Modern mergers and acquisitions have changed. So has the cost of money. What remains the same is the need to carefully align the business goal with the target.
The buyout or purchase of a controlling share in a company as a component of private equity investing has evolved significantly from its origins. In the past buyouts were referred to as “bootstraps”; financial entrepreneurs or management insiders would buy a company with borrowed money (i.e., loans/debt) generally for 90 percent or more of the purchase price. Oftentimes the buyout would be financed with virtually no equity capital. These transactions were commonplace in the late 1970s and early 1980s, and at that time often focused less on the quality or nature of the business than on the financial “engineering” of the deal. Frequently, the thinking was that if a company was bought with 5 percent equity and the business was able to pay down some debt and improve the margins a fraction or so, then one would realize a very large return. Ultimately if the business failed to thrive, the lenders bore the greatest risk of financial loss and the brunt of the actual losses, which was a much better outcome for the buy-side entrepreneur.
Ahhhh….for the good old days of yesteryear.
Buyout investing has transformed from the bootstrap purchasing of businesses using large amounts of leverage and tiny amounts of equity as a hedged bet on the, oftentimes, misguided hope of profitability. Today, equity is king and the triumvirate of the modern competitive landscape, the pricing of transactions, and credit parameters of lenders all require that buyouts be structured with significant amounts of backing.
In the current market climate a feasible buyout must have a disciplined investment strategy coupled with a clear vision for each company it buys and a well-defined path towards value creation.
“THE NEW APPROACH DEMANDS A NEW METHOD TO CHART THE COURSE. ONCE CHARTED, ACTIVISTS ARM THEMSELVES TO WIN.”
Successful companies execute their vision of value creation. Generally a unique mix of strategic support services and planning are required to successfully target, acquire, or merge portfolio appropriate companies.
We specialize in providing strategic and tactical support services that are generally some combination of fee or equity-based.
PROJECT PARTICIPATION CRITERIA FOCUSES ON MAKING A POSITIVE IMPACT
After many hard lessons learned I now prefer to participate in the pursuit of profitable companies with a value of between $5 and $250 million.
Generally this means companies that have EBITDA (earnings before interest, taxes, depreciation, and amortization) ranging from $2 million on the low side to $30 million or more on the high side. Generally I will not invest my time or capital resources in smaller companies or “Mom & Pop” businesses for a variety of reasons, the most important of these being that businesses smaller than the aforementioned generally cannot attract, afford to pay, nor effectively utilize the level of professional management I believe companies need to have in order to benefit from my participation. Ultimately businesses outside this range tend not to have developed the scope and scale to be leaders in their industries, and suffer from increased instability.
After determining that a company falls within the requisite size parameters, there are three additional criteria I look for:
- First, does the company have what I believe are sustainable competitive advantages?
- Second, are there clear, identifiable opportunities to build the business in an industry disruptive way, i.e., to take the company to a game-changing level while working as partners with management?
- Third, are there mechanisms to help these mature and profitable organizations stay adaptive and increase their social impact?
In my view, for a company to be considered to have sustainable competitive advantages it needs to be one of the leaders in its market. Given that private equity investors will someday seek an exit to provide returns to their investment in us, this leadership must be based on competitive advantages that can be sustained not just during our ownership and/or partnership, but a future owner’s as well. These advantages often take various forms, but often include scale that few competitors can match, proprietary processes, products, services, technology and/or distribution channels, as well as time in business. These advantages invariably present significant barriers to new entrants to the company’s markets. I want the company to be able to differentiate its products or services from competitors’ on a basis other than price that allows it to command pricing that results in strong free cash flow.
Companies that meet this criterion generally have excellent returns on investment capital, strong customer relationships that have stood the test of time, and usually do not suffer from excessive customer concentration.
The second criterion is arguably the most important for my internal consideration. I am looking for companies where my team can build the business while working as partners with the management team. I will not, and should not, pursue any transaction unless I can identify opportunities to achieve significant growth or create value. I learned this lesson the hard way, but now this criterion is ingrained in my approach.
The third criterion I seek is that my involvement represents capital for change and impact. Frequently companies I invest my time in were previously family owned or business units of larger companies. They may have been restrained from pursuing growth opportunities because the family or parent company
- prioritized cash distributions to the owners;
- was averse to the perceived risk; or
- chose to focus on other priorities.
Unleashing companies I invest in to take advantage of opportunities is integral to our future success. I trust that acquisitions, including add-on and strategic acquisitions, are a very important growth strategy for the companies and I put specific emphasis in building relationships that create a clear path to achieving success utilizing this approach. I strive to find areas where companies can also improve the breadth and scope of their social impact as well as evaluate the positive social and/or environmental outcomes of my participation as an integrated component of the investment process. Growing a business and managing that growth are ever-present problems, but the opportunities to be found for creating value during these transitional periods in a company’s life are the greatest by far.
NEW OPPORTUNITIES FOR THE INDIVIDUAL INVESTOR
Although still in its infancy, the Jumpstart Our Business Startups (JOBS) Act, passed in 2011, is a game changing piece of legislation. The new legislation amends the Securities Act of 1933 to establish guidelines for what constitutes an Emerging Growth Company (EGC). As defined in the Act, an EGC is a company with annual gross revenues of less than $1 billion. A company can remain an EGC until the earliest of the following:
► Five years from its IPO.
► It reaches $1 billion in revenue for a given fiscal year.
► It issues more than $1 billion in non-convertible debt over a three-year period.
► It is deemed a “large accelerated filer,” defined as having $700 million or more in outstanding common equity held by non-affiliates.
With the ability for both accredited and unaccredited investors to participate jointly in offerings for the first time in nearly a century we believe that we can provide investors from all strata unique opportunities to generate value.
COMPANY POTENTIAL & MY PHILOSOPHY FOR SUCCESS
Ultimately the goal is to make money for ourselves, our investors, and our stakeholders. That is the first goal of any business in a country based on the democratic and persistent practice of free enterprise. The philosophy and approach to accomplishing this goal is tried and true. It requires a team committed to developing a corporate culture, practice model, and customer depth and breadth that drives:
- Thoughtful, conscious strategic decisions specifically geared to avoid one-offs — Our commitment to generating value should be thought through, carefully planned, and deeper than the execution of a single transaction.
- Steady, sustained growth — Clients and new service additions should be cultivated slowly and carefully to avoid disrupting our current client relationships.
- Broad and deep client relationships — This is an essential point of potential differentiation and our dominance here requires the efficient and effective delivery of services that result in high levels of customer satisfaction.
- An institutionalized/systematized service model — This will help us ensure that the infrastructure is in place to support new relationships while effectively managing and sustaining client expectations and high service levels.
- Awareness of new products, solutions, and industry players — Technology developments are a cornerstone of modern industry and it has become a critical business practice to have the ability to identify technologies that may enable more efficient and profitable operation. In addition, vigilance in regards to competitors and service developments are necessary as part of a discerning approach to identify and implement the best new solutions for value creation.
To be successful, a buyout firm must have a disciplined investment strategy and a clear vision for each company it buys, with a defined path towards value creation. A key criterion I look for is whether I can build the business, working as partners with the management team. I will not pursue a transaction unless I can identify opportunities to achieve significant growth and value creation. I have often found acquisitions to be a very important growth strategy for those companies I have worked with. A successful acquisition strategy entails planning the targets in advance, and pursuing candidates that create real benefits to the combined company.
My experience is that this is achieved in acquisitions fitting one of the following profiles:
- Geographic expansion (the target company enhances penetration of the acquirer’s products or services in specific geographic markets)
- Augmentation or expansion of products or services (the target company provides the acquirer with broader services or products to put through its sales and marketing channels)
- Acquisitions of direct competitors, especially where there are infrastructure savings or opportunities for vertical integration
In times of change winners disrupt the paradigm.
It is essential that the team, from the employees to the officers to the esteemed members of the board, have and contribute specific expertise and knowledge with respect to the business, its clients, and my clients’ acquisition targets. While comprehensive due diligence is essential in all transactions, acquisitions also require integration plans that must also be carefully developed.
My focus is not only minimizing the inherent risk of any acquisition, but the realization for the client companies in the shortest path possible the benefits of the acquisition.
Prevailing wisdom is that acquisitions often do not create value, and in fact compound the inherent risk of buyout investing. By utilizing our strategic services and support approach to acquisitions not only has our team never had a portfolio company under-perform due to an acquisition program. Our ambition, our call to action, our purpose is to spearhead a series of acquisitions that prove to be an integral aspect of building numerous portfolio companies and creating significant value.
As companies seek more growth and greater value for what they spend, they’re looking for new ways to monetize what they have, beyond incremental or simply iterative product innovation. In the new world order, innovation can mean turning a product into a service, or taking an experience and turning it into a product. It can also mean discovering and opening entirely different channels for existing products, even if that causes the need for disruptive change in existing dealer networks.
In the near future, I expect M&A activity to accelerate. That said, I am not an M&A Adviser, which is a regulated task limited to (SEC) FINRA-licensed broker dealers, and consequently you should do perform your own due diligence before attempting to apply anything you read here.
SAFE HARBOR STATEMENT
This paper is part of a series of my own internal policy and approach viewpoints and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of May 2015 and may change as subsequent conditions vary. The information and opinions contained in this paper are derived from proprietary and nonproprietary sources deemed by myself to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Todd Hill nor any organization which I may consult with, work for, or own including any such organization’s officers, employees or agents.
This paper may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader.
This document contains general information only and is not intended to represent general or specific investment or professional advice. The information does not take into account any individual’s financial circumstances or goals. An assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial or other professional adviser before making an investment decision. This material is solely for educational purposes and does not constitute an offer or a solicitation to sell or a solicitation of an offer to buy any shares of any stock or fund (nor shall any such shares be offered or sold to any person) in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. If any funds are mentioned or inferred to in this material, it is possible that they have not been registered with any securities regulator in any country and no such securities regulators have confirmed the accuracy of any information contained herein.