The impact of M&A and why you can’t ignore it

Business owners today cannot afford to ignore the world of M&A — even if they’re not actively looking to buy or sell. That’s because your competitors are out scooping up a new technology, diversifying into new geographies, pinning down their value in order to raise capital without dilution and implementing long-term plans that help them run their companies better.

There’s a reason North American M&A has retained momentum from a strong 2018, closing 4,754 deals worth $849.7 billion in the first half of 2019, according to Pitchbook.

We spoke with executives, serial entrepreneurs and advisers who handle transactions every day about the role of mergers, acquisitions and dealmaking in business today. Here’s what they had to say.

Breaking growth ceilings

Mark Kovacevich, president of North American operations for Improving, is involved in all aspects of dealmaking — from identification and transaction development, to due diligence and integration. The Texas technology management and consulting firm, which is on track to do $100 million in annual revenue this year, has purchased six companies since 2010.

Kovacevich started an IT technology firm in Columbus, which was acquired by Improving, and he’s been with the organization ever since. Today, he’s responsible for strategic mergers and acquisitions, as well as international operations, execution, corporate integration and implementation of Improving’s vision and purpose.

“When I chose to go with Improving to be acquired, I was looking to be able to tell my story quicker and at scale. I was trading time and speed,” Kovacevich says. “The story of scale is so much more powerful in our business than it is in some other ones.”

From the buyer side of the deal table, Kovacevich holds up Improving’s leadership development and other initiatives as a way to help acquired organizations jump to the next level.

He says this is important because businesses hit plateaus and bump into ceilings. In Improving’s industry, those road bumps often come at the $1 million mark, the $5 million mark, the $25 million mark and the $50 million mark.

“Many times, entrepreneurs are so intimately involved in their business that, at some point along that organization’s lifecycle, they are actively impeding their own growth. They don’t know it, though,” Kovacevich says.

It may require someone else to help apply processes, systems and leadership to knock that ceiling up into the next phase of growth. And in Improving’s case, the company isn’t looking for owners to hand over their company and ride into the sunset. It’s looking for partners who want to scale their organization.

“That’s one of the reasons I think business owners should be very in tune with M&A. You have to be honest with yourself: Am I the reason my business is not growing? It’s a hard thing for entrepreneurs to answer, because at one point in time, they were the reason that the business was growing,” Kovacevich says. “So, you have to apply a little bit of self-awareness to be able to navigate that and maneuver within that ego that ties people up.”

In addition, while acquisitions are integral to Improving’s growth strategy — allowing the firm to diversify in geography and add service capabilities — acquired growth doesn’t have to come at the expense of organic growth, he says.

One example of this is Improving’s Houston enterprise. In 2012, when it was acquired, the company did about $500,000 in revenue. This year, the Houston enterprise is on pace to exceed $15 million in revenue.

“We believe that through leadership, development and coaching, we can unlock these enterprises’ growth. Each one of the enterprises that we have acquired has accelerated to varying degrees, and it has sustained growth organically,” Kovacevich says. “The acquisitions give us that big spurt, that big injection of growth.”

Pinpointing value, making connections

Serial entrepreneur Hugh Cathey has a slightly different perspective. The CEO and chairman of ChromoCare is running his ninth startup. He doesn’t build a company to sell, he builds a great company that then attracts buyers.

“That’s not really your shining star that you’re headed after, but it is one of the measurements of how good a job you’re doing on building a company,” he says.

Cathey spends more than half his time understanding the roadmap of where ChromoCare needs to go and how it gets there. Part of that involves staying connected to dealmaking, which helps him understand the value of his company.

If you’re out raising capital, he says, you need to know the proper valuation of your company — and that requires more than just sticking your foot in the water once a year. Cathey also can use this information for business development. If he notices a venture capital firm invested in a company in his sector, he’ll look through its portfolio to see if it’s invested in businesses that could be customers of his company. He isn’t afraid to pick up the phone to see if he can make connections and get ideas.

“In the Midwest, it’s very, very common that I read about a company that’s being acquired. I find out who the CEO is, reach out to him, and nine times out of 10, they take your call and they’re willing to share non-proprietary data or information with you about the space,” he says.

Cathey likens it to a football team — you constantly want to know what the other teams are doing and what their best practices are.

“You want to be fully expert in your industry — not just your product individually, but your industry in general — and the only way you can be expert is if you are paying attention to what’s going on,” he says. “Are financial investors, as opposed to strategic investors, coming into your sector because they see the potential for a rollup or for bringing two technologies together, where one and one equals three?”

Or, do you want to hold off on a sale, because a university is developing a technology that could help create a quantum leap forward in terms of valuation for your company? If so, does that mean you need to find a private equity partner that’s prepared to wait, that can buy out your early VC partner?

“It’s easy to get so focused on what you’re doing that you’re always looking inward and you’re not looking outward,” Cathey says. “It’s smart to look outward from time to time and really understand the ecosystem that you’re working in.”

Exit strategies, unlooked-for opportunities

If you don’t want to sell your business, you still need a long-term strategy. That means not just a succession plan, but an exit strategy, says Bill Remias, senior vice president at Huntington.

“An exit strategy meets the needs of the owner, where a succession plan meets the needs of a business,” he says.

Business owners should have a living document that changes as their situation changes, in order to put in the right financial controls, management team, business entity, tax strategy, protections around intellectual property and more.

“When I talk to business owners and they tell me they have a plan and they can articulate it, especially if they have a written plan, typically I find that they’re better run businesses than companies that don’t,” Remias says. “So, putting all of this in place can help you run your business better.”

With all the money that’s out there, it’s always good to be ready, says Steve Bennett, Central Ohio Regional President of U.S. Bank.

“Even if you’re not thinking about M&A, it’s always good to be prepared because someday you might get the knock on the door, and you may get a valuation that’s like, ‘Oh my gosh, I never thought my business would sell for this much. Yeah, let’s go,’” he says.

On the buying side of things, Remias has clients who don’t want to set up an acquisition strategy. They plan to grow their business the way they always have. But sticking to the status quo usually isn’t the best business plan.

Many baby boomers plan to exit over the next five to 10 years. At the same time, the U.S. is in the middle of the longest economic expansion in its history, and eventually that will cycle into a downturn.

The convergence between those two events could present an opportunity for younger businesses, especially if a company knows where it would like to grow, he says.

“Being knowledgeable about acquisitions, gaining experience in it, and working with some of their advisers and their management teams to develop a plan, even if they don’t need to exercise it, could be extremely valuable,” Remias says.

Buying a business is risky. It may make sense to dip your toe in, doing a small acquisition or add-on to understand how to integrate systems and people.

“You just think you’re going to put one and one together and it’s going to equal three. And sometimes you put one and one together and it equals one and a half, because you’ve missed on integration and culture,” he says.

Good growth is great, but doing it the wrong way can damage the value of your business, Remias says.

 

Sellers

Time your transactions and keep price expectations realistic

If you’re thinking about selling, timing a transaction isn’t easy. Wade Kozich, senior adviser with boutique investment bank Footprint Capital and head of Transaction Advisory Services at GBQ Partners LLC, recommends sellers look at three things to make informed decision.

  • Where are you personally? Are you 40, 50, 60 or 70 years old? Are you burned out? Are you invigorated?
  • Where is the company is in its cycle? Is it on its way up, or down? You don’t want to sell on the way down.
  • Where is the M&A market? Right now, it favors sellers.

Rob Ouellette, partner at Ice Miller LLC, says many industries find it difficult to grow organically, so acquisitions are the only option. This puts sellers in the driver’s seat — for now.

“It’s the most attractive seller’s market in a decade, and things aren’t likely to continue this rosy. So, if you might be thinking about selling in the next few years, it’s probably time to accelerate that thinking,” Ouellette says.

That doesn’t mean sellers can skate through the due diligence process, though. If the financials or operations aren’t in order — and buyers realize they can’t scale or maximize value — a seller may have to take the company off the market and clean things up over 12 to 18 months, Ouellette says.

He’s also noticed more business owners open to keeping a minority stake. It’s not all or nothing anymore, if they believe in the business.

“The multiples are high enough and the money is attractive enough that you can take enough money from the sale of your business to do what you want to do in life, but still keep a piece of it,” he says. “Many business owners find that attractive, to keep their hands in.”

The negotiating leverage of well-run businesses is at its zenith, Ouellette says. With plenty of money looking for transactions, prepared executives can get a premium for their business.

However, he cautions that a good price for one industry and one business may not apply to you.

“If somebody hears that somebody sold their business for 20x EBIDTA, they automatically think their business is worth the same. Human nature ignores the transactions that are done at 7x or 8x,” Ouellette says. “You want to hear the highest and best price, whether or not that applies to your business.”

Mark Kovacevich, president of North American operations for Improving, has seen something similar in this overheated seller’s market. The tech space’s average multiple is 11x, but that’s driven by blockchain organizations that get 40x, or artificial intelligence startups that get 30x.

“If it’s a $10 million or $15 million firm with a single location. It doesn’t have strategic significance to merit that 10x or 11x. It’s just a single location, serving a single market, usually in just a segment of services. It doesn’t have strategic importance to the overall market,” he says. “I think expectations start to get out of line when they hear the average tech company is going for X above multiple.”

Buyers

Staying objective in an overheated market

The first time Chris Gabrelcik decided to buy a company, he first went to the bookstore and bought “Mergers and Acquisitions For Dummies.” The founder and president of Lubrication Specialties Inc. still has the copy on his shelf, but he’s learned a few things firsthand along the way.

He knows he’ll easily see the possibilities and potential of an acquisition, so he needs a second set of eyes to be more skeptical.

“After I went through it, I would hand it off to somebody, just a friend, and say, ‘What do you think about this? What could go wrong?’ Because it’s really the surprises that poison the well,” Gabrelcik says.

Scott Barbour also sees the value of minimizing surprises — although his dealmaking is on a much larger scale.

The president and CEO of Advanced Drainage Systems Inc. recently spearheaded buying Infiltrator Water Technologies for approximately $1.08 billion. He was pleased with the process, including how fast his employees were able to move through a deal process that was announced and closed on the same day.

However, there’s always something to learn. Next time, he says he might take more time upfront with key people to run through challenges to the deal structure and negotiation.

“There are always surprises that come, things that you don’t anticipate,” Barbour says. “You would like to have anticipated those and have good, thoughtful answers and strategy to counter strategy.”

ADS was able to anticipate some things and adjust to others as they arose, but the company was perhaps a little too focused on going down a certain path at the beginning, he says.

“That devil’s advocate, that’s a useful meeting — sometimes a painful meeting, but a useful one,” Barbour says.

Looking at both sides and trying to anticipate negotiating and integration challenges can also help buyers stay objective, especially if an aggressive buying strategy is necessary to achieve synergies and your company’s growth goals.

“With the economy being somewhat stable and a low GDP growth, that’s how a lot of these companies are growing, because maybe they have to,” says Steve Bennett, Central Ohio Regional President of U.S. Bank.

Wade Kozich, senior adviser with boutique investment bank Footprint Capital and head of Transaction Advisory Services at GBQ Partners LLC, sees both strategic and financial buyers getting more creative, such as moving up and down market as they get more aggressive.

However, if you’re buying companies in today’s market, it’s critical to not chase price. You need to prove out the numbers in your model and stick with them, says Brett Motherwell, managing partner at Kassel Equity Group.

“Buying and selling companies has the ability to be a highly emotional event, both for the seller and buyer,” he says. “You can say that there are some folks out there who are unaffected, but odds are, it’s probably not their capital. When you have that type of emotional connection to a deal, don’t chase it. Don’t chase it up, and don’t chase it down, both on the buy and sell side.”

 

Culture

Its impact cannot be underestimated when growing your business

Philip Derrow takes culture seriously. Very seriously. The CEO of Ohio Transmission Corp., the parent company of OTP Industrial Solutions and Air Technologies®, accesses cultural fit early in the buying process. If it’s not right, his company doesn’t even get to the letter of intent stage.

“You can’t pay too little to make up for the bad cultural fit,” he says.

In his experience, the minimum time to change culture is three years, and those three years can be costly both in money and time. And there’s no guarantee the effort will be successful.

After buying more than 25 companies, OTC’s only culture failure was one of its very first transactions, Derrow says. Luckily, it was a very small company, so OTC was able to bear it and learn from its mistake.

Of course, no matter how close the cultural fit is, there’s always some adjustment. To deal with those differences, OTC adopted a business Hippocratic oath.

“We have a policy of first do no harm,” Derrow says. “What that means in practice is we change nothing right off the bat. We rarely change the name. We never change pay plans. We almost always have to change insurance, just because it’s almost impossible to keep the previous plan. But we work hard to make sure that there’s no harm that results from changing the insurance plan. We don’t change reporting structures. We don’t change phone numbers. We don’t change email addresses.”

Joe DeLoss also understands the importance of culture. After the Hot Chicken Takeover founder raised his first preferred equity investment round, he almost crippled that culture in 2017 when the company went from about 40 employees to 170 in six months. He underestimated the operational demands of opening two new restaurants.

“We instantly went from directly managed — I had two or three leaders that intervened in every employee relations issue, every training opportunity, myself included — to having multiple layers of management,” he says.

In addition, the value system wasn’t locked down.

“We hired a lot of people out of that 100 that didn’t fit our work culture and so experienced a ton of volatility because we were growing too quickly, and it felt out of control,” DeLoss says. “That rolls downhill pretty quickly and had a lot of collateral damage.”

Only at the end of 2018 did Hot Chicken Takeover get past the issue.

“We realized what the secret sauce is that we won’t jeopardize and have a better understanding of what it’s going to take to build infrastructure around that,” he says.

 

To hear more about how culture drives growth and its impact on critical M&A decision-making from Derrow, DeLoss, Matt Golis of GiveGame and Clara Kridler of Root Insurance, don’t miss the luncheon roundtable at the Smart Business Dealmakers Conference Sept. 25 at the Hilton Columbus Downtown.