WEBINAR TRANSCRIPT
Nick Donato: Hello, everyone. Welcome to our Virtual Roundtable, where we’re going to be talking about what we’re calling the “Known Unknowns” of Cross-Border M&A, or if I were to put it differently, we want to call it some of the hidden due diligence risks that you should be mindful of whenever you’re transacting abroad.
And there’s a reason that we chose this particular topic today and frankly it’s because the cross-border M&A activity is on pace to set new records this year. Yes, it’s true that overall M&A activity, especially in North America, went down in the first half of 2017 but the rate of cross-border deals has actually been increasing. So according to PitchBook, we’re at about now one in seven deals in Europe have involved a buyer from North America in the first half of this year, which is about up from about one in ten deals in 2010.
And we’re also seeing that Cross-Atlantic deals are on pace to set new records in terms of volume too. So in 2017, and again this is from PitchBook, European investors struck about $140 billion worth of deals in North America in the first half of this year alone, which really represents a huge jump. And a similar jump happened the other way too, with North American investors completing about $67 billion worth of deals in Europe, which actually represents a 34% increase from last year, which for us raises the question of well why is this happening? You would think that with the slump in global trade, and we’re now seeing more protectionist politics in the air, that things would go in the other direction. But actually what we’re hearing from clients in the industry at large is that North American PE firms especially now have well-established European offices that are up and running, many are further branching out in Asia, and the same holds equally true for increasing number of European firms. So really it’s the case that deal-makers are not suppressing their international ambition because of politics or a slow down in global trade. And then fueling that trend is the fact that modern technology and workplace tools continue to make it easier for a cross-border collaboration, that is both in terms of striking deals and how portfolio companies are being internationalized.
But before we get into all of that and what all these deal activities should mean for your own risk management strategy, allow me to introduce myself. I am Nick Donato. I am an industry specialist here at Navatar, which provides cloud software to manage your deals, investors and clients. And I’m joined here today by three cross-border deal specialists. We’re going to share, not the big cross-border risks that you are probably already able to identify for yourself, but some of the lesser known risks that really only become visible through experience. All three of our speakers will introduce themselves shortly. But before that, some very quick housekeeping, if you have any questions… In fact, I encourage you to submit questions. We will be happy to field them at the end of our discussion, which as your moderator I’ll do my best to keep at around 30 minutes or so. Also, only because this comes up a lot, yes the recording of today’s broadcast will be emailed out to everybody, so just look for that in your inbox as early as tomorrow but no later than early next week. I should mention too, that all three of our speakers are Navatar clients.
So I’m going to move on to the next slide here, so I can give you some background on us. Navatar is the leading cloud software provider wholly focused on the private capital markets. What we’ve done is built out a platform that can manage your investors, clients, deals and portfolio. We are the leaders in our space. We have over 600 customers across 35 countries. And, in the context of today’s webinar, I should have mentioned too that we have developed a number of tools that make it easier for you to track your deal flow, intermedia relationships and pinpoint exactly who is delivering your firm the most promising opportunities. And likewise, for the M&A side, there are tools to manage your buyers and do things like build intelligent target lists. We’d be happy to walk you through any of those tools and features. Just go to navatargroup.com and you could find all of our contact details there.
Also a quick shout out to our friends at the Association for Corporate Growth or, as many of you know as, ACG, which is the global community for mid-market M&A deal-makers and business leaders. I can say, having accumulated enough years in the PE and M&A industries, that ACG events and meetups are by far the best place to really just shake hands and meet with the right buyers and sellers. You can learn more about ACG and the events that they are hosting across the country. And I should mention, they are making a big splash in Europe now too. So if you’re across the Atlantic, check out ACG by going to acg.org.
Now then, I am excited to introduce our roundtable. I am joined here today by Daniel Domberger of Livingstone Partners, a global M&A and debt advisory firm. Joshua Adams of OpenGate Capital, a global private equity firm. And Jeremy Ellis of Genesis Capital, which is an Atlanta-based M&A advisor. We’re excited to have all three of you on board. And so what I would like to do now is to have each of you provide some further background on you and your own firm. And Dan, let’s begin with you.
Daniel Domberger: Thank you Nick, that’s very kind. So I am Daniel Domberger. I’m a partner at Livingstone, which as Nick said, is an international middle market focused M&A and Debt Advisory firm. We have offices in London, where I sit in Chicago and in Los Angeles, and we’re also in Germany, Spain, Scandinavia and China. For us, middle market tends to mean transaction values up to around $250 million. We’re amongst the most prolific firms of our size. We do about 70 transactions per year and more than half of those are cross-border deals.
Nick Donato: Thanks, Dan. Moving on. If could we hear from you, Josh?
Joshua Adams: This is Joshua Adams from OpenGate Capital. As Nick referenced, OpenGate is a global private equity firm, I myself manage the business development origination efforts for the group globally. I reside in our Los Angeles global headquarters. However, as you may tell from the accent I’m actually from across the pond itself. I’m actually sat today in our Paris office where we have our European headquarters. OpenGate is a specialist in complex transactions of which cross-border clearly tick that box, in addition to that spend significant amount of time with the corporate community buying businesses who are selling businesses across multitudes of different geographies. And also similar to Daniel, I look at the business as a lower middle market, it’s sub 250 million.
Nick Donato: Thanks, and then Jeremy?
Jeremy Ellis: Yeah. Hello everybody, this is Jeremy Ellis. I’m a managing director at Genesis Capital. We’re an investment bank based in Atlanta, Georgia. We focus most of our time on working with publicly traded companies and multi-generational family businesses helping them think through ways to grow their business both through buy-side M&A and sell-side M&A. Cross-border is a very big part of what we do. So far this year we’ve executed transactions in Canada, Japan, Israel, Sweden and the UK. We’ve seen a tremendous rise in the last three or four years very similar to Daniel’s, a big part of our business and similar to both Daniel and Josh, I think most of our points of discussion will focus around enterprise value less than 250 million.
Nick Donato: Thanks to all three speakers. And I was giving this some thought and I think the best way to start this conversation is to address one of the points that I had made during our intro. And that is to… For us to give our analysis on exactly why it is that cross-border M&A is on the rise. I had mentioned that there is this slump in global trade. We had talked about that there are more protectionist politics. So what would each of you personally attribute to the fact that deal-makers are ignoring those trends and can continue to internationalize? And Jeremy, let’s start with you.
Jeremy Ellis: Yeah, no I think it’s a great question, Nick. I think, for probably most of the people out there who are looking at this… I think politics is probably playing less of a role for them. I think some time last year people on the other side of the pond from us got comfortable that Brexit was going to take a long time and that stabilized things, and then over here we had our big US election last year. And it looks like we’re going to have a continued theme of not getting a whole lot accomplished in Washington. So I think people by and large are ignoring the protectionist politics that the media likes to talk about, and are really focused on the slump in global trade that’s out there.
And I think it’s mainly, as we’re looking at markets at all-time highs, the pressure from shareholders to achieve higher returns and continue the growth to justify the stock prices that are out there or the valuations for private companies is really forcing people to look at new regions that can open up exposure to different economic market or consumer dynamics for them to really help them grow their business and we’ve seen this with… Whether it’s one of our clients in Milan in high-end audio products business was bought by a large Japanese conglomerate, Roland. Roland needed a new product and they hadn’t spent the capital investment themselves to get there. And so they needed to go out and buy a product. So I think that buy versus build strategy that exists whether it’s domestic acquisitions or cross-border is still the main theme that’s driving for people of how do we accelerate the growth of our business?
Nick Donato: And I open that question to our other two panelists. What would you attribute to this rise in cross-border M&A activity?
Daniel Domberger: It’s Daniel here. I think Jeremy’s hit the nail on the head. I think we are still in a relatively low growth environment, low macro growth environment. And companies and business leaders, even down to divisional business unit leaders all have aggressive growth targets that they are charged with meeting, and are all finding it challenging to do so through purely organic means. And that means increasingly that growth by acquisition becomes a way to fulfill not only a wider organization level strategic objective which might be quite long-term and far-sighted.
But I think it’s also being used to achieve relatively smaller scale, in effect tactical objectives, all the way through from, “What are we going to be doing next year?” As Jeremy described. “What’s our new product pipeline? We have a hole in it. How are we going to fill it?” All the way through to, “What are we going to announce the next quarter’s growth? And how do we actually deliver on those promises once we’ve made them?” So, I think that hunger for growth and investor pressure for growth is a fundamental driver and I think the relative availability of capital in that low growth environment means that the resources to pursue greater volumes of transactions in that way are available in a manner that they probably want since the crash effectively.
Nick Donato: Josh, your thoughts?
Joshua Adams: If you don’t mind, sorry if I’ll go over one or two comments but I think definitely the lack of top-line growth that I think even our portfolio companies are seeing certainly has an impact on looking to try and certainly try and find opportunities to grow your business internationally and therefore have a stronger, if you will, equity story upon exit. That being said, as a buyer as well, a principal buyer if you will, I think the unique perspective that we probably shared here is, definitely to look at the valuations in the market you’ll see, I think Nick, you made this comment earlier about the growing number of private equity firms both European and North American both looking at the different side of the pond to see where opportunities may lie.
We’ve all seen the valuation gap that takes place in North America. And they still exist, between Europe and North America, there’s probably about a one-and-a-half to two terms valuation gap depending on the industry and therefore you’ve seen that continue to happen with North America firms looking at Europe as more of a value buy. I can certainly attest to the fact that some of our peers in the market have spent more time in Europe of late and with that in itself it becomes complex, and I’m sure we’ll get into this a little later but that’s definitely how we’ve seen a lot more opportunity for ourselves is spending time in the European market for that valuation opportunity. As an example we’ve, in the last 12, 18 months we’ve invested in six businesses, three in North America, three in Europe. I think that just goes to show that there is a lot of opportunity in European market as well as North America.
Nick Donato: And building on that point and this is an open question to the entire roundtable, how easy it is to make that business centric case to either investors or to target company executives? When we are seeing the headlines talk about things like Brexit, talk about things like renegotiating international trade agreements. We’re seeing a lot of volatility in the FX market which I know can spook people. Is it a challenge to get pass those, let’s call them “obstacles”, when making this business case?
Joshua Adams: This is Josh. I would say, having recently just gone through a fundraising, and have plenty of times … LPs during that and respective LPs, they want to know your strategy and they want to know that you can do… Execute your strategy. So shifting and saying, “Oh we’re going to go now look into Europe,” is not something I think many people feel comfortable with doing, and therefore I think all of those points, Nick, that you just made are risks and something that has to be taken into consideration.
Ourselves here at OpenGate have been, on the ground in Europe for 10 years now. In 2007 when we… Two years after founding the business we opened up in Paris, and I think that in itself is testament again. The cultural credibility, what you build up from your experience during that time, I think if you’re about to look at the market and say, “Oh… ” My earlier point there’s opportunity there because of the valuation or maybe because of the dislocation you’re seeing through fiscal instability, if you will, across Europe. I think, yeah very, very valid points but if you’re an investor, if you’re an LP and you’re looking at the market you’re saying, “Focus on what you do well and make sure you can navigate through that.” So I think it’s a limited universe for those who have, certainly gone into the other markets. I think, between Jeremy and Daniel, they’re probably on a better position to talk about how strategics and other groups may look at things as they look to grow top-line and other things and the risks that may come with that but from a principal buyer perspective, that’s how I think about it.
Nick Donato: Yeah, it’s an open question and especially if we can touch on the FX aspect because that’s something that I’ve heard pop up during more and more conversations with both PE buyers and M&A advisors.
Daniel Domberger: Yeah. It’s Daniel here. There’s no denying that FX plays something of a role. I think we have seen, and we continue to see from strategic buyers that if a target business or a target market is not a strategic interest. The fact that, in the case of Sterling for example, it suddenly became 20% cheaper because of the Brexit referendum. That, in and of itself is not enough to make it an acquisition priority. So I think, focus on the fact that things have suddenly become cheaper implies a degree of strategy, less opportunism, which I don’t think really applies to most of the big, sophisticated strategic and parties with whom we’re interacting. I think the other… We’ve seen some sellers try to use the decline in Sterling in particular, again around the Brexit referendum, as a way to seek to get a buyer to justify a higher valuation, as in you are paying for this in pounds, the pounds cost you fewer dollars than they did. You should share that windfall gain with me, the seller.
And that is an argument too, it’s cute, it’s superficially attractive, sellers love it. In practice if you’re sitting, for example in Josh’s position as an acquirer or a principal investor, your immediate response to that is going to be, “Yes, fine it’s suddenly 20% cheaper,” but actually the profit stream that I expect from the business when translated back into my home currency, let’s say dollars, is itself going to be worth 20% less. So I have a short-term financing benefit but also I have a longer term lower level of return on that investment particularly if I end up sharing it with you. So we’ve seen, it seems that we’re moving forward have been accelerated, take advantage of currency shifts but I wouldn’t point to that as a major driver, and in fact the more volatility there is in the FX markets, the harder it is for strategic buyers or investors really to make proper plans and to pursue or discipline their acquisition strategies.
Jeremy Ellis: And this is Jeremy, I would echo what Daniel said and then I would look at it slightly differently, which is when you look at where the dollars are coming out of and going into, you’re seeing the slow growth, in China in particular, those dollars are now flowing out of China and into the US and into Europe because they are not going to be able to get the growth that they need for their shareholders in their domestic market. You’re seeing the same thing with Japan, I think something like 60% of all the Japanese M&A now is dollars going outside of Japan and going mostly into the US and the European markets.
And back to the political instability, if we’re all candid, we’re mainly talking about relatively large politically stable markets that people are sending dollars into, whether that’s the US and Canada, whether that’s Europe, whether that’s Japan, whether that’s China, we’re not spending a lot of time, at least here at Genesis chasing things into unstable South American countries, African countries, politically unstable Middle East countries, we’re talking about largely very stable political environments where there may be some shifts, as Daniel was talking about, in currency or there may be some tax or some other things that have some short-term impact but in the long-term those have been very stable political environments that people know what the outcome is going to be. And I’d echo Daniel’s beginning point which is that M&A then is largely driven by the long-term strategy of the organization of where are we going to go and find new customers and new markets to add growth to our core business strategy.
Nick Donato: All good points, and it’s very valuable to get into the nuances of things like FX, clearly large components of any cross-border transaction. What I’d like to do now is shift gears again to some of the, what we’re calling the “Known Unknowns”, that others should be more mindful of here. And Daniel, let’s start with you. What are some of the risks beyond these headline risks and the FX risks that you only become more aware of through experience?
Daniel Domberger: Yeah. Thank you, Nick. So it’s Daniel here. I think, there’s a quite a wide spectrum and they go from the technical, I would say down through to the cultural and it’s often the cultural ones that are the most intractable and most likely to trip people up. The technical ones, they’re pretty easy for any season deal-maker to identify. You’re going to have differences of accounting treatment where the things are run to US GAAP or international accounting standards or local GAAP. Your’re going to have, flowing out of basic accounting treatments, you’re going to have intricacies of things like revenue recognition, deferred income. You might, in some cases, depending on the sophistication of the target, you might have the struggle between proper revenue recognition and cash accounting which is more common than one might say. There’ll be differences of taxation, and we can spend a lot of time talking about tax differences and the way they end up impacting on things. I would say there are challenges of integration which reflect the cultural and legal perspective.
So in France, for example, once you’ve made an acquisition, it is relatively difficult to make changes to the target company, it’s certainly difficult to lay off large numbers of workers. In Germany it’s a little bit easier but it has to be done in consultation with them. So there are steps and processes and hurdles that you need to overcome in order to be able to pursue integration once you’ve done the deal.
But then, on the softer side the more cultural side, Jeremy mentioned before, Japanese acquirers. They culturally tend to be reluctant to participate in aggressive Anglo-American style auction processes with very rigid time-tables, there may have been no previous interaction with the company and they’re suddenly being asked to jump through hoops to meet an advisor’s designated process. So there might well be a cultural reluctance to engage at all with certain jurisdictions particularly coming out of Asia that can be a reluctance to say, “No”. So you feel that you’re making tremendous progress on your transaction because everything you ask for the response is “Yes”. You raise what you think is going to be a difficult issue, you propose a solution but you’re not sure how well it’s going to be received and the response is “Yes”. And all the way along the line, you get a “Yes” until the very end when someone different shows up and says, “No,” and you realize you’d been wasting your time that whole time.
There are other cultural nuances to be aware of where… For example, it may be more or less common to employ family members within the company to keep assets outside the corporate entity. So in, certain jurisdictions including in Europe, it’s quite common for entrepreneurs and owner operators to hold personally key intellectual property, that as a buyer or investor you would regard as essential to the underlying value of the business. So making sure that what you are being asked to buy comes with everything that you need in order to continue to fulfill its potential, will be important. You might find family members employed in relatively superior positions, you might find wives, children in positions of apparent seniority.
And then coming back to what I said about tax as a wrap-up for a lot of this. Unless you are aware of some of the relatively intricate personal tax implications of the structure in a given jurisdiction, getting to grips with the underlying P&L performance of a business may be quite difficult. For example in the UK, dividends are taxed less heavily than income. So a lot of entrepreneurs here, very legitimately, will pay themselves a token income and take most of their remuneration out of the business in the form of a dividend. Now that’s fine unless you as a buyer are assessing the business on the basis of EBITDA, in which case you’ve probably got a reasonably significant chunk of management compensation that is in effect not being put through the P&L, or not being put through the P&L above the relevant line item. So, conscious that was a relatively quick skip through, quite a wide range. I would say, as I said at the start, that they can be very technical, often tax-driven, but it’s really the cultural ones that can trick you up the most.
Nick Donato: And let me extend that same challenge to our other two roundtable participants. And I will narrow the question in saying some specific country risks that someone should be mindful of that you’ve encountered in your own experiences.
Joshua Adams: Thanks. So, I would touch upon an extension of what Daniel said, the one thing that in US is not a bigger issue as we see here in Europe, is really pensions. Pension as a whole is a completely different world to how they are valued and how they sit on the balance sheets and how they’re looked at from an evaluation point of view as well. So those nuances there, again, go back into that very well-defined ways, as Daniel was saying, both nuanced in the form technical and also cultural, but you have to be mindful of that. We have been constantly looking at businesses that, unfunded pensions or, you may even find businesses that are very nuanced in a way that they have been… How they have been handling both pensions and other benefits through the employee base as well.
So, something that we are obviously always mindful of the key areas, but again really are the UK and Germany specifically, and also France, three of the biggest economies in Europe, all struggling to really make that easy for those who require it. And I think that’s been also bit of a barrier, if you will, for new entrants into that markets. Many people have assumed these liabilities or assumed what they believe are the liabilities then find out that they are far greater, and later in their ownership. And I think that comes to the point of really trying to make sure you’re working with the right people, having the right advisors, knowing that going into the process as well. So certain things like that certainly stand out to me. Pension is probably one of the largest topics along with tax, but by no means nuances. They’re very, very fundamental parts of evaluation of a business but certainly it can catch a lot of people out.
Jeremy Ellis: This is Jeremy, I was just going to echo Daniel’s comment about the cultural differences. I think people underestimate the importance of understanding the other people on the side of the table and how they like to interact with things. For example, when we were selling an Italian business, they wanted to have a lot of social time. So it wasn’t just business, they wanted a lot of social time with the buyer to really get to know them and spend time with them. And so that meant long dinners, long meetings, social outings. But then there’s other cultures where people don’t… All of us here on the phone probably are very comfortable having lengthy phone discussions. Our experience with the Japanese have been that they do not like to cover things on the phone, but would rather sit down face-to-face. And so you won’t make progress through definitive agreements, and even otherwise, without sitting down face-to-face to have discussion about the points. And so I think those are big cultural nuances that we’ve encountered that people really need to understand to be able to make progress and also to be able to actually get a deal done or prevail in a competitive process.
Daniel Domberger: This is Daniel here. I think… Sorry, Nick. Just to add to something Jeremy said there. I think that that emphasis on social time and the different ways that different cultures treat it and value it is absolutely spot on, I think it’s a very, very important point. In Spain, for example, you categorically do not talk business over lunch. Here in the UK, we would think nothing of bringing sandwiches in to a working meeting and everyone grabs a sandwich at the meeting room table and we’ll just keep eating, keep talking and life goes on. And in Spain that would be considered very, very impolite. In fact you stop the meeting, you go out somewhere, you have a proper lunch at a proper restaurant at which no business is discussed. It is entirely a social event, just as Jeremy describes Italy. You talk about your children, you talk about football, and then you come back into the meeting room. And I would say the importance of that to buyers and investors can’t be understated.
If you look at a market like Germany where so much of the volume of transactions is still driven by the Mittelstand, many of these businesses are third or fourth or fifth generations family firms. They’re not necessarily in major urban centres, they’re really embedded in the life of smaller towns, regional towns, significant employers in those regions. And for those entrepreneurs, the idea that they are selling the family business can be a very wrenching transition for them to go through, very difficult emotional journey and therefore making sure that you as a buyer or an investor are seen as an appropriate custodian, if you like, of that business going into the future is very, very important. Jeremy’s quite right, you can’t do that on the phone necessarily, you can’t do that just in meetings to discuss tax treatments and sale and purchase agreements. You’ve really got to work hard on the hearts and minds and building a relationship but I think… Well done, Jeremy, I think that was a terrific point, couldn’t agree more.
Nick Donato: If I were to build on that point myself because of these complexities and cultural nuances, we’re seeing when someone is conducting a cross-border transaction, they are taking whatever precautions that they can make. Something that I’m aware of is that there’s this new trend of due diligence packages that are being prepared by vendors, starting off in the EU then coming into the US. But what should buyers look out for in these due diligence reports, can they be wholly trusted or there’s some caveat to mention? And that is an open question to the roundtable.
Daniel Domberger: It’s Daniel here again. The interesting thing about those vendor due diligence reports, as they are called, is that they are commissioned by the sellers but they are ultimately signed over to the buyer and the due diligence provider does have a duty of care to the buyer. But because they are commissioned by the seller in the first instance and the seller will probably have had the opportunity to review them extensively to correct any fundamental errors creeping in but also inevitably to put forward a point of view or a perspective, you certainly cannot and should not trust them whole-heartedly. And as a buyer or an investor, we would strongly recommend that you conduct your own, what we would call “top up due diligence”, to assess that report and make sure that there aren’t any areas that it should have identified and doesn’t, should have explored in more detail but doesn’t.
Nick Donato: Anyone else?
Joshua Adams: I couldn’t agree more and that’s exactly it. Even if you, and I think, again, the US, as you rightly said, are adopting this, then you do due diligence mentality which is certainly a cultural shift from what’s coming over from Europe. But all you got to do is look at the financing banks or the like. They don’t trust them. They want you to do your own, they want it to come from you, and therefore when you hire a third party it’s something that you are signing up to as opposed to, it’s certainly coming from the vendor itself. So then, they are incredibly helpful, they allow you to assess the business a lot more, however as they’ve come from Europe to North America, I think there has been a lot more skepticism about them as well and certainly very, very helpful documentation but certainly not to be relied upon.
Nick Donato: Yeah. I have heard horror stories myself about it coming to light that sometimes junior staffers have been taking the lead in preparing these reports, which is not as comforting as knowing a senior member was involved. But that being said, and in considering this level of risk, we are seeing more reps and warranty insurance also being taken out, that’s been a precaution that’s another trend on the rise. Are these valuable? Are they… Is it typically the case that they are worth it? Open question roundtable. If you take out this type of insurance yourself, why or why not?
Jeremy Ellis: Yeah, this is Jeremy. I think the rep and warranty really started in the US market and is moving into the European market and other markets, so the opposite of the vendor due diligence. I think the main reason we’ve seen a lot of benefits out of using the product, are really two main benefits. One is the ability to deliver more cash to the seller at closing because you don’t need to hold as much money back in an escrow. And the second reason is in most of the cases, back to what Daniel and I were talking about as it relates to culture, particularly when you’re dealing with some of these family businesses, they don’t really understand indemnities and they don’t understand the length of the indemnity. They don’t understand that the entire purchase price could be at risk for some of them, a portion of it for others.
And if you really are a strategic buyer and you’re buying this family business and you really want to partner with this family, if you have a breach of a rep and you’re going to go after them under the indemnity, you’re now suing your partner. And so, the use of the rep and warranty insurance now aligns you with a partner that you could have spent hundreds of millions of dollars to partner with. It now aligns you that you’re going after an insurance company versus going after your partner. So we think it delivers more cash to the seller at closing and it aligns the interest between buyer and seller, and then there’s a third benefit that it’s hard to quantify, and any of the lawyers on the phone will disagree, but in theory it should make the negotiation around the reps and the warranties and the indemnity that are a lot of times a contentious part of the deal negotiation, it should make those easier.
Nick Donato: Interesting. And Jeremy, you mentioned lawyers, and we’re talking about insurance providers, and so there’s clearly a network that needs to occur of external advisors when considering a cross-border transaction; I think that’s important to talk about. Open question to roundtable, the best way to leverage those external advisors and work with intermediary agencies and advice?
Joshua Adams: This is Josh… Maybe…
Nick Donato: Yeah, let’s start with you, Josh.
Joshua Adams: As two of my colleagues are both advisors, let me take this, the first part. I think you’re right. Again, I’m fortunate enough to be sat here saying that this is a very important part of the process, and it is to us as well even though we have a group of 10, 12 investment professionals on the ground. What you’ve seen over the last several years is a lot of, as we said, North American European funds, almost suitcasing back and forth between the two continents to find opportunities. And the importance of the advisory community, in that is huge, whether you leverage your existing relationship or your global network through the law firms you’ve been working with and using is typically how most people do it, but really just leveraging your network and understanding who are the right people to work with. Obviously the Big Four, in accounting, from their point of view have done a great job of continuing to grow their platform and offering these services as well, I think they have done a great job as have the ones just below the Big Four, more regional and local accounting firms to have support consultants, and consults with the buyers as well as the sellers.
So, I definitely think that this is a very, very important point that you bring up, Nick, that we as a firm have actually leveraged quite a few of these advisors, in particular debt advisory groups within groups like Livingstone who have a very good practice in that, but actually spending time with… And the importance of having those groups, to be candid, in that role is really to make sure that you are making sure that you pick up on all of those nuances we spoke about, the cultural nuances, how you’re negotiating an SBA in the context of financing, and the term sheets that go along with them, especially this multi-jurisdictional, if you’re picking up capital across the continent, across Europe as a whole, it is, every single geography is different and what you can use and leverage the base and inventory base is different between the Netherlands and the UK versus Germany and the Nordics; it’s very, very unique in a way that it’s handled, it’s not as simple as the US model.
However that in itself, debt advisory mandates is something that we’ve worked with quite a few of late, especially as the transactions get bigger and more specific you want to make sure you have the right people helping you, and also you’re getting the right deal. So when you’re in a position of negotiating against several different parties providing term sheets you are obviously putting them off against each other and the debt advisory groups certainly help in that context. The cultural piece that both Jeremy and Daniel have spoken about, I think this goes hand in hand here as well. When you think about cross-border transactions, the immediate thought is just complexity in itself, and I think it’s not for everyone. And in doing so you just need to find the right people to work with. If you don’t have a local office, if you don’t have the local platform, you need to have people who have the experience, as Jeremy and Daniel have spoken about from their experience, you need to have individuals who know how to operate within these local yet global markets that we operate in.
So, for me at least it starts with tapping into an existing network, whether it be law firms, whether it be accountancy firms which we all appreciate are global, and they all have a global network whether it be an affiliation or a part of the global network that they operate within and really trying to understand the local nuances you may find there. That to me is probably the best and most logical sense to do that. And then, again, when you hire people on the ground whether it be… People on the ground to help build out the team or such a like, it has to be people who have the same culture as you. I think I can attest to that. I’ve seen many firms be successful in doing that first deal; I’ve seen several firms being unsuccessful in doing that first deal and putting them off doing further deals in either a geography or across the continent as a whole. So that first deal is such an important one to get done correctly, and therefore any advisors you have to help is important, although too many cooks spoil the broth as they say, so you have to be very mindful of not having too many people in the room at any one time. So lawyers, obviously, financing groups, plus also environmental and the like, are all very, very important as you come across to Europe in particular.
Nick Donato: And that’s an interesting point that you make, Josh. So you mention that at minimum you’re going to want your M&A advisor, you’re of course going to want your legal team. I imagine there is an insurer in the mix. And in that, if you go too far beyond that, too many advisors can be a bad thing. What are the consequences of having too many advisors? If you can elaborate on that?
Joshua Adams: Yeah, and to be clear as well, the good thing about some of the networks, whether it be environmental, legal, as I touched upon, but others as well, are they are typically global in nature. So if you’re working with some of the larger providers in North America, they have operations in Europe. That’s an easy tap into, because they have that local knowledge. But I think, specifically to your question, Nick, I think the reality is, is that, you see again the culture in Europe at least, the buy-side where you have an M&A buy-side advisors involved are becoming more and more normal here in Europe as well as North America. And I think that becomes certainly an important topic to navigate between. Too many? Good question.
I think the reality is if you are, as the principal buyer, you are the decision maker. You can only bring in enough information to help you make that decision whether it be commercial advisors. And everyday, investing today, everyone is bringing in, financial, commercial due diligence providers to help support that, so there’s a point clearly where it gets too much. I would say that this present time it’s okay to making sure you have the key boxes checked, and I think that certainly starts with those key fundamentals I mentioned. If it goes too much further than that, then clearly you’re going to maybe put off that investment that you’re thinking made sense, or maybe you’re going to be making an investment based on other people’s advice rather than your own advice which is what you’ve been successful in doing in the past.
Daniel Domberger: Nick, just on that, it’s Daniel here. One distinction, that is important to make, which comes out of Josh’s description there is the distinction between domain specific, if you like, technical advisors, due diligence providers, commercial assessment of the market, legal review, pension review, environmental review; and advisors who are in effect doing what Jeremy and I do, which is to represent a certain constituency. I think, when you’re asking questions like, at what point does it become too many? I think, without wanting to speak for Josh, if there is an area of particular technical concern being identified, he is not going to be doing himself any favors by not getting an expert in that area to do an incremental piece of work to assess how important to risk it is and whether it should influence his wider thinking. If there is a situation where every individual shareholder has their own person, in effect negotiating on their behalf, and you need an auditorium to sit them all in, then it can just be very difficult to make progress.
And you see, interesting distinctions where if you look at the venture deals, they’re often done without corporate finance advisors or investment bankers, for some reason they are done primarily just by lawyers. Equally, if you look at the UK market, there’s a very well-established need for something called “management advice” in a secondary private equity transaction, where one private equity house is being replaced by another. It is very normal here for the management team to have their own advisors negotiating their deal. That is almost unheard of in the US. So it’s important to bear in mind that there is no magic number that is the right number of advisors to have. There’s a point at which negotiating advisors… You can’t have too many of those which just slows things down, but if there’s an important constituency that wants to be represented, they are going to be represented, but I think when you’re talking about functional domain specific technical advisors or experts, that is very much driven by the risk profile of the target and any specific risks that have been identified or found.
Nick Donato: Interesting. I guess this question is more for Dan and Jeremy, how much it makes sense to tap one of your initial advisors network for finding other suitable advisors, and if I can make that a two-part question. If a PE firm is coming in, or someone else, the best way for them to analyze your own cross-border credentials or track record, what’s the best way to test them on their claims?
Jeremy Ellis: Yeah this is Jeremy. I’ll jump in real quick. To start, I think it is extremely important for the clients to surround themselves with the right advisors. And a lot of times, particularly when you’re dealing with companies sub 250 million of enterprise value, if you’re on the buy-side and you know you’re going to go and look at something cross-border, you’re starting from the get go with, thinking about putting the right advisory team in place. But a lot of times on the sell-side, where Daniel and I still spend a lot of time, you may not know that your buyer is going to be somebody from a cross-border. So if you are a $100 million business, you may hire a great US-based law firm to advise you on the transaction and then you find out that you’ve got a Swedish buyer that’s going to come in and ultimately be your buyer, and then you find out that the partner in charge of that hasn’t spent time understanding the difference between a lockbox concept and a working capital adjustment, and so now you’ve introduced risk into the transaction because you didn’t have the right advisor on the front end.
So, you can’t always pick the advisors going in, but I think you can augment your team as you go through the process and bring in special people, special advisors, special M&A council or make sure you’ve got advisors. If you do think you’re going to have somebody on a global approach that you’ve got a law firm or an accounting firm, those two in particular, that have expertise in cross-border. I think Daniel would agree the way to assess somebody’s credentials when it comes to that is actual deals executed. It is great to say, “Yes we’ve done something, we’ve approached people,” or, “We’ve thought about this.” But actually closing transactions in those jurisdictions, there’s nothing that replaces that actual experience that you have on your team from being on the ground in Japan or China or Canada or throughout Europe and spending time within those cultures and getting transactions closed there.
Nick Donato: And Dan I imagine that you…
Daniel Domberger: Yeah. [chuckle] I completely agree with Jeremy’s perspective. I think, particularly on the sell-side, it’s difficult to know which of your buyers is going to emerge as the frontrunner, and therefore difficult to know specifically which jurisdiction you’re going to end up dealing with. That then becomes a question of the breadth of cross-border experience that they’ve had. So it is ideal if your advisors have specific experience of that particular jurisdiction and its culture. But equally just the fact that they have closed deals in 30-something countries means they will be coming to every new situation with an awareness that there are, as this whole webinar has explored, those known unknowns and that they need to approach them with a degree of caution and sensitivity. So I completely agree with Jeremy.
Nick Donato: Interesting too. And I’m being conscious of time here, but I do want to sneak in one last question because what I feel we have accomplished is identifying these known unknowns. What I would like to do now is challenge each of you to get more into the weeds about a particular known unknown that we have talked about at a higher level, whether that relates to accounting, whether that relates to valuation or legal risks. I will challenge you to take your pick. But Jeremy, if I could start this challenge with you. Any particular known unknowns that you would want to get on the soapbox and warn people about?
Jeremy Ellis: Yeah, so I think… This is Jeremy. I think one of the big ones I’d hit on, right, which is this lockbox mechanism is really a mainstream convention now in European deals. It’s very rare in North America and Asia Pacific, but people are getting more accustomed to it. In the US we would call it more of a working capital adjustment, and I think sometimes people on the front end think, “Oh, well it’s a lockbox, it’s like a working capital adjustment,” and they don’t recognize that it can have some significant impact on the economics of a transaction. So I think that’s one point that people really need to dig in and understand, making sure they’ve got the right advisors that can really articulate to them what it means if you’ve got a particular deal mechanism, such as a lockbox versus a traditional working capital adjustment.
Nick Donato: And I’m going to kick that same challenge over to either Josh or Dan.
Joshua Adams: Hi, this is Josh. So, I would say I’m going to go more into the cultural stuff because I think that’s a little bit more nuanced, as we’ve said. I would go with something that Daniel did mention earlier actually, which was management teams, and the importance of management teams. Not only they been advised through that process by their own external advisors. And that’s not just in private equity, that’s also through the course of any transaction, whether it be a trade from a corporate to a private equity firm or a like. But the point I would like to make is the importance in a management team in the North American market versus European market. In Europe we continue to see these management teams who’ve typically, not to generalize, but typically it being with a parent company, typically a public company that we have had experiences with, more so than most, where they have a very, very valuable say. So we’ve had management team members being on the board of public companies of the seller, and eventually had a very, very big say in whether this transaction goes forward or not.
So when you think about the management incentive plans you put in place to protect your management team and to make sure that they are aligned with you, as a private equity buyer, trying to make sure that you have an understanding of all of those trigger points that you can pull on to get the transaction done and understanding how important they are in that process. I know that some people may think, “Well, surely management’s important across any investment.” 100% agree, they absolutely are. But for me, the European management team members are a lot more… You have to be very conscious of how you deal with them, and make sure that you are working together from day one, and understanding that they also can… If you don’t get on with them, some of those… If you’re not having the right lunch or the right dinner with them, then unfortunately it can have an influence on how a transaction may play out. So simple things can have a big impact on entering the European market.
Nick Donato: And Dan, can we press you to shine a brighter spotlight on one of these known unknowns?
Daniel Domberger: Yeah, and this is a hybrid of a cultural and a technical in a sense. So, it’s very common in transactions in the US to have a general retention against the warranties and indemnities. That is, a portion of the purchase price is put on one side, normally in either a joint escrow account or an account controlled by the buyer. And that is there just in case something comes up. So it’s not there to protect against a specific and identified risk that would have its own retention. So that’s very common in the US market. It’s very normal for US buyers to request them. It is not very normal at all in the UK. And it is a perpetual battle when US corporates, in effect, demand one, and UK-based sellers and management teams throw up their hands in despair and say, “It’s totally unreasonable and egregious.” So just being aware what you take for granted in your home market may be different elsewhere as we’ve been discussing, but then my all-time favorite retention story is that I was advising on the buy-side, advising US corporate on an acquisition in to Europe. And my client had dinner with the seller and he walked out of that dinner, and the first thing he did was call me and say, “We need to double the retention.”
And I said, “Why? Why do we need to double the retention?” And he said, “‘Because I’ve just had dinner with this guy and he said he’s going to take all of the consideration that we’re about to pay him and invest it in a buffalo farm outside Hong Kong in order to produce high quality buffalo mozzarella to sell to the high-end Italian restaurants in Hong Kong.” And he said to me, “Daniel, I can tell you now, if there is a problem, there is no way that I’m going… I’m re-posessing the buffalo from some farm outside Hong Kong in order to make good on a warranty claim. We need to double the retention.” As it turns into advice, I think there are two parts there. One is be aware that what you’re asking for may or may not be normal, and the other is if you’re a seller, I don’t think you should think aloud about your zany ideas when you’re in a private dinner with the buyer because we said hearts and minds are important as your buyer trying to build relationships with the seller. As the seller, you want to appear as sensible and risk-averse, and trustworthy as you can. No buffalo here please.
Nick Donato: Yeah, and maybe that you want to always have a pair of cowboy boots handy. That’s another known unknown I would say. Thank you to everybody. I’m going to move on to audience questions over here. We’ve got about, I’d say five to 10 minutes left so I’m going to quickly go through these. The first one coming in, and I’m going to paraphrase some of these is, “How are roundtable balances the need for growth? So things like the search for cross-border transactions. Would things like the potential perception of doing a deal for tax purposes, which I think is referring to the big inversion debate that’s been going on.”
Daniel Domberger: It’s Daniel here. I would say that it’s only the… Well, the deals most likely to come on the scrutiny for tax reasons are most likely to be the larger deals. And generally in the middle market, those transactions are… They’re not motivated specifically by tax drivers and even if there are tax advantageous elements to them, they are less likely to attract the same level of press scrutiny and political scrutiny.
I would say whether that, in particular political scrutiny comes in much more in the middle market is where you get into areas of potential national security. We’ve done a few deals recently, and inside the security and those have… Because of the importance of the intelligent services to some of those relationships, those have needed to be blessed one way or another, formally or informally. We’ve also seen transactions with Chinese counterparties come under intense political and regulatory scrutiny in effect to make sure that sensitive technology is not going out into markets where it is not deemed to be helpful. So, I think tax is very important. In the middle market tax is not a key driver normally of transactions, and therefore that level I would say of a press and political risk tends not to apply, but it certainly is a feature, and the factor of tax-driven mega deals.
Nick Donato: I’m going to try to sneak in two more questions just before we have to wrap things up here. Cultural differences, nuances to consider specifically within the tech sector, somebody is asking about. Daniel, I know that you mentioned cybersecurity, but open question to everybody.
Jeremy Ellis: Yeah. I was going to say, I think the cultural differences that we’ve been talking about, I would articulate as more country specific or region specific within parts of the… When parts to the globe. I think that you’ve got… As you get into then subsectors there whether it’s industrial, or chemical, or consumer retail, or technology is the question was asked about, there are the nuances within those as it relates to culture. And so, in some of the technology work that we have done, it would not be uncommon for some of the discussions to take place across text messaging, or instant messaging, or to use some more technology-driven tools like Slack for working groups that you may not see outside of the technology sector. Hopefully that addresses the question.
Daniel Domberger: Yeah. I was just going to add one thing which I think is in tech particularly. So much of the culture in a sense radiates out from Silicon Valley that actually the mindsets amongst tech entrepreneurs strangely tend to be more aligned in a cross-border way than some of the larger organizations and potentially even investors. The US has a very rich, very well-developed venture investing marketplace, and large numbers of very successful investors and funds who have really nurtured and encouraged that for a long period of time. The climate in Europe is encouraging, but it is in no way as sophisticated or as well-developed. And I would say generally here, even extensively tech-led investors are quite a lot more cautious and risk-averse than their US-based counterparts. So, strangely I think the cross-border differences within the tech sector reside more at the investor level than they do at the company target or entrepreneur level.
Nick Donato: We have one final question that I want to sneak in here because this is interesting. If I can have all three of you give your responses in a quick timeframe. Someone is saying that they are a private equity group considering opening a London office. And they want to know how long does it typically take for a new office to be up and running and matching the type of deal flow seen at headquarters? And for our two M&A advisors, maybe we could rephrase that question in terms of your own pipelines.
Joshua Adams: I would say how quickly, it depends on the people you have on the ground. I mentioned the comment earlier around the suitcasing effect of suitcasing Americans over to European markets has been tried and tested. Many a times I would say it hasn’t been the most successful, I think you do need to have local people on the ground who, again, touch on those cultural credibility and understand the dynamics that take place, how quickly you’re able to get a deal flow picking up, like you can pick deal flow up pretty quickly, I think that’s the building up a reputation is far different to just bringing in deals. So now the reputation is something that’s going to be on from the experience you’ve had in North America.
And how, again, I can’t stress this enough about first deal. The first deal you do, how you do on that transaction, again I can attest that people have failed unfortunately in certain geographies and they will not do deals in those geographies again if you do things incorrectly. So, depends where you are in the market, if you are on the buy side, if you’re on the more mature investing or the other side of the market or value investing for that matter. All of them have their different stress points that you need to be aware of but I would say that you definitely need the right people. So I would say it’s going to take you a good couple of years and you have to be willing to make that investment.
Nick Donato: And to our other two members if anyone wants to tackle that.
Daniel Domberger: Yeah it’s Daniel here. I think you’ve got to get yourself on the radar of the advisory community as quickly as you can to be seeing those, seeing that deal flow, basically. Most of the international funds that we have seen set up London offices have done so after having done a couple of deals. In a number of cases they’ve been on the radar, they’ve been seeing some flow out of the UK and/or Europe. They’ve ended up executing, as Josh described before, they’ve executed a deal or two effectively out of the suitcase in a hotel room. They’ve realized that there is good stuff that they could be doing here, they’ve probably seen more flow and they’ve certainly find it easier to execute if they had a permanent presence on the ground.
And what we’ve seen most of them do is second someone from the States and then recruit locally around them and by doing that they get the balance of cultural consistency with the mothership back home but also they get a slightly greater degree of native sensitivity to the differences in that specific market. I think Josh has covered really well the different parts of the market and how much time it might actually take to get to the same level of transacting. But in general we don’t see people arrive and put up a sign and say, “Send me some teasers I’m willing to do some deals,” we see people, we see firms in particular, transacting in this environment, building that level of comfort and then establishing their ground station thereafter.
Nick Donato: Yes, and I think if there’s anyone or two major takeaways it is that the patience and attention to detail are going to be your saviors. That being said, that is all the time that we have for today, I want to give a big thanks to our roundtable again, Daniel Domberger of Livingstone, Josh Adams of OpenGate Capital and Jeremy Ellis of Genesis Capital. You can see contact details for all three participants on that last slide there, as well as contact details for me at Navatar, as well as ACG, any type of questions, please by all means feel free to reach out. So on behalf of Navatar and ACG as well as our fantastic roundtable, I’m Nick Donato, and enjoy the rest of your day.