PE Q&A: CohnReznick's Jeremy Swan on what to expect in 2016
January 08, 2016
CohnReznick principal Jeremy Swan is the firm’s Private Equity and Venture Capital Industry Practice Leader and M&A Consulting Services Leader. To contribute to our 2016 Crystal Ball Report, he took some time to chat with us about what to expect this year in private equity, covering topics such as due diligence, add-ons, and deal multiples in sectors such as cloud and mobile tech.
What are some of the broader issues you’ve been seeing when helping conduct preemptive due diligence lately?
We have seen sell side diligence continue to grow in popularity whether or not the company is private equity backed. In some cases we are seeing the sell-side investment bankers require a sell-side report prior to launching the sale process. In this kind of a market, it really makes sense. A well-prepared sell side diligence report will help identify issues before launching a process and prepare the management team for the eventual transaction process leading to a greater certainty of close. Due to the competitive nature of today’s market, there is greater emphasis on reducing the time horizon involved in closing the deal. As such, we are seeing more detailed letters of intent and a greater willingness from both buyers and sellers to discuss difficult issues earlier in the process.
For quite some time now, bolt-ons have been a byword—from sector to sector, how much do the rationales for mitigating valuations via bolt-ons differ? For example, what do private equity buyers look at when looking to mitigate a pricey software deal by lining up a handful of add-ons?
Given the robust valuations for quality businesses in today’s market, private equity firms need to spend considerable time vetting their investment thesis for a new platform acquisition. In order to drive the growth of a new platform to meet their desired eventual exit criteria, add-on acquisitions can be one of the better growth vehicles for these companies. Private equity firms look to have a thorough understanding of a company’s market position and the potential add-on opportunities prior to closing the transaction and will look at the fit of potential add-ons to determine the benefits of product and geographic expansion, management team, valuation (will the add-ons dollar average down the total cost of the platform), and growth profile.
In a recent industry insight of CohnReznick’s, the firm identifies cloud and mobile tech bolt-ons as a driver of overall M&A in 2016. We’ve been hearing there can be significant accounting issues with businesses coming to market—often as they tend to be on the younger side—but what have you been seeing?
Early-stage technology companies face different opportunities and challenges than their more mature counterparts. They are more likely to focus on the refinement of products and services and in developing sticky relationships with their users, clients and customers. There tends to be less depth in the management team and gaps in certain back office accounting and reporting functions and systems. To many early-stage companies, raising capital is a significant focus and investment of time. From an investors’ perspective, we’ve seen more interest in technology companies that demonstrate more maturity in and depth among their management teams and their business plans and strategies. Companies with sound revenue models, solid financial reporting and operating systems along with a commitment to continue to support and build their accounting teams provide investors a certain degree of comfort.
When it comes to deal multiples within that space, do you expect them to persist at high levels, so, more of the same, essentially?
We think deal multiples will remain high in the near term, but they may moderate as we expand the time horizon. Keep your eye on the relationship between valuations and multiples in the private and the public sectors. If valuations and multiples in the public sector cool, we may see a like effect in the private market. The emphasis on sustaining growth and the challenges associated with organic growth have placed additional emphasis on mergers and acquisitions transactions. Combine this with a shortage of investment opportunities and multiples are likely to remain high.
Feel free to add any more insight as to what you are expecting for 2016.
Looking forward to 2016, while there are considerably more risks on the horizon than the start of 2015 (domestic and international economic risk, geopolitical risk, Fed rate changes and the upcoming election’s impact on tax/economic policies), we anticipate a continued seller’s market. In response, private equity firms will place greater emphasis on developing in-house resources to originate and close more deals. The development of greater proprietary deal flow will be seen as a more critical strategy to moderate steep valuations. Smart private equity firms will work to differentiate themselves as the "buyer of choice" focusing their efforts on specific industries and specific situations. We also see private equity firms shifting more attention to the integration of new acquisitions, and more often including discussions concerning integration during the diligence process.
Jeremy Swan, Principal, is the firm’s Private Equity and Venture Capital Industry Practice Leader and M&A Consulting Services Leader. In addition, Jeremy is the liaison between CohnReznick and CohnReznick Capital Markets Securities, the firm’s investment banking division. Jeremy specializes in providing strategic transaction advisory, mergers and acquisitions advisory, financing advisory, transaction readiness (including IPO readiness) and post-transaction strategy and integration advisory to our clients.
To get free access to our 2016 Crystal Ball Report, click here.