Steven T. Lawrence, a business lawyer at Milligan Lawless, recently had the opportunity to speak with Michael R. Starkle, Managing Director at Timepiece Capital, to discuss considerations for a middle-market company coming to a point of sale.
Steve: When you are looking at a prospective target, is there one aspect of the business that gets you excited, other than financial performance? Obviously, financial performance is likely your first criterion but, beyond that is there something that you would say we look for this when we look at a prospective acquisition?
Mike: I think the thing that I would say about that is it is something that I would call “deal dynamics” which first and foremost means to me: Is there a good reason for a transaction to be happening in the first place? When we are looking at a target, obviously that’s the first question that comes to mind. Why are you selling your company or doing a transaction? Frankly, a lot of times it is not for a great reason. We are looking for a good rationale for sale. Another characteristic that I would put in the “deal dynamics” bucket is the issue of continuity. Is there a prospect for good management continuity after the sale? Obviously, that can mean a lot of different things. Sometimes when we are getting involved with a business, the owner is ready to step away and retire, step away and sell the company. But, if that is the case, it would be great to see somebody on the management team that’s either capable of taking the lead spot or a good enough operating person that you feel comfortable going forward that even if you have to bring in a new CEO or lead person you’ve still got a nice team in place that knows the industry, the business, the institutional history, all of those things. Unless it is a turnaround situation, you do not have a big break with the company’s past. We also like to see somebody have skin in the game. Now, again, that does not have to be somebody that was at the business before we got involved. But, that does help the deal dynamic if either the current owner or somebody in the ownership group or somebody on the management team continues to have some economic equity or skin in the game after the transaction. That goes a long way towards making us comfortable. I group all of those things into what I would call “deal dynamics” and say that that’s a key piece of what we are looking for when we are looking at a business. We are looking for a good business, as you said. We are looking for a good financial performance, good prospects for future performance, but the deal dynamics are very important to us as well.
Steve: What are you seeing as the biggest kill the deal factors today? Are there items for which you say – that’s too high a risk for us to get involved in or just that’s not going to work moving forward?
Mike: I will group this into a few different categories, too. One of them is unique to where we are today and two of them are just constants. That one that I think that is a little bit more unique to our environment today relates to cyclicality. Are you at a cyclical peak in an industry? A lot of industries, as we know, go through natural cycles. We understand that and factor that into our thinking. You are always asking yourself: is this an industry that seems like it is at a cyclical peak right now, or is this an industry that seems to still have some runway? So that is one that is unique—whether it is today or some other period in time—that is unique to a timeframe and to a specific industry. I would say that the other two that are always floating around relate to customer concentration and company performance during the deal process. If there is a lot of customer concentration, it almost invariably makes a deal very difficult to do for a buyer like us. In those cases, oftentimes a strategic acquirer, someone who is already in the industry, usually makes more sense. And then the other big one relates to performance. Once we get involved, is there a performance miss during the negotiation and diligence process? As a seller, you always want to have momentum through the whole sales process. So, if you are all of a sudden missing your budgeted numbers and starting to stumble a little bit during the sale process, that is one of the things that will get in the way of a deal getting done successfully. Those are the three things I would throw out there.
Steve: Are valuations too high today? In our practice, in the fourth quarter of 2016 and first quarter of 2017, we have seen some historically high valuations, maybe even “frothy.” Good companies are commanding high multiples—in some instances historic multiples. What is your perspective? Have we reached the peak? Is it too high?
Mike: Sure. Great question. I definitely agree that valuations are high right now, but I think they have been high for a while. It has been a sellers’ market for a number of years from our perspective – certainly that has continued. Part of the reason for that is that interest rates are low. Many of the buyers that are out there that are looking at these types of companies are very sensitive to the availability and cost of debt when they are structuring a deal. That makes it easier to legitimize high prices when you can get really inexpensive capital to finance a deal. So, I do not know if they are too high, but it is certainly a sellers’ market. I think anybody that is a potential seller or company owner that is thinking about a transaction would be well served to think long and hard about an exit in the near term here as opposed to waiting. I do not think there is much reason to believe that valuations are going to go higher than where they are today. I guess in that sense, we might be near a peak. I am not predicting some sort of massive decline in the next year or so, but you never know. It is certainly an opportune time to sell if somebody’s inclined to think about that in the near future.
Steve: What advice would you give a CEO thinking about making a sale and beginning to prepare for the acquisition process that you wish they knew at the beginning?
Mike: One of the things I would say is I would refer back to the answer of the first question which is deal dynamics. That is an area where an owner does have more control to prepare a company for a good sale process if they can make sure that there is a good transition plan in place. Do you have the right team in place to ensure good continuity and future performance? You don’t want to hire somebody two weeks before you go to market with your company if you’re trying to make sure that the management team is in place to take the company into the future. Making those types of necessary hires at least a year in advance of the sale process makes a lot of sense. It is going to show that those people are up to speed and capable of carrying things forward once the owner steps back. That is a big part of it. Have a management team that’s ready and capable of taking the company forward. Also, it is a difficult to time these things so you always want to leave some opportunity on the table for the next buyer. Sometimes people tend to try and sell at what they see as the absolute peak of their business. That makes it a lot harder to get a buyer comfortable that there is still a good growth story, a good growth opportunity in front of them. The other one—not everybody does this—but one of the other things that frustrates us as buyers is when we see companies where the owner calls out a lot of add backs to their earnings to try and justify a high valuation. This is especially challenging if it is a situation where an owner runs a lot of personal expenses through the business and they are trying to get credit for those being added back at the eleventh hour. For anybody that is running a lot of personal expense through their business, my advice is always to stop doing that well in advance of a sale process because the cleaner the books are, the less you have to explain and justify to a buyer, and the better off you are going to be. This will ultimately result in a smoother sale process. Those are the main things that I would tell somebody that is thinking about this type of a process in terms of getting ready.
Steve: As we look ahead to the remainder of 2017, give us your thoughts in terms of what you see as the outlook for the market for the remainder of the year. Now that the Trump Administration has settled in, seems like the markets have settled a bit and now looking at the M&A climate for the remainder of the year, what are your thoughts in terms of outlook?
Mike: I would not forecast any dramatic changes here in the near term. We are still in an environment where the economy is maybe slowly improving or at least not getting worse. I do not think that the debt markets are going away any time soon. I think that the one wild card right now, though, is tax reform. I am certainly not smart enough to predict how that is all going to come out. But, I think some of the things that are being considered could have impacts on pass-through entities or other different issues that might come into play when people are structuring and financing an acquisition. Those affects, I think, are still very much a question mark right now as nobody knows what will eventually get passed and enacted. I think there is some uncertainty in terms of how things may look in the future from a tax standpoint which, again, I think, means that for now, it’s probably a good time to try and get something done if you are ready to do it. I don’t see any reason to believe that the market is going to soften materially any time soon, but there is that one aspect of uncertainty out there that is still hard to predict.
Michael R. Starkle is a founding member of Timepiece Capital. Immediately prior to founding Timepiece, he spent two years as a Managing Partner with the buyout firm 17th Street Capital Partners. Mr. Starkle’s prior work experience includes investment banking stints at Tucker Anthony Sutro Capital Markets, Security Capital Group, and LaSalle Partners Limited. Mr. Starkle also spent six years as CEO of CRE Industries Incorporated, an investment vehicle for the acquisition, growth and disposition of two manufacturing and distribution companies. Mr. Starkle currently serves on the board of directors of all of the Timepiece portfolio companies. He graduated with honors from Harvard University.
Mike can be contacted at firstname.lastname@example.org or 480-999-0259.
Steven T. Lawrence is a Shareholder with Milligan Lawless. Steve is a business lawyer with a practice focused on the legal and business needs of companies and individuals. Steve handles every aspect in the life of a company from start-up and formation to operations matters and agreements to company acquisitions. Steve has extensive experience in a wide range of corporate and transactional matters, including mergers and acquisitions, licensing, securities offerings, entity formation and business structuring. Prior to joining Milligan Lawless, Steve was a shareholder at a large Phoenix-based firm, served as Corporate Counsel to SkyMall, Inc., and was Associate General Counsel to JDA Software Group, Inc. He began his legal career as a Judicial Clerk to then Chief Judge Thomas C Kleinschmidt of the Arizona Court of Appeals. Steve is listed in Best Lawyers in America for Corporate Law and Chambers USA for Corporate/M&A Law. Steve holds a J.D. With Distinction from the University of the Pacific McGeorge School of Law, Master of Laws (LL.M.) in Health Law from Loyola University Chicago, an M.B.A. from the W.P. Carey School of Business at Arizona State University and a B.S. in Business Administration from California State University, Sacramento.
Steve can be contacted at steve@milliganlawless or 602-792-3536.