To help businesses, investors, and deal professionals better understand the evolving M&A market, Robert Connolly—a partner in LP’s Corporate Practice Group—shares a series of conversations with M&A experts.
Below is part 2 of his conversation with Michael Norton, Director of Business Development at Houlihan Capital, a solutions-driven valuation, financial advisory, and investment banking firm. In this Q&A, Michael delves into valuation and deal trends, buyer-seller dynamics, and advice for sell-side businesses.
The responses below have been edited slightly for brevity and clarity.
How are deals being financed, and what is the capital availability?
The financing environment is better than it was a year ago. The deals we’ve seen proceed – whether from our investment banking arm or our valuation arm – have closed with banks opening their purses a little more than 12-24 months ago. That said, due diligence on the debt side is high. Although banks and non-bank lenders are putting money into the market, their level of scrutinization is probably the highest among the various types of due diligence that we see. Given the interest rate environment, they’re all hedging their bets slightly.
We have a lot of capital sources right now. There are a lot of non-bank lenders, especially finance companies. We’ve seen family offices make debt-like investments. Debt is available, and as private equity drives deal activity over the next couple of years, they’ve gotten very creative on financing their transactions. You won’t get three turns of EBITA on a transaction straight from a bank right now, but it’s a better environment than it was a couple of years ago.
The non-bank lenders have been great – everything from SBIC funds to private credit funds to new ’40 Act funds and ’40 Act vehicles (like interval funds) are making direct loans. There was a rush to that market from institutional investors. As I noted, a lot of private equity funds have been sitting on assets and not returning capital at the rate the institutions would like. So many of these private credit funds have become quite hot from the institutional investors’ perspective. There’s just a lot more money out there, and they’re able to be more creative than a bank or traditional commercial lender. They’re willing to put more skin in the game. They’ll take an equity-like interest or direct equity in the company. Some want to take down the entire capital stack, whereas others like to be in that mezzanine position with their equity kicker. They’re putting money up with the intent of being recapitalized three or four years down the road. That’s good for them; they’ll get a balloon payment and it doesn’t have them in the game too long. Part of what we’re seeing is a lot of COVID-era debt coming due right now, and recapitalizations of that debt can also fuel activity.
How have buyer-seller dynamics changed in the past few years?
The types of buyers in the market have changed in a big way. Our sell-side practice focuses on deals valued at $10-150 million. The primary buyers in that space are private equity funds and strategics, with strategics leading the way. Two newer legitimate buyer bases are family offices and independent sponsors/search funds. Small deals — those with $500,000-$4 million of EBITDA — have a good base of buyers. Most of them have solid backing to be considered by a search fund. A decade ago, search funds were not a legitimate buyer base, but they are very well trained. They have capital to deploy — or capital commitments to deploy — and they’re legitimate buyers for our smaller deals. In some cases, independent sponsors could not raise funds or were spinning out of a private equity fund or family office and couldn’t raise a fund right now. Raising funds has not been easy, so many professionals are buying companies via the independent sponsor model to get a few under their belt. By adding these additional groups to the mix, we’ve been able to run a good process for our deals.
Strategic buyers have been active yet much more cautious in terms of how they evaluate a transaction. When they see a strategic fit that they’re going after hard, the big trend in terms of buyer dynamics is just the number of other types of financial buyers that are in the mix now in a meaningful way.
For instance, going back eleven years ago when I got hired, there could be a negative connotation with independent sponsors because some would interpret that as someone with no money. However, they’re now considered legitimate buyers by the seller universe. That’s been a sea change in terms of the types of buyers in the market and our willingness to show deals to independent sponsors these days.
Over the last 5-6 years, a trend has just been the predominance of family offices as active buyers. We work with several family offices on the valuation front that are doing deals a lot more. Rather than the sleepy connotation of a family office as a passive investor, there are more sophisticated buyer teams, making them a prominent player within the buyer universe. For anyone looking to sell their business, that’s great because you have so many different legitimate types of capital right now compared to ten years ago when we were only looking at big companies or private equity as options.
To expand on that, the independent sponsor segment has matured to a point where it’s its own asset class now. Often, lower middle market deals have an independent sponsor rather than a larger fund because of the maturation of the capital side and the nimbleness of their platforms. Years ago, investment banks were a little leery of showing deals to someone who didn’t have committed capital behind them, and I don’t think we see that as much anymore with established independent sponsors who have a track record of execution. What are your thoughts?
I would agree with that. Every bank selling lower middle market companies probably has a war story where it got burned by a “fundless sponsor” posing as an independent sponsor. That’s where some level of branding still needs to be done by the independent sponsor community. That said, you are 100% correct that independent sponsors can do a phenomenal job if they pitch their operational expertise and vision to a seller.
We did a deal just a couple of years ago where we sold a capital equipment manufacturer, and the initial group to which we showed the deal was an independent sponsor from California. They had a packaging equipment company and a lot of experience in and around packaging. They had reached out to me, and they did a great job marketing themselves and their experience. They were able to team up with a great group out of the East Coast to assist in the financing. The debt was a given once they had the equity backer, and the deal has been quite successful for them. But ten years ago, would we have taken the initial call as seriously as we did four years ago? I don’t know. The increased role of independent sponsors has been so great for the market. We have those buyers out there now and it rounds out our process significantly.
What do you see when it comes to seller motivations? Are you seeing sellers who want to partner with private equity or an independent sponsor or want to retire and not be involved with the company post-closing?
We see both ends of that spectrum and always try to maximize value. That’s our job. That’s how any investment bank gets paid. For deals below $100 million or companies in the $50 million range, there is typically a preset range of valuation multiples at which they trade. We aim to get them to the higher end of the range and position them in a way that exceeds that. When we’re talking about the seller’s financial motivations, we try to be very transparent with our clients at the outset about the range because the last thing we want to do is run a process, get a nice buyer in place, and then the deal doesn’t proceed due to a valuation gap. When that happens, something wasn’t right at the outset.
There has always been the 70-year-old seller who’s looking to retire. Many founders — or family-owned business owners whose parents or grandparents founded the company — care quite a bit about legacy. We’re in talks with one business right now, where the company was founded decades ago, and the word legacy came up in the initial meeting. There was a focus on how we would take care of the employees and the company. For instance, will the company stay in the municipality or state where it’s currently located?
Most business owners I talk to are very good people and they want reassurance regarding the legacy element. They don’t want to see 40-50 individuals unemployed because of the transaction they did. They are not going to be bargain sellers or value sellers either; they want to be paid appropriately for what they’ve spent their lives creating. Those in the older generation looking to retire want that transition and leadership, either someone in-house who they’ve pegged or a buyer who pitches them with a vision of how they will grow the business. They bring a vision, and that speaks to these sellers very well.
However, aside from the older generation looking to retire, the biggest wave of interested parties we’re seeing now are owners who are about 20 years younger. The 40-55-year-old business owner who isn’t looking to sell right now, but given some of the uncertainty in the market is asking what they can do to better position themselves and their company for the long haul. We’re seeing a lot more engagements where we serve a presale planning capacity to sit down with them, explore their options, and map out their options from a financial perspective.
For instance, we’re working with one business right now — a very well-run business with an owner in his late-40s — and the focus is on how they can grow to a next level to create generational wealth for his family and take some chips off the table in the interim. The owner is a very smart individual, and he understands that he can grow his company at a specific rate, but to really scale, he needs the proper partner. Part of our role is to consider: How do we show them on paper? How do we show that growth? How do we think about both inorganic and organic growth? We ask those questions at the company level and then consider what the appropriate partner looks like, which is so key.
It’s promising that we’re seeing so many more business owners thinking about the right partner because it shows this new wave of business owners thinking about the scalability of their business. That’s the key motivation: scaling in a meaningful way and taking care of their employees and family.
Are you seeing gaps in valuation?
The vast majority of the people I’m speaking with are great people. Most of the sellers we work with aren’t looking to scale for growth’s sake. They’re not looking to grow at the expense of people they trust and built their business with. But they want to grow and build the best business they can. If they’re going to take some chips off the table, they’re going to take it off at a fair value.
We’re seeing good alignment from buyers and sellers because there aren’t many “A” assets right now. Buyers are being more reasonable in terms of how they will help the seller achieve what they want to do and fulfill their motivations for selling while also achieving their vision for the asset.
Even though there’s been good alignment from both sides, there will always be some valuation gap between the seller and the buyer. The negotiation points focus on valuation and the operational upside. How can we grow the valuation of this company and provide some form of security on exit for the seller? That’s a great thing because it leads to a smoother process in most cases. The buyers we’re bringing into the processes we’re running come in with a clear vision. The management meetings are about the two sides achieving that vision together as opposed to a “me versus you” mentality.
What best practices can you share with potential sellers?
The gold standard would be if someone came to me three years before selling, though that’s rarely the case. But even if a seller doesn’t come to me, they should talk to their attorneys and accountants to let them know they are thinking about selling in the next couple of years. It would be a great time to work with their service providers to get their legal docs and house in order. They should talk to estate planning lawyers about getting their estate plan in order.
Preparation in that two to three-year window allows us to do many things. It enables us as dealmakers to be far more creative. We can work with accounting, legal, and maybe an operations consultant to make improvements at the company that can lead to better margins, higher valuations, and proper structuring to make the most tax-efficient transaction so that our client walks away with the best dollar figure possible. Many people focus on the offer only. It’s great if you get an $80 million offer, but if you’re only walking away with 30, that’s a bad thing.
Our process takes time; we like to have 5-10 months. A five-month process from start to finish is quite quick, especially in the extended due diligence environment. We can get the deal in the market relatively quickly, assuming we have appropriate financial information, but a lot of time is spent building the materials to position the company properly.
If someone wants to sell in 2025, they better get going quickly. The deals we’ve seen recently have tended to take a little bit longer, whether that’s due to financing due diligence or an increased focus on operations where additional forms of operational consultants are brought into the mix to make sure the buyer understands what they’re buying and whether any of the unknowns could have an inventory issue or working capital issue. They want to see if there is anything that isn’t apparent on the initial review of financial documents that could set the buyer back.
We are also big proponents of having the right team together. We are the ones selling the business. We want to ideally be the quarterback of the transaction because we’re guiding it through the whole process. But we want to make sure our client is properly represented from all sides with a focus on legal, accounting, and financial advising. Those are the three areas that affect all companies. We rarely get audited financials from a $40 million business. We might get reviewed financials, but there’s typically a need for additional accounting support either from their current provider or someone we bring in. The same is true on the legal front. We want to make sure our clients are properly represented and many of our clients have an attorney who has been their long-time attorney but has never been involved in a transaction. We focus on those best practices for due diligence because we want to make sure our clients are set up properly. We can guide them through the deal, but we’re not going to be able to do all those other things.
What is the market outlook?
The one-to-two-year outlook is cautiously optimistic. We need to get a bit more certainty from D.C. and the state governments thereafter to know where things will go through the end of the current administration. The outlook is optimistic, but I wouldn’t say we’re looking at banner years for valuation in the in the next 12 months. That said, trends we think will continue in earnest are private equity driving deal flow and the increasing role of independent sponsors and family offices. That financial buyer universe is driving a lot of the deal flow in the lower middle market. There’s a lot of dry powder exiting portfolio companies, and the availability of financing options and creativity when structuring transactions allows them to sell off some of their assets. The dry powder and independent sponsor/family office activity are going to be the drivers. Once we have more insights from D.C., we’ll have a much better idea of what industries might peek their heads out in 2026 and 2027.
What are some lessons learned for sellers?
I’ll talk about one deal that is a good example of the importance of driving value and how we were able to help the seller pull the appropriate levers to drive value. A couple of years ago, we sold a profitable distribution business. They had several different distribution facilities operating at various levels of profitability, which is common in that industry when you have multiple sites. We worked with them to determine what the business should look like going forward and make sure there was a clear strategic vision we could explain to a buyer. It was obvious that a portion of its facilities were driving most of its profitability. We said, “This is what’s driving your value,” and helped them divest other sites, which resulted in a capital distribution. Their profitability also went up, and so did the actual multiple on the OpCo. They also owned real estate, so they were able to take three bites of the apple instead of one.
We’re seeing this with a couple of the other deals we’re working on right now: What levers can we pull to drive up value with the operating business? Every business owner should know themselves what they have that will make them more valuable and how that is portrayed in the community.
On the flip side, we’ve had a couple of instances in recent years where operational issues weren’t immediately apparent and caused us to pull the deal from the market because it wasn’t the right time to sell them. There was no way the sellers would get the valuation they wanted from the buyer universe. This is an example of the importance of being ready. There was one instance where there was an inventory issue that we couldn’t have known about at the outset. Working with the appropriate service providers to have the package ready is so important. Had we known about the issue at the outset, we would have told the seller we’d help them from a planning perspective to sell in a couple of years. It wasn’t a misaligned expectation; it was a lack of information that caused the deal not to be prime for market.
We want our sellers to be prepared, which allows us to uncover those weaknesses and address them. We want to be able to clearly articulate what our seller strengths are, so we’re positioning them to get the right partner at the right valuation. The timing and planning perspective is very important right now. The key is having a conversation about the business early on to get the right advice regarding timing given the uncertainty that currently exists.
For more information on Michael Norton, view his bio. For more information on Houlihan Capital, visit their website.
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