The channel is consolidating at a fast rate, but the M&A landscape could soon change dramatically.
Economic trends in Europe indicate that private equity firms will likely offer lower multiples to prospective sellers.
So says John Holland, managing director of Corporate Finance Associates. Holland, whose investment banking firm advises midmarket businesses on M&A, said macroeconomic factors are depressing share prices even amongst the hottest technology companies. Thus, companies looking to sell their business shouldn’t be surprised if they receive lower valuations than what their peers reported getting last year.
Holland will participate in a session called “Channel M&A: Everything Today’s Leaders Need to Know,” alongside Total IT Technology Solutions’ Steve Dunmall and August Equity’s Mehul Patel. The session will happen at Channel Partners Europe, 14-15 June, in London.
In this preview, Holland shares insights with Channel Futures about trends impacting consolidation and private equity in Europe.
Channel Futures: How would you summarize the state of channel M&A in Europe? What trends are you seeing among both vendors and partners?
John Holland: The volume and aggregate value of M&A transactions in Europe in 2021 were extraordinary. According to Pitchbook, the trend continued into [the first quarter of] 2022 with record volume and aggregate value. The robust demand for technology businesses with recurring revenues has elevated valuations to lofty levels as certain sectors have undergone rapid consolidation. However, there are dark clouds on the horizon.
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CF: Private equity is one of the most notable forces engaging in channel consolidation right now. What’s one important thing prospective sellers should know about these private equity firms?
JH: Debt is the fuel that propels acquisitions. The low interest rates of the past decade have driven a record volume of mergers and acquisitions. Private equity firms utilize leverage to acquire businesses. Leverage boosts the return on investment in ordinary macroeconomic scenarios. However, as the global economy faces extraordinarily high inflation, interest rates are rising dramatically worldwide, thereby elevating the cost of capital for private equity firms. Meanwhile, the risk of recession seems to be rising as higher fuel costs dampen economic activity. In this macroeconomic environment with higher risk of recession and higher interest rates, private equity firms are likely to adopt financial models with lower valuations. Business owners who are contemplating selling their businesses need to understand that the high multiples on EBITDA (earnings before interest, taxes, depreciation, and amortization) of the past will likely decline.
The public equities market for technology shares might be a harbinger for valuations of privately held technology services firms. Even hot cybersecurity and cloud technology companies like Crowdstrike, Zscaler, and Microsoft have depressed share prices now. In the European IT services area, major players like SoftwareOne, Computacenter and Softcat are way below their 52-week highs.
CF: What’s one key question a prospective seller should ask a prospective buyer, and vice versa?
JH: Sellers of businesses spend an enormous amount of time providing prospective acquirers with financial documents and other confidential details about the sellers’ businesses. Before providing any prospective acquirer with any information, a confidentiality agreement should be executed. Prospective sellers of businesses should ask prospective acquirers to demonstrate the financial capacity necessary for the acquisition. Also, it is important for the seller of a business to understand the goals of the acquirer, the potential synergy with the acquirer, the acquirer’s expectation for the role (if any) of the seller in the acquired business, and the acquirer’s plan (if any) to integrate the seller’s business into a larger entity. Sometimes acquisitions involve the seller rolling over equity into the acquirer’s business. Rolling over equity requires extensive due diligence on the acquirer’s business – just like in any other investment.
CF: Is there anything else you’d like to add?
JH: The best way for a business owner to maximize the value of his/her business on the sale of the business is to have an investment banker orchestrate a confidential auction-like process that pits prospective acquirers against each other. Negotiations between a business owner and a private equity firm are asymmetrical. That’s because private equity firms have teams of legal and financial advisers with years of experience in mergers and acquisitions. Sellers of businesses should level the field by seeking legal and financial guidance from experts.