LBO Shenanigans pt 1

As I mentioned previously, I'm a fundless sponsor. It means that I raise capital for acquisitions on a deal by deal basis. I have loosely committed capital from equity and leverage sources. The upside to this method of investing in businesses is that I do not have any pressure to make investments. Also, I can make investments based specific investor criteria.

An interesting phenomenon within the past three years, is that middle-market CEO's initially wanted too much for their company. They were looking to extract as much value from their companies as humanly possible, thereby indirectly guaranteeing bankruptcy or default, post acquisition.

NOW? CEO's have been brought down to reality. Why?

1. Sponsors are weary of the market. Companies have flat top line growth. Cutting costs can only do so much for earnings. Unless a target company has a ridiculous amount of sales backlog, it will be difficult to prove that your company is growing.

2. Low interest rates have artificially inflated asset values, and simultaneously driven down equity risk premia.

3. The Facebook Effect: The recent FB IPO debacle proves the point. Most companies are overvalued. Other examples  include Zynga, Groupon, etc.

SOLUTIONS?

1. Sellers should be more willing to meet buyers more than halfway. If CEO's actually believe that their company is worth X + 30%, they should be willing to reinvest or defer compensation over a number of years.

2. Buyers should take advantage of low interest rates. I've seen middle market companies borrow at sub 3% rates. In such a case, buyers can become creative when structuring acquisitions. A mix of reverse PO financing, vendor financing, mezzanine, hard money and SELLER financing should do the trick. With more leverage, you can offer sellers a significant premium to close immediately.

With M&A activity down more than 18% YoY, I wonder if everyone has cold feet, or if there's something else coming around the corner. Either way, there are a lot of opportunities in this market place, and I intend on taking advantage of it before the party is over.