M&A in private equity: Firms get selective in acquisitions


Longer-term view gives PE an edge


The start of 2023 has seen a period of refinement in acquisition activity by private equity (PE) firms, with buyers proceeding selectively in their approach.


Even if broad economic conditions had remained favorable, the frenzied buying at high multiples that occurred late in 2021 was unlikely to be sustained. That outburst of transactions might never be duplicated, as it was fueled by the unique and sudden release of pent-up demand that was created in the early stages of the COVID-19 pandemic.


The changes in the market can be compared with the maturity in a golfer’s game over the years. Where a newcomer might be happy just for the opportunity to swing a club, a more mature player will choose the right club based on the distance from the pin, the weather and the course conditions.


“The PE clients that we’ve been working with feel they can be much more specific and ask for more things than they have in the past to make a deal come through,” said Michael Patanella, National Managing Partner for Asset Management at Grant Thornton LLP. “Although there’s money out there, people are being more careful and asking for things and prioritizing more than they did a year ago.”


The deals that have the best chance of getting done most likely target acquisitions in high-growth industries at companies with strong management teams for a price that’s not as high as the multiples that were common in the buying craze of late 2021.


24:45 | Transcript


"One-time costs often aren't accounted for pre-deal. But there can be significant one-time costs for systems integration."



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Results matter





Growth markets are preferred


PE’s focus on growth markets puts companies in the healthcare industry at the top of the target list for acquisitions in early 2023.


Subsectors that will be high on PE firms’ wish list include:

  • Next-generation energy and environmentally focused companies.
  • B2B service providers such as CPA firms, other accounting and financial advisory firms, and IT service providers.
  • Vehicle electrification companies.
  • Defense contractors.
  • Innovators in data analytics, artificial intelligence, machine learning and the internet of things.
  • Cybersecurity providers and innovators.

PE deal activity may be somewhat muted in other industries at the beginning of 2023 as some dealmakers have taken a wait-and-see attitude to evaluate the fundamentals of companies as they’ve navigated through a challenging period for the economy. Grant Thornton Mergers & Acquisitions Services Partner Colin Singleton anticipates that the pace of acquisitions will increase in sectors such as consumer products, consumer services and business services in the second and third quarters.


“We’re expecting activity there to pick up again toward the middle of the year if all is well in the economy and there’s more certainty around the inflation environment and the interest rate environment,” Singleton said.




Management needs industry experience


In evaluating potential acquisitions, PE buyers are focusing heavily on the quality of the management team in their portfolios.


Extensive industry experience is one of the most important components of a strong management team that is tasked by their PE firm to quickly scale the business, Singleton said.


“PE firms are commonly looking to go about a profitability enhancement exercise post-acquisition that will involve revenue and profitability expansion and a cost efficiency exercise,” Singleton said. “The best-placed people to deliver on that are a management team that has had at least two to three very relevant roles in the industry and has a reputation for having delivered on growth.”


Grant Thornton professionals have also seen an increase in PE’s use of operating partners with industry experience to run businesses post-acquisition, especially at middle market companies.






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Deal basics still apply




The price has to be right


After a period of sky-high valuations, sellers are having to adjust their expectations and accept prices that are a bit more modest.


“There aren’t as many buyers at the table willing to go higher,” Patanella said.


Grant Thornton Partner for Mergers & Acquisition Services Eric Burgess said that when his PE clients are open to paying high multiples, they’re only willing to do it when all the fundamentals of the deal are as strong as advertised and the potential portfolio company is ready for immediate growth. If the deal looks less than perfect, buyers are generally pulling back or demanding that the valuation be adjusted appropriately.


Small issues that wouldn’t have scuttled deals three or four years ago for Burgess’ clients are killing acquisitions now.


Meanwhile, PE firms are in an unusual spot related to availability of funds. On one hand, the rise of interest rates by a total of 425 basis points in 2022 has discouraged borrowing for deals. But on the other hand, after two strong years of fundraising — including a record-breaking haul in 2021 — many firms have lots of capital available to deploy without needing to borrow.


“You don’t have an option as a PE fund to raise the money and then sit on it,” Burgess said. “If you wind up returning it without investing it, then typically you’re not going to get that money again. So even as we see some changes in the market such as higher interest rates and a little bit of a recessionary period going on, you’re going to find PE is still looking to create value and invest.”


So PE funds are still actively searching for acquisitions, but they are showing discipline in the prices they are willing to pay.




Value can be enhanced


In these lean economic times, PE’s ability to take a longer-term view provides an advantage over public companies in acquisitions.


Because public companies report every quarter, the success of their transactions is evaluated often and almost immediately. PE firms, meanwhile, can take the typically three to five years leading up to a sale to develop value in their portfolio companies.


This presents opportunities to improve the value of the portfolio company in numerous ways. In some cases, PE has an opportunity to complement organic growth with inorganic growth through a rollup strategy that can see multiple small companies in the same sector purchased and then consolidated.


“What comes along with that is really effectively integrating and achieving cost synergies and revenue synergies,” Singleton said.


The key to success in rollups is to buy the smaller acquisitions and add-ons at a multiple of six to eight times EBITDA and selling the consolidated company for 14 times EBITDA, Burgess said.


If a rollup is not an option, the value of portfolio companies can be addressed organically through improvements in multiple areas including strategy, supply chain, cybersecurity, finance function structure and environmental, social and governance initiatives and disclosures. But although the time frame for raising value may be three to five years, PE leaders may be wasting an opportunity if they are not ready to make improvements immediately.


“You have to be ready at close,” Burgess said. “You have to have that 100-day plan in place and execute it in order to achieve those models in your investment thesis. Time is really your enemy. The longer you wait, the less you’re apt to do it.”




Lisa Walkush

Lisa Walkush is a principal at Grant Thornton Advisors LLC. She boasts significant experience in enterprise-program management, customer-relationship management and operational excellence, as well as compliance, validation and technology-consulting services.

Philadelphia, Pennsylvania

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