Outlook for Private Equity and M&A for Remainder of 2023

EMS:
Absolutely, Cory. So to kick off the conversation, tell us a little about yourself and how you got to where you are today.

CM:
Yeah, I started off my career in 2005 in leveraged finance after graduating with a degree in finance and economics from a local university here in Minnesota. 2008, the recession hit and there was limited opportunity, so I went back to grad school and started the CFA Charter as well. After finishing up my MBA in 2010, finance positions were still kind of limited, especially in kind of the capital markets where I was coming from. So I ended up working with an oil and gas company out of Miami in their counterparty credit risk department and specifically the Treasury Department for about six months. Then RBC Capital Markets reached out to see if I was interested in an institutional equity research position covering oil and gas. This was kind of the time of the shale boom where the horizontal and directional drilling was quickly evolving and kind of an effective tool for unlocking trapped oil and gas in plays that were traditionally difficult to extract from.

I did that for about three years between Minneapolis and New York, and then decided to come back to Minnesota, left RBC and I made kind of a pivot in my career and I went into advisory, specifically transaction advisory and M and A services with the national firm. Spent about three and a half years with that firm before I launched my own transaction advisory practice with the regional firm here in Minneapolis called Lurie about five years ago. Fast forwarding now five years, we combined Lurie with EisnerAmper in September and the transition's been great.

EMS:
Cory, it's definitely an interesting time right now with respect to deal making activity with deals taking longer to complete and more, and love to hear your high level outlook for M&A for the remainder of this year.

CM:
Yeah, so in February I put out an article highlighting the issues that buyers and sellers were facing heading into 2023. Nothing surprising, inflation, rising interest rates, tight supply chains, uncooperative labor markets. Now those issues are still present, but changing in some regard as the Fed is either done or close to being done with raising rates. Inflation is still an issue, but there's some data now showing that the rate of change is starting slow, the bottle neck on supply chains seem to be loosening up. We are seeing some additional capacity down the labor markets, albeit it's a little bit more industry specific.

The good news is that the issues that investors were facing in 2021 and 2022, starting to be a little bit more transparent now and they get their arms around, but now the problem is kind of that old adage of no one really wants to catch a falling knife, but the new kind of the macro paradigm for the last 10 years of zero interest rates, investors assessing historical resorts are trying to understand what's sustainable and what's not and what kind of the new path of growth is going to look like.

The investment banks I've been chatting with are generally hoping for a slow ramp up into 2024 where they kind of expect deal volume to pick up in the back half of 2023, but fully expect 2024 to be a more robust year. Investors are cautious with the sell side advising its clients to hold off to maximize their own value. It's going to take some time to work through the system. So like everybody else, I would expect 2023 deal volume to be materially less in the past couple years, but then 2024 picking up.

EMS:
And Cory, given where you sit in the Minneapolis, St. Paul area, love to hear any specific trends you're seeing in that region with respect to deal making.

CM:
The Minneapolis market is very similar to other markets nationally, we're experiencing a broader slowdown locally. The disconnect on valuations, it's becoming more difficult to get senior financing in place. With that being said, we are seeing quite a few industrial manufacturing transactions in the Midwest, business services, healthcare, healthcare tech. It's also a great market for family owned or first generational companies. I have personally spoken with quite a few families over my career that are curious about bringing in private capital partners and want to learn more about that process. They generally are looking for like-minded investors that tend to take a long duration approach, family orientated, concerned about their legacy. You're starting to see transactions here locally where philanthropy is part of the structure of the deal itself. So it's starting to get a little bit more unique and specific out here with deals and how they're getting them done and what's really valuable to the family, what's not.

EMS:
Cory, I know you touched on this in the beginning of our conversation about the current macroeconomic environment presenting challenges to deals closing, love to hear more specifically, which macro factors have had the most impact on your clients who have recently closed during the process of closing an M and A transaction?

CM:
Yeah, I think the biggest factor right now, what we're seeing a lot, funds or deals are having more difficulty raising that senior debt and it all comes back to interest rates and the slowing economy. I specifically talked to one fund client that has a number of insurance LPs and they go to market and the first individuals they go to are their LPs looking for a senior debt. They put out 15 term sheets over a more recent deal and only got three back. So it's telling you that the markets are really tightening. So really the biggest issue right now is getting that senior debt financing lined up in line with expectations on valuation and returns.

EMS:
And that leads into the next question I have for you, Cory, about valuations and how has the economic climate impacted those?

CM:
It's a domino force in the marketplace right now. There's a huge spread between seller and buyer expectations on valuation and what the investor believes the intrinsic value is or what they're willing to transact and what the seller believes their company is worth. Again, you had 10 years of near zero interest rates where cost of capital kind of distorted market valuation for a long period of time. Those valuations have become really ingrained in the seller's mind. It's really hard to move a seller off that valuation until there's some experience or an event that kind of brings some rationality back to the marketplace. And it takes time for those expectations to work through the market. And I would expect over the next six to 12 months, you're going to start to see seller's expectations and buyer's expectations come back together, but it's going to take a little while.

EMS:
And what about the macroeconomic client? How has this impacted the due diligence process?

CM:
Yeah, COVID really changed due diligence. Prior to COVID, you almost always went on location to meet the shareholder, the ownership groups for a few days, kick tires, shake hands, get a sense of the management team. During COVID travel was obviously not an option and firms weren't really willing to take the risk to send people and getting sick. However, transactions were still kind of going on at that time. So the workaround was video calls. Clients were able to get comfortable with video calls, with management teams, data rooms became more important. Video calls became more important. I think the biggest issue that we're starting to see now, which I was a little bit more surprised about, is we haven't seen a return to onsite management meetings.

And in the Midwest where you have heavy industrial technology or heavy industrial manufacturing companies with inventory at times, that can be problematic as you're trying to understand what inventory levels are there. And when you had a seller's market as what we had in the last couple years, it's been harder to get on site because the bankers just weren't allowing due diligence teams to go in and kick the tires. I would expect that to change a little bit now with the buyer's market starting to develop and buyers getting more leverage with some of the due diligence processes left.

EMS:
And Cory, what about trends that you've been seeing with regards to purchase prices and EBITDA multiples? And how do you think these trends will continue for the rest of the year?

CM:

Well gone are the days of the three million dollar EBITDA company getting eight to nine times. What we are seeing now, and I think what we're going to continue to see over the next 12 months is a tighter distribution of multiples. For deal sizes in that 10 to $50 million enterprise value range, and we're seeing kind of four to six times for deal sizes in that 50 to $250 million range, we're seeing seven to nine times. I would expect those to come down a little bit over the next maybe 12 months. But what you're not going to see is you're not going to see that small company getting eight or nine times in a deal process, and you're not going to see that $250 million enterprise value getting 15 to 20 times. Those days are gone, cost of capital has risen and it's just not a rational valuation anymore.

EMS:
Cory, what is one key piece of advice you would give to a company contemplating a buy side transaction and also a company that's contemplating a sell side transaction?

CM:
Yeah, I think for both, having a solid trustworthy advisory teams, both they go financial and tax, it goes a long way with getting the transaction done and getting your capital partners comfortable. Specifically on the sell side, I would say that the whole process, the key to getting that deal done is being organized before going ahead of a due diligence process. So making sure the data's up to date, all the accounting and finance markers are in there. Having a sell side quality of earnings completed will help speed that process up. So doing the things that you need to do to get a buyer comfortable ahead of time is going to win you points in that process.

EMS:
Cory, ESG has been top of mind for the private equity deal making industry and wanted to hear your thoughts on how this factors into evaluating companies.

CM:
ESG hasn't quite made its way yet to the lower middle markets where we typically transact at. What we are seeing is more impact investing happening. So you're seeing funds go in with the idea of thinking about, hey, how do we have diverse board of both male and female participants? How do we change our electricity use in the manufacturing plant from pulling off the grid, putting back in the grid? And that may be consisting of putting solar panels in the excess areas where they can, things like that, probably less ESG formalities, but more impact investing happening across the board there.

EMS:
Well, Cory, I wanted to thank you so much for sharing your perspective with our listeners.

CM:
Well, thanks for having me, and I look forward to chatting in the future, Elana.

EMS:
And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.

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