Insights

The Institutionalization of M&A
POSTED 3.27.19 M&A

In recent years, the number of companies with “institutional backing,” i.e. they are assets of Private Equity or Venture Capital firms, has grown dramatically. And that means that the number of companies backed PE and VC firms that are being acquired is increasing, too.

In fact, according to Pitchbook’s 2018 Annual M&A Report, there were a record number of those types of acquisitions in 2017 and the trend continued in 2018 with another record at 20%.

The simple fact that there are more of these types of companies, means more will be acquired.

But also consider that the target companies are more sophisticated than a typical founder-owned firm, making them more attractive to Buyers, who would rather deal with professional investors. This, of course, means savvy, experienced parties on either side of the table, leading to, as the Pitchbook report put it: “…increased price discipline, possibly leading to more aggressive price negotiation from Sellers and fewer cheap deals.”

But because these types of companies are enjoying increased valuation, Sellers are more likely to sell companies in their portfolio. Over half of PE-backed exits in 2018 involved sales to other PE firms, which is called a secondary buyout.

Of course, this means that the share of founder-owned businesses being acquired is shrinking. And although the percentage of publicly traded companies being acquired was actually increasing until 2018, this amount is expected to drop steadily as the number of publicly traded companies overall continues to decrease and economic uncertainty makes Buyers hesitant to make these sorts of deals.

But why are the numbers of PE and VC backed companies growing? In the case of VC especially, that funding source has become very popular among startups that are ready to scale up to either go public or be acquired (which is usually what happens).

Expect to see the acquisition of companies with institutional backing to continue in 2019. We’ll see if we have another record year.

One thing both Buyers and Sellers should consider in these types of deals where portfolio companies are changing hands is Representations and Warranty insurance.

With this coverage, if there is a breach of the Seller’s Representations, the insurer pays the financial damages suffered by the Buyer as a result of the breach.

In today’s complex deals, R&W insurance is a must in my mind for any M&A transaction. But it’s especially necessary when portfolio companies are being acquired. With a full portfolio, the Seller won’t know each individual business well… and might not recognize potential issues.

There’s been one case I’ve been keeping an eye on that’s a perfect illustration of this.

Back in 2013, Citadel Plastics Holdings, a portfolio company of PE firm, HGGC (formerly known as Huntsman Gay Capital Partners), acquired Lucent Polymers.  Then in 2015, A Schulman Inc. bought Citadel. But the next year, A Schulman discovered that Lucent had falsified test results to show its products were Underwriters Laboratory certified. Next step, a lawsuit seeking $272 million in damages from Citadel Plastics that has yet to be resolved.

In this case, the PE firm didn’t know what its portfolio company was up to and paid the price. But, if there had been R&W coverage in place, there would be no legal issues because the insurance company would have paid the damages.

As a PE or VC firm looking at acquisitions in 2019, it’s clear that R&W insurance is the protection you need, especially when acquiring portfolio companies.

I’m happy to chat with you about what’s covered, the price, and the process for securing a policy – which is much cheaper and easier than you might think.

You can call me at 415-806-2356 or send an email to pstroth@rubiconins.com, and we can set up a time to chat.