Middle-Market Mergers & Acquisitions Holding Steady In 2013

Begin Planning for an Exit

by Terry Stidham, President of Target Search Group

The middle-market for Mergers & Acquisitions has significantly improved in the past two years according to The Babson College Middle-Market/Small Business Mergers & Acquisitions Survey conducted by the business school’s MBA students in the first quarter of 2013.

Yet according to the report, growth in 2013 will be flat versus 2012 because of a stalled economy, challenges in Washington around tax and estate issues, hesitation by business owners to relinquish, and the gradual recovery in the debt market.

The Babson Survey directed by Babson College Professor Kevin J. Mulvaney in collaboration with members of the Association for Corporate Growth (ACG) and Exit Planning Exchange (XPX), assesses and defines current trends that impact buyers and sellers of businesses. The survey population included leading national middle-market investment banks, large business brokerage firms, advisory professionals, and commercial bankers.

The M&A environment for both small and mid-sized business exits or recapitalizations is stable and may improve in the coming years,” commented Mulvaney, “ It is a very good time for entrepreneur owners to begin planning for their capital event.



Among the survey’s key findings:

Middle-Market Volume is Strong - Small Business M&A Activity Grows at a Slightly Slower Pace

• The volume of middle-market deals is steady and a majority of respondents project a continuation of the current level through the rest of the year. Only 20% of respondents foresee volume increases as the year unfolds.
• Services industry sector remains the strongest with increased activity reported in e-commerce, health and medical services, and aerospace and related industries.
• The small business arena is growing more slowly (an average of 0.5 times increase in EBITDA valuation over 2012) with no expected rise this year in valuations.
• The environment for M&A activity is about the same as a year ago. Babson authors project an increase in the number of private equity buyers in the next eighteen months because of increased debt availability on more acceptable terms.
• Underperforming or weak companies are not viable deals and receive lowball offers and very little interest from financial buyers. The market is willing to pay a premium for revenue growth potential and predictable EBITDA performance.

Buyers Demand High ‘Seller Assistance’ for Smaller Companies

• The percentage of seller assistance (earn outs, deferred money, etc.) continues to be high. The smaller the company (on a $1-100MM survey scale) the higher the demands for seller assistance from the buyer.
• Good news for sellers – the deferred component of the purchase price has dropped from an average of 30% to 20%. The survey also found that sellers are beginning to dig in their heals demanding a larger component of cash up front.

Timeframe to Complete Deals Lengthens

• Due diligence by buyers who have concerns about a sluggish economy and perceived challenges to building revenue will increase deal-making timeframes by a month (formerly 6-9 months). Strategic buyers are also organizing more outside expertise than ever before to prepare their due diligence reports.
• Sellers need patience and must be prepared with information and the ability to respond quickly to buyer requests to increase chances of closing deals within six months. Like buyers, seller success is dependent on acquiring the right legal and deal-making expertise.
• It is still a seller’s market for quality companies. Whether selling or restructuring capital, sellers must develop a knowledgeable game plan to evaluate options and potential deal partners.

Financing for Buyers Grows and Terms Improve

• More financial lenders are making loans with terms that represent a fair balance between what the lender and borrower feel is acceptable.
• The Babson survey projects an increase in the number of opportunities for every type of middle-market financing. This is good news for private equity buyers when balancing leverage versus equity contributions for new M&A deals.
• For smaller deals, there has been a strong rebound in SBA loans especially from community banks, that will help contribute to the growth of small business deals moving forward.
• Surprisingly, the survey found an increase in the percentage of equity needed by qualified buyers of small businesses. This had been a minimum of 20% but some experts see an increase to a minimum of 25%. The increased equity demands from lenders may have contributed to the slow growth of small business sales.
• Middle-market stability is reflected in increased pressure on pricing for financial institutions involved in M&A deals. Yields on mezzanine debt dropped to 12-14% from historical averages of 15-20% and financing costs declined as the volume of financial buyer deals increased.

QE Fuels Inflows

Markets Surge

by Terry Stidham

The U.S. will not end its quantitative easing program (an asset purchasing program in which the Fed has been buying $85 billion in Treasuries and mortgages a month in order to provide monetary stimulus) before 2014, according to Christian Menegatti, managing director of research at Roubini Global Economics. The U.S. central bank has kept benchmark interest rates close to zero since 2009 and has tried to stimulate the economy through three rounds of quantitative easing, or bond purchases.

This has meant good news for equity markets, which have gotten used to the flow of easy money. Wall Street's Dow Jones Industrial Average has rallied over 17 percent so far this year.

Private Equity - 130 private equity funds raised $69.3 billion globally in the first quarter of 2013. This is similar to 2012 when on average $73.7 billion was raised in each quarter. However, the total represents a significant upside vs. fund targets of $59.9 billion. Although the LP's have improved confidence they continue to seek firms that can deliver.

VC - VC Funds invested $6.9bn in US start-ups across 841 deals during the first 3 months of this year, up from $6.8bn in the fourth quarter of 2012, which saw 834 transactions, a study by industry database CB Insights has estimated.

According to the analysis, funding for internet companies soared by 12% on a sequential basis during the first quarter of 2013, to over $2.7bn.

Hedge Funds – The Hedge Fund Review reports that the hedge fund industry assets surged by $122 billion to a record $2.375 trillion, with the top ten funds receiving the majority of the new capital in Q1. John Van, VP of Van Hedge Fund Advisors reported that, “The average U.S. hedge fund was up 4 percent through March, while the average equity mutual fund was up only 1.7 percent”. 

IPOs - U.S. companies are on track to raise the most money through initial public offerings since before the financial crisis, driven by the same thirst for risk among investors that has pushed the stock market to new highs.

Through Q1, 64 U.S.-listed public offerings had raised $16.8 billion, according to Dealogic. In the same period in 2012, the biggest year in dollars since the financial crisis, 73 companies raised a total of $13.1 billion.

If an investor had bought shares in every IPO raising more than $25 million in 2013, they would be up 15% so far this year, according to Dealogic, matching a 15% gain if they had owned the Russell 3000, which includes large- and small-cap companies, since the beginning of the year.

Mutual Funds - U.S. investors poured $184 billion into long-term mutual funds in the first quarter. With the stock market climbing, investors “are buying at a higher price. But are they overpaying? They’re sick of being cautious and making nothing. They've got kids to send to college. They need cash. They’re telling their advisers to address the issue that they’re not getting enough of a return on their investments.

As they have for nearly two years, taxable bond funds made the strongest showing during the quarter. But funds focused on U.S. stocks showed signs of life, posting their first positive quarter since early 2011, according to a Morningstar Inc. report. Investors plowed nearly $80 billion in new money into all stock funds in the first quarter, compared to net inflows of $5.3 billion a year ago.

Boston mutual fund giant Fidelity Investments saw net inflows of $8.9 billion in the first quarter, and just shy of $3 billion in March, according to Morningstar. A year ago, Fidelity’s net inflows were $4 billion in the first quarter and $425 million in March.

Eaton Vance also saw a dramatic turnaround, with inflows of $5 billion for the quarter and $1.5 billion for March. That’s compared to net outflows of nearly $900 million for the first quarter a year ago and $365 million in March 2012.

Net inflows were $362 million in the first quarter at Putnam Investments, which was hit hard during the Great Recession. It saw net outflows of $60 million in March. A year prior, Putnam’s first quarter outflows were nearly $1.1 billion, and outflows for March totaled $350 million.

In addition to U.S. stocks, international stock funds and alternative investment funds posted strong first quarter flows compared to a year ago. Inflows to international stock funds were about $47 billion for the quarter compared to $5 billion a year ago, while net flows into alternative funds totaled $9 billion for the quarter compared to $3 billion the previous year.

Leon Black with Apollo Global Management recently said that he has never seen such a good debt market. “The financing market is as good as we have ever seen it. It’s back to 2007 levels. There is no institutional memory,” Black said. He believes that rising equity markets and cash-rich corporations are making it difficult to buy and much easier to sell. With interest rates at historic lows, how can someone afford not to be an active investor?

Musical Chairs – We all know the game and what happens when the music stops. Somebody is eliminated, the music restarts and the game proceeds until there is only one person left who is deemed the winner.  Can anybody answer what happens when the music or in this case the presses stop and we still have all of this capital floating around in the economy?  How will the markets react? What happens to interest rates when the Feds stops the repos? Is it time to care? Should we care? or as they say in South Louisiana, "Laissez les Bon Temps Roulez".

If you are executing or contemplating an acquisition or investment strategy and need help in sourcing targeted opportunities then contact the business development and deal flow specialists at Target Search Group today.  

Investors Move into the Hedges

Follow the Money

by Terry Stidham, President of Target Search Group

Q1, 2013 funding for VCs and for Private Equity are up and according to Hedge Fund Review, hedge fund industry assets surged by $122 billion to a record $2.375 trillion, with the top ten funds receiving the majority of the new capital. John Van, VP of Van Hedge Fund Advisors reports that, “The average U.S. hedge fund is up 4 percent through March, while the average equity mutual fund is up only 1.7 percent”. 

Investors like the performance of late along with the flexibility hedge funds have to make among a broad set of short-term investments.  Many strategies are being used (long/short equity, credit, macro, statistical arbitration, etc) with trades lasting from milliseconds to years.  Most hedge funds are staying in relatively liquid securities so that they can trade out at any point in time to lock in their profits.

Sondra Harris gives us the following 8 Reasons Why the Hedge Fund Industry Deserves a Second Look in 2013 that she picked up from Michael Collins at the Investment Management Institute earlier this month:

1. Managers are better than ever - With the froth of the ’90s over, we are seeing less of the accompanying frenzy that had people putting money into hedge funds without really knowing what they were getting.

Today there is an expanding group of good managers, a better crop than we've ever seen, so the quality tends to be good, and because of the various market forces at work, their fees are going down. 

2. Correlations in markets are down, and that’s a strong tailwind for hedge fund strategies - The high market correlations in recent years contributed greatly to dampened hedge fund returns. That’s changing. Spikes in correlation over the last 18 months are far shorter. That gives managers some breathing room and prevents whiplash. They can put on the trades, make a profit and move on. This type of environment should help raise the tide for all hedge funds.

3. Hedge funds are good bond alternatives - This is even more important for institutional investors like pension plans. They know that holding a portfolio with a 30/40 percent traditional bond allocation may be a potential time bomb. The free ride on their bond portfolio for the last 30 years is over. They’re all focused on it. Good hedge fund managers will either avoid unattractive bonds completely or profit from the inevitable sell-off.

Hedge funds can do very well in those sell-offs. Managers can short or actively trade a hedged portfolio of bonds, whereas, traditional bond funds cannot. Increasingly, investment advisors are substituting a diversified portfolio of hedge funds for part of their traditional bond allocation.

4. Holding periods are shorter; manager expertise is deeper - Geopolitical shocks and general market sentiment are driving hedge funds away from longer duration holding periods. Managers are using a variety of trading strategies, not just putting the position on, taking it off and going on to something else, but being able to trade it both ways and do that very profitably.

They can do this nowadays by relying on markets with deeper liquidity. This is good for individual investors, as well, whose own time horizon has come in dramatically in the last couple years.

5. It’s a buyer’s market for hedge funds - In general, redemption terms for all of the very best performing hedge funds will become more favorable as all funds are going to have to compete for assets. Frankly, it’s become a buyer’s market. Again, a good thing for investors. It also means more liquidity. In fact, liquidity has become as important an indicator as performance when evaluating hedge funds.

6. The general landscape for hedge funds will become even more populated - This will happen as the number of options for new and creative ways to trade and manage risk becomes more sophisticated. Investors who want to add hedge funds to their portfolios will need help from their advisor in selecting managers who can build a dynamic and diversified portfolio.

7. Fundamental long-short managers are paying a lot more attention to technical indicators - Traders have acquired new tools and quicker access to more data over the past couple of decades. These modernizations of hedge fund trading can improve managers’ abilities to protect their capital should the unexpected shock occur. Frankly, as we’re all beginning to learn, tail events seem to be the new normal. The good news is that the managers are even more aware and prepared to adapt quickly to different environments.

8. We’re seeing more and more hedge fund mutual funds - This used to be considered an oxymoron. It’s now becoming a necessity, driven by demand from investors who want even more transparency. They also want more liquidity, daily liquidity. They want daily NAV. 

The funds that demonstrate performance and innovative strategies will continue to attract the bulk of the investors. Other major investor considerations are:

• Investment Objective: Is it lower volatility, enhanced return, less correlation to other investments, etc?
• Structure: Is the fund have a single manager / strategy fund to build out an allocation or is it a fund of funds?
• Team: What is the makeup of the investment team in terms of diversity, experience and history, and the culture of the overall organization?
• Sophisticated Risk Management: Is risk management an independent function that provides checks and balances to the investment process?
• Operations: Does the fund have a sound operational infrastructure backed by dedicated support groups (e.g. legal, technology, due diligence) to allow the investment team to focus solely on investing?
• Improved Transparency 

Terry Stidham is the President and founder of Target Search Group. He is a Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment.  He has served as the head of entrepreneurial organizations as well as Fortune 500 companies.  He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions.  Mr. Stidham has been instrumental in aiding thousands of business owners prepare their businesses for eventual sale by teaching them how to maximize efficiencies in operations leading to significant increased cash flow.

Here Come the CVC's

Corporations Dive In With CVC's by Terry Stidham

An increasing number of our corporate clients are setting up an in-house CVC team. The Corporate Venturing Capital (CVC) community recently had a US conference, where nearly half of the 450 represented organizations present had set up a corporate venturing arm during the previous five years. The remainder of the group is planning to set up a unit within the next 12 months. 
 

Corporate Venture Capital (CVC) - CVC as a subset a venture capital whereby a company is investing, without using a third party investment firm, in an external start-up or early stage venture that it does not own.
 

Corporate Venturing refers to when a company supports innovation and new projects internally. It is defined by the Business Dictionary as the "practice where a large firm takes an equity stake in a small but innovative or specialist firm, to which it may also provide management and marketing expertise; the objective is to gain a specific competitive advantage.
 

The London-based, Global Corporate Venturing magazine ranks CVCs and sees funds with $billions available, some (such as Google) investing $300+ million per year. Deal volumes vary from just one to over 80 per year.

In the last two years, more than 200 corporate venturing units have been launched. In 2011, over 500 corporate venturing units globally invested more than $26 billion, which is similar to private VCs at about $28 billion.

CVCs are on the way to becoming more important in providing venture capital than VCs. These figures omit business angels, who provide, worldwide, $20 billion or so.

Some will argue that this trend is cyclical, but Corporate Venturing is definitely on the ascendancy in this decade and for good reasons. Venture Capitalist funding has declined as exits are scarce and raising new funds is difficult. Despite the global problems of the last half decade, businesses in whatever stage of their lives still need funding, which may come from various sources such as customers, loans, grants and equity.

The big challenge for both VCs and CVCs with or without an internal business development team is sourcing quantity and quality opportunities that are aligned with their investment strategy, criteria, and focus.

Companies find it easier and less costly to buy innovation than to develop it in-house. This is due to a mixture of the agility of smaller organizations, the ability for a small company to motivate and reward high caliber people and the freedom from corporate structure and processes. 

There is a significant difference in the return calculation between the two funding classes. 

1. Private VCs - Measured by financial return (although a small minority also use social enterprise metrics). 
2. CVCs - Measured by an organization and even deal-specific mix of financial and strategic return.

This doesn't mean it is any easier for an investor to steer through the negotiation and due diligence process (and in fact it may be tougher, as some corporations impose internal investment processes on external opportunities), but it does mean that, if the strategic fit works, CVC money may be available where VC money is not. In addition, many VCs have time-limited funds – commonly five years to invest followed by five years to divest. Most CVCs do not have these pressures.

Both VCs and CVCs need to see a minimum monthly recurring revenue before taking it further. However the VCs then would dig deeper into the financial numbers, whereas the CVC would first look at how their own product and channel infrastructure could help with scaling their business.

Early stage or growth stage companies that are seeking $1 million plus in funding should put one or more CVCs on their list. It's important to understand the strategic aims of those CVCs before approaching them. If CVC money is available it needs to be determined if it would prevent other similar corporations from becoming customers and/or potential acquirers. 

Contact us today to discuss your needs or interests.
 

About the author Terry Stidham
Terry Stidham is the founder and principal of Target Search Group. He is a B2B Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment.  He has served as the head of entrepreneurial organizations as well as Fortune 500 companies.  He specializes with mid-market companies in a diverse array of industry sectors from service and manufacturing to technical and professional firms.

Mr. Stidham speaks the language of both the seller and the buyer having vast experience on both sides of the transaction. He has been directly involved in the execution and successful closing of hundreds of investment banking and corporate finance transactions.  Mr. Stidham has been instrumental in aiding thousands of business owners prepare their businesses for eventual sale by teaching them how to maximize efficiencies in operations leading to significant increased cash flow.

Target Search Group (TSG) is a business development firm that works with a select number of private equity investors and corporate clients to source and originate investment opportunities that fit their size, focus and strategy on both a generalist, opportunistic, and a specific search basis. 

TSG sources acquisition and investment opportunities throughout North America in companies that range from startups to businesses with revenues up to $500 million.

Borrow It While It's Cheap

Borrow it While it’s Cheap, says Leon Black Apollo Global Management's Co-Founder, Chairman and CEO.

by Terry Stidham

Surrounded by other private equity titans at the Milken Institute’s global conference in Los Angeles, Black said he has never seen such a good debt market.

“The financing market is as good as we have ever seen it. It’s back to 2007 levels. There is no institutional memory,” Black said.

Black was there at the birth of the junk-bond market nearly three decades ago, helping lowly-rated companies raise debt alongside Michael “the junk-bond king” Milken himself.

“We have never seen rates like this,” Black said.

Those rock-bottom financing costs, mind you, aren't going to prompt Black to go on a buying spree. Quite the opposite. Rising equity markets and cash-rich corporations are making it difficult to buy and much easier to sell, the Apollo chief said.

“We are more of a net seller today,” he said. “It’s almost biblical: there’s a time to reap and there’s a time to sow. We are harvesting now.”

So far this year, Apollo has reached a deal to sell its majority-owned Metals USA Holdings for $770.7 million to India’s Reliance Steel, as well as stakes it held in Charter Communications and SourceHOV.

TPG ‘s co-founder David Bonderman, also on the panel, only half-agreed.

“It’s a good time to be a seller but it’s not a terrible time to be a buyer,” because of the cheap financing.

Terry Stidham - President and Founder of Target Search Group. Business Development Leader with extensive knowledge of the M&A process, combined with an in-depth understanding of the constantly changing global capital markets environment.