Recap by Alim Bhanji
The General Manager of the LA Dodgers once said, “if you’re rational about every free agent, you will finish third on every free agent.” While we think our private equity clients should definitely be rational when making acquisitions, we do see a need for creativity in investment theses…to not finish third on every process. Then, of course they need to back that thesis up with strong diligence.
The Private Equity deal environment changes are well documented and often discussed: Capital is flooding to the private markets, causing absurd amounts of dry powder and multiples in excess of public market multiples. Recently SATOV Consultants and CVCA brought together a panel of advisers to discuss the how they and their clients are adapting. Kurt Sarno (Partner at Blakes, Cassels & Graydon) moderated a panel with Heidi Melsheimer (Managing Director at Marsh) Richard Pay (Transaction Services and Private Equity Leader at PWC), David Lee (Managing Direct at Pipar Jaffray) and me.
The central theme of the day was the need to be more efficient in the diligence process. Efficiency means both getting smarter earlier in the process and going deeper on value creation opportunities which together get to more confidence to be able to pay the multiples needed to get over the line. Or of course walk away earlier.
The increase of capital to the private markets was certainly not something David Lee was complaining about. He noted that fewer of his deals are following the traditional playbook of sending a book to 100+ buyers and waiting for the highest bid. Recognizing that there are enough buyers willing to pay the market-clearing price, sellers are looking for a buyer who can bring a unique angle as a partner, through some complementary investments or skills or even just through demonstrated early investment.
At SATOV, more of our clients are engaging us pre-LOI or even pre-IOI to have a quick look at an asset before they go further. In our earlier stage offering, we prioritize a few specific areas of focus in the investment thesis, which often call for some degree of customer research. Sponsors find it allows them to get more conviction in key areas of their investment thesis.
My fellow panelists stressed the importance of getting ahead of processes. Advisors are being engaged earlier across the board: tax, insurance and legal diligence are all happening earlier and faster. Heidi shared that in addition to diligence many clients are working on a plan to create value on insurance spend before the deal closes. Kurt noted that the average US private equity deal process has compressed to 6 months from 12 months and is expected to drop further. With PE transaction processes showing no signs of slowing down, earlier more efficient diligence can help Sponsors be best prepared.
We still see many clients calling us with a signed LOI in hand asking for a classic diligence sprint. In times where we have already done pre-LOI diligence, the work earlier in the process allows us to be more efficient in a post-LOI study (with time and resources), but also go deeper on the most critical issues. Recently, we worked with a Sponsor looking to acquire a financial services asset: pre-LOI we helped assess market attractiveness and post-LOI we went deeper on customer purchasing behaviour and the Target’s reputation in the market.
Multiples in the current environment require a strong perspective on both downside risk and value creation opportunities. It’s now more important than ever that Sponsors put together a creative and efficient diligence process.
Thanks again to CVCA for co-hosting this event with SATOV and to our amazing panelists for their insights.