Insights

  • 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.

  • Bud Moore | Why Community Matters in M&A
    POSTED 3.10.20 M&A Masters Podcast

    In today’s episode, we sit down with Bud Moore, who is the founding partner of Valesco Industries– a lower-middle market private equity firm in Dallas, Texas. We love everything Valesco is doing, especially because there is a large need for their expertise, guidance, and capital in the lower-middle market.

    “Our ideas are muscle, and so we put that behind companies to help them grow and become a bigger and better version of what they were,” says Bud on the topic of how Valesco came to be. 

    We’ll chat about Valesco’s primary markets, value-added distributions, and…

    • Moral and ethical commitments
    • Banishing preconceived notions
    • M&A trends
    • Rep & Warranty

    Listen now…

    Mentioned in this episode:

    Transcript

    Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. We’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today I’m joined by Bud Moore, founding partner of Valesco Industries, which is a lower-middle market private equity firm based in Dallas, Texas. Bud, thanks for joining the podcast today.

    Bud Moore: Hi. Patrick. I appreciate you including me.

    Patrick: The reason why we reached out to you is that there is a growing ocean of opportunities in the lower-middle market. There are more and more opportunities. We are seeing not only in here in Silicon Valley with technology, but throughout the country for a variety of reasons. 

    And as I speak with experts in m&a I’m struck by this growing chasm between the middle market and upper market companies and the amount of services and resources available to them. And then you get to the lower-middle market and there is just this crying need for not only capital, but expertise, guidance, and so forth. And it’s, there’s just this wanting audience out there that’s really looking for help. 

    And I think firms like Valesco Industries are ideal to come in and provide just the types of help that they need to move on. I didn’t want to steal your thunder, but if you translate or define the term Valesco, that means to grow strong, which is a very, very helpful name. And that’s where a lot of the lower-middle market companies are trying to be. They’re trying to do that before they ultimately go to an exit. So I appreciate you making yourself available. Before we get into all things. Valesco, let’s talk about you. How did you get to this point in your career?

    How Bud Got To Where He is Today

    Bud: So mine was a bit of a circuitous route. I started out actually in investment banking on the sell-side. And did that for a number of years in a market downturn, decided I would switch to the buy-side and did that for about four or five years until I found myself in a place that I was so full service for my clients that I felt like I was a private equity guy and not getting paid for it. So I thought I’d fix that problem and actually get into the private equity side of the industry. 

    And did that in 1994 as in what today is referred to as an independent sponsor. So our ideas are muscle and putting that behind companies to help them grow and become a bigger version and a better version of what they were when we made our investment. So did independent sponsor work really until the great recession of late 2007, early 2008 timeframe. 

    And during that period of time, we had exited almost all of our investments, I’d like to say because we were brilliant and saw a recession coming, but really more so people found value in what we had. And in that particular market, we’re paying quite well for what we build. So we sold what we had, and then a private moment, sat back and thought about what we hadn’t done that we should do next and thought raising a private equity fund might be a great idea. And so we set off to do that and raised our first formal fund in 2011. 

    I guess the lesson that I learned from that is, if you’d like a lesson in humility, you should ask everyone you know for money in the midst of the worst recession they’ve ever seen. But fortunately for us, it was successful. And that’s led into a successive fund and we’ve had great success and putting that to work and what for us is our lower-middle market companies and we kind of define that as 25 to $75 million in revenue.

    Patrick: Okay, and then the industries that you target being based in Dallas, people are going to assume it’s either, and now, this is a Californianian speaking, but if you’re based in Dallas it’s either you’re doing something in the energy or the cattle industry. Tell us what are your specialty areas.

    Bud: It’s a great assumption. We’re actually kind of embarrassed being here in Texas. We’ve never actually done an oil and gas transaction. And we really regretted that several years ago and went out and spent quite a bit of time doing a white paper on whether or not we should invest in the energy industry. And what we discovered was we just weren’t smart enough to do that. That’s a very complicated industry. So for better or worse for us, we’ve really focused on manufacturing, value-added distribution and business services. 

    And that’s been our focal point for a long time. And if you take a look at industries, there are some industries where we’ve had better luck in and others. The food industry has been good for us, heavy equipment, things of that nature. But I would tell you, we’re looking really more for a unique profile than a particular industry. And in doing that, we find really great niche market companies that we’ve had good succession growing and building. 

    Patrick: When you say unique profile either operationally, a need they’re fitting, location, what do you mean by that? 

    Bud: So and we kind of boil this down to three basic financial characteristics that define a broader list of operational characteristics. For us, we take a look at the EBITDA margin, you know, our principles say it needs to be 10% or greater. I would tell you most of our investments are far greater than 10%. We look at working capital efficiency being defined as inventory and accounts receivable as a ratio to sales being 30% or less. And we look at six asset utilization compared to sales for turns or greater. What that tells us is we’ve got a company that is in a niche market in its industry, it’s able to produce, it doesn’t burn working capital. 

    It generates working capital and doesn’t have to invest every dollar of earnings into its next dollar of growth. Let’s just roughly speaking kind of the principles that we’ve operated under. And as we apply that against industries that we’ve looked at and invested in, you’ll find really a broad variety of things all the way from aerospace to heavy equipment to food manufacturing. We even currently own one of the largest producers of drug testing for professional and amateur sports in the world. 

    So it’s a wide variety of things that we’ve invested in, but what we like a lot and we think this is true across numerous industries, and even in an industry that people would consider to be unattractive, they’re always one or two players that have figured out how to do it extraordinarily well. And what we’re looking to do is invest in those companies, work with that team to be able to continue to professionalize and build that business and really grow it into something of true significance.

    Patrick: One of the things you mentioned earlier was value-added distribution is value-added. Explain that for me.

    Why Value-Added Distribution?

    Bud: Sure. Value-added distribution is we take a look at distribution. Commodity-oriented products really aren’t of much interest to us. We would define that as products that generally carry kind of a 20 or 25% gross margin, resulting in maybe a 5% 6% net margin at the end of the day. Unfortunately, if you want to grow in a distribution business like that, you’re investing this year’s earnings and next year’s growth. 

    And you really don’t really generate any free cash flow for your investors. You just invest in the business with, you know, with your end being when you decided to stop doing that. So for us, we look at businesses that are taking products and doing something tangible to them. 

    A great example, we invested in a business a few years ago that was producing high school promotional and high school fundraising items. So think of it as your local sports team for your high school but instead of buying cookie dough or pretzels or things that you probably really don’t want to support the team, you go to our online portal and you buy the team’s sweatshirt or t-shirt or ball cap and you support the team that way. We were mining substrates that are already manufactured, t-shirts, or anything that we were making. 

    But we would put on them the school’s insignia and then sell them out to their fan base. And to us, that was value-added distribution. And, you know, that’s the type of thing that we think really has, you know, great consumer desire in the marketplace. And we really like businesses like that, that have figured out a creative way to address a customer or consumer want or need.

    Patrick: As I was researching your organization and looking through your website, it’s unmistakable that you see this undercurrent, talking about not only the financial component of what you’re doing and adding value to your investments and so forth, but there’s a real moral and ethical commitment that seems to drive your operations. Can you talk about that, please?

    Ethical and Inclusive Operations

    Bud: Sure. We, when we look at the investing in lower-middle market businesses, we really can’t make the claim that our money is greener than anyone else’s money. There are a lot of investors that try to invest into that space. What we focus on is how do we do the right thing for the business, the right thing for the employees, the right thing for the community. It’s something that’s extremely important to us. 

    And the way we look at it is, you know, every day the companies that we’re invested in are providing hundreds of jobs for people in the community that allow them to have mortgages, allow them to have, you know, pay for their family’s expenses and overhead and really creates the future for them in their community. And so, that’s extremely important to us. So rather than just putting money into a business, we really like being able to come in and make a difference in the business to make it a bigger and better company. 

    So that people have a career and not just a job and, you know, you’ll see that throughout our companies in the way we’ve invested in teams and in areas. Not all of our companies are in a lower-income community. But many of the people that work for our businesses may go home tonight to a lower-income community. And so we’re respectful of that. And you’ll find that better than 60% of our employees are minorities and the businesses that we’ve invested in, you’ll find that we have promoted women and minorities into positions of leadership within the companies. 

    And so we really, we believe strongly in people that want to work hard and apply their abilities, that we should be giving them the opportunity to succeed. And that’s been a driving principle for us. In addition to that, we try and spend a lot of time working with the companies themselves, to help people with a vision of how they get better in terms of their business. And I think that’s something that not everyone in private equity, actively does. And we’ve prided ourselves on doing that for a long time.

    Patrick: I think as I got into working in mergers and acquisitions, you have a preconceived notion on how the players work and the relationships and so forth. And then when you get deeper into it, as you see, particularly if you’re a target company out there and you’ve got more than one option for prospective buyer or partner, financial partner. It’s not always the top-line number this out there that leads to a successful close or successful exit. 

    I always look at this as, you know, this isn’t company A buying company B. It’s people working together. Mergers and acquisitions as people. And one of the great value adds that I think private equity, your entire industry can deliver. Particularly for owners and founders is they can only grow so large on their own. And to take that next step, they need partners to get them there otherwise they may take a misstep or, you know, not get to where they want to get. 

    And, you know, the concept with private equity where I’m sure you guys do this, too is you know, making a partial investment or maybe rolling, they roll over some equity. It is amazing how an owner or founder may sell 60 70% of the equity in their firm to a private equity company. And then five years later, their remaining 30 or 40%, is worth significantly more than the original batch of equity they had sold over. 

    And I think that’s just that second bite of the apple is something I did not know about with private equity until I got into the business. And boy, that’s a real great thing, particularly for the people that are responsible for coming up with these companies and these services that in most cases didn’t exist until the owners and founders created them. And I think that’s a great thing you do. As you look you know, you’ve been involved with this for a while, are you seeing any trends in m&a that you can comment on?

    Recent M&A Trends

    Bud: I think the ones that everyone sees out there right now there’s just a lot of capital seeking return. And the public markets have been pretty good over the last year or two. But just in general, if you look over a more extended period, you know, those types of returns are not projected to continue. 

    And so people are looking for return. And as they look for returns, alternative investments, of which private equity is one, tend to drive a lot of interest. And I think it’s different in the lower-middle market. Looking at putting your money to work there is different than putting it to work and KKR or Blackstone or someone like that. This is money that’s going to work for which you’re going to have to put elbow grease behind it to really make it pay off in the right way. So as money comes into the marketplace, I think it has the hazard of increasing prices. It’s not great for us, it’s great for sellers. 

    But as it increases prices, you really gotta have a plan for what you’re going to do with the business because you can’t just put money in and step away and hope that that works out. So we think that the real trend that’s going on right now is, we can’t change pricing. So what we need to do is change how we look at the value proposition. And I think if you’re going to step up and pay a larger price for a company, in this market, you have to be convinced of how you’re going to grow that business going forward. 

    It won’t be for a flat company, it’ll be for a growth company. So I think right now, lots of capital in the marketplace, I think people looking for ways to grow that business and grow that enterprise are really the big things that we’re seeing going on. And then what I hope I’ll continue to see as more and more people focusing on the operations side of the business, to help make that plan for growth really come true. Because it’s all great on day one when you see the hockey stick projection of what we’re going to do over the next five years, but you’ve actually got to execute on that to be able to make it real. 

    Patrick: I think also that there are if you get a target at the right price, that capital tends to be a little more patient than other capital. And so I think it all, it goes in with that where you really do have to have not just this idea of an investment, but Okay, now how do we make it work five years down the road from now? And I think there’s a lot more focus on that delivery than just we have to get this target right now at whatever price.

    Bud: No, I think your statement is right, as far as, you know, look, how you look at the investment, how you want to optimize it. but the thing that we try and keep in mind, it’s really more than just the day of the investment and it’s more than financial economics. If you want the economics to turn out in your favor, you’ve really got to get the team behind you. The people that you’re investing in, they have a business and yes, we’re buying in some cases, patents and we’re certainly buying brick and mortar and we’re buying machinery and equipment but what we’re really investing in is people. 

    And we’ve got to work with those people to help them be better at what they’re doing. We’ve got to create a relationship that makes them want to grow and build their business. We have to give them an understanding of how they win in this process. And I think doing all those things together really makes for the right investment. In our experience, if you’re selling a business, this is the most one of the most precious assets in your life. It’s really, it’s more of your family, in some cases, than your family itself. 

    You see people more that you work with, you’re there five days a week, if not longer, you’re there for long hours. And when you’re ready to exit, you have a lot of personal connection to those people and when you sell, you want to make sure that you’re selling or taking on an investor that’s got the same passion for helping and working with those people and growing them that you had. And I think that’s part of what makes an exit meaningful for people that are really looking and do it the right way.

    Patrick: Bud, quick question. We didn’t cover this when we spoke earlier but just off the top my head, have you guys on any of your acquisitions or your transactions, have you guys use rep and warranty? I’m just curious if you have, what kind of experience you had with it.

    Why Rep and Warranty?

    Bud: You know, we’ve used rep and warranty on numerous of our transactions and really made that almost a universal standard practice probably three years ago. We’ve found it to be, it’s not covered that we have very often had any type of claims on. But I can tell you, it makes our closing process much easier. Dealing with the representations and warranties inside of a purchase and sale agreement is one of the scariest things that I think sellers deal with. 

    They don’t want to have their big payday and then turn around and write checks back to the company. They really don’t want to deal with big escrows that everyone’s going to argue about later, whether or not there should be a claim or not. And so what we found by using rep and warrant insurance, it’s really eliminated many of the discussions about what the reps and warranty should look like it comes down industry standard set of reps and warranties. 

    There’s a very minimal exposure on the sellers part. And from an insurance standpoint to the extent that you have a bad circumstance, that’s why you have the insurance protection there to be able to cover that eventuality. And we found that to be a really seller-friendly process. And so we’ve adopted that over the last few years as our standard.

    Patrick: I could not have said any better than that. So I won’t. Thanks very much for that. Bud, how can our audience reach you? How can they find you?

    Bud: Probably the easiest way is through our website valescoind.com. That’s valescoind.com. On there, we have all of our bios, our history, many of the videos on the management teams that we’ve worked with, as well as our contact information for easy access. 

    Patrick: And I would say it’s a story that is worth reading and worth following. Bud Moore, thank you very much for joining us today.

    Bud: Patrick, thanks. I appreciate you having me on.

  • The Rise of Smaller M&A Deals in 2020
    POSTED 3.3.20 M&A

    We’re not yet to the end of the first quarter, and we already have a solid idea of where M&A activity is headed in 2020.

    Deloitte put out a report, The State of the Deal: M&A Trends 2020, based on a survey of 1,000 corporate executives and PE firms that looks back at what happened in 2019 and their views and plans for 2020. And the outlook is good for M&A, although there will be some key changes to keep in mind.

    As noted in the report, M&A activity will continue to be very solid this year. Only 4% of those surveyed anticipate a decline in the number of deals. Sixty-three percent forecast an increase in transaction activity. That’s down from 79% last year.

    There will probably not be as big an increase compared to the last seven years, a boom time that has seen more than $10 trillion in domestic deals alone since 2013. But that’s to be expected as this level of growth in transactions is hard to sustain.

    As Russell Thomson, national managing partner of M&A services for Deloitte & Touche LLP put it in the report:

    “We’re fairly long into this M&A boom cycle, so it’s not surprising to see a drop in expectations for larger deals. What we’re seeing in the marketplace is more interest in deals in the sweet spot between $100 million and $500 million. Deals aren’t going away; companies are just being a little more careful about those larger deals.”

    So the boom is tapering off a bit, but it’s still a rising trend due to several factors, including…

    • Ample cash reserves in both corporations and PE firms.
    • The strong stock market that closed 2019 at record highs (which helps equity-funded transactions).
    • A belief that tariffs/trade wars aren’t too much of an issue.
    • A conviction that current interest rates will not have an impact on deals (and, in fact, 45% feel the interest rate environment will actually accelerate deals).

    But this is the biggest change we can expect in 2020:

    Fewer “Megadeals,” More Deals Under $500M

    The number of deals over $500M in transaction value will likely come down and be replaced by deals in the $100M – $500M range… and as low as $20M. This is for a variety of reasons.

    1. More corporate divestitures. Companies are looking to offload assets in this lower range. According to Deloitte, 75% of corporate execs expect to have divestitures this year, due to financing needs, change in strategy, and the need to offload technology that doesn’t fit a new business model.
    2. Returns for larger M&A deals have not been as valuable as expected. Firms just aren’t getting enough bang for their buck. According to the survey, 46% of respondents said that less than half of their transactions in the last two years gave them the ROI they were looking for. So look for them to reduce their risk and pursue smaller acquisitions that offer more impressive returns. Smaller targets, acquired at lower prices, are just a lot more efficient, cash-wise. To hedge and improve ROI, companies are looking for smaller targets. This isn’t at the expense of profitability. In fact, you can have a higher return on a $100M acquisition – 40% to 50% – than on a $1B deal.
    3. Strategic Buyers are also increasingly pursuing smaller deals because they have a greater need to acquire new technology as today’s tech is already obsolete. They need technology that is a better fit going forward to stay competitive. 
    4. Buyers can take advantage of more favorable terms when they go after smaller targets, especially those under $100M. 
    5. PE firms like smaller targets because they are increasingly looking for new acquisitions that they can “bolt on” to existing portfolio companies instead of hoping those portfolio companies grow organically.

    When they add on new acquisitions, the firms can expect to sell those portfolio companies at a much higher multiple than before. This is why they are getting better returns with smaller targets.

    What This Means Moving Forward

    Based on this Deloitte survey, it’s clear that M&A activity has slowed a bit but is still going strong, continuing a trend of an unprecedented level of deal-making that started back in 2013.

    Also, on the rise: the use of Representations and Warranty (R&W) insurance to transfer indemnity risk away from the Seller to a third party – the insurer. With this coverage now available to sub-$20M deals, look for this insurance to be a part of an increasing number of deals in 2020.

    Whether Buyer or Seller, R&W insurance coverage can offer many benefits including smoother negotiations, more cash at closing, and less risk. But it is important to have a broker with extensive experience with R&W insurance and how it can impact a M&A deal. If you’d like to discuss coverage for your next deal, please contact me, Patrick Stroth, at pstroth@rubiconins.com.

  • How R&W Insurance Has Changed the M&A Landscape Part 1 
    POSTED 2.4.20 M&A

    Representations and Warranty (R&W) insurance is not just here to stay, but growing – not to mention changing the way deals are structured.

    More than a dozen insurance companies now offer this specialized product that transfers the indemnity risk away from the deal parties over to a third party – the insurer. And while only the big deals were eligible before, Underwriters will now take on deal sizes as low as $15M, which opens up a new world for Buyers and Sellers in those mid- to small-market companies. Plus, policies are cheaper than ever before.

    Strategic buyers, VCs, and PE funds are all talking R&W coverage. Sellers are insisting on it because it reduces their escrow obligations and indemnity risk, and Buyers find having this insurance in place makes it easy to move forward.

    All Signs Point to More R&W in Deals

    This widespread adoption of R&W insurance has had a tremendous influence in the M&A world, not just smoothing out negotiations and getting deals done faster but also altering very specific and often contentious deal terms when it comes to the Purchase and Sale Agreement.

    All this provides a critical mass that will bring R&W insurance to the forefront, with wider awareness and adoption in the coming year almost a given, even as it changes deeply ingrained accepted practices.

    First, a little context and background.

    You know there is a sea change going on when even the most resistant “old guard” companies change the way they do business.

    For years, SRS Acquiom was the go-to provider in M&A deals for holding escrows and other financial guarantees. It’s no wonder that for a long time they actively discouraged Buyers and Sellers from using R&W insurance. They maintained that having cash in escrow was safe and more advantageous than spending money on insurance.

    But they weren’t able to hold back the R&W tide, and now they’ve set up a brokerage within the company to sell… R&W coverage. So, they’re finally catching on. It’s a can’t beat ‘em, so let’s join ‘em type of thing.

    The major change resulting from the wider spread introduction of R&W insurance is how it’s disrupted the balance of “power” in the M&A world.

    The Buyer Power Ratio

    SRS Acquiom has a metric – the Buyer Power Ratio (BPR) – that they use to gauge the negotiating strength of Buyer and Seller. It’s a simple calculation: Buyer Market Cap / Target Purchase Price = Buyer Power Ratio. For example, if a Buyer’s Market Cap is 25 times the value of the target company, then the Buyer would have a BPR of 25. The higher the BPR, the greater the leverage for the Buyer in terms of size.

    Basically, the larger the Buyer is compared to the Seller, the more power and leverage they have to get favorable deal terms. For example, companies such as Apple, being a thousand times larger than any potential acquisition target (thus a BRP in excess of 1,000), will always have the complete upper hand. In deals where Buyer and Seller are similarly sized… the less leverage and the more negotiation will take place.

    R&W insurance has introduced a wrinkle here. When the Buyer Power Ratio is low, Buyers are now increasingly using R&W as a way to make themselves more attractive to Sellers while decreasing their risk.

    For example, it’s harder for the Buyer to exercise their walk rights once the Letter of Intent is signed and the target company is off the market. At this point, the two sides are joined at the hip.

    If the Buyer tries to walk away, the target feels like they’re damaged goods and will have a hard time attracting another potential acquirer. If the Buyer wants to abandon the deal at this stage, they face a severe financial penalty. It’s like canceling a wedding at the last minute and not getting your deposit from the caterer or hotel ballroom back.

    However, this puts Buyers in a tough spot if they spot something during due diligence in the run up to closing the deal. They want to walk away but is the issue worth the penalty? That’s where R&W insurance comes in.

    The Buyer can shift this risk to the insurer. By hedging the risk, they can feel comfortable moving forward with the deal.

    Overall, the mindset of Buyer and Seller going into deals when they have an R&W policy in place is:

    What steps can we take to shift risk to the insurance company? And, how can we make sure the insurance company will accept risk?

    Now, we see two parties angling to have terms that they consider a risk to be covered by insurance.

    In part 2 of this article, we’ll drill down into some of the specific deal terms that are changing with the introduction of R&W insurance and how it will impact a M&A deal going forward, including elements like the double materiality scrape, non-reliance clauses, and more.

    For now, if you have any questions about Representations and Warranty insurance and how it could change the dynamics of your next M&A deal – whether Buyer or Seller – you can contact me, Patrick Stroth at pstroth@rubiconins.com or (415) 806-2356.

  • This Could Change Everything in M&A
    POSTED 1.21.20 M&A

    There is a potential game changer in the M&A world, especially for Strategic Acquirers, and Representations and Warranty (R&W) insurance is an integral part. And with this coverage available for transaction sizes of $20M (or even lower) the impact will be widespread.

    Tech powerhouse Atlassian, which offers software solutions for workplace collaboration, coding, and more, does a lot of acquisitions. It’s a multi-billion-dollar company, and it buys dozens of smaller companies to expand its services into new areas.

    So far, pretty standard.

    Most large companies use that leverage to “bully” the smaller business into accepting whatever terms of the deal they put on the table.

    But Atlassian has shaken things up… to put it mildly. 

    As Tom Kennedy, the company’s chief legal officer, and Chris Hecht, head of corporate development, put it in a statement announcing this bold move:

    “The M&A process is broken. It’s outdated, inefficient, and combative. Which is why we’re publishing the Atlassian Term Sheet to fix it.”

    Why the New Atlassian Term Sheet Is a Game-Changer

    The traditional way to go about M&A deals is to conduct negotiations in which one side wins and the other loses. The larger company will always win.

    Commandant #1 in the traditional M&A world is, “Those with leverage tend to use it.”

    But…

    You win the deal at the sake of losing trust from the those on the Seller’s side. It makes everybody uncomfortable. And it’s counterproductive.

    When bringing in a target company, you want them to be your next rock stars that will help you capitalize fully on your new investment. If you’ve beaten them into submission and they have to show up at the office on Monday, it can be quite difficult to really put your heart into your work.

    One of the biggest points of contention (and cause for resentment): Why is it standard to have escrows that are 20% to 30% of transaction value? Breaches are typically tiny. Big escrows are unnecessary. Atlassian is saying they will give their targets a choice: either provide a 5% escrow for 15 months or pay for a Buy-Side representations and warranties policy and provide a 1% escrow (this insurance would cover the other 4%). That represents a seismic shift from what well-leveraged Buyers usually do.

    After going through plenty of deals where that happened, Atlassian decided to make a radical change and be transparent during the whole M&A process, from the beginning.

    With the Atlassian Term Sheet, they’ve shown potential Sellers exactly where they stand on:

    • Closing Date
    • Due Diligence
    • Deal Documents
    • Holdback
    • Proposed Purchase Price
    • Outstanding Equity Awards and Other Equity Rights
    • Employment Offer Letters and Non-Competes
    • Employee Retention Pool
    • Indemnification
    • Escrow
    • Insurance
    • Transaction Expenses

    These terms are non-negotiable. A Seller can take it or leave it. And, in many cases, they should take it because if you read through the term sheet, you’ll see that Atlassian – the Buyer – actually assumes a lot more risk according to this term sheet than in a similar, standard M&A deal.

    This Seller-friendly stance horrifies M&A attorneys. But Atlassian is fine with it because they know there is not much risk in these deals. There are actually very few breaches in deals post-closing, especially with IP. And if there is a breach, it’s small in the vast majority of cases.

    Atlassian is not rolling over. Everything is still contingent on extensive, rigorous diligence.

    How R&W Coverage Fits In

    R&W Insurance is an instrumental part of this document. The glue that holds it together, in a way. And, the term sheet outlines that the Seller will pay for R&W insurance and D&O Tail insurance.

    For R&W coverage, the term sheet states that the Seller will pay for it, including any fees, premiums, taxes, or commissions, for a policy limit of 4% of the Purchase Price. It’s quite affordable, costing less than ½ of 1% of the transaction value.

    One of the reasons Atlassian can feel comfortable offering these terms is that if there is a breach, the R&W insurance kicks in. It transfers all the indemnity risk to the insurer. If there are any breaches post-closing, they file a claim and get damages – no need to go after the Seller.

    Ever since I first saw R&W insurance back in 2014, I’ve had the opinion that as M&A progresses, this specialized type of coverage will become as standard as title insurance for buying a home. Because of the speed and frequency of M&A deals – which is only increasing – things have to become standardized.

    And things are heading that way. PE firms and VCs, as well as Strategic Buyers, are being drawn to this insurance more than ever. There are about 20 insurers offering this coverage today, up significantly from a handful just a few years ago. And there are policies even available for deals under $20M, which is a development in just the last year or so.

    There is no good reason not to get this coverage, in most cases.

    How Will This Term Sheet Impact M&A in 2020 and Beyond?

    I think this is going to soon expand beyond Atlassian.

    This could be a potential signal for other Strategic Buyers out there. They know they had better streamline the process. Why are they reinventing the wheel for every deal and grinding the Seller into submission? That attitude is as productive as old school football coaches who wouldn’t let you drink water to toughen you up.

    Think of it this way. Forty-niners coach Bill Walsh established a policy of no-contact practice mid-season on. There wasn’t any need. And unlike other teams, his players weren’t beat up for pivotal games late in the year.

    The NFL is a copycat league, and other teams soon followed Walsh’s tactic. Corporate America is full of copycats, too. So I think you’ll see them follow suit when they see that the term sheet has made Atlassian very attractive in potential Sellers’ eyes.

    With everything, there is a hard way… and a smart way. The Atlassian Term Sheet is the smart way. This is a more efficient and cheaper way to get deals done.

    They have an eye on the end result: integrating the acquired company. This company wants peace, love, and happiness in their M&A deals going forward, and they’re not having to take on very much risk to get it.

    Be sure to check out the Atlassian Term Sheet in-depth. Then I’d invite you to speak with me, Patrick Stroth, about how Representations and Warranty insurance is a key part of this new way of thinking… and how it can protect you in your next deal. You can reach me at pstroth@rubiconins.com or (415) 806-2356.

  • Pejman Makhfi | Easier Acquisitions for Mid-Market Companies
    POSTED 1.14.20 M&A Masters Podcast

    There comes a stage in every company’s life where organic growth is no longer enough. A strategic acquisition is the only way forward.  

    But for middle-market companies, this is a tricky proposition. The management team is running the business… they don’t have time to research potential targets, negotiate price and terms, and all the rest that goes with an M&A deal.

    Pejman Makhfi, the founder of Silicon Valley-based Synrgix, which provides a process management system to support growth through acquisition for middle-market companies, has a solution. And it’s vital that it’s implemented now because data shows that mid-market companies that aren’t acquisitive are likely to fail.

    Tune in to find out…

    • One thing any CEO or CFO must know to manage M&A deals
    • How to manage ongoing M&A activity with minimum impact on resources
    • A strategy to balance organic growth and growth through acquisition
    • Why lack of resources doesn’t have to mean stalled growth
    • And more

    Listen now…

    Mentioned in this episode:

    Transcript

    Patrick Stroth: Hello there. I’m Patrick Stroth.

    Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders, and their investors. Today I’m joined by PJ Makhfi. PJ is the founder of Synrgix, a Silicon Valley-based startup company with tools and services to support the execution of the processes in the mergers and acquisitions domain.

    Middle market companies hit a stage in their journey where they face pressure to sustain growth, pressure from the board and shareholders in one direction, and market agility and competition out there from the other direction. Both of these make ma critical to a strategy for middle-market companies if they want to grow. I noticed the immense importance of this effort based on recent discussions I’ve had with PJ and his team, which is why I asked him to join us to talk about synergetics and how they can solve the problems for the middle market.

    PJ. Thanks for joining us today. Welcome to the podcast.

    PJ Makhfi: Thank you, Patrick. Pleasure to be here and thanks for the opportunity.

    Patrick: Tell us before we get Synrgix to tell us what brought you to this point in your career.

    PJ: As you may know, my background is in software with many years of experience in BPM. For those not familiar with BPM, it is business process management. BPM help optimizes and automate business processes, and let you put tools in place for continuous improvement. In the past, I’ve been a part of several acquisitions both on the buy and the sell-side of the deal. What I noticed was that while the deal rationales made sense, and clear synergies, where there, acquisitions didn’t fully deliver on the promises, so I decided to take on the challenge, dig deeper and see if I can make the M&A process more controllable and rewarding. I talked with many executives and practitioners and studied past successful and failed acquisitions. These gave me the insight and a chance to solve the problems that directly impact M&A success rate, lined up a strong team of like-minded members and advisors, and built a solution to help our executives take up M&A without hesitation.

    Patrick: I didn’t know that happen. That’s fascinating. What markets when we talk about middle-market now, what markets are you targeting? And specifically, what are the challenges that they’re facing? How do they know, not succeed in these M&A deals?

    Middle-Market Challenges

    PJ: We’re focused on helping mid-market companies. I would say our sweet spot is from 50 million to 500 million revenue. Our typical clients are companies that strive for rapid growth but have reached a stage where organic means are no longer sufficient. They would like to reignite and accelerate their growth. Just think about what it takes to take a new product from conception to market and scale or taking your existing product to different markets, domain expertise, engineering, marketing, sales, partnership, etc. The organic means are often too slow and uncertain in an age where disruptions are happening every day and everywhere.

    Patrick: I didn’t think about that. Well, when you consider you’ve got a choice for growth is either you get Do It Yourself organically or you grow through acquisition. There are merits to both sides of the equation. And I would just think, anecdotally about Coke and Pepsi where it’s cheaper and faster for them to acquire another flavor than to develop their own sports drink. I think it’s easier for them to just go buy Gatorade, but there’s still that tug between organic and an M&A. Why do you think M&A is the solution over organic for growth?

    PJ: There are some numbers that can share with you, Patrick that support this. Over the past decade, 73% of mid-market companies have disappeared. Of those who survived 70% were acquisitive. historical data shows that M&A helps companies grow three times faster and give a 75% higher chance of success, even an economic downturn. Surveys also show that 60% of mid-market companies considered M&A, but only 22% building into their strategy is M&A gets quick access to revenue and reduces costs. You would ask why don’t all adopt this?

    Patrick: Well, those numbers are compelling. Why is that? Why are more companies not going for acquisitions if it’s such a no-brainer?

    PJ: Good question, this goes back to lack of experience and resources in a very complex and delicate process. On average, our CEOs have point nine acquisitions in their lifetime. There is uncertainty, complexity, risks and high expected costs. Plus there is still the existing business that they need to run, leaving them with little time and resources to commit to the m&a initiative. There are also concerns about using third parties. Today, the M&A ecosystem is suffering from misaligned incentives for service providers. And the corporation’s several players in the M&A process work in silos and are compensated regardless of their returns.

    Patrick: Yeah, that would pretty much make me pause. I always look at this as if you’re running a medical corporation and you want to acquire another medical corporation. You’ve got to go out and almost get finance and a law degree. Just understand what’s happening, and fortunately can’t do all that at one time when you’re running a company. So what does Synrgix do to offer these companies so that they’re stepping out into the unknown, and they can do so confidently?

    PJ: So we started exactly what the mission to address the challenges that I just talked about. We created a software platform to guide the execution of the M&A process. The platform allows CEOs and CFOs to track and manage the entire M&A process successfully. From strategy planning all the way through integration, and synergy realization, we offer on-demand services to augment the in house team, our need basis. And we aligned our compensation with our client’s success metrics to create a truly trusted relationship.

    Patrick: So you can make the process as simple or as hard as it needs to be. The client has full control There is less of a chance of a conflict of interest because of compensation structures different. That’s fantastic. I’m sure there’s a lot more in it when people dig deeper with the platform and so forth, you can’t be the only one out there. So with other players out there that are providing services to M&A parties, how does Synrgix differentiate itself in the space?

    Why Synrgix is Different

    PJ: The first and foremost difference is that Synrgix uses a process-based approach with end to end transparency. In other words, it gets rid of silos, there is so much at stake in a transaction our CEOs and CFOs want visibility throughout the entire process. Second, objectivity, experience, and control are in the fabric of our solution. We target its identification, due diligence, valuation or integration. We provide visibility and decision support to execute a successful deal. And finally, the curated on-demand services give our clients and the extended deal team they can tap into when needed. That allows them to manage m&a initiatives with minimum resource impact and risk to their in house projects and day to day business. So you’re providing transparency, objectivity, and the ability to pick and choose the services as you need is need fit so that you’re controlling costs. I think that’s fantastic with everything you’re offering there. Is there anything else you’d like to share with the listeners when it comes to this platform? Yes, I like to encourage our CEOs and CFOs to think more about how long and what it takes to prepare for M&A.

    We have learned that M&A transactions take a lot of upfront work before you have a solid plan and a green pilot pipeline of targets. My advice to you or executives is to be proactive in order to stay on top of your game. And ahead of the competition. You can start big or small, build a strong strategy, and in house capabilities and have the processes and tools in place ahead of the time. Be the one-off acquisition or scaling through several acquisitions, make sure you have a repeatable process that builds on top of and learns from the past deals.

    Patrick: I think was really important to keep in mind just something that we forget from time to time is there’s always the focus on a potential target company, thinking that they’ve got a plan ahead and get organized and think about all the things they have to do to get organized to be acquired. And we don’t really think about the other side of the equation we’re all the pre-work has to be done. Done. If you’re thinking about an acquisition, and you shouldn’t wait until you have a clear target in mind, you’ve got to start doing a lot of this pre-work ahead of time and kind of get yourself staged up for that. And it’s helpful to have someone out there that can guide you and do that pre-work without this big, long, cumbersome commitment. Why don’t you run us through a scenario on how you work with a client? Let’s say you’ve got a company that has a concept they do want to grow, and they want to get started, but they don’t know exactly where they’re going. What would it look like for them if they commenced engagement with you?

    PJ: It’s very simple. Patrick. On sign up. What we do is we work with our clients to understand their situation and needs. Our success manager helps them capture their acquisition and growth strategies, selection criteria, and process templates to follow best practice execution. Clients can kick the tires and go at that point, they can use our sourcing services to get a pipeline of pre-scored targets, or do their own target sourcing. It’s as easy as that.

    Patrick: So they can sit down with you get some guidance on a profile and not only get their processes for acquisition and bringing somebody on board, but they can also talk to you and get guidance on where they could find targets with your sourcing services. So that really is a big value add out there. Tell us about the pricing for this out. How is it based?

    PJ: Our pricing is very competitive. It’s a very reasonable monthly subscription fee with no upfront cost or yearly commitment. Our clients get a success manager to help them onboard and run a smooth process. On top of that are on-demand sourcing and other supporting services are there for those clients who like to tap into with a pay as you go, payment model?

    Patrick: Well, I think one of the things we can overlook on this is what you’re doing if you’re an acquirer, what’s the difference between an acquirer and a serial acquirer? A serial acquirer has done more than one acquisition. And I imagine with Synrgix if you can get the templates set up for processes here, and you may come up with more than one target, but you may go for one target at a time. I think it was great as this sets up an individual platform for each and every company. So you’re not only equipped and ready to go ahead and process assessable transition and acquisition for one target. But you can set the template for this being used again and again and again. And I think that’s very valuable that this is not just a one-off tool. This is something that can be deployed and after successful deployment, it can be used as an Again and again and again. And so I think that leads to more acquisitions, which we’re happy about because the smoother acquisitions become, the more there will be and we love more, not fewer acquisitions.

    PJ how can our clients reach you?

    PJ: Your audience, you can reach us by visiting our website www.synrgix.com or email us at info@synrgix.com. We can offer a free readiness assessment or a demo as our client requests.

    Patrick: Well, that’s outstanding and to our listeners out there, I would strongly encourage you, you have absolutely nothing to lose in these processes to learn something that is a potential tool that can be an absolute game-changer for you, if not for making something easier, at least giving you peace of mind to know that There’s something out there that you can use as a reference point. PJ, thank you for joining us and we look forward to talking to you again!

    PJ: Thank you for the opportunity and I look forward to working with you.

     

  • Middle Market Privately Held Firms Fearful of M&A
    POSTED 1.1.20 M&A

    Every business must have some plan for growth. That’s obvious. But how they achieve that growth is another story.

    There are basically two methods:

    1. Organic growth
    2. A merger or acquisition

    Companies usually use a blend of both. But those that try to rely solely on organic growth, which takes a significant amount of time, even with the best businesses, will be left behind in the marketplace.

    M&A is a much more effective choice to add to their product offering, boost their capabilities, reach new groups of consumers, or expand their geographic presence.

    But there is an issue, at least among middle market, privately held firms. They might understand that organic growth is too time-consuming, yet they won’t move forward with promising M&A deals that seem like a good fit.

    In fact, a study from Synrgix, a business application development and consulting company, found that one out of 5 of the 25,000 middle market companies surveyed that are looking to execute an acquisition, actually do so.

    Why is this the case?

    There are several factors at play.


    Mainly it’s fear, due to lack of expertise… lack of time… lack of resources.

    These are relatively small, privately held companies. They don’t have an internal corporate development department. Besides, they don’t have the experience or knowledge base in how to conduct M&A deals, so they decide not to do it.

    It takes time to search for targets – and it always helps if you know what makes for a good acquisition. It’s usually a CEO or CFO that is placed in charge of an acquisition, but they have a full-time job already and often don’t even know where to begin. So, deals fall by the wayside… and growth stalls.

    The Consequences of Delaying an Acquisition

    Only when pushed to the brink in desperation do these middle market companies go through the whole acquisition process – or at least attempt to. They might eye a potential target only to find out a competitor grabbed them first, while they struggled to get their ducks in a row.

    If that potential target had a capability they were looking to add, it gets even worse. They might lose the target and lose an existing client that expected the company to serve them with that capability.

    Another consequence: the company was contemplating entering a new market and a competitor makes the acquisition and enters that market instead. Bad for business.

    There is a solution. Synrgix offers a software platform that streamlines acquisitions by helping organize the process and schedule milestone events until the deal is done.

    With a platform like this, companies eager to engage in M&A don’t have to hire an outside corporate development firm. They can do the work internally and spur deals that will allow them to add new capabilities, clients, geographic market, and more – all elements critical to growth. You can see the Synrgix platform yourself at: https://www.synrgix.com.

    Another element that can help spur successful acquisitions is Representations and Warranty (R&W) insurance. With this coverage:

    • Negotiations are generally much quicker and less contentious.
    • Any risk from breaches of reps in the Purchase and Sale Agreement are transferred to a third party (the insurer).
    • Insurance companies do pay claims.
    • Less money is held in escrow and there is no chance of clawback.
    • Both Buyer and Seller feel peace of mind as a result.

    There is potential risk in every deal, but R&W insurance mitigates it. And in the last couple of years, costs for this coverage have been coming down because more insurers are getting into the game.

    Not to mention, deal sizes as low as $15 million are being covered by multiple insurers – that’s perfect for middle market companies looking to grow through M&A.

    If you have a middle market company but haven’t been able to pull the trigger on a much-needed acquisition, I’d be happy to speak with you further about how you can avoid obstacles that are in your way.

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

  • Craig Lilly | 3 Reasons Foreign Companies Are Looking at U.S. Acquisitions
    POSTED 7.9.19 M&A

    When we usually see cross-border deals, it’s a U.S. company acquiring a foreign business. But increasingly the reverse is happening, says Craig Lilly, corporate partner at the Palo Alto office of Baker McKenzie, and there are three primary drivers for that trend.

    But cross-border deals with foreign buyers aren’t without their pitfalls, especially with newly enacted regulatory and anti-trust and merger controls – at that’s just the start. Just look at what is happening with Chinese telecom giant Huawei.

    Cross-border M&A is far from a done deal. Foreign companies are still acquiring U.S. companies, says Craig, but just engaging experts like his company to shepherd the transaction.

    We talk about where cross-border M&A is headed in 2019 and beyond, as well as…

    • The two biggest concerns in cross-border deals
    • How changes at CFIUS have vastly changed the playing field
    • When a cross border deal isn’t really a cross border deal – and why
    • How American companies are taking advantage of Asian company’s hesitancy
    • And more

    Listen now…

    Mentioned in This Episode: www.bakermckenzie.com and Winning Strategies in Cross Border Deals Tips for Success Presentation

    Episode Transcript:

    Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak to 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 Craig Lilly, M&A and corporate partner at the law firm Baker McKenzie in their Palo Alto office. Craig’s practice focuses on acquisitions, divestitures, joint ventures, and strategic investments.

    But it’s in complex cross border deals where he’s really developed great expertise and he’s now thought of as an industry leader. Craig’s been a regular contributor on Bloomberg, the Wall Street Journal, and other M&A specific publications. Craig, welcome to the program and thanks for joining me today.

    Craig Lilly: Thank you, Patrick. I’m glad to be on the program.

    Patrick Stroth: Well, Craig, now that we’re getting past the first quarter here in 2019 rather than just focusing on cross border deals which we’re going to get into in depth. Tell me what your perspective is as an expert on what the state of M&A is here in 2019.

    Craig Lilly: Well, I think MNA is very strong and still in 2019, the values is increasing even though the volume may be slightly lower. 79% of executives say that the M&A will increase in or remain the same in 2019. We’re seeing record amounts of a private equity raise as well as venture raise which is really good for the ecosystem in mergers and acquisitions. In the last 12 months alone, we’ve seen over 3.6 trillion in deal value over 19,000 deals in US and Europe. So that’s a very strong technology M&A is up 20%.

    Also, we’re seeing M&A more institutionalized. 20% of all targets, Pat, are backed by either private equity venture firms or professional investors. Also, there’s record levels of what we’d call dry powder or money to make acquisitions. The PE dry powder is estimated to be over 1.7 trillion and also, the top five tech companies alone have over 340 billion in dry powder. And that includes Apple, Google, Microsoft, Facebook, and Amazon. So the key M&A drivers that we’re seeing are really for strategics are customer expansion and diversification. And so those are all I think big drivers for M&A and which will continue in 2019.

    Patrick Stroth: Well, we’ve got just a confluence of changes that have been happening over the world where you’ve got either the world getting flatter or a lot of capital looking for places to be put and maybe people aren’t looking at their backyards anymore. They’re looking overseas. They’re looking cross border. And which is why I wanted to come speak with you about this. But before we get into the technical issues on cross border and the ins and outs of it. Give us a little bit of context for you. What brought you into becoming an M&A attorney first and then to specialize in cross border acquisitions?

    Craig Lilly: Well, I had a background in financing and accounting so I was always interested in M&A and investments which really drew me into it. I originally worked in private equity back in the cottage days of private equity when it was a very early industry. And then I started working in technology over the last 16 years or so. And one of the things to that really interests me about the technology and in M&A is that companies at earlier and earlier stages are expanding internationally which is a big driver of cross border M&A. So those are the things that really interest me is the international aspects, the complexity, and also getting to learn new industries and verticals.

    Patrick Stroth: So what makes a deal a cross border transaction? Is it as simple as we think just anything outside the US borders?

    Craig Lilly: Well, really it’s really any deal with foreign aspects. It could be the buyer or the seller or material assets or it could be a US company acquiring another US company that has material foreign assets as subsidiaries. So typically almost every kind of major US corporation has some type of foreign aspects. So all those acquisitions even though it may be a domestic acquisition really is a cross border because of the foreign aspects or subsidiaries that a US company may have.

    And we’re seeing this in an earlier stages of the companies. A lot of early companies are young companies are expanding overseas whether to develop technology, develop manufacturing or to acquire customers through diversification.

    Patrick Stroth: A lot of times we’re thinking of US going outside and looking to foreign markets for acquisition targets. But it’s also on the flip side, according to what you just told us where you’ve got foreign-owned companies coming to the US which intuitively we think that the US is too expensive a market for targets. But that’s not necessarily the case. There are things that must be driving these foreign-owned companies to come and invest in the US. What drives the demand from their side to come here?

    Craig Lilly: I think it’s three primary drivers for foreign companies to want to make acquisitions in the US. The first one obviously is technology. We’re seeing the fourth industrial revolution happen here in United States where technology is embedded in almost every different vertical or industry whether it’s automotive or manufacturing or artificial intelligence within industrial manufacturing. And so that’s spurring a lot of the investments and acquisitions by foreign acquirers here in the US.

    The second is just customer acquisition. Companies are looking to acquire customers and essentially diversify their base. And a third driver really is not only the diversification within a customer base but diversifying their own different revenue streams where they could be diversifying in a new analogous business that maybe is very synergistic with your existing line of businesses.

    Patrick Stroth: I agree. One of the things that changed my perspective when we talked about this a while ago was that the focus always on customer basis and so forth. People immediately think China or India where they’re billions of potential customers out there completely overlooking the fact that while we may not have the largest population. We probably have one of the richest. So if you can make a stand here in America with a very friendly consumer base, you’ll do very, very well. And that was one of the things that really came up when you and I were talking about the US being such a great target for them. This can’t all be that easy. What are the challenges that are germane to cross border deals versus ups or domestic deal?

    Craig Lilly: Well, there’s definitely changes or challenges in regulatory, whether they are antitrust or merger controls. Obviously, CFIUS which we’ll get into later is a major challenge for companies investing in the US and CFIUS is the Committee on Foreign Investments in the United States. And also, structure and tax issues. Furthermore, key issues when a foreign company comes here is complying with employment laws. It could be unions or the WARN Act. When you want to terminate employees. Intellectual property, data privacy, and security are a major concern as well.

    You’re seeing often more and more companies are having inadvertent data breaches. So that’s a key issue for any company in any type of transaction particularly for cross border where you could have cultural issues and other different challenges in data privacy. Also, anti-corruption is always a big challenge for companies and having internal compliance programs implemented to correctly deal with those types of issues. And obviously, in any type of transaction diligence, culture, deal execution, and also, post-closing integration is a major issue. And in post-closing integration, something doesn’t start after closing. It really starts very early in the acquisition process.

    Patrick Stroth: Can I ask you this is a little off topic but with all of those challenges that are there that’s probably a role that you and your firm will give guidance to if you can’t have absolute on the ground consulting recommendations you have resources or can provide resources to companies to address those various areas of concern?

    Craig Lilly: All right. We have great breadth in over 45 countries around the world and have over 70 offices. So we have experts in all these areas. And really that’s what you need is a specialist or cross border specialist teams because of the numerous landlines involved in foreign deals and some of the really kind of two big areas that companies are very concerned a bit right now obviously is data privacy. But also the anti-corruption issues that are involved and because of the stiff penalties can be imposed and that’s really you outbound or inbound.

    And so we see companies take a very in-depth look at that. One of the things we also look at every transaction, we try to very early on the process is sit down with a client and discuss what are the really high-risk areas, where is really the concerns for the company, where’s the value? It could be in the intellectual property and so we’re going to really take a deep dive in intellectual property to potentially a freedom operate analysis to make sure that they’re protected. And if they do buy the company that they have the freedom to use it the way that they intended to have synergies with their existing businesses.

    Patrick Stroth: Talk about CFIUS a little bit. Should every company now be aware of it, not just the ones that are the traditional chemicals and military applications number one? And then number two, CFIUS is US. Explain what happens if other countries have something similar.

    Craig Lilly: Well, the Committee on Foreign Investments in the US or CFIUS is where a foreign company proposes to acquire a target a US business that generally either produces designs, test, manufactures, fabricates or develops one or more critical technologies. And because of the recent changes in the law, even a 1% investment in a company with critical technologies could trigger a CFIUS filing. So its critical technologies has been expanded for CFIUS and includes such things as defense articles, and defense services, commodity software, and technologies on commerce control list or controlled for reasons relating to the national security, chemical or biological weapons, missile technologies or for reasons relating to regional stability or surreptitious listening.

    It also can include energy and things subject to Department of Energy regulations such as nuclear equipment, software, and technologies, and also includes emerging and foundational technologies which is not to be defined which is very broad. There’s actually currently 27 pilot program industries identified by NAICS code which will require mandatory filings. Also, CFIUS applies if the target owns, operates or manufacturers or supplies critical infrastructure or real estate.

    And critical infrastructure is broadly defined. It can include systems and assets so vital to the United States that the incapacity or destruction would have a debilitating impact on national security. For example, the purchase or lease or incession of a foreign person to a foreign person or any of real estate is located in the United States and is located within an airport or a maritime port or close in proximity to a US military installation that is sensitive for national security reasons.

    And why should an acquirer be concerned about CFIUS? Well, US Treasury which oversees this can unwind the transaction or impose very harsh equitable remedies and fine. Also, each party can pay up to the amount of the purchase price for the fine. And yes, other countries do have similar laws. The EU also has a similar law. Seven transactions last year were blocked by the EU and we had over 14 deals either blocked or abandoned during the last few years. Over 240 deals were actually formally reviewed by the US in last year. And so CFIUS has very wide overreaching kind of application.

    Previously before the recent changes, a company that was making an acquisition in the US could make an investment of 9.9% or less without being subject to CFIUS. But now it applies even to a 1% investment in critical technologies and that’s a mandatory filing. So it’s a very broad expansive type of law and it’s not just only in the US. EU also has these laws as well and a lot of people also are also concerned about China. And why is China’s such a huge presence in cross border here over the last decade? Well, in 2008, China inbound was 1 billion. However, eight years later, by 2016 inbound was 48 billion.

    So that alone has led to a lot of the concern over CFIUS. Also, there are a lot of changes in capital markets and venture capital. Previously DARPA was very heavily involved if there was some type of sensitive technology being developed. But because of the expansion in private markets and venture capital, there’s all types of new technologies that are being developed where DARPA is not involved at all anymore. It used to be decades ago, DARPA would be almost involved in any type of development of critical technologies because it was usually done by larger companies. Because of the expansive venture capital over the last 20 or more years. Now we’re seeing critical technologies being developed even with very small companies.

    Patrick Stroth: At what stage are you filing for CFIUS? Is this where you pass a letter of intent and you’re beginning to get things structured up there or is it something where it can be preemptively checked before advancing too far into an M&A transaction?

    Craig Lilly: Well, generally, we will recommend clients to do a CFIUS assessment of the risk very early on prior to the letter of intent stage. Typically, companies will be even talking with the Treasury even during this letter of intent stage. And that’s generally what we recommend so that we can basically get some initial advice from the Treasury as to whether this is a very high-risk type of assessment which would require a filing. And in most cases, it can be a mandatory filing.

    But typically, you will file this generally right around or medially before the execution of the contract. And that’s just to sign a contract where you may later do the acquisition usually in a two-step type transaction.

    Patrick Stroth: The other question for you. Its something we didn’t talk about. But you triggered my thought process here. Compared to a US deal, I know every deal is different depending in industry and size and everything but are cross border deals routinely larger? And if so, how much larger than a domestic deal for technology or pick a case study?

    Craig Lilly: Well, historically, we saw a lot of large investments but now we’re seeing even the very small investments. There has been just a rush of investments over the last decade of all types of foreign and Asian investors in the US it was particularly with technology companies and so that’s helped a big surge in venture capital investment as well. But we’re seeing across the board obviously, some of the investments by some of the Asian investors has decreased over the last year just because of some of the CFIUS concerns in the regulatory landscape. But there’s no particular size for cross border or a foreign investment we’re seeing across the board all different shapes and sizes just like you would see with a domestic acquisition.

    Patrick Stroth: And assuming that CFIUS gets taken care of. There are the other kinds of risks out there that are germane to M&A. A lot of those risks can be mitigated or controlled or completely eliminated with ensuring a deal through rep and warranty insurance and it’s been used at an increasing rate in domestic deals. How has rep and warranty impacted cross border M&A?

    Craig Lilly: Well, representation and warranty insurance actually was more expensive in the EU and in Europe before it really came to the US. And so it’s very prevalent in Europe and generally, there’s lower price premiums as well. As you know, representation and warranty insurance essentially allows sellers to walk away with more cash at closing while giving buyer’s interest protected in the form of an insurance policy against loss.

    So typically whether it’s in domestic buyers in Europe or otherwise, there’s been the landscape for representation and warranty insurance and in Europe, particularly is fairly widely accepted. And because it’s a less litigious type environment to typically the prices and premiums and risk retention’s are much lower for a Europe-type acquisition.

    Patrick Stroth: Craig, you mentioned China before and how they ramped up very extensively of going from a billion dollars in deals and then a very short term, they come up to $48 billion in transactions. What do you see aside from the slow down right now which could be temporary but what do you see going forward both in Asia and cross border M&A overall? What trends do you see there?

    Craig Lilly: Well, it definitely a cross border M&A has slowed down because of CFIUS and you’ve seen with the recent trade restrictions that were imposed on the Huawei by the US that that’s a definitely an impact on perception at least for Asian investors here in the US. I definitely think it’ll probably be very slow for a lot of the Asian investments in the US. I do think you’ll see more and more US buyers throughout the world whether it’s in Asia or in Europe. I think some of the big drivers for that though is just because there’s a lot of dry powder available for not only private equity funds but also a lot of the large institutional and strategics.

    As I mentioned before, the top five tech companies are 340 billion in dry powder. But also you’re seeing a lot of kind of old-line companies that are really trying to expand whether it’s through technology whether it’s a FinTech or an agricultural tech or some other kind of emerging tech or they’re trying to diversify their customer base or their revenue streams. And also you’re seeing obviously you see continued outsourcing whether it’s through manufacturing or assembling happen and that’s throughout Asia. And also we’re even seeing a lot more in Mexico and Latin America because of the close proximity and probably the more respect or for the cultural aspects of the United States including protection of IP.

    So I think we’ll see kind of more and more US companies do a lot more cross border. The acquisition of tech is obviously a very driving aspect but obviously, the customers diversification, aqua hires, and other things too. And I think you’re seeing this across all different types of verticals whether its artificial intelligence or robotics, FinTech. Of course, auto tech’s been a very big area servicing a lot more of different transportation companies that are trying to expand and drilling through multiple verticals here. It’s a whole… Electric car, autonomous vehicles. The communication slash smart car and also ride sharing too as well. Those are all things that are kind of driving the transportation industry and I think we’ll continue to see that.

    Patrick Stroth: So we’ll be doing a lot more US buying outside our borders as opposed to the last couple of years where we’ve had predominantly Asians coming and buying into the US. That trend looks supportive because it seems that there are more and more service providers out there and advisors such as Baker McKenzie that can make things easier for US buyers to go abroad where they probably were reluctant to do that because of a lot of the bear traps out there that they didn’t know what they didn’t know. And they’ve got resources like yours now that they can bring to bear that will help. At the same time, CFIUS is making it harder for the foreign-owned companies to come in and maybe easier for us to go out. So it may have not the same sustainability or robust outlook as you do domestic but it’s still fairly positive. Would you agree?

    Craig Lilly: No, I agree. And also we’re seeing kind of a trend that’s really developed over the last few years is that you’ll see a US slash Delaware Corporation basically as a holding company but really their operations are really abroad and even though any M&A or acquisition is of the Delaware company as a domestic acquisition, essentially the company is a foreign company. And so we’ve seen a lot more of those types of transactions and that’s obviously been spurred by the not a venture capital investment here in the United States as well. And I think we’ll see that continue.

    That’s why I’m saying M&A is also becoming more institutional-wise where 20% of all targets are backed by some type of institutional investor whether its private equity or venture capital. So I think we’ll see that continue. Obviously, we’ll see a lot of I think secondary private equity sales. And what that means is one private equity funds selling a portfolio company to another private equity fund. Now those type of exits account for somewhere close to 30% now of all private equity exits. I think that trend will continue as well.

    Patrick Stroth: Well, you’ve got a lot there for us to consider, particularly just not the cultural differences but a lot of the other regulatory and compliance traps and so forth and just how things are different outside. But that shouldn’t stop you from taking advantage of some great opportunities out there. And if there are organizations like you and Baker McKenzie that can be brought to help smooth that transition, that’s all the better for a lot of owners and founders out there. Craig, how can our audience reach you? Because I’m sure they’ve got a lot more questions than I can give you.

    Craig Lilly: Well, I’ll have a presentation which I’ll have on Rubicon’s website after this. And then also you can reach me at our website or my email address which is just craig.lilly@bakermckenzie.com. Also, you can reach me through my phone number 650-251-5947 plus I’ll have a cross border presentation that I’ll post on Rubicon’s website that can be accessible and will have my information as well.

    Patrick Stroth: Well, that’s absolutely fantastic. Thank you very much. And you can check the show notes here under the insights tab at Rubicon, R-U-B-I-C-O-N-I-N-S as in Sam, rubiconins.com. Go to the insights tab there and you’ll have the show notes along with a link to Craig’s presentation and you can also reach out to Craig directly. Craig, very informative. You cracked open a lot of different avenues of thought there so I greatly appreciate it. My audience will appreciate it as well. Have a good day. Thanks so much for joining us today.

    Craig Lilly: Thank you, Patrick, very much.

     

  • Why M&A Is Booming and What It Means for the Future
    POSTED 3.21.19 M&A

    We’re living in a Golden Age of Mergers and Acquisitions. The numbers are in and… there were $2.2 trillion in M&A transactions in 2018 in the United States alone, compared to just over $2 trillion in 2017. That marks the fourth year where the level has breached $2 trillion.

    Some other signs of this very healthy M&A environment:

    • Median deal size is increasing steadily, to $60 million in 2018. That’s up 22.4% from the previous year.
    • In 2018, there were six deals above $50 billion. Buyers are confident to spend more and more money.

    Although there was a slight dip in 2018 in the number of deals done (11,208 compared to 12,647 in 2017), I expect this trend of increasing M&A activity to continue. Here’s why:

    • There’s a lot of “dry powder” out in the marketplace. Investors are looking for places to put their money to work. PE firms, which also have more capital on hand from recent tax reform, are obliging.
    • Tax reform also put more cash in the hands of corporate acquirers.
    • A looser regulatory environment.
    • A strong stock market.
    • Cheap financing.
    • Buyers are on the hunt for acquisitions, and many companies are ready to be bought. Acquisition is their exit plan. Most do not want to go the IPO route. In 2018, there were 11,208 acquisitions in the U.S., compared to just 190 IPOs.
    • Corporations and PE firms are increasingly divesting units or portfolio companies.

    The consensus is that going forward in 2019 and beyond, we’re going to see more deals, and bigger deals. This is despite ongoing global economic uncertainty, rising interest rates, anti-trust issues, the impact of tariffs, capital market volatility, and some concern that the economic conditions that have driven the rising trend could turn.

    A recent survey of 1,000 PE firms and M&A corporate executives conducted by Deloitte bears this out.

    • 76% of M&A executives say they expect to close more deals in 2019.
    • 87% of executives at PE firms feel the same way.
    • 21% anticipate a drop or leveling off of M&A activity (that’s compared to 30% last year).
    • 70% of all those surveyed say they expect bigger deals in the coming year.
    • 51% anticipate more deals in the $500 million to $10 billion range.

    The main reason for this rising trend: the PE firms at the forefront have larger funds, and they’re not sitting on that money. They’re leading the charge. In fact, in that Deloitte survey, an impressive 94% of PE executives at funds over $5 billion expect more deals in 2019.

    This is confirmed when you look at what’s happened over the last few years. According to PitchBook’s annual report, PE firms accounted for 34.2% of M&A deals in 2018; that share of the market has risen steadily since it was at 25.4% in 2015.

    (Not to be discounted as an element of this trend, is the growing corporate M&A strategy of acquiring companies to expand their customer base and/or diversify their offerings. Corporations also have more cash on hand due to the recent tax reform. They view M&A as the best way to grow.)

    Another trend we’ve seen, especially among savvy PE firms, is the increasing use of Representations and Warranty (R&W) insurance to cover deals.

    According to a study from Harvard Law School, the number of R&W policies written has grown from a few hundred just five years ago to more than 1,500 in 2017. Their report also notes that more than 20 insurance companies are now writing these policies.

    Essentially, this specialized coverage puts the risk of breach of Representations in the hands of a third party: the insurer. That gives peace of mind to both Buyer and Seller and speeds up negotiations because a main sticking point, indemnity, is off the table.

    The Seller gets more cash at closing because less money is held in escrow (and won’t be at risk if there is a breach). The Buyer won’t have to pursue the Seller in case of a breach; the insurance company will pay claims promptly. And with 19.4% of deals subject to a claim in 2018, at least at insurer AIG, it’s clear why this protection is important.

    With the complexity of today’s deals, it’s easy to miss something in the due diligence process, and R&W insurance insulates you from that risk. And, it’s much more affordable than you might think.

    If you’re part of this rising trend in M&A activity, you should consider making R&W insurance part of your next deal.

    I’d be happy to discuss with you what these policies cover, how you apply, and the estimated cost. I can easily put together a quote with just a few pieces of information from you.

    I can be reached at 415-806-2356 or by email: pstroth@rubiconins.com

  • [Best of the Podcast] Why M&A Is Today’s Clear Exit Strategy
    POSTED 1.23.19 M&A Masters Podcast

    This episode was originally published on August 29, 2018.

    In an era when few companies go IPO and there are even fewer unicorns, M&A is more popular than ever, says Mihir Jobalia, a veteran of KPMG’s Silicon Valley operation.

    In fact, among VC-backed companies in the last 10 to 15 years, he estimates that more than 90% exit through M&A. And business in the last few years has been especially good.

    We dive deep into what makes the current environment so appealing to M&A, who the big players are, and best practices for companies hoping to exit with this strategy.

    Read More >