Given how competitive the PE dealmaking landscape has been in 2021, what has helped your PE firm clients adapt in order to continue closing transactions?
The reality is that on each potential deal there are other investors that are also evaluating the potential investment. Sell-side age demographics, tax planning considerations, and increased valuations have helped increase the supply of willing sellers, but the demand for quality targets is still at a historical high, and earnings multiples are very rich.
With this comes pressures on early bid valuations, pressure from the sell-side to execute deals quickly, and internal pressures for investors to execute. As a result, our clients are performing more robust pre-LOI due diligence in not only financial but operational, compliance, and regulatory areas. The use of more data analytics during the pre-LOI phase to strengthen valuation models as well as financial and operational diligence has been a key ingredient to lowering the execution risks of deals in the post-LOI phase of transactions.
In this season of incredibly high valuation multiples, it is imperative that the impacts of COVID have been carefully considered within the deal model and pricing – not only with respect to revenue impacts, but the post-COVID impacts to the seller’s cost structure. Determining the “new normal” for operational / cost structures has proven to be extremely challenging in many situations where the sellers are still dealing with the impacts of COVID, particularly when sellers have revamped key employee compensation arrangements to address volume impacts as well as the intensely competitive labor market.
Where more of the deal issues are engaged with sellers pre-LOI, and financial and other due diligence is confirmatory, our clients are executing at record volumes. Where these issues remain to be understood and solved post-LOI, execution risk goes up as buyers are faced with either absorbing the updated financial information into their models internally or communicating and revisiting valuation with sellers and lenders.
There is a flip side to this attractive market for our clients that have more mature investments. As exit opportunities abound, more of our clients are having financial sell-side diligence performed irrespective of whether the portfolio company has been historically audited. With compressed transaction timelines, selling management having a view of their diligence adjusted earnings prior to launching a process will lend more credibility to and sustainability of the deal value and reduce the likelihood of the contemplated transaction being re-traded.