Outlook for Dealmaking: Technology Spotlight

EMS:

Hi, Chad. Thank you so much for being with me today.

Chad Johnson:

My pleasure. Thanks for having me, Elana.

EMS:

Absolutely. Chad, to start off the conversation, tell us a little about yourself and how you got to where you are today.

CJ:

Sure. I joined Cherry Tree in 2007 after a brief stint with another local investment banking group, and after a software company I was running had been sold. I have what would be a non-traditional background in investment banking. I came in as a vice president. I was never an analyst or associate. I had gotten my MBA at the Carlson School at the University of Minnesota and then worked as an analyst at a venture capital firm and then spent several years doing corporate development for a publicly traded education software company. And so today I work nationally with education companies and locally a bit more of just a technology generalist.

EMS:

Great. Chad, it's definitely an interesting time for dealmaking in M&A. I'd love to hear your high-level overview.

CJ:

Sure. The good news is that pitch activity and engagements were both up in first quarter, so I think that bodes well for the rest of the year, and most of what I've heard from other bankers and attorneys and M&A professionals is similar. It seems that many potential sellers are gearing up to higher bankers or have hired bankers, and many PE firms have decided it's time to sell some of their holdings.

EMS:

Great. Chad, and more specifically, I would love to hear your outlook views on the Minneapolis St. Paul market for dealmaking.

CJ:

Sure, certain segments are more attractive than others, especially in the technology market where we do a lot of work, we see segments that are garnering a lot of interest. We have engagements in IT services, in cybersecurity, for example, and those have received a great deal of interest as have some of the projects that we're doing in education, and I think because so many companies are PE-backed today, the market in a sense has built in some reoccurring revenue, if you will, and so these companies are trading hands every three to seven years.

EMS:

Chad, the current macroeconomic environment has clearly challenges to deals closing. I would love for you to discuss which macro factors have had the most impact on your clients who've recently closed or are in the process of closing an M&A transaction?

CJ:

Okay. It varies by market is our experience. Overall, PE firms are doing a lot more diligence nowadays than many years ago and are spending millions of dollars on their diligence efforts. We've had situations, for example, where customer or market surveys are done that add a decent amount of time to a normal process, and in some markets environmental reviews are becoming more of a holdup, but for most of our clients we find that adequate planning on the front end can get you out in front of any potential issues that could be a delay and we're not seeing a delay from issues such as bank financing.

EMS:

Chad, what about valuations? How has the climate impacted those?

CJ:

Well, we deal with a lot of technology companies including a great number of SaaS companies, and that is a sector that has seen some of the biggest changes in valuations. As an example, what might have been a company that was worth seven to 10 times ARR in 2021 might be four to six times today with the disclaimer of course, that there are a number of factors that will ultimately determine the valuation of any specific company. In 2021, there was much more of a mindset that for growth-oriented PE firms, they believed in growth at any cost. If you were growing rapidly and you had strong economic unit economics than for technology companies, they were less concerned about profitability. Today, many firms are telling us that even though they are growth equity firms, their LPs won't let them invest in companies that are not profitable, and that has had a negative impact on valuations for sure.

EMS:

Chad, what about trends that you've been seeing in purchase prices in EBITDA multiples, and how do you think those trends will continue into the rest of this year?

CJ:

They have stabilized in the past 12 months. There is less concern, I'm speaking broadly now about a recession. Interest rates have stopped climbing or even talking about cutting them at some point, and we continue to see that for the higher quality companies with nice growth, strong profit margins, they're getting much better multiples than what you'd consider the average company, but overall valuations have been stable for the last 12 months or so.

EMS:

Chad, what is one key piece of advice you'd give to a company contemplating a buy side transaction? And also, I would love to hear your thoughts about those contemplating a sell side transaction.

CJ:

Well, the most important thing completely not self-serving is to say to both hire a good investment banker, but beyond that, with a buy-side transaction, which we do a fair amount of, we find that you need to begin with the end in mind. Experience shows that if companies have a strategic plan, they've looked hard at internally what assets they have that can be leveraged, and whether your core markets or adjacent markets have most potential, those are the type of questions that are going to lead to a good M&A plan. The data shows that core acquisitions are the most likely to be successful and that the closest adjacencies are the next most likely on the sell side. If you have flexibility on timing, then you want to aim for a time when you are showing both growth and profitability and there is plenty of opportunity or meat on the bone as we like to say for the buyer. And then of course, you have to have your house in order, have cleaned up any problems operationally or with financials, things like having contracts digitized. Doing that type of work on the front end can definitely save you some pain and make for a smoother process when you are ready.

EMS:

Chad, ESG has been top of mind and I wanted to see how ESG factors into evaluating companies.

CJ:

Well, this is another topic that it depends on the market or the market segment that you're looking at. In some market segments, they are another buyer group that you have to be aware of, you have to be familiar with, you have to understand what they're looking for. We spend a lot of time in sectors like education that has attracted ESG investors, and so if you want to be in that market, you have to understand them, what they're looking for, and be able to reach out and connect with those individuals. They are a very motivated group with capital to deploy, and they should be part of your list of potential buyers if you are a company that would be a good fit in the ESG world.

EMS:

Chad, we've covered a lot of ground today and wanted to see if you have any final thoughts you'd like to share with us.

CJ:

The main thing I would remind people of is that economists have correctly predicted 19 of the last three recessions, so to not get too caught up in what the external predictions are for the market, external factors matter, but oftentimes sellers are much better served to focus on the things that they control and not worry about the things that they don't control.

EMS:

Chad, I want to thank you so much for sharing your perspective with our listeners.

CJ:

My pleasure. Thanks again.

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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