Time to Get the M&A Party Started?

Is it time to get the M&A party started? Judging solely by the title of its recent article, the Wall Street Journal’s answer appears to be “no” (see It Still Isn’t Party Time for Buyouts, February 18, 2013). Yet the fact that the article was written at all indicates that there are enough favorable indicators out there to ask the question. With several large transactions having recently been announced, everyone wants to know if happy times are (finally) here again.

In the years since 2007’s peak deal volume, there have been many times in my firm’s transaction practice that the floodgates appeared to be opening. But in between those particular months when multiple transactions inexplicably converged, things would settle back down to the “new normal.” Do the recent headlines reflect a similarly random clustering of data points, or something more? Even if the recent spate of activity continues, how long will it take for the trend to percolate from the mega-deals down to the lower-middle market?

Any optimism ought to be tempered by 2012’s experience, when most M&A professionals, myself included, wrongly thought that impending year-end tax rate changes would motivate sellers and drive deal activity. In hindsight, there were several reasons that this did not happen in the lower-middle market:

  • Potential sellers felt that their valuations were still suppressed, and believed, rightly or wrongly, that if they delayed an exit they could raise their valuations enough to overcome an increase in tax rates
  • Potential sellers were leery of a liquidation event in such uncertain times. The thought process goes something like this: “I know what my business has been generating, even during these past few years of weak economic conditions. If I sell it, where do I invest the money in this economy? I feel more comfortable with the risk/return of my own business!”
  • Other potential sellers did want to exit, but simply underestimated the complexity and duration of the process and could not get a deal done in time
  • Still others were selling what nobody wanted – i.e., poor quality deals
  • Owners/investors chose to monetize a portion of their holdings prior to the tax rate changes through dividend recapitalizations or other transactions rather than outright sale

Empowered by hindsight, we develop narratives to explain previously unforeseen events, which only increases our false sense of confidence in yet another round of predictions. At a recent program hosted by the Philadelphia chapter of the Association for Corporate Growth, the consensus that emerged from a panel of M&A professionals was that 2013 would be a big year for transaction activity, although perhaps skewed toward the latter half of the year. Of course, for every positive factor supporting this optimism (lots of money on the sidelines, low cost of capital, improving economic conditions, higher valuations, etc.) there was a negative variable to temper the enthusiasm (continued slow economic growth, poor supply of quality deals, increasing competition from the IPO market, etc.).

My own predictions are as irrelevant to the ultimate course of economic history as anybody’s. But just to play along, my guess is that 2013 will not see an appreciable increase in lower-middle market deal activity. As the WSJ article notes, the favorable elements are not new; many of them have existed for two or three years. Even the additional tax-related variables in 2012 did not generate the activity we expected. So it is hard to be too optimistic about 2013 when that particular positive factor is gone, there are no noteworthy new ones, and there is arguably an uptick in certain negatives such as competition from IPOs. Meanwhile, the overall economy slogs on in the darkening shadows of Federal, state and municipal budget deficits and Congressional logjams. Maybe the passage of time is itself enough to generate some increase in M&A activity, as more sellers get tired of waiting for the perfect time to exit, more corporate buyers turn to acquisitions to drive growth, and private equity money comes under increasing pressure to be put to work. We shall see.

But regardless of what 2013 holds, I am bullish on the longer term, and quite certain we will see a boom in lower-middle market M&A activity sometime between now and the end of 2015. Demographics alone will help drive future deals in this segment of the market, as baby boomers need to exit their businesses to fund retirement. It may not be time to get the M&A party started just yet, and it may be impossible to predict exactly when it is time. But who doesn’t love a surprise party?

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Virtual Reality

On Tuesday, February 12, 2013 I had the privilege of moderating a panel discussion on outsourcing at an event held by the Entrepreneurs Forum of Greater Philadelphia (EFGP). The program was entitled “Virtual Reality: Using Outsourcing & Virtual Business Models to Achieve Peak Performance.” The objective of the panel discussion was to give potential buyers and providers of outsourcing services an overview of trends, opportunities and challenges in outsourcing. Particularly for the growth companies that the EFGP serves, we hoped to provide an overview of the resources available through outsourcing as a company grows and evolves, and to provide guidance in navigating the decision of whether to outsource and how to outsource.

Key discussion points included:

  • The value proposition of outsourcing: While there are many benefits, the overarching value proposition is to be able to focus on your core competency. As Tom Peters said, “Do what you do best, and outsource the rest.” This might have been expanded to say, “Do what you do best, and outsource the rest TO WHOEVER DOES THOSE THINGS BEST.” Patrick Gibbons, co-founding partner of The Emerson Group, eloquently described Emerson’s wildly successful business model that provides outsourced services while itself relying upon outsourcing for non-core functions.
  • Outsourcing levels the playing field and enables smaller, earlier-stage businesses to successfully compete with larger encumbents. Joel Cardis, Inhouse-Counsel.net, described several examples he has seen in his role as outsourced general counsel, while explaining how his proactive role with his clients is a modern twist on contracting out for traditional legal services.
  • Outsourcing is continually evolving, and within each functional area (finance, IT, marketing, logistics, etc.) outsourcing is at a different stage of maturity. Outsourcing services are moving up the ladder from handling routine or transactional tasks to more value-added, knowledge-based and strategic activities. Staffing, a form of outsourcing, has progressed from temporary factory workers, to temporary office workers, to interim executives, and now to “fractional” executives, or “executives as a service,” evangelized by panelist Sue Cyliax of Chief Outsiders. Similarly, staffing solutions have evolved into managed services, whereby the management of an entire business process or functional area is outsourced, such as recruiting process outsourcing, represented by panelist Emily Biscardi, founder of Xelerate.
  • Advances in information technology – namely, cloud-based and mobile applications – have made outsourcing more practical and pervasive. As Anthony Mongeluzo, President of ProComputer Services (and EFGP President) noted, the “cloud” is really just a new name for something that has been around for a long time, but broadband technology has made it possible to move vast amounts of data digitally and wirelessly to and from the cloud. Sam Vinovich, a colleague of mine at Fesnak and Associates LLP, described Fesnak’s use of cloud accounting technologies Intacct and Bill.com to remotely provide a robust accounting and financial management solution.
  • Outsourcing is not a job-killing practice and should not be confused with offshoring. It is creating whole new career paths for professionals. For example, a controller in a middle-market company may have no upward mobility if the CFO she reports to stays in her job for a long period of time. But at a firm that provides outsourced accounting services – where her area of expertise lies within the firm’s own core competency and reason for being – she has unlimited opportunities for advancement. And outsourcing provides a wide spectrum of experiences to the professionals delivering the services, which in turn adds to the value proposition for buyers of those services. To use Mongeluzo’s metaphor, an IT professional at an IT outsourcing firm is an “alley cat” that has been exposed to all sorts of ever-changing experiences in the outside world. An in-house IT professional, in contrast, is a “house cat”: limited to the experiences seen inside his or her company, confined by that one company’s vision, resources, budget and existing technologies.

It was a dynamic panel discussion that I was pleased to be a part of. Judging from the audience questions and feedback surveys, it was well-received. Being in the outsourcing field, it is easy to forget that outsourcing is still not necessarily mainstream, at least not in all functional areas, and business professionals still have a number of questions about how it all works and can best be leveraged in their organizations. The panel discussion was a great opportunity to continue to educate the marketplace and evangelize the benefits of outsourcing. Thanks to EFGP, the panelists, and all who attended the event!