State of M&A: Too much capital, too few opportunities

Listening to the attendees at ACG’s annual InterGrowth summit, one thing was clear: even in the current positive economic environment, M&A is not always easy.

2017 was a massive fundraising year for private equity and private credit. The former had its best year since 2008, while the latter went gangbusters, beating its previous record by about $40 billion.

Now managers face a central question: where do they deploy that capital?

That query seems to have no easy answer. With dealflow down and dry powder up, there is no shortage of competition for leveraged buyouts and add-on acquisitions, according to attendees at the Association for Corporate Growth’s annual InterGrowth conference in San Diego this week.

And with such competition, buying the right companies or lending into the good credits is even more crucial because truncated auction processes and lenders playing fast and loose on covenants and documentation up the stakes.

It’s important for a private equity firm, and a private credit firm, to be able to answer four key questions when considering a deal, one InterGrowth attendee noted.

The first and most vital question is, does the business have a reason to exist? Put more bluntly: if the business shut its doors tomorrow, would its customers be worse off?

The second question is, does the business have a reason to grow? The third, does the business have inefficiencies that can be fixed or issues that a buyer or lender can help address to make the business grow?

The fourth question revolves around whether a potential portfolio company will meet a firm’s return expectations.

For equity investors, is there sufficient upside to turn a profit when it sells the business, and is the price right? For lenders, are they being compensated with the right pricing and any additional economics that are part of the loan?

These central questions, one economist noted, are set against a backdrop of uncertainty. The Federal Reserve is trying to put the brakes on the economy by hiking interest rates, while the Trump administration is greasing the wheels with tax cuts.