects. Many vulnerable companies pulled themselves off the market. And they are strengthening. The multiples and competition for these targets is going up, not down. So, if you’re waiting for a dip in evaluations…it’s not happening.

    It’s clear that it’s going to be an interesting year in 2022. And I’m happy to help with your M&A insurance needs.

    You can contact me Patrick Stroth, at pstroth@rubiconins.com.

  • Michael Kornman | Navigating M&A Deals with Founders and Family-Owned Businesses
    POSTED 11.2.21 M&A Masters Podcast

    On this week’s episode of M&A Masters, we speak with Michael Kornman of NCK Capital.

    NCK Capital acquires controlling interests in lower-middle market companies and takes them to the next level with “right-fit” capital structures, inspiring management incentives, and nurturing support.

    Michael says, “We love the lower middle market. It’s a great place to build value…” Listen as he walks us through: 

    • Why NCK Capital loves the lower-middle market, their unique perspective and target markets
    • Three rules to ensure success in lower-middle market deals
    • Their secrets for fostering organic growth, and (long term) focused wealth creation
    • And much more

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there, I’m Patrick Stroth, trusted authority in executive and transactional liability, and president of Rubicon M&A Insurance Services, now a proud member of Liberty Company Insurance Brokers, a nationwide network of specialized insurance brokerages. 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 Kornman, managing partner of NCK Capital. Based in Dallas, NCK Capital acquires controlling interests and lower middle market companies and takes them to the next level, with right fit capital structures, inspiring management incentives, and nurturing support. Michael, I’m really looking forward to this conversation today. Thank you for joining me.

    Michael Kornman: Thanks for having me, Patrick.

    Patrick: So, Michael, before we get into NCK Capital and what you’re doing, which I think is next level, with transitions and so forth, which our audience is really going to enjoy. Let’s set the table, we’ll start with you. What brought you to this point in your career?

    Michael: Yeah, so I you know, my brother and I founded in NCK Capital in 2014. And before that, we had built and run a number of lower middle market businesses, and a few different industries. And so we felt we were well positioned to, to add value to the you know, lower middle market companies. And also had a unique perspective where we, you know, walked in the shoes of a lot of founders. We’ve we’ve dealt with the same issues they they’ve dealt with and understand those on an intimate and very personal level. And so we, we thought we’d be we’d stop building companies, you know, from from a dead stop and start start investing in the lower middle market.

    Patrick: And now, as we transition to NCK Capital, I always like to find out about companies, you know, how they’re named, because NCK Capital is not necessarily your initials. So give us that background, then walk in and tell us about NCK Capital.

    Michael: My last name is Kornman with a K. So everybody assumes that it’s something something Kornman, but that’s not it at all. Grant and I have three daughters, Natalie, Claire, and Kate. And we were originally going to name the company, oldest to youngest. So Claire, Kate, Natalie, we got the URL, we were building out the marketing materials, and it kept looking like Chicken Capital. And so we just, we just couldn’t deal with that. So we rearranged the letters, we got the NCK. And it’s our daughter. Grant does have a son. He came after we founded the firm. He’s still he’s still, you know, a beneficiary. So it’s okay.

    Patrick: Well, yeah, he will, we’ll find something separate for him down the road, that’ll be something, it’s amazing, you’re not the first guest to, you know, share with us that getting the URL had a big role in how the name ultimately came out. Si it’s just one one thing for the new age. Now you’re focusing on the lower middle market, you’ve been around for a little while. Explain why lower middle market? What is it about that, and your thought process?

    Michael: Yeah, we love the lower middle market. It’s a it’s a great way, it’s a great place to build value. You know, there’s, there’s so many lower middle market companies, and there’s so much capital in the middle market, that need folks like us to grow these companies to the scale that they need so that they can invest in them. And so we’re generally the first institutional capital not always, and we have, we have two portfolio companies that we acquired from other private equity firms. 

    But generally we focus on family or founder owned businesses. And we love it because it’s just, the market seems endless and, you know, our story, we’re a family. You know, Grant and I built the firm. There’s other people here now, but you know, it really resonates with sellers. And so we’ve, we’ve had, we’ve had good results.

    Patrick: Yeah, I think that in addition to having the lower middle market, where it’s is a vast market out there. I think that’s where you can really make big change because so many owners and founders out there, they work hard, they’re very successful, but they can only get a company their company to grow so far. And then they get to that inflection point where they’re, you know, they’re they’re too big to be small, they’re too small to be enterprise. And they don’t know how to take that next step. 

    And it gets scary because it, without organizations like NCK Capital out there, you know, they may default and either go with a very large institution or a brand or go to a strategic which may not necessarily have their best interests in mind. And so the more options that are out there and the awareness that we can we can bring to the lower middle market is our way of serving this market. Because if they don’t know about this, they’re at risk of being underserved and overcharged and we can’t do that to the owners and founders out there. 

    Because they’re, they’re the back backbone out here. A big distinguishing element of NCK Capital is that you do, and you mentioned this on your site, you target family owned businesses, as opposed to a startup and so forth. Talk about that focus a little bit more. Why that’s so personal? Is it just because you guys, you and your brother are family?

    Michael: Yeah, we walked in their shoes, we’ve dealt with the issues that that small business owners deal with. And these are, I mean, make no bones about these are small businesses still. I mean, we we invest in companies with two to 10 of EBITDA and our sweet spot is really like two to six. So these these companies definitely are in the early stages of their of their lifecycle. And you know, we have we’ve, we understand what it’s like to have invested personal capital over a long period of time. 

    We understand what it’s like to, to build out an organization where you where you have real issues with people and challenges and you know, you’ve you’ve you fought in the trenches alongside those people for a long time. We understand what it’s like to build a culture, and develop that culture, and how important that culture is to founders. And, you know, so we’re user friendly, that’s really important to us. And I think that’s, that’s one of the reasons we’ve been successful.

    Patrick: One of the things I think is really exciting, because you’re coming from an operating background, so you’re not trying to kind of financially engineer these these organizations, you know, from maybe, you know, performance to great performance, just by cutting expenses, and moving moving around numbers. I think you got an operational tilt. I’m just curious with some of the things that you’ve experienced, have you ever had an experience where you’re sitting with the the portfolio company, the management team, and they put their trust in you. And you talk about well we’re going to try doing X, Y, and Z, and you just see this epiphany, where they just look and they just like, I didn’t expect that, wow, we can do that. Did you have any kinds of things, this is kind of off script, but you know, that those things happen.

    Michael: It happens, it happens regularly, and it’s really fun to see. I mean, so our focus in NCK is, is in addition to buy and build, which is obviously a common common strategy in private equity. We really focus on companies that where we can, we can get organic growth. And we think that that, you know, that’s, that’s really important. We like businesses with high cash flow conversion, that, that we can, we can grow organically. We like businesses that we can deploy, you know, whether it’s a digital marketing strategy, or, or a more sophisticated sales and marketing marketing strategy, or, you know, or, or some, you know, some of the more traditional people process and technology and operations. 

    You know, we like businesses that we can grow in a way that a founder would understand. And so those conversations are do happen, and it’s, it’s fun to, to riff and collaborate with, with founders and sellers and oftentimes, you know, sellers are rolling over a substantial amount of equity. And, you know, that’s, that’s an important part of our process is educating them on kind of how how we approach the world. What we’re going to do post transaction and explain to them you know, kind of our excellent returns and, and that that helps us win deals as well.

    Patrick: Well I think one of the scariest things out there for anybody, I just from personal experience, I’m getting emails constantly about marketing, lead list strategies, all these things, and I can imagine, you know, if you’re the owner, or the founder, you’re you’re operating your business, you need to get sales up, you don’t know how, and it’s such a gamble. I mean, it can be very expensive. If you don’t know what you’re doing, it’s really really scary. So I think that your experience there on helping them bridge that gap on you know, opening marketing channels, sales, bringing in people, those are all the scariest things for owners and founders, because they have so much to risk and you give them peace of mind because not only do you have the resources, you’ve got the experience and you can just walk them through that.

    Michael: I mean, some of these founders want to stay on and continue to run the business but want to take a substantial amount of money off the table. And you know, their analysis up to this point is hey, I can grow this business but I’m gonna it’s gonna reduce my distributions. And you know, I’m gonna have to go it alone, where, you know, we come in and we’re, you know, we, we’re a team. So it’s a lot of fun to collaborate with these, with these folks. And the the leverage you get is, is huge.

    Patrick: Now I’m gonna go back to something we talked about, at the very beginning about, there are a couple of elements that distinguish what NCK Capital does, again, as a Californian, it’s like the software approach with business. But you are doing a couple of things here. If you could just give us a sentence or two, just how you mean it. And we’ll start with right size capital structures.

    Michael: Yeah, I mean, that’s a really great, great question. In the lower middle market, these small in the, in the lower end of the lower middle market, when you start to start to grow these businesses, there’s definitely a J curve. There’s definitely a dip in EBITDA. And so you just have to make sure that, that you’re, you’re planning for that. Because if you if you in generally it’s through over equitizing the business, but if you use that, or the wrong kind of debt, or or too much debt, rather, we all use debt. But it can be it can really be painful and disruptive in the in the early part of the investment period. 

    So we just like to make sure that that you know, we’re set up for success and you know, there may be a, you know, period where things things are a little less smooth than you’d like. I mean, generally, the inflection point in our experience is two years. The first few years you’re investing, you’re growing and you know, it really takes about 18 months to two years for the EBITDA to really really be able to grow to materialize.

    Patrick: That’s a term that a lot of people tie in with family offices, they call that patient capital. But you know, if you know that out front that you’ve got this time window, don’t panic let’s just go through it and I mean at our age now 18 months goes by really quick. You’re gonna get to the other side. So you bring that on, and I think that’s very helpful because it also brings the temperature down. Especially following you know, the closing, I’m sure management is they roll over they want to hit the ground running and they’re they’re very stressed. They want to make a good impression. Relax, you know, you want that so that that’s a great way to ensure success. The other thing you mentioned is not just management incentives but inspiring management incentives. So talk about that a little bit.

    Michael: Yeah, so a lot of times we’re we’re recruiting managers from outside the business and and that’s where you experience a lot of a lot of growth just hiring fantastic people that you know, some of these businesses just haven’t had exposure to people of this quality and sophistication before. And so, you know, our focus is we really we really view those management teams as partners and a lot of people say that. You know, we’re really focused on wealth creation for them, and that is we want to make sure that they’re they’re focused on the long run, they’re focused on you know, ultimately the exit and you know we we get really excited when when when our our management team partners build considerable amounts of wealth in these in these deals.

    Patrick: Kinda fun, kinda fun when you watch that. The, it ensures just everybody everybody’s interests are aligned and what why wouldn’t that be. Because I’m personally have an abundance mindset. So if that’s being passed out that just only inures to the benefit of all which is which is fantastic. And it also speaks to a track record for future investments down the road. I think I think that is just credibility, that can’t be questioned. 

    The final thing you talk about again, as as Californians, we look at this, we’ve talked about nurturing, and culture and things, which I there are a lot of people that look at that sideways, maybe 5, 10 years ago. But then the book, Infinite Game came out with Simon Sinek. And you’re seeing a change in mindset with management, looking at things like culture, where they’re, they’re, like, grading it, they are measuring it, and so forth. Let’s talk about what you do when you’re talking about nurturing.

    Michael: Yeah, well the first thing we do when we talk about culture, well, we provide a lot of support to our management companies. I’ve never walked in I’m sorry, to our management teams. I’ve never walked in to a company where people were sitting idle, and they were they had a lot of extra capacity. But we you know, they’re they’re dealing with, you know, day to day issues running a business. And we all agree as a as a, as a team, there are certain initiatives that can can add a lot of value that that may or may require outside resources. It may be us at NCK Capital. 

    It may be it may be the right consultants, but we like it could be something like, sourcing the right vendor for additional marketing initiative. It could be selecting a new site for you know a new location, geographic expansion. It could be really, really anything that an executive team member would do, that they may not have, have capacity to do. So we will parachute in, we’ll help will work alongside of the management teams. And, and, and get those high value initiatives completed. But we also back to the culture discussion, we we really believe it’s important to understand the culture of the business and understand the people and no matter how much diligence you do, it’s really hard to, to understand that completely pre acquisition. 

    So when it comes to culture, which we think is an incredible accelerant for, for value creation and growth, we take a I wouldn’t say a passive approach, but a more patient approach in stepping back and observing and learning. And that’s, that’s just, you know, I think there’s a lot of everybody’s pressured to move fast in this business. I think that’s one place where you just can’t move move that quickly.

    Patrick: Yeah, I think that’s everybody mistaked culture for well, we’ve got a very formal dress code, you know, attitude versus, you know, relaxed dress code. No it’s how you do things. There are some some organizations that are comfortable, just do putting as much, throwing as much on the wall as possible, see what sticks. Then others don’t want to go step by step on a process, and you’ve got to get that kind of synched up. And and and you do this. And I’m remiss, are there particular industries that you target?

    Michael: Yeah, so we really like services, businesses. And that could be any service that provides an essential service to another, any business that provides an essential service to another business. Could be tech enabled service, it could be environmental service company, it could be a we have a building services company in our portfolio. Really, we like healthcare services of certain types.

     We really like all all all sorts of service businesses. We also kind of what, it’s a little bit different and not in everybody’s investment criteria is we really like for-profit education. We have two, well, we just exited one, we have two vocational schools in our portfolio. And, and really, really like education, businesses of all types. Not just schools. Specialty distribution businesses, we’re working on one now. And then niche manufacturing, where we, those are our four buckets.

    Patrick: Okay, fantastic. When we talk about mergers and acquisitions, in the lower middle market, we’re dealing with, you know, two parties. We got a one party that that’s experienced, that’s almost always the buyer. And then the less experienced is the seller where they don’t sell their business every day, this is usually their one time. And when you have situations where you have a deficit of experience, fear and distrust can come in, where you know, once I say we’re going to do X, Y, and Z, and this is market, this is how it works. And then the unfamiliar side is just like, wait a minute. 

    I didn’t see this coming. And so there’s always the real danger for these deals happening. And they look good on paper, but when you’re dealing with people, okay, we’ve got those elements of fear and greed out there and you can’t get around that. And so as you go through the myriad of the process with due diligence, and everything else, and all these things can side track a deal and sometimes it comes down to the people. What we’re very proud about in the insurance industry is we found ways because with fear, it’s fear of risk and fear of loss of money, and so forth. 

    And what’s been nice is the insurance industry has come in with an insurance product called reps and warranties insurance. The buyer suffers a financial loss as a result of a breach of the seller reps. Now the seller is looking, saying wait, I’ve disclosed everything to you. You’ve done diligence. If I didn’t know it, I didn’t know it. And the buyer says I’m sorry this is market we have to do this. We have to you know put this little backstop on, it’s what everybody does, and we just have to do this to go forward. 

    And so there’s an element of distrust. Well, if you’ve got a rep and warranty policy, all of a sudden an insurance policy takes the place of the seller’s indemnity obligation. Seller gets a clean exit. If the buyer suffers a loss, buyer’s made whole. And so it’s just been a real revolutionary product that’s accelerated deals getting closed successfully. It’s lower the temperature, it’s done a lot of wonderful things. But you know, don’t take my word for it. You know, Michael, good, bad or indifferent, what experience have you had with rep and warranty insurance?

    Michael: I mean, it’s the greatest thing since sliced bread, right? I mean, we we we just exited one of our portfolio companies. So reps and warranties, warranties policy there. You know, of course, reduce the escrow, maximize proceeds to the seller. It made negotiation of of the purchase agreement considerably easier. And you know, we’re excited being in the lower middle market that that’s now available. It obviously started in the middle market. And is is, you know, a tool that is available to us in the lower middle market. And I just, we use it everywhere we can.

    Patrick: But I’m very pleased because you know, especially for the lower middle market, there’s been a little bit of a threshold. Because while rep and warranty does come down to smaller deals, there’s there’s a point at which the cost for due diligence to be eligible becomes a barrier to entry. And this is largely on deals where the transaction value starts falling below 20 million. A lot of buyers do not want to incur the expense to do all the diligence to get there. And at this time in 2021, the insurance industry is so full with the larger deals, there’s absolutely no bandwidth to even entertain small deals. 

    What I’m very excited about is that there is a new facility out there. Provides a sell side policy. But it’s one where it’s designed exclusively for micro market deals where the transaction value goes from under a million to 10 million. Where the policy we can ensure that deal all the way up to full transaction value up to 10 million. There is no underwriting fee, there is no diligence process required. It’s just an application. And it’s designed to address that area. And you know, we’re using this as a platform to get the word out because even though a lot of lower middle market deals are involving companies larger than 10 million, you always have add ons. 

    And it’s really nice if you can backstop you know, a sub $10 million add on where the seller has a policy at the seller’s expense so the buyer has some protection. And so it’s called TLPE. So I want to make sure that we just make a mention of that. Because for NCK Capital forward as they go on, this could be a fit on some areas where the traditional rep a warranty policy just just doesn’t work.

    Michael: Sounds like a fantastic tool to have in the toolbox, especially for add ons. So that can make, make that, make those a lot easier.

    Patrick: Thanks a lot. Thanks a lot for your comments on this. I’m glad that you know you got you got that one deal done. It’s interesting. We’re we’re kind of curious with private equity, the view of private equity is they are very reluctant to incur insurance premium expenses. If they can transfer risk, however, they can limit their expenditures, they won’t hesitate. Rep and warranty is the one exception where they they gladly go. And I’m very proud, because it’s been the good performance by the insurance companies. 

    They’ve kept their word. They’ve delivered on claims. And so we’re very, very happy. But as we get back into, you know, NCK Capital, Michael, where I mean, I blanked, and we’re already planning for 2022. You know, could you tell share with us, what trends do you see as we go end of 2021 into 2022? Either macro or NCK Capital in particular? 

    Michael: You know, sentiment is mixed. Some people think that, you know, there’s going to be reduced deal volume in 2022. And everything and some of the proposed tax changes were driving the, or anticipated tax changes, were driving 2021. Deal volumes, obviously 2021 was incredibly busy for everyone. You know, I’m a little more optimistic. I think there’s I think there’s a lot of businesses that are waited to come to market due to you know, they wanted to get some, some some time away from the pandemic. 

    And I think there’s going to be an enormous number of great businesses in the marketplace. One of the things that I think that we’ve, we’ve seen just from a deal structure standpoint is it’s been more structure in deals this year, then then, I mean, earnouts were dead pre pandemic. I mean, they’re just, they just weren’t, weren’t very commonly used. And you’re starting to see those more and more. And I think that’s really interesting. So I think that’s going to be I think that trend may continue on into 2022 as well.

    Patrick: Right. I agree. I see no end in sight with M&A. I think that we’re just going to get a lot more creative as we go forward. And I think that tax issues, taxes are gonna go where taxes are going to go, that should never be your primary motivator for doing things. I also agree there have been a lot of sellers that have been on the sidelines because they’re kind of refilling their balance sheets, and just upping their value as they go along. Well, Michael Kornman with NCK Capital, how can our audience members find you?

    Michael: Yeah, I thank you for asking. Our website is NCKcapital.com You can find both Grant and I there. And, you know, really a pleasure to chat with you today, Patrick. It’s a great podcast. I listened to it regularly and I I was honored that you invited me on so. So thank you very much.

    Patrick: Thank you so much. And I will just as a shameless plug for NCK Capital, I would say too and we’ve got quite a few audience members out there that are family owned businesses that are owners and founders out there. Give NCK Capital a quick look, especially because I think they’ve got a soft spot for you. And that always works to everybody’s benefit. So Michael, thank you again.

    Michael: Thank you so much.

  • Scott Hendon | Fund Managers’ Biggest Tax Concern in 2021
    POSTED 7.13.21 M&A Masters Podcast

    Our guest for this week’s episode of M&A Masters is Scott Hendon of BDO. Scott has been with BDO for 20 years and currently serves as the National & Global Practice Leader for Private Equity. A true icon in M&A, he brings a unique perspective as he knows both the investment side and the service side.

    Today we sit down with him to talk about the recently released Spring 2021 BDO Private Capital Pulse Survey Report. The survey polled 100 private equity and 100 venture capital middle-market fund managers across the United States.

    On the show, Scott talks about the key takeaways from the report and offers his insights into: 

    • The current key M&A drivers
    • The 3 top impacts of Covid-19 on deal making
    • The biggest tax concern for fund managers
    • The biggest surprise in the report
    • And more

    MENTIONED IN THIS EPISODE:

    TRANSCRIPT:

    Patrick Stroth: Hello there, I’m Patrick Stroth, President of Rubicon M&A Insurance Services, and trusted authority for transactional liability. 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. I’ve got to say just on a personal note, real quick. When you’re doing these interviews, your big dream is to have a monster guest who’s breaking some news out there. 

    So I no pressure to my guest, Scott here. But this is something I’m very, very excited about today, because we’ve got a true icon in mergers and acquisitions in America right now. Today, I’m joined by Scott Hendon. national and global practice leader for private equity for BDO. BDO is the fifth largest accounting firm in the world that generates over $10 billion in annual revenues, has 191,000 employees working in 167 countries. So it’s a special treat to have Scott here because today we’re going to talk about the newly released BDO private capital pulse survey report, which was just released. Scott it’s a pleasure to have you. Welcome to the podcast.

    Scott Hendon: Thank you, Patrick. Maybe just a little bit about myself. Well, as you said, Scott Hendon here and I just to cover a little bit about my background. I’m, originally from Lubbock, Texas, I moved to Dallas, Texas about 35 years ago. Went to Texas Tech University. I got an MS in taxation, I started my career at Arthur Andersen. And I’ve been with BDO for 20 years. I learned early on in my career that I wanted to get into private equity. So it didn’t take a brain surgeon to figure out that there’s a lot of money in motion, a lot of action. So I really wanted to get into the private equity side. 

    And once again, I realized that there’s a lot of services, and a lot of value that you could add to private equity. So as you said, once again, I’m a partner at BDO and I currently I’m the national and global leader of the private equity practice. I’m also on the board of directors for BDO USA. And I’m also on the board of directors of BDO capital, which is our wholly owned Investment Bank of BDO USA. Besides actively coordinating services and resources for private equity clients globally, I’m also an active investor. So I also invest in private equity and invest in pre spac deals, PIPEs and CRONs so I have a unique perspective. And I know both the service side to the private equity funds, as well as being an investor in there.

    Patrick: So you’ve been on both ends of the table, probably, you know, there are four, four sides to a table. You’ve been on all four of them.

    Scott: That’s right. And it’s been very good to me on all sides, there, Patrick.

    Patrick: Outstanding. So let’s talk about the private capital pulse report. How did this come about? What is it about? And give me some comments before we get into details. 

    Scott: Sure, so first of all, the we’ve been doing the private equity survey for over a decade, I will say that it used to be a lengthy report that we did every 12 months, and we track year over year, what the trends were. And once again, we interviewed 200 private equity firms, or I’m sorry, funds, 100 private equity and 100 venture capital funds. So that had been working great. And we’ve been doing it for over a decade, we had a big following. It’s covered by the press very well. Then we came into to 2020. And we did back then we’re doing one survey a year. So we did our questions in late February, early March. 

    And then we published in early April. So as you can imagine, the change that happened between February to April in 2020. The, it was really you know, once again, a lot of the data, a lot of stuff that we’re tracking, and it just wasn’t relevant, right? Because obviously COVID was the thing of the hour. So we pivoted on that and we went to more concise reports. It’s our current pulse survey. And we’re doing that two times a year. So we do a spring and a fall. So we just released our spring, and we’ve done a release for Fall of 2020. 

    And I think it’s a lot better. It’s more concise. It covers a lot of the major issues out there. But more importantly by doing it every six months, it allows us to have a better beat on fund managers. You know, it’s more frequent. It’s, we can tell what emerging trends are doing, you know, real time sense of what’s going on. So, once again, that’s kind of the history of that and once again, we get a lot of following out there, it’s when we get a lot of coverage globally in regards to what’s coming out of the survey.

    Patrick: Well, that’s a good clever name having a private capital pulse. Because if you’re doing this a little bit more, as real time as you can, you are on the pulse of thing. So yeah, you know, kudos to your marketing department to come up with with with that good title there. We can go in a lot directions with this on this because it is a big report. But why don’t we just get get a little macro first? All right. What’s the marketplace like for deals for private equity, you know, specific to mergers and acquisitions? 

    Scott: Sure. So first of all, at a high level, and then I’m going to dig down a little bit into to the survey. But as we sit today, the activity is incredible. So q1 of 2021, it’s one of the best quarters that the BDO private equity practice has ever seen. So that’s kind of where we’re at today. Now, if you roll back to 2020, not to look back, always looking forward. But you roll back to 2020. Yeah, there was two and a half trillion dollars of dry powder sitting there on the sidelines, deals were frothy. 

    This same from January to March, everything was going great. You know, pricing was good. Then COVID hits in March. And then from March, yeah, exactly. From March to June, the deals basically all got pulled back, everything came to a screeching halt. The banks weren’t loaning the private equity funds, we’re just trying to hunker down and figure out, you know, how to how to thrive and how to be resilient during the COVID crisis. So anyway, so there’s little activity from March to June. And starting in June, I think the private equity funds we’re getting a lot more comfortable and how to do due diligence, how to mitigate the risk.

    Patrick: Learn how to work Zoom.

    Scott: Absolutely. So anyway, some of the deals started coming back and banks started loaning again. So then you roll forward to the q4 of 2020. And, you know, private equity is very resilient, they figured out how to adapt. And so the deal flow, all the old deals, were coming back on the market that were pulled. A lot of new deals, a lot of people because of pricings good. I think a lot were saying, hey, are we going to have another wave of COVID or some we’re anticipating potential capital gains increases. 

    So we just had this tremendous amount of deals come out plus SPACs, were really getting the momentum going out, they’d raise a lot of capital. So q4 was really hot. And then we roll into q1. And just like I said, not to be redundant. But you know, it’s been q1 of 2021, has been extremely, extremely hot in a good time for certainly from the deal market and a lot of activity going on there.

    Patrick: Is it safe to say, you know, because we’re still in the pandemic, but I’m going to call this post pandemic right now, for purposes. But would you say that activity and financial strength in this period right now, post pandemic has surpassed the pre pandemic levels? Is that safe?

    Scott: You know, I would say it’s right there. I will say just the I think one thing that came in is all the deals that got pulled and put back on plus all the deals coming out. So it has, you know, it certainly is right there. The as far as the banks, the lending, you know, everything’s come back with a vengeance. It’s, it is amazing how resilient and resourceful that private equity has been. And I’ll go into maybe a little bit later on some of the things we’re saying the survey, but certain things have changed out there. You know, the what tailwind companies and certainly there’s young, there’s new industries, you know, a lot of digitalization other things, but man, the the market is, is really good. I’d say it’s as good or even better than pre pandemic.

    Patrick: I would say, I would want to ask, as you get in just you could take whatever direction you want, but you had a section on there for key competitors. And one of the things I find this very encouraging about mergers and acquisitions, just the American economy, in general is just how it is constantly expanding is constantly evolving. And you just look at the number of private equity firms out there five years ago, you know, there were maybe 1000 private equity firms, or just over 1000 there are 4000 plus private equity firms now, yeah, I think it’s closer to 5000 just in the US. So, you know, let’s draw from that. Let’s talk about competitors in this landscape now.

    Scott: You bet. So I’m gonna in that I’m looking at my survey here too Patrick but yeah, so the competition now once again, we did I’m going to do a comparative analysis from the fall survey today so what what’s the we pulling the you know what I’m personally seeing I think it’s consistent what what the fund managers feedback they gave us now, the number one competitor for deals, it’s generally strategics and private equity are kind of one one and two. That’s what we generally see. Of no surprise, strategic buyers came in as what the fund managers thought in the next six months would be the major competitor for deals. 

    So that came in about 52%. It’s up three and a half percent over the fall survey. One thing that’s really surprising is is that hedge funds and mutual funds. And what the fund managers said in the survey, they said it was it came in the number two spot at 51% said that they would be a major competitor for deals, and that’s up 12 and a half percent since the fall survey. So I was really surprised on that sovereign wealth funds were in at 40.5%, it was up about 4%. And then, PE and VC funds had fallen down usually once again to one or two for what they the fund managers themselves were saying. They said that they thought the most competition, you know, what would be coming out in private equity and VC firms were coming in at the four spot or fifth spot at 35%. 

    So they dropped eight and a half percent. So a little bit surprised about that. Now, we also just added SPACs, because I think if you look at the the SPAC cycle, you know, if you go back a few years, you know, they were kind of downstream, they were a major player, obviously, today, you know, the major banks, and they’re raising a lot of capital now, they only 23 and a half of them said that they saw the SPACs as a major competitor. So once again, that was a little bit lower than I thought, and we don’t have a comparative analysis. But we’ll we will start tracking that for future service.

    Patrick: Yeah, let’s let’s let’s just, you know, focus on the SPACs real quick, because the one thing about the SPAC is, you know, for for us that are in the transaction world, you know, the a and SPAC is acquisition. And so there’s no vehicle that’s more ideally suited for mergers and acquisitions. And for the the insurance in that area, then the SPACs, and while there’s been legislation proposed and rule changes proposed as really cut off the SPAC IPO activity, you still have over 400 SPACs out there looking for an acquisition the next two years. And so, you know, I agree with you, their presence just showed up overnight. And you know, it’s still early in the game. But I mean, what are your feelings of these of these SPACs out there in the marketplace? 

    Scott: Yeah, so first of all, I think just what we’re seeing on the survey, I think it’s just the the magnitude of the site, you know, there’s so much capital out there. I don’t, I think SPACs, you said that it had slowed down somewhat, you know, SPACs, you’re right, there’s over 430 SPACs, looking for acquisitions, I think maybe 100 have been identified, but they’ve raised a lot of capital, and they’re, they’re coming out with really good prices. And if they don’t get their acquisition within a 24 month period, they have to give the capital back. So certainly, you have SPACs that are out there. And I see this long term too, it’ll continue out there that you’re talking about, the SEC came out with basically just an interpretation of how warrants should be accounted for. 

    So you had that out there cut, there’s a quite a few restatements that are going to be done. But you know, the SPAC market slowed down quite a bit in the pipes have kind of slowed down as well. But I don’t I don’t see that as a long term effect. I think the main thing is that there’s so many out there looking for deals, I think that, you know, some of the IBs, you know, once again, or slowing it down, maybe some are trying to get some people to pivot IPOs. But they’re a great vehicle an option to go public, as you said, there. You know, there’s a lot of advantages on there. If I were to have enough time on on this podcast to go through, but I like it out there, I think it’ll continue will continue to be a competitor out there. 

    I just think the 23.5% I think the only reason it’s that low is just because the magnitude of all the other players out there, but I can see SPACs still being, you know, a viable option going public, it’s really, you know, it’s a lot easier to do an acquisition related than roadshow, there’s, you can get 50% your capital back. And anyway, that, you know, there’s a lot it generally it’s faster to market than a typical IPO. So there’s a lot of benefits out there. And I will say even though they’re a competitor to private equity, there also have been a really good exit strategy for private equity. 

    So a lot of PE backed companies, we’re seeing a lot of the funds that are wanting to ensure that their portfolio companies are ready to to SPAC or get into de SPAC transaction. So they’re definitely, you know, competitor on one side, but a great opportunity on the other. And then we’ve also seen some of the private equity funds do their own SPAC raise for certain verticals out there just because once again, it’s a good vehicle to raise capital and go.

    Patrick: And you know, there’s got to be exits for somebody in and as, as these portfolio companies are getting bigger and bigger, you need a bigger fish to eat this whale that you develop, you know, from a guppy and so I think is great for the M&A ecosphere, that there’s another place for these bigger exits to go.

    Scott: Absolutely. And I will say one thing, I don’t think it had a huge impact on this. But some of the funds, you know, we had a certain number that were under, you know, 2 billion or, you know, of assets or management. The SPAC  market, obviously, is the bigger deals out there, too. So that might have had a little bit of impact. But I think, overall, the reasons it’s at 23 and a half percent is just because the size of you know, yeah, the 2.2 $2.9 trillion of dry powder that’s sitting out there. 

    Patrick: Exactly. You mentioned the reports and key drivers for M&A. Why don’t we touch on those real quick? That’s more of a macro issue as well. 

    Scott: Sure. Yeah. So great question, Patrick. Now, what we saw in the survey for the drivers of deal flow, or what the fund managers thought would be driving it over the next six months, first of all, the private company sales and capital raises. So that’s it’s at 50% said that would be the major driver. It’s exactly the same as the the fall survey. So those are exactly the same as what I’d expect to see there. One thing that was a little bit surprising was succession planning. 

    So I think a lot of them think that some of the the generational companies that typically send it on to the next generation, they’re going ahead to exit out maybe it’s COVID, who knows. But anyway, for whatever reason, they they thought that succession planning would be one of the major drivers of deal flow coming up in the next six months. And it dropped from our fall, it was at 37, it went all the way up to 48%. So there’s big a big jump there, as far as the next one down would have been trades to other financial buyers or strategics. That came in at 46.5%. No surprises there, investing in distressed assets was next. 

    And that actually, we’ve we’ve been expecting, you know, distress assets to come to the market, right, because you kind of wait for the other shoe to drop. But anyway, there, it actually dropped the anticipation on that 2%. But once again, for whatever reason, the banks have been, you know, trying to work out and in a way we’ve seen, you know, there’s maybe stimulus money and other things. We haven’t seen the distressed assets on the market yet, but that they listed that is number four out there.

    Patrick: That was a surprise. Yeah, we were, the industry was preparing for a lot more distressed.

    Scott: Yeah. And you would expect eventually that’d be the case. But I think that’s what based on what the fund managers are saying or what, you know, anyway, that that was their anticipation of the market. Also on public to private transaction or taking private transactions. They 41% said they felt that would be driving deal activity. So they’re looking for any public companies, even though I would say the public markets have been pretty frothy, as well, anyway, they’re still looking for, you know, key deals out there. 

    And that was up 2%. Corporate divestitures is, it’s up six and a half percent day. And that’s it proximately 38.5. And with that, in that that makes perfect sense. And because a lot of the company big companies out there trying to shed non strategic businesses lean and mean, lean and mean, get back to their, you know, what they do best and, and jettison out wood and have a clear focus. So whether they’re anticipating to see a lot of investor transactions and a lot of ones that can come out, take, build it, and, yeah, build it out and flip it.

    Patrick: Yeah, we’ll see. And the comment I had on is the observation is, is from a conversation you and I had earlier because we’re both old enough to have gone through multiple cycles between whether it’s 9-11. You got the .com implosion, you had the financial crisis. And then now you got the pandemic and in business owners that have gone through that cycle. At some point, I’m sure they’re putting up their hands. And they’re just saying enough. In addition to that, you guys situation is one thing about that didn’t change in the pandemic is time didn’t stop. Everybody’s getting a little bit old.

    Scott: Yep. And I think that has a lot to do with where they go back to succession planning, private company sales, for exactly what you said, Patrick, so I agree. 100% on that.

    Patrick: One of the other things I found that was that was surprising. This is just one of those being from California. It’s a nice sounding thing. But it’s now in the nomenclature in the boardrooms. And that’s ESG the environmental, social and governance, prerogatives and the issue about that, as its, you know, its ambitious and as aspirational as really good stuff out there. And everybody’s got great intents, but the rules for ESG are still fluid. And if you fall short of those rules that can have catastrophic implications. And you mentioned this, but I didn’t realize this is organizations likeBDO have a solution to that to keep companies abreast of that. Let’s talk about ESG and then what BDO does.

    Scott: Absolutely. So first of all, in our survey, Patrick, we added, this is the first time that we added an ESG questions. And what came back on that or survey showed that 94% of the fund managers said that incorporating ESG investment criteria into their investment strategies was a priority to their LPs, and only two and a half percent said it wasn’t important. So I don’t know that I’m surprised about that. But once again, it was a really large number and a very small number that said that it wasn’t important to that to their LPs. 

    And I think what’s happening out there, no one is going to help out on exits, I think that everybody’s looking at private capital fund managers are feeling the pressure from LPs and other stakeholders to think within sustainable investment framework. So ESG is about your framing decisions to include the consideration of these risk factors. And, you know, they don’t necessarily affect the financial statements directly. But it’s material to the sustainable operation of the company. 

    And then I know, many are working to incorporate sustainable investment thinking into their business models, or there’s also regulatory issues, metrics that the SEC has gotten, and they’re starting to look at, you know, certainly for public companies, but on the private equity and private capital markets, they’re starting to look at the disclosures that are being made out there. And there’s accountability. And then if you go overseas, certainly the regulators in the EU and some of the other places, you know, they have pretty pretty stringent disclosure requirements they have to do out there. As far as the services that we’re working with the funds to look at how they get system set up to track benchmark and see how they’re doing. 

    And they’re certain metrics like RPI is or whatever that they track, and they give themselves grades, and then they’re tracking hey, how well are we doing on the various SCG components. And that’s important, both, you know, for them from a business perspective, to report back to the LPS. And I think that there’ll be a premium to the extent you have a company that, you know, following ESG principles that you know, that I think the return on investment will be there as well. And certainly, you know, I think you’ll get a premium on that.

    Patrick: Yeah, I think it’s along the book title, you know, the infinite game, you got a long game, a short game, and then the infinite game. And this, you know, dovetails right into that, and it’s just, you know, implementation and, and establishing systems and you know, who better than BDO to come in and monitor and help help firms adjust? So it’s not one rule for everybody, but it’s customized. So I think that’s a, that’s a tremendous value add that you have, right, we can’t have a survey like this without addressing COVID. Okay, and so, and I don’t want to steal your thunder, if you want, you had to send your report has the sentence of this whole event. And and I’ll leave it to you. But talk to me about, you know, how COVID impacted things now going forward?

    Scott: You bet. So first of all, it was in our big what you’re referring to, we had that everything’s changed, but nothing’s different.

    Patrick: Yeah, everything’s changed, but nothing’s different.

    Scott: Let me explain that. First of all, I’m going to go through what the fund’s told us about, you know, how things have long term impacts of COVID-19, especially specifically on deal making. So specifically said digital capabilities of acquisition targets, you know, once again, a key variable in the deals, importance of a robust risk management and acquisition targets. Hire long, long term ongoing valuations for certain industries, clear robust supply chain strategies, because obviously, we saw some of the weaknesses and what can happen when the supply chain breaks down, fewer in person meetings throughout the process, lower long term ongoing valuations for certain industries, and a shorter, shorter due diligence process. 

    So those are the main points that came out from the survey itself just on long term impacts of COVID. But what do we mean by everything is changed, but nothing’s different. And I’m going to throw out an analogy to you, Patrick. So if you kind of think through think of the forest versus the trees, so if you look at the trees, yeah, there’s new species that pop up, and maybe some grow faster than others. So if you throw that over to what’s going on right now, you know, some industries are faring much better, they actually thrived and grew and grew out of COVID-19. 

    So you have those, you have certain ways that how we work is changed. So you have a lot of these new industries. And so, you know, from the tree perspective, we’ve got, you know, new species or you know, once again, companies are growing, you know, there’s been a significant change out there. On the flip side, you know, if you look at the forest, I don’t think anything, the overall picture has really changed. So you still need to kick the tires, you still need to connect with leadership, do due diligence, you got to return, get generate return on investment in, you know, the the, the major theses is if you, you know, tend to or properly, you know, build out these portfolio companies, you’ll get superior yields. 

    And, you know, basically, that’s, you know, the big thing is to find quality deals, basically do smart things do add ons, hopefully you don’t overpay for it. And once again, it’s all about return on investment. I think, fundamentally, that’s what it’s all about. So hence, everything’s changed. And that a lot of the industries and how things are done is change. But nothing’s really different in regards to private equity, and how they invest and what the process is for making their investment. 

    Patrick: Sound business practices, or sound business practices. And that’s how I got. Okay, so absolutely. Tactics might but not overall strategy. 

    Scott: Absolutely. Absolutely. 

    Patrick: Well, now, Scott, this wasn’t in the report. But I do want to ask you just about because you’re with private equity and throughout M&A, what COVID has taught also in recent experience right now is having insurance on M&A transactions, specifically reps and warranties, insurance, and then directors and officers tail insurance and tax policies and so forth. The early returns that we’re getting on all the servers for 2021 rep and warranty is only getting stronger, it’s only getting better, people are buying it more often and bigger policies. 

    And it’s because the track record has been just outstanding throughout this and private equity, if something doesn’t work, they cut it off immediately. But, you know, don’t take my word for it, you know, as the head, you know, both national and global with, you know, private equity, and they’re in the business of mergers and acquisitions. What’s your perspective on rep and warranty insurance? Good, bad or indifferent?

    Scott: Absolutely. Great question, Patrick. And, first of all, the others besides rep and warranty, all all important, but rep and warranty insurance. If you roll back four or five years, you know, wouldn’t it as common and you know, it’s not on some of the bigger deals. I’d say today, almost all the deals about the buy and sell side has rep and warranty insurance. And I think that’s gonna continue and the major reason that they’re getting reps and warranty insurances, you know, first of all from the buyer side. You know, just to start out we’re generally a lot of the you want to negotiate what the major terms of the deals are price and other things. 

    And usually the indemnification escrow that’s always a non productive negotiation anyway. So we’re you have a seller that’s offering say a 5% indemnity escrow, but the buyer wants, you know, what market is about 10%. So instead of having, you know, negotiations, probably non productive on that, bring in indemnification, or I’m sorry, reps and warranty coverage. And it allows you to basically drop it down, you can drop it down to 1%, which makes the deal the package more attractive to the seller. 

    And then also, you can negotiate, you know, better better coverage, and you get out of the typical indemnification escrow. Also, it’s generally a longer period where you get a three year coverage period versus a one year so. And then lastly, which I think is really important in you know, a lot of times there’s going to be disputes, right. And it’s a lot better if you have especially a middle market companies, if you have the prior owners that have the sellers are still coming in, they still have some, you know, some rollover equity, but a real important to the business. 

    The last thing you want to do is being you know, having a pissing match or not sorry for the words, but you know, basically suits or whatever the case is with prior ownership over the indemnity versus if you have the insurance company in there. Once again, it’s not the same same issues, right, you can just negotiate with the insurance company about, you know, settling up on whatever the you know, reps and warranties were. As far as the seller, well, it’s easy, because once again, they just want to get it closed as fast as possible. Reps and warranty insurance allows it to that. 

    And if you can negotiate a 1% versus a 10%. That means that they get more of the indemnification escrow to them instead of being tied up in a low returning escrow account so they can get more of their money and get it to work. So it’s really a win win. And it’s, it’s, you know, it would be almost uncommon not to see it in most deals these days.

    Patrick: Yeah, I would if it’s if it’s done properly for the buyer, if you present the terms to the seller where you either go uninsured with a big escrow and you’re at risk for a major clawback or we’re gonna get this policy for you and your escrow goes from five or 10% transaction value down to 1%. And you can keep the rest of the money because we’re not gonna claw it back. 99 times out of 100, that seller, not only will go that direction, but they’ll happily pay all the cost. So if you’re a buyer, okay, you’ve got all the benefits, you take all the tension out of the room, you get rid of that uncomfortable post closing conversation saying, yeah, that escrow you want to get, we have to, you know, we lost it, sorry, that’s all gone. 

    Combined that that is free, because the cell is going to pay for virtually bad faith on the buyers part not to bring this up at least be open to bring it up. What’s great is rep and warranty is now available for the add ons where you’re looking at sub $50 million transactions. And those you just pump those out. I mean, and we really appreciate it just in our industry, because the the claims history, and the satisfaction rate on this product has never been higher. And I’m comparing that to any other insurance product out there. So we’re very, very proud of it is great to hear that. Yeah, it’s been embraced by private equity, which does not like spending a lot of money on insurance.

    Scott: Yeah, but once again, for all the benefits that you just relayed. And what I did, once again, it just makes sense. It gets deals done. And also it’s just a better way to get it done and get good deals done, get money back to the seller and in also have proper coverage.

    Patrick: I’m curious Scott, I know, we didn’t cover this earlier. But was there anything in the report that surprised you?

    Scott: Some of the things that I guess that surprised me the most. Well it was just I think we’ve already covered it. But you know, when you had the the mutual funds and hedge funds jumping so far, that I was really surprised about that? I don’t know exactly, you know, we don’t go back and separately interview the 200 poll participants, but that was one I just wasn’t expecting. I know that they do, you know, go out and do direct deals and some of the VC deals, but for them to be in the number two spot, that was really surprising for me.

    Patrick: Now, again, you go, the purposes of this is not only to take a quick snapshot back, but then using that data, you know, looking forward, what are some of the trends based on this? And we can find what are the trends you see going forward? You know, at macro micro, whichever you like?

    Scott: You bet. So some of the key takeaways from there, we already talked about ESG. So obviously, I think ESG is going to continue to be more important, what we asked the funds on what they thought about asset prices, and 91% expected asset prices to rise in the next six months. So almost virtually everybody thought it would raise and there was about 50%. 50% expected to raise between 10 and 24%. 

    Patrick: Wow. 

    Scott: And then you had five and a half that that actually started would rise more than 25%. And we’re talking about a six month period. So what that was, anyway, so I think the key takeaway there, the way things are going, you know, with all the dry powder, the spax out there, prices are gonna continue to go up. So it’s key to kick a lot of tires and make sure you do quality deals.

    Patrick: Just like real estate in California. My goodness.

    Scott: Hopefully, yeah. So what what happens in the, you know, in 2022, I guess yeah, we’ll see on that. But anyway, that was one of the big things out there. Also, the on taxation of digital services of product. So it actually came in higher than the concern about the rise in capital, capital gains rates.

    Patrick: Could you clarify that taxation on digital services? So you are paying tax on Saas kind of services?

    Scott: That’s correct. So it’s digital products and services. And I think the reason it’s going to be rising, probably twofold. That one, there’s a lot of, obviously a lot of stimulus money, a lot of expenses that both foreign governments as well as state governments are going to have to cover. And also I think there’s concerns with all the digitalization of products and services that, you know, how do you keep from losing your tax base, because a lot of it, you know, has been hit typically on you know, you have people or you have a physical presence and location. 

    So there anyway, there’s a lot of activity going out there. From the foreign side, there’s there’s an oecds, kind of a, they’re looking at a framework of how to tax digital services and products, they should have something coming out in the summer. That’ll give some guidance out there. Once again, all this a lot of the states are changing their policies on how to tax digital services and products. And then lastly, I’ll just mention Mexico is another key example. 

    They just implemented a 16% VAT on digital, electronic or digital services for b2b and b2c. So I think it’s a real it’s a big issue. Once again, I think the countries and states are gonna have to continue to, you know, figure out how they get their tax revenue and how they cover some of the costs. And just with the big changes in a digital environment, you know, it’s real important for to understand what kind of impact that will have on the business, especially in technology businesses.

    Patrick: The innovation doesn’t stop at the at the tax level, that’s for sure. So they’re gonna, they’re gonna keep that going. We mentioned Scott that there are now 5000 plus private equity firms out there, they can’t all be BDO clients. So, you know, for our members, the audience out there if they wanted to get you know, not only copy the report, which we will have in our show notes to link up to but how can our audience members find you and get access to the BDO private equity services?

    Scott: Well, first of all, Patrick, I would like to thank you for having me on your podcast, but anybody everybody’s free to contact me directly. My email address is Shendon@BDO.com or s h e n d o n@BDO.com. Or you can go to our website at www.bdo.com. Click on our industry, private equity. And there you’ll find contact information. We also there we do have copies of the current as well as prior surveys. We have thought leadership’s and we also have podcasts out there. You can also sign up for to be notified of future surveys, thought leadership or podcasts that are coming out as well.

    Patrick: Well, Scott Hendon from BDO, your private equity capital pulse report for 2021. Thank you so much. It’s been a real pleasure having you here. 

    Scott: My pleasure. Thanks a lot, Patrick.

  • The “Dating Site” for Lower Middle Market M&A Deals
    POSTED 5.11.21 M&A

    Pre-pandemic, the M&A world was all about hitting the road, with companies meeting potential capital providers or Buyers personally in board rooms all over the country. That’s a lot of airline miles.

    But for the last year or so, the majority of business development has been done online. And an innovative online platform that facilitates these sorts of interactions has taken off in a big way.

    Axial makes it easier than ever for lower middle market companies looking to raise money or get bought to meet privately with PE firms, VCs, Independent Sponsors, and even Strategic Acquirers.

    I liken it to the Match.com of M&A. Companies that are looking to be bought, or are seeking capital, post a profile and what they are looking for. Buyers and investors do the same.

    Axial also provides “concierges” who help connect appropriate members on either side who could do business together.

    The platform has been widely adopted in the time of Covid. According to Axial, 5,000 companies with EBITDA between $1M and $5M privately marketed their deal on the platform last year.

    Lower middle market companies, many of whose founders and management teams are not well-versed in M&A, can also hire advisors through Axial to help them find potential deals and walk them through them.

    And here’s the thing: Even as travel resumes and we move towards business as normal in many parts of our lives… don’t expect in-person business development to go back to the old way. Firms have discovered just how much they saved on travel during the pandemic. And how effective the Axial platform is at facilitating relationships between Buyers and Sellers.

    Any attachment Acquirers and investors had to conferences and other face-to-face meetings at almost every step of the deal process is fading.

    As Mark Gartner of ClearLight Partners put it back in Sept. 2020:

    The game of staffing up one or more business development professionals to focus their energies on literally the exact same strategy every other private equity fund is employing is simply dead. The famous investor Sir John Templeton once said, ‘It is impossible to produce superior performance unless you do something different.’ This is sage advice as we usher in business development 3.0 and say farewell to the following activities that are sort of like rocking chairs – they give you something to do but don’t really get you anywhere.”

    Gartner cited the following strategies as “dead”:

    • The conference circuit
    • High volume/low value city visits
    • Book collecting

    These strategies, of course, still have some sort of place going forward in M&A, but it will be radically different. I think most PE firms will reserve travel for when deals are further along… and make first contact online. And Axial is ideal for this new strategy. They’ve more than proven they can handle these deals and facilitate them quite nicely.

    Take this example…

    Trinity Consultants is an air quality consulting firm out of Dallas that has made more than 20 acquisitions in the past 12 years. But most of those deals were in the air quality space. They turned to Axial to find deals in new industries and from new sources.

    As the company put it in a case study on the Axial website:

    “Axial brings deals to us and helps us think about the realm of possibilities that could make sense.” 

    Working with Axial, led Trinity to acquire ADVENT Engineering, a life sciences engineering consulting firm. Says the ADVENT CEO of the deal:

    “Without Axial, there’s no reason the company or their banker would have heard of us, and no reason we would have heard of them.”

    It’s deals like this that make Axial so powerful…and the leader in this space. Over the last 10 years, it’s grown into the largest online platform for buying, selling, and financing private companies.

    The Paradox of Choice

    Common wisdom is that the lower middle market is underserved… that these small companies are the redheaded stepchildren of the M&A world and all the services are geared towards bigger companies.

    Peter Lehrman, founder and CEO of Axial, has a different view. He says the problem is there are too many providers. There are all different types of investors and service providers who are vying to do business with lower middle market companies.

    The Buyer’s universe for lower middle market companies includes 4,000 PE firms, tens of thousands of Strategic Acquirers looking to grow inorganically, thousands of family offices looking to invest in something other than the stock market…and even Independent Sponsors, individuals who, backed by private equity, are looking for companies to run and take to the next level.

    The problem is, says Lehrman, is that potential acquisitions in this space actually have too many choices, and it’s tough to navigate them and find the right providers and potential acquirers. And that’s precisely why Axial focuses on this space.

    As he told me in a recent interview:

    “I think the lower middle market has a level of dynamism to it that makes it a market where information problems plague Buyers and Sellers, that make it harder for Buyers and Sellers to find one another, to be found by one another, and to assess one another as counterparties and partners.”

     “There are a lot of problems and challenges that are, I think, much more unique to the lower middle market than to really any other sort of ‘category’ of private capital markets.”

    This reminds me of some relatives of mine from Ireland who were visiting recently. They needed aspirin, so I sent them to the chain drug store down the street from my house. They came back empty-handed. Faced with 30+ different varieties of pain relievers they couldn’t make a choice.

    Adds Lehrman:

    “I don’t think [the lower middle market] is underserved. I just think it’s very, very hard, as a business owner, to know how to sort of assess all of these potential partners to work with. And I think that’s actually the bigger challenge. It’s not that there are not enough people serving the lower middle market.”

     “It’s about helping the owners and entrepreneurs navigate that huge list of choices. They’re looking at say 100 private equity firms, and they’re thinking ‘What am I going to do, go to every single one of their websites? They all sound the same and say the same thing, right? So how am I really going to figure this out?’”

     “So that’s what I think is actually the bigger challenge. It’s not that they’re underserved. It’s that there’s too much choice, and they need help slicing through those choices by getting their hands on good information and good resources.”

    The paradox of choice in action.

    Potential investors and acquirers of lower middle market companies also face difficulty. These small businesses are scatted around the country… and there are tens of thousands of them owned by private equity. And as some firms grow and enter into the middle market, new entrants come in. It’s a constant churn.

    It’s no wonder that a platform like Axial, which uses technology to connect potential partners, has become a go-to for savvy dealmakers.

    Next Steps

    Of course, no matter how Buyer and Seller came together, there is a unique insurance product, which has become available to lower middle market deals only in recent years, that is a must have for M&A transactions.

    Representations and Warranty (R&W) insurance, which transfers indemnity risk to a third party (the insurer), has been…

    • Recognized as advantageous for both Buyers and Sellers
    • Shown to speed up negotiations and eliminate potential bad feelings between the parties on each side of the table
    • Opened up to smaller deal sizes, especially to the lower middle market transactions
    • Reduced in price

    I specialize in this type of insurance, and I’d be glad to discuss how it can specifically benefit your deal. Please contact me, Patrick Stroth, at pstroth@rubiconins.com.