(Charlotte, NC – September 18, 2018)
A number of macroeconomic and capital market trends – low interest rates, high leverage levels, and high multiples – have increased competition for quality targets, driving more and more buyers to differentiate themselves with speed and certainty. We’ve seen first-hand that buyers who can submit lightly marked, seller friendly definitive agreements at the IOI stage, augmented by a willingness to forego intensive due diligence, are winning deals in auction processes.
This practice is becoming more common among Private Equity (“PE”) buyers in particular. Record equity funds, higher debt multiples, and fewer covenants have enabled PE to match or outbid corporates in terms of price and certainty of closing. PE has adopted several actions to speed up due diligence as they battle to deploy $1T of accumulated capital:
- Rely on vendor due diligence reports: The seller’s report, or vendor due diligence report, is often the only diligence used by a buyer. Typically, the reports compiled by the sellers are comprehensive enough that limited, complementary analyses are the only remaining diligence required. Furthermore, some PE buyers are willing to accept more diligence risk than historical thresholds. This could be due to lightened debt covenants or the pressure to deploy capital for investors.
- Create a proactive pipeline of targets: Many PE firms also create a pipeline (or database) of targets they actively track before the targets become available for sale. The database usually contains quantitative or qualitative information on the most appealing businesses in any given sector. This allows PE firms to track target performance, develop an investment thesis, and perform a market assessment over time. Therefore, when a target comes up for sale, they are already ahead of the diligence process.
- Seek secondary buyouts: When PE firms buy assets from other PE firms, they are often able to get comfortable with diligence findings more quickly and without as many follow-up discussions. Furthermore, secondary buyouts may appear more reliable as lenders and advisors already know the company and may have already reviewed the assets.
While corporate buyers can and should maintain a pipeline of potential targets, relying on vendor diligence reports is more difficult given their inherently lower risk tolerance. However, corporate buyers can take several measures to improve the speed in which the complete diligence.
- Develop an efficient diligence process: Corporates that are repeat acquirers have a set M&A playbook that is applied to each deal. This playbook will include key areas for operational, financial, and business diligence and an associated risk factor. When the diligence team has experience executing the playbook, it can prioritize key diligence areas and better evaluate the vendor due diligence report. While corporates may not adjust their risk threshold, they can speed up diligence by identifying and resolving key areas at the onset of discussions.
- Don’t wait for the book: Corporates can and should create a robust pipeline of targets they assess regularly, just as PE firms do. Corporates should also develop relationships with those targets. These relationships can be established at trade shows, industry association meetings, or through supplier/customer interactions. Even if the target has no interest in a transaction today, establishing a solid relationship will favorably position a buyer to get the call when/if the target company becomes interested in a deal. In certain instances, sellers may be willing to avert a process and have a one-off negotiation with an interested buyer, especially one they already know. In other words, don’t wait for the book to begin your diligence or relationship building process. It may be too late by that point.
- Identify PE owned companies: Corporate buyers should also identify private equity owned companies in the industry. Track the holding period and reach out to PE owners to ensure you are included in an auction process or at least given the opportunity to bid. PE owners may also provide pertinent information regarding operations or facilities to allow you to prioritize and speed up diligence efforts.
Some or all of the above approaches may work for certain corporate buyers to speed up the M&A process. We appreciate and expect that diligence requirements will inevitably vary for each buyer and for each deal. However, at a minimum, corporate buyers should be aware of the growing trend of final bids being submitted earlier in auction processes and know strategies available to prevent missing out on desired deals.
“North Inlet Advisors, LLC” provides financial advice to companies on capital formation, mergers, acquisitions, divestitures, restructurings, and other complex corporate transactions. North Inlet Advisors is not a retail broker-dealer, does not conduct underwriting activities, provide research, analyst reports, or solicit or carry accounts, or offer or sell securities products to retail customers. North Inlet Advisors is registered as a broker-dealer with the U.S. Securities and Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority (“FINRA”) and Securities Investor Protection Corporation (“SIPC”). Please visit www.finra.org and www.sipc.org, or North Inlet’s regulatory webpage for more information.