M&A continues to evolve

Dealmaking experts examine the current market and what may lie ahead

As the cost of making deals continues to increase, Umberto P. Fedeli wonders what the effect will be on the M&A climate globally, domestically and right here in Northeast Ohio.

“You have more capital chasing deals than there are deals available,” says Fedeli, president and CEO at The Fedeli Group. “It’s a simple case of supply and demand. When you have more money chasing deals, the price people are paying for companies in both the public and private sectors goes up. The more you pay for something, now you have to cut costs and you have to grow because you made a major investment. The more you spend, the more execution risk you have.”

With an estimated $1.7 trillion already committed to private equity firms, according to multiple industry experts, the market is as flush with capital as it has ever been. M&A activity in Cleveland was brisk in 2017 and the fast pace of dealmaking has continued into 2018.

Stewart Kohl, co-CEO at The Riverside Co., doesn’t see any evidence that this trend will change.

“People are recognizing that it’s a frothy seller’s market, as interest rates remain quite low and there is a lot of dry powder to be spent,” Kohl says. “Savvy business owners are doing their best to make their company attractive to investors, whether they are seeking to cash out of their business or simply want a minority partner with whom to grow.”

We spoke with Fedeli, Kohl and several other M&A experts about what is driving the dealmaking market in 2018, and what risks might be lurking in the shadows that could threaten the positive momentum.

Get up to speed
Technology is an area that all dealmakers need to understand when studying the market, Kohl says.

“The most successful investors are those who find the disruptive companies that are harnessing technology to defeat legacy competitors, grow considerably faster than average and offer exceptional returns at exit,” Kohl says.

“Simply put, technology is advancing quickly and changing everything in our world, which means that every successful company must be a technology company on some level — nimble enough to adapt and clever enough to benefit from constant change.”

Kohl speaks from experience. In March, Riverside bought Vivid Learning Systems, one of the nation’s fastest-growing providers of online safety training, to its Health & Safety Institute platform. Technology is a factor in whatever industry you’re playing in these days.

“We used to look at the past five years of a company’s performance when evaluating their prospects, but now we concentrate much harder on where the company is likely to go in the next five years,” he says.

It can be tough to sort through all the noise, however, to find the right partner for the deal you’d like to make. SunTrust Bank’s David Neubert sees a market that is flooded with potential buyers.

“Business owners are receiving a lot of inbound calls from private equity firms and other potential buyers seeking to learn more about their businesses,” says Neubert, managing director of the Business Transition Advisory Group.

“Buyers are faced with increased deal competition, and this can make it particularly hard for a business owner seeking to grow his business through acquisition when competing with more potential buyers, such as private equity firms.”

Given this climate, Neubert says it’s more critical than ever for dealmakers to be on top of their game.

“It is important for business owners to become deal-ready, aligning themselves with advisory resources to help them evaluate and potentially execute M&A deals,” Neubert says.

“A key factor for business owners is understanding value. An experienced adviser can bring significant insight to this concern. Additionally, being deal-ready at the personal level has increased in importance. Business owners who transition their business well spend the time to address personal wealth planning and structuring ahead of a deal in order to maximize value and peace of mind.”

PE has done well
So what’s driving all this energy in the M&A sector? To some degree, it’s a product of 50 years of strong returns through private equity investments, Fedeli says.

“You have pension funds, you have union funds, you have wealthy individuals allocating more and more money toward capital,” he says. “Historically, over the last 50 years, private equity has had the best returns, and capital will follow where the deals have been good. So there has been more allocation toward that asset class.”

Another factor isn’t new to the investment community, but is still very relevant: the fear of missing out on the next great deal.

“The hardest thing in the world to do, being a good investor, is controlling human emotions,” Fedeli says. “You have the business and economic piece, but then you have the human nature part. It’s about controlling those emotions. When people are afraid, they don’t want to do anything. When they feel like they’ve missed out and there is a lot of money to be made, they want to jump right in. Things move faster today, but there is nothing new about human emotions when it comes to investments in the public and private sector.”

Debt could be a problem
Another common trend in the economy is its cyclical nature. Tax reform has instilled confidence in business owners and should fuel more dealmaking activity.

“When you have all the money that’s in foreign countries being brought back that is now going to be taxed at a very favorable rate as corporate tax rates come down, you should see a lot of M&A activity,” Fedeli says.

“Companies are going to have more money to invest and redeploy. Maybe the president’s style is unique for some, but when businesses feel there is less regulation and the environment is favorable, they are more apt to make investments.”

A couple potential hiccups to that forecast could be continually escalating debt and a trade war.

“We have a $1.5 trillion tax cut that will stimulate jobs and create more M&A opportunities,” Fedeli says. “The government will end up with more tax dollars. But we keep increasing the deficit. As interest rates go up, because they have nowhere to go but up, the cost of servicing the debt becomes more expensive. The world has a lot of debt and sooner or later, it’s real.

“The concern is people who believe in supply side economics think that as you cut taxes, people spend more, wages go up, it creates more jobs and government ends up with more tax dollars. I believe that to be true, but as you do it, you have to lower debt. We haven’t done anything to lower debt. We keep on creating more debt.”

As for where the debt goes from here, time will tell. On the trade war front, Fedeli is optimistic that cooler heads will prevail.

“I think it’s more to get certain countries’ attention,” he says. “You could have the right intentions, but have adverse consequences if we end up in too much of a protectionist environment. I hope that won’t happen and I don’t think it will.”