Unpacking the journey behind mergers and acquisitions

Mergers and acquisitions. The moment when a business is sold is something that gets a lot of attention, because of the effects it has not just on employees and entrepreneurs within the business, but its potential to affect the lives of customers and citizens. It’s a wealth-creating process for entrepreneurs, and it drives a lot of activity in the D.C. region. However, it’s not always clear how these deals get closed, or how active the merger and acquisition market is in the area. To talk about those issues and others are three experts: Dan Ilisevich, CFO at Compusearch Software; Kevin DeSanto, managing director at KippsDeSanto; and Andy Jones, managing director at the Maryland Venture Fund.

ABERMAN: Kevin, I’ll turn to you. I hear a rumor that the D.C. region is going through a really hot time in business sales. Is that so?

DESANTO: I don’t know if I can debunk the rumor. This is a very, very attractive market right now, when it comes mergers and acquisitions. The D.C. region in general is home to many, many great companies, mature businesses that are at the end of their life cycle, that are in the process of being acquired. Many, many interesting startups that are raising capital, and are having a positive impact on the overall technology environment that we’re in. And that market, that the companies in this region, the quality of these companies, has attracted a lot of outside investors, and a lot of potential buyers of these businesses.

We’ll get into some details as we go through this, and specific transactions, but the high-level sort of rationale for this is cheap capital. So, the interest rates that banks and lenders are charging is at an all time low, we have equity values, or public pricing, for a lot of companies that are inquisitive, at all time highs, and we have, in this region, a particularly positive environment around government funding, with the current budget and the current spending opportunity. So, we’re just seeing a ton of activity across this market in both the federal and commercial technology areas.

ABERMAN: Andy, what are you seeing? I know at the Maryland Venture Fund, you are all involved in a lot of companies, you do cyber, you’ve done some government-related companies, but you’re broader than that. What are you seeing?

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JONES: Well, what Kevin said, we would add that we’re seeing a lot of activity, inbound interest into our companies. People are looking for growth as well. Corporate balance sheets are super strong, you know, post-recession, which is now nine-plus years, companies have built up big cash balances. One of the things they’ve struggled with is growth. So, we see it in these emerging, growing, venture-backed companies that offer high growth. We see the bigger companies wanting to come in and grab that, sort of put that growth onto their P and L.

ILISEVICH: Yeah, I think that’s a large part of the environment. Some of the bigger companies are willing to buy to get into new markets and find growth, because it’s harder to get organic growth than perhaps it was at one time. And then there’s just the supply side. As Kevin mentioned, there’s a lot of money available, either from financial sponsors that have just raised outrageous amounts of private equity, or venture capital funding.

They need to put that money to work, to earn a return. And the debt markets have been as good as they’ve been in a very long time. So, if you’re a solid company, with good backing, it’s really easy to borrow debt. We finance most of our acquisitions at Compusearch with debt. But we’re backed by a premiere private equity firm, so that gives the banking community, the lenders, a lot of confidence, that they’re putting their money into a good place.

ABERMAN: You mentioned debt. Interest rates, I think maybe are trending upwards. I’m thinking to myself, with the tax cuts and the changes, and what’s going on in the economy, do you think that we are still in a good place, or, put your economist hat on, are you worried about the market at all? Dan, I’ll start with you, since you’re living with the market as a CFO.

ILISEVICH: It’s really hard to kind of predict where the market’s going to go. We don’t worry too much about interest rates, quite frankly. If you’re borrowing money, it’s more around the terms that you’re getting the money on. The leading indicators of a change in the debt markets are not that the interest rates are going up, so much, it’s that the covenants, the rules, the things you have to comply with start to tighten, and start to get more onerous. And that’s the leading indicator for us.

DESANTO: And how low rates had gone, over the last few years, really any increase is going be uneventful in the short term. And so, the idea that that increase is going to impact the M&A market is just not something that we believe in right now. It would take a lot of movement up, in terms of the cost, in order for it to have an impact on the deal flow, and the pricing, and the interest that we see today.

ILISEVICH: Well, we’ll finally get back to points where there’s no Libor floors and death deals, which is something that came in after the recession, sort of a minimum interest rate.

ABERMAN: There was such a deflationary spiral. The government was literally pumping money into the system. Money was virtually free, you were penalized in some ways for holding cash. It was a very different time. It seems to me that tax cuts will increase or enhanced the ability of corporations, that there should be more money on their balance sheet. Andy, I’m wondering, with respect to fundraising, the change in the tax rules, the passive investment rules, do you think the fundraising environment might change for venture funds, or private equity funds, that it might be easier to raise money? Because they drive a lot of activity, too.

JONES: I don’t think the macro factors are really driving it. I agree with what Dan said, though, money is just flowing everywhere. So, the fundraising environment is very positive right now. There’s a lot of capital out there. Again, we mentioned corporations are looking to acquire companies for growth. Investors, in the yield-starved world that we live in, are looking for return, and you’re seeing a lot of that flow into PE and venture capital, because the bond market’s challenging. Kevin mentioned earlier that equity valuations are at an all-time high. So, there’s a big world of capital out there, and it’s flowing, looking for return, and we’re seeing it on the venture and the private equity side. There’s a lot of inbound interest putting capital into funds.

DESANTO: Yeah, and I would say that one of the things that we see, as a result of this environment, is that larger transactions are really the focus of a lot of organizations. Because you’ve got some of these unique factors contributing to an environment where you can actually pull that off, in a very efficient and effective manner. And so, we’re seeing lots of larger acquisitions or mergers of companies, versus what we might have seen historically. People are able to be a little bit more aggressive than they have been in the past.

JONES: And to that point, though, one of the things that’s interesting in the regulatory landscape, when you see these larger acquisitions, the world is changing, in terms of competitive looks when these big massive companies are coming together. You know, there’s there’s talk of vertical-integrated companies are now getting larger scrutiny, or horizontal. So that’s a little scarier. People don’t know how to handicap that. The normal course would steal breakup fees, and what have you, but that competitive risk of some government authority nixing a deal is out there. That’s really changing right now. It feels like shifting sands to me.

ABERMAN: That’s a really interesting point, the regulatory aspects of that. And that’ll be a good place for us to stop. When we come back after the break, it sounds to me, gentlemen, that there is a torrent of money out there to be had. After the break, tell entrepreneurs how they can get in the way of that money.

ABERMAN: Before the break, We’d started talking about what you have to do to get in the wave, but you raised something really important and I don’t want to lose track of it. Regulatory. Do you think, Andy, I’ll start with you, that the current regulatory environment is, or could become, challenging for big deals?

JONES: I think it’s absolutely challenging right now. I think there’s a lot of question marks. NDOJ or Canada Competition Authority or EU, all the regulatory bodies around the world are changing how they look at these big, giant transactions. And that’s causing big buyers and big sellers to pause a little bit. You know, if you don’t know what the regulatory landscape is going to be like, it’s tough to enter into a transaction. It’s also creating opportunity, as we said on the break, for private equity firms and smaller acquires, because if these transactions are getting bottled up, or pieces are having to get carved out in order to obtain approval for the transactions, it’s creating opportunity for other M&A folks in the food chain.

ABERMAN: If we’re taking ten-billion-dollar, twenty-billion-dollar deals out of the equation, which is what we’re really talking about, what does that mean for this region, or for businesses? If the big deals can’t happen, does that mean that more smaller deal happen, or does everything get choked?

DESANTO: No, I think it means that the smaller deals do happen. Part of the benefit of some of these larger transactions not happening is that, you maintain the prospective buyer universe. When two companies come together, you’re losing a buyer, effectively. That’s the way I would think about it from the seller side of this equation.

And so, there is some benefit to that. But there’s also benefit when these deals go through as well, because there are carve-outs and divestitures of assets. Whether they be contract vehicles, or IP, or other parts of the business that the go-forward entity just doesn’t view as core to their operations. There can be significant opportunities for other companies to step in and build their business, by acquiring something that already exists. So, there’s a lot of that activity out there. And there’s a lot of potential deals that fall out of it. So, we see both sides being beneficial to the community, given that.

ABERMAN: We’re talking about buying a business, but it would seem to me that, if you have large companies that can’t merge their way to becoming larger, the other way they’re going to do it is doing partnerships. It would sound to me like a lot of revenue opportunities now for smaller businesses. Dan, what do you think?

ILISEVICH: Well, I think that’s actually something that goes on all the time, particularly around the federal government. The federal government is unique in its belief that really there’s no single company that can supply what it needs. And so, teaming and partnering is very, very typical when you’re serving the federal government, unlike businesses that I’ve been in serving financial services, serving the telecom industry. If you sell something to Bank of America, they certainly don’t want you also selling that same thing to Deutsche Bank. Whereas with the federal government, you’ve got companies that are competing on one deal, that are partnering together on another deal at the same time. I think that also becomes a stimulant for, basically, deal-making.

Because nobody wants to basically buy a company that they just learned about when a banker showed up with a book. They’re more likely to be interested in buying a company that, perhaps, they worked with successfully on an opportunity.

ABERMAN: Which leads me to the other thing that I tagged before we came in for the break. How do you get in the wave? How does a business get into a position where this torrent of opportunity washes over them, and they get into this position to sell? Kevin, I’ll start with you, because my guess is that you get asked that question a lot.

DESANTO: We do, and I would piggyback on what Dan just said, and what Andy said earlier. It’s growth. Every entrepreneur out there that’s thinking about the value of their business has to think about how the outside world, how an investor or buyer would view their company as a growth channel, as a growth opportunity, as a way to stimulate the buyer or investor’s rates of return. I mean, that’s really what we’re getting at here.

And so, the companies that we see, that have a well-established growth plan, and have a track record of executing against that, are the ones that are getting the best valuations in this market. So, from a very simple standpoint, whenever we talk to owners of businesses, or folks that are in a position where they’re seeking to sell, the valuation is typically dictated by what that growth trajectory is. The higher the slope, the higher the valuation. The higher the slope, the more likely it is that you have other high-quality buyers that are valued very richly, or at higher multiples, that are coming to the table. And that’s when you get these great opportunities to come away from a transaction with a very exciting valuation.

JONES: I totally agree with what Kevin said. I’ll piggyback on, at least in the venture capital-backed company world, growth, happy customers, retained customers, a long life history of customers, very important, but I’ll go back to the partnership point. One of the tried and true venture model plays is established partnerships, you’re filling a need with your technology or product that the bigger companies don’t have yet, they see that, they establish a partnership with you in the early days to blow out that product or technology into the market. That leads to growth. As Dan said, you have a two year relationship with a couple of partners, and then M&A happens naturally. One of the partner says, you’re more valuable to me inside my organization than as a partner, and it all happens naturally.

ILISEVICH: That’s exactly right. And as you go farther up the growth curve, and the companies get a bit bigger, buyers will tend to look at what they refer to as the total addressable market for what that company is doing. So, not so much just the rate that I plan to grow over the next three years, but how big could I become as a business in ten years.

ABERMAN: Big take-away from the segment sounds to me is, don’t run a business to sell it, run a business to grow it like crazy.

JONES: Absolutely right, and make sure your customers are happy, to keep them forever.

ILISEVICH: And be creative! I think if you’re afraid to go out and talk to folks about partnership, and you’re afraid to go out and get into the mix, and look for different ways, or different channels to grow the business, buyers are going to see that. And if it’s that secret, if it’s that perfect, you can’t get there. You can’t get enough scale.

ABERMAN: So, after we take this break. We come back. Now that we’ve talked about the revenue that’s coming, and we said, if you want to get in the middle of it, grow a great business, I want to talk after the break about some of the best practices that business founders should be thinking about, once they get into the process about how to get a deal successfully done.

ABERMAN: You’ve got in yourself a position where somebody wants to buy your company. What are some of the things you have to be really mindful of in order to succeed? Andy, I’ll throw to you. Often, if a company gets to the finish line, there are going to be some investors involved that financed the company. How does an entrepreneur, or founder, or management team have to be mindful when they’re managing their relationship with their investors as they get somebody interested in buying the company?

JONES: Well, I think the good news to start with, investors are attracted to high growth, new market type opportunities. Once you take that investment from a venture capitalist or private equity firm, you’ve really raised the bar in terms of corporate governance. You start to, as I say, take the training wheels off the bicycle and start to ride the bike down the road. And that’s a good prelude into ultimate M&A because you start to develop best practices in terms of financial statements, in terms of audits, in terms of rev rec, in terms of corporate board reporting. I mean, investors enforce that. I mean, Dan has a great set of private equity investors in his business today. That good corporate hygiene that they enforce in that partnership, if there is an M&A event five years from now in his business, they’ll be set up perfectly for it.

ABERMAN: When you say corporate hygiene, what you’re talking about is having board meetings, having audited financial statements, doing the things that a buyer would expect a business to have.

JONES: Exactly. So, when they start their diligence process, you’re ready to go. It’s not a fire drill.

ABERMAN: Now Andy, I’ve experienced the investment industry as well, we all have. Even when I was doing C stage investments, earliest, I was always thinking about seven years out, is this a team that could successfully sell a business? The management, or the founders, they may be talking about exit from a standpoint of stars in their eyes, one day I’ll get rich, but the dynamics of selling, they don’t know. But, have you ever made an investment in a company where you didn’t have some inkling these people could get it all the way to the end?

JONES: Yeah, I mean it’s a journey, as they say, and sometimes the team that’s involved in the earliest stages won’t be, necessarily, the team that’ll get you to the finish line. Maybe they’ll be part of that team, but they’ll be in different roles in the organization. Some people, founders, are good in that zero to 20 million growth stage in the beginning, but professional management like Dan comes in at a later stage and they’re very good from that 20 to 100 million. So, it’s a journey. It’s a mix. We will invest, though, knowing that it might not be the same set of folks from the beginning to the end. We are attracted to new technologies, high growth, brand new markets. And if we think the people are good to start with, we won’t invest in bad management, that can be enough to get it going.

ILISEVICH: well, I think it’s particularly important if you’re thinking about selling a company, to a financial sponsor, that the management team is self aware. They know what their role is, that it’s clear, that they work together as a team, because a potential buyer will see right through any kind of potential friction or dissension inside the management team. So, if this is a first time experience for an entrepreneur and his team about to sell their business, they should really spend some real quality time kind of thinking through the kind of questions that are going to be asked, making sure they’re aligned on strategy, making sure they have the same view of market, because a savvy buyer will come in and try to pick that apart, and figure out whether there’s something in the business that the team isn’t telling about.

ABERMAN: You know, that’s a great point. I’ve done a lot of M&A over the years, as a lawyer, investor, and so forth, and I’ve seen more deals fall apart where the founding team, where the management, their interests become misaligned, and all of a sudden, everybody’s really focused on, wait a minute why do you own ten percent? I only own eight, or I want out, and you want to stay in. It sounds to me like one of the best practices we need to encourage is the time to talk about what a merger or acquisition transaction means is not after you’ve gotten the call. It’s something that you should be preparing for. So, we’ve gone around. We said prepare and run your business as if you’re running your business. But now it sounds to me that we’re saying, but in the back of your mind, make sure you’re ready to sell.

DESANTO: But isn’t it the right thing to do to run your business like a professional institutional owner would want to? I think part of having a great management team is that you understand corporate hygiene is not just a preparation for sale, but it’s the way to optimize your business. It’s the way to protect your intellectual property. It’s the way to make sure that you’re not focused on cleaning things up, but you’re focused on winning the next deal. And so, I think it works to think about that in the context of how you run your business day to day. It’s ultimately very beneficial in the context of a sale transaction or an investment. But we should all be thinking that way. We should want to own a business the same way that an institution would.

JONES: Exactly. And I would piggyback, though, the second you take institutional capital, whether it’s institutional capital or private equity, these are typically ten-year partnerships. They have a limited life cycle, and they are going to need an exit at some point, so don’t take their money if you’re never prepared to sell your business, because you are on the clock, as you say, Kevin.

ABERMAN: Alright, so, I’m an entrepreneur or CEO, and I’ve gotten an unsolicited offer to buy my company. Kevin, what do I do next?

DESANTO: Yeah, call me. Or Dan, or Andy, or anyone that can help you think through what to do in response to that.

ABERMAN: And what things do I need to think through?

DESANTO: There’s probably two key areas. One is, what information have you provided to this potential buyer, investor? How close to reality is that? You want to provide as little information as possible in these advanced discussions, or in the early stage of these discussions.

ABERMAN: Because most deals fall apart.

DESANTO: Right, and you have to shape what the view is to be consistent with what they’re going find in their overall due diligence. And that is often a very disconnected concept. People have a presentation that shows their business, but when you get under the covers and look at it, it’s everything but that. That’s a real challenge for people from a credibility standpoint, so you have a hard time getting those deals done.

JONES: Also, a guy like Kevin, you get an unsolicited offer from a business, Kevin, a good banker, will know the ten competitors of that company, and you might not know them as well. And if offer’s not really market value, maybe you and your board decide to run a process where we’re actually going to go to these ten qualified buyers who would have an interest in your business.

ABERMAN: I thought you guys were going to say that the most important thing was to have somebody tell you what your business was worth, because if you’re growing your business, you don’t really know.

JONES: Well, that was my point right there, that the market will tell you what your business is worth. But if that first offer is an under-market price, a guy like Kevin can help go to the rest of the market and obtain a marketplace for you at the end of the day.

ILISEVICH: I think there’s a couple of takeaways that I think about when I look at it from this perspective. One is, most successful entrepreneurs are successful because they’re good at building a business. and understanding their market. and working well with customers. If they haven’t actually been through an exit, they don’t know what they don’t know. And so, the most important thing, from that perspective, is to go get a banker that you can trust, and go get an attorney, that’s basically a deal attorney that you can trust.

Those are your two really key outside advisers, to help you sort of understand what’s going on, to set the expectations with you and your management team on what to expect as you kind of go through the process. And then the second point is, if you’re not committed to selling your business at a market price, you should probably come to that conclusion early, rather than playing with potential buyers.

ABERMAN: Yeah, I recently was exposed to an entrepreneur I met who was looking for advice. Very early company, with 500,000 dollars revenue. And I said, how much do you think your business is worth? And he said 75 million dollars, which is only about 72 million dollars more than market value. And I thought to myself, did somebody tell you that, or did you just make it up? And you don’t go making stuff up in an M&A deal. That’s what I’m hearing is, you don’t want to go in there and BS your way through it, you’re not going to succeed.

DESANTO: Not at all. And that has ramifications that are far reaching, because this is a small community. Most of the investors know each other, most of the financing sources know each other, most of the executives know each other. So it’s just not an area that you want to take lightly. The other piece of this is that competition drives value. And so, when you think about exiting, one offer is great, but two or three allows you to control your destiny. It allows you to have a higher probability of success in the effort that goes into this. These things take months, sometimes a year to accomplish. So, you’re not just going to skirt through it and show up on the other side with a bag of money, without putting the effort into it, or without all of the work that goes into it. It just has to happen.

ABERMAN: So, the conclusion to this is that mergers and acquisitions, selling a business, is not an event that happens in a moment in time. It’s the culmination of an eight year journey, all the way along. I think that’s great advice for all the entrepreneurs and CEOs that are trying to build value for themselves and their shareholders. Gentlemen, I want to thank you very much for taking the time today, this was just terrific. That was What’s Working in Washington EXTRA, unpacking the dynamics of the regional M&A market, and how you can in the way of a big river of money, with Dan Ilisevich, CFO at Compusearch Software; Kevin DeSanto, managing director at KippsDeSanto; and Andy Jones, managing director at the Maryland Venture Fund.