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Trends in Exits: Auctions, Regulations, and Sponsor-to-Sponsor Transactions

Last night, Axial hosted a panel discussing exit strategies for portfolio companies. The panel — which was moderated by Jon Marino of — included John S. Castle of Branford Castle, Tim Shanley of Huron-backed Victoria Fine Foods, and Elgin Thompson of Marcum Cronus. Using their experiences as a buyer, operator, and intermediary respectively, the three discussed major trends and techniques currently impacting exit strategies.

Below are some of the key takeaways from the panel. View other upcoming Axial events here.

How is the overall M&A environment?

All three panelists agreed that the current M&A environment is relatively sluggish. With few quality companies coming to market, mostly attributable to the rush as the end of last year, there is a severe limited availability for activity. To further the problem, many companies are demanding exceptionally high multiples. Many investors are unwilling to pay the premium prices and instead are waiting on the sidelines for a return of normalcy — which is hopefully coming sooner rather than later.

Thompson, agreeing with the rising multiples, did not think that the quantitative easing program would have much impact in the middle and lower-middle markets. While minor ticks in basis points may have significant impacts for mega-mergers — like Vodafone and Kabel Deutschland — many smaller firms do not need to rely on the debt markets to fund the acquisition. As such, the higher multiples will remain prohibitive to activity.

How are bad companies getting high multiples?

The panelists explained that auctions are the likely culprit for the transactions with exceptionally high multiples. The right bidding war can help drive prices, especially if there is an irrational or inexperienced buyer in the mix. However, strategic acquirers are also somewhat culpable. Occasionally, a strategic will buy an otherwise unsellable company at an incredibly high multiple — typically just to prevent a competitor from acquiring the asset.

Shanley — who helped sell Carvel as CEO — explained that the best way to sell a company for a high prices was to identify your ideal buyer years in advance of the actual sale. By taking the time to build a solid relationship, the trust and transparency pays dividends when it comes time to sell. After two failed sales, Shanley and his team at Carvel worked hard to identify the four or five most appropriate buyers for Carvel. Two years ahead of the planned sale, one of the relationships requested to buy the company — for a very healthy price.

Impact of regulations and federal presence

Certain industries — namely healthcare, defense, and energy — are particularly “radioactive” because of their highly regulated natures. Thompson explained that, despite their ripeness for disruption, progress in these industries is being slowed by excessive oversight regulation. Thompson added, however, that it would be unwise to stay away from great assets solely because of their industry — a great asset is a great asset and will be able to realize a sale.

On a similar note, Shanley explained that regulations are also prohibitive from an operator perspective. Since many regulations are costly and require capital allocations, they limit the operators’ ability to be creative and risky with their strategies. With limited bandwidth, many companies would prefer to avoid any unnecessary risks.

Sponsor-to-sponsor transactions

The three panelists had differing views on the importance of sponsor-to-sponsor transactions. Castle explained that, while Branford Castle may consider the transaction, it has never won the process because of the high prices. Since an exiting sponsor will look for the highest possible value — and an auction process will likely drive it — sponsor-to-sponsor transactions often reach the upper threshold for financial buyers.

Shanley explained that the sponsor-to-sponsor transaction can be particularly valuable for the operating company if the company is sold to a more experienced sponsor. Often — especially in the franchise industry — newer private equity firms will purchase regional stores to bring them to the national level. Upon exit, once that next level is reached, the more experienced players have developed an interest and can take the company even further — aiming for a strategic exit at the end of their 5-7 year window. This “upward sell” is very popular.

Lastly, Thompson thinks the nature of the sponsor-to-sponsor transaction largely depends on the nature of the capital behind the acquiring sponsor. He explained that patient capital from family offices or HNWI will drive very different deployment strategies than watchful capital from pension funds. If the fund is patient and less IRR dependent, it will likely look at more sponsor-to-sponsor transactions.

What about IPOs?

Thompson mentioned that going public is not a trigger decision — a mentality which many companies and firms adopt — but rather a sense of readiness. It is a bad idea for a company to go public because it could not succeed on the auction block.

Castle, agreeing with the limited IPO opportunities, explained that some firms will often run dual processes upon exit — one banker for a sale and one banker for an IPO. Whichever processes yields a higher value is the one to be followed. The JOBS Act has done little to encourage IPOs for middle market companies.

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