My comments here refer to private businesses and not the publicly-traded stock market.
I’ve never seen a seller’s market quite like the one we’re in now for privately held companies. In almost any industry, especially if it’s white collar, professional services and has a recurring revenue stream. There are thirty buyers for every business and they’re paying record-breaking multiples. There are opportunities to sell and stay on to manage, or sell to cash out (and bro down). There are rollups rolling up all the things that can be rolled up.
Please don’t take this as personalized investment advice, your own situation will be unique. I’m just thinking out loud and speaking generally here.
I’ve got anecdotes pouring out of my ears from the last few months. I won’t relay them all. In my own industry, private equity firms have come in to both make acquisitions as well as to back existing strategic acquirers. This isn’t brand new, but the pace is furious and the deal size is going up. I’m hearing and seeing similar things happening with medical practices and accounting firms and insurance agencies.
Anything that can be harvested for its cash flows and turned into a bond is getting bought. The competition for these “assets” is incredible, by all accounts I’ve heard. Money is no object.
Here’s why – low interest rates (yes they’re still low) for a decade now have pushed huge pools of capital further out onto the risk curve. They’ve also made companies that rely upon borrowing look way more profitable than they’d ordinarily be.
At the same time, pensions and insurance companies and corporate treasurers and family offices are all in the private equity game. They’re either allocating to funds or trying to do deals directly, by themselves or with the help of consultants. The historical returns of the private equity “asset class” are eye-poppingly good and now everyone wants an allocation. Trillions of dollars have come pouring in to both enormous funds and tiny funds.
Now here’s where the incentives part kicks in (it always does)…
Private equity funds have to put the money to work in order to earn fees on it. If they don’t invest it, they have to send it back. There are time limits. Nobody gives money back. It will be put to work. You can’t raise the next fund if you haven’t allocated the last fund. Everybody wants to raise the next fund. You can’t raise $4 billion and then sit on it until the cycle turns and more opportunities present themselves. You need to make something into an opportunity now. Small funds face the same issue. There are a million small funds now that the asset class is so popular. No one starts a hedge fund anymore. It’s all about PE.
Go talk off the record to some real PE professionals. Not one of them will tell you there are bargains out there, or that current multiples for what they’re doing make any sense. In some of the deals I’ve heard about, tiny companies within an industry are being rolled up by one small PE fund just to turn around and sell it to a larger PE fund, which is already planning to flip the whole thing in an IPO. The managers are seeing three and four moves ahead during the dealmaking process, there’s no intention whatsoever of a seven-year holding period in these cases.
Buy it, merge it, chop expenses, remove cash, repackage it, flip it, take it public. People are opening and closing deals in the span of a cellphone conversation.
I’ve had multiple conversations with business sellers this spring / summer who’ve said “I can’t believe what they just paid me…I had to say yes.” I think if you’re in your fifties or sixties and you have one of these recurring revenue kind of businesses that are so highly in demand right now, you’ve got to be strongly considering the environment we’re in.
This can go on for awhile but not forever. And when the music stops, a lot of these rolled-up private equity creations will not end up being particularly sexy. Whether or not the pain will be greater for private vs public companies in the next recession remains to be seen.
And if you’re a buyer…are you a forced buyer? Is the money burning a hole in your pocket? Because if you’re not in the race to allocate, don’t pretend you are. Chill out and watch for awhile.
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