Outlook for Private Equity and M&A in 2023

EMS:
So Peter, to kick off the conversation, tell us a little about Bentley Associates and how you got to where you are today.
PW:Bentley Associates is a boutique investment bank. We've been in business for, I think, close to 30 years. We have a relationship, a key relationship with Morgan Stanley, where if a deal comes into the corporate parent and it's too small, it gets referred out to a set of banks and we're one of those referral banks. So we work closely with Morgan Stanley, which is a great relationship. And most of the people from Bentley come from the bulge bracket, so it's really taking the bulge bracket approach from bringing it to the middle markets.

My background, by the way, was previously in private equity. I was with a group, formerly known as, I guess, Patricof and then Apax. And then I, along with two other partners, ran a fund in the 90s, AIG Horizon, so I've been in private equity for 25 years. And I had a family office, a small family office, nothing too terribly large, but we were buying some companies, and I joined Bentley at the time that it had a structure that allowed me both to stay in this small family business as well as getting back involved in the M&A world.
EMS:So Peter, as a follow-up question, I'd love to hear some key trends that have been driving deal making and how you think these trends will continue to influence M&A activity this year.
PW:There's no doubt that deal activity is down. So undoubtedly interest rates are up, the credit markets are a little bit tighter. Evaluations have come down. Clearly, a lot of sellers have high expectations and when things come down rather rapidly, sometimes there's a spread between the bid and the ask. But I would say the following. First is that with regard to the amount of capital on the equity side, there's something like 1.2 trillion of uninvested capital out there in terms of private equity money that's been raised that still needs to be deployed. The credit markets are tighter, but nonetheless, the private equity community does have ample resources.

The public markets, it's been kind of interesting. I do a bunch in tech and there has been a pretty material reduction in terms of valuation. So if you look to the public markets, just some of the multiples have come down from on average 12, 13 times revenues down to five to eight times, and you're starting to see some going private transactions. And so what I think you're going to see over time is some of those industries, which may be temporarily depressed but have long-term favorable prospects, despite credit being a little tight, you'll see I think some transactions getting done. So that'll be one.

And two is as it relates to cash negative companies, they're either going to be sold or they're going to have to scale back and cut costs to preserve their capital. So I think you're going to find, one, some consolidation activities with regard to some of the cash negative companies, and two, a step-up in terms of the pace of M&A. It may be delayed until things get a little bit more favorable on the financing side, but I think you're starting to see some backlogs and some interests starting to percolate, and I think you'll start to see the activity really kick later in the year. And I think it'll be those sectors that are temporarily depressed that still have favorable long-term prospects.
EMS:And Peter, I'd love for you to address the challenges that the current macroeconomic environment has presented to your clients who've recently closed or in the process of closing an M&A transaction.
PW:Well, yeah, there's two things. So one is financing. So the financing environment today is a lot less favorable than it was six, 12, 18 months ago. So in terms of... first in terms of private equity, the availability of debt is down fairly substantially. It used to be that you're looking at five and a half times debt EBITDA. That's come down. I mean, in some instances now we're seeing three and a half times. So you have two extra turns of debt that that's come off the balance sheet.

So one is the amount of debt available has been down. The credit underwriting standards have really tightened. So it means that you have to be better quality in order to get the deals done. And interest rates are higher. So obviously then that means that in a lot of the instances here, the amounts you can pay with those higher interest rates and still achieve your returns means that the buy-in prices may come down.

So what we're finding is lower purchase prices, a lower amount of debt, higher equity checks, and longer due diligence periods. And there has been less activity, but deals that are in sectors that have... nothing is really recession proof, but a little bit more recession resistant, those are more than likely to get done. So whether it's healthcare or some other sectors that tend to be somewhat less affected by a downturn, those still seem to have a decent amount of interest. Although, again, activity is down because of the financing markets.
EMS:Right, absolutely. That makes sense, Peter. And I'd love for you to discuss some trends you've been seeing in purchase prices and EBITDA multiples. And how do you think these trends will continue this year?
PW:So the answer is first, multiples are down. So when you look at the public markets, as I discussed, if you look at a bunch of the software companies that we're interested in, SaaS-based stuff, the revenue multiples are down from anywhere from the 13 to 15-plus range down to somewhere closer to that three to seven... three to seven, maybe pushing eight, nine, but the we're down pretty substantially, down 30%-plus in most instances. And in terms of EBITDA, the same holds true. When the amount of debt obviously goes down, when interest rates go up and the amount of equity contributed obviously goes up, all that means if you look at the combination thereof, in order to get your returns, yeah you can't pay quite as much in a higher interest rate environment as you could in a lower interest rate environment. And so we're seeing prices come down.

So in terms of multiples, also more... we do a little bit in other growth-related sectors in addition to software and services, a little bit in healthcare and elsewhere, and we're seeing a turn or so with regard to. But all that said, if it's a really good business, there's still lots of interest. I mean, as I indicated before, you've got on the one hand, difficult financial conditions, higher rates, tougher debt to get, on the other hand, you got all this money that was raised and they need to put it out. So when anything's the least bit interesting, suddenly you get a pretty hot auction. And so the prices tend to... they go down, but not quite as much as one might expect.
EMS:So Peter, what is one key piece of advice you would give to a company contemplating a buy-side transaction? And also I'd love to hear your thoughts on advice you have for a company contemplating a sell-side transaction.
PW:First... do you want me to do both the buy side of the sell side? So on the buy side, what I would say is that it could be over the next six to 12 months that we're heading through some challenging economic times. So I would say that it's critically important that you make sure that you've got synergies that are achievable, that you know what you're buying, that the integration risks are manageable and that you're somewhat skilled, you understand all the elements involved in buying and integrating a company successfully. So be extremely cautious and careful during times when there's lots of, call it economic risk. You don't want to couple that with a lot of business risks. So you got to make sure you try to find whether you're just buying a product and putting it down your distribution channel, something where you can understand and really define the risks you're taking, you feel comfortable doing it. That would be the buy side.

The sell side, I would say that in the old days, it used to be that having somebody who was an industry specialist was critically important. They might have few unique contacts in that industry, but I think today that's dramatically changed. There's a huge number of buyers, both strategics and financials and getting to potential buyers is no longer a real edge. What is an edge is curating a story. What is an edge is putting together an investment case. What is an edge is understanding from the buyer's perspective how they're going to charter their return. So if it's a strategic, defining for them where the synergies may come from, whether it'll be volume purchases, whether they could be G and A takeout, what they can do to grow revenues and cut costs. If it's a financial, it's putting together a blueprint.

I taught a course at USC, and we used to always focus on what we call the blueprint. You buy a company, you won an auction, congratulations, you outbid everyone else. And so the blueprint is how do you generate a return on that investment? How are you going to grow your business? How are you going to increase cash flow? How are you going to make a return on your invested capital? And so we try to lay out in our... I'm sorry, our confidential information memos when we're selling a company this blueprint. So I would say to the people who are thinking about selling, you got to make sure you have a durable base and you got to have some kind of plan to a really ramp the business. And that would be to a financial. And if it's going to be a strategic, there's got to be defined, achievable synergies that we think we can bring to them to make it compelling.
EMS:Peter, I have a couple more questions for you before we wrap up. So I'd love to hear your thoughts on ESG and how the prominence that we use in evaluating companies.
PW:I would say the following, first is ESG, although I think it's, some of what they're looking to achieve, makes good sense and it's difficult to disagree with. I think the fundamental thing that people are looking to achieve are returns. And I think that when you hire a manager, hopefully the manager, whether they're bringing a fund or making a company, is looking to maximize profit, is looking to maximize their competitive edge. And insofar as it relates to community relations or good governance, those things can be additive and those can be good business practices and that can help you achieve an edge, but if you're going beyond the traditional kind of call it profit to maximization approach, and now you're adding on incremental cost to be a good citizen and doing things from a social perspective, I think that may be outside the purview of management and could add an extra layer of cost and render you less competitive than others.

So I would say that I think the question is are the objectives of ESG consistent with creating a better, stronger business? If the answer's yes, then I think they're looked upon very favorably. If the answer is that they're kind of extra cost and fall into the area of someone doing something socially good, I think there's plenty of room to do socially good and I think you could do that on your own through contributions, donations, philanthropy, getting involved, but I'm not so sure that it's necessarily appropriate in the context of a management, whether it's a fund or a company.
EMS:Peter, we've covered a lot of ground today and wanted to see if you have any final concluding thoughts or takeaways you'd like to share with us.
PW:The only concluding thought I might say is that the private markets, whether it's private equity, private real estate, private credit, have really matured over the last decade, and so as we're discussing today, private versus public, I think fundamentally people have to stop looking at the distinction. At the end of the day, if you're... and, again, I'm 25 years plus in private equity, if you're in the asset management business, you're looking to achieve a return. You're looking to accept certain risks and for those risks a certain return. And I think the distinction between public and private over time is going to fade. You're almost somewhat agnostic. The objective is to get a great return and the method of getting it, both of these are fundamental analysis on companies. They happen to take different forms. But I think both of these industries, at one point private, was way more inefficient than public and it affords you greater opportunities to find mispricings and make money. And today I'm just not sure necessarily that's the case.
EMS:Well, Peter, I wanted to thank you so much for sharing your perspective with our listeners. And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.

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