In addition to sitting down for a Q&A to do this podcast, Clinton Johnston, a managing partner with Benchmark International, sent along some of his thoughts on several key issues in the M&A market, summarized below.
EW’s editors were super-impressed with your background. What got you excited about working in M&As?
I started my professional career in the Coast Guard. Saving lives was a pretty powerful source of motivation, but it’s a young man’s game.
I attended law school and dabbled in litigation matters, eventually deciding that fighting over conflicting views about past events was not rewarding enough for me.
But then I was exposed to the world of corporate law. When you have two parties trying to lay out the ground rules for building something as opposed to squabbling over the past, I felt that positive vibe that I had as a Coast Guard officer. I graduated and went straight into corporate law. I stumbled into venture capital, private equity and securities matters at a big firm. I saw M&A as the most challenging form of corporate law.
As time went on, I got a bit tired of dealing with one board-managed company on one side and the same on the other. I saw the smaller deals, where the seller was the founder and operator, as ones where I could get a stronger bit of that “feel good vibe” from my days at sea. Helping the underdog, having the strength of my efforts make a real difference in someone’s life and some family’s lives.
Could you tell our listeners about Benchmark’s range of markets and team?
We are the world’s leading sell-side-only, middle-market M&A advisory. We are on three continents, with 13 offices and 500 employees. Benchmark has grown every year since founding and will close over 200 transactions this year.
Benchmark does only one thing – we assist business owners find the right partner for the largest financial transaction in their life, and make one of the most important transitions in their life. We work with companies across all industries as long as they are healthy and bringing in between half a million and $50 million EBITDA. While they vary greatly in size, geography and focus, what is common is that they are family-owned, family-run businesses with no outside investors.
As such, they share a tremendous set of key attributes when it comes to M&A. They tend to be fly-by-sight instead of fly-by-instrument. They don’t need fancy spreadsheets and projections because they have an intuitive feel for the business health and needs because they live it every day and often times have lived it for over 20 years.
The buyers on the other hand are super-sophisticated, often spreadsheet junkies, that don’t trust other people’s instincts. So they want data, data, data. Our clients don’t have it.
One of our key roles is to bridge that gap. Finding the buyer, marketing the business, negotiating the deal, working with the client’s attorneys on the documentation – are all important, but understanding our client base is key. They need that data bridge and they need someone who understands the emotional side of the process, two key areas we’ve built our business around.
Why are you seeing high demand for electrical companies focused on supporting, repairing and maintaining the grid?
In uncertain times, buyers flock to stability. Utilities have been known to benefit from this in the public markets for decades. People may stop buying Peletons, but they are not going to stop needing electricity. Manufacturers may go out of business leaving a company holding the bag, but utilities do not. Given where we are on the economy's anticipated soft-landing/hard-landing, stability is a key value driver these days.
Electrical demand is surging and the anticipation that it will continue to surge is no secret. EVs and AI are only accelerating that surge. Everybody wants more electricity. So even absent a flocking to stability, it’s a growth market where those are hard to find at present.
Then there’s climate change. Power lines cause fires in California, so utilities are installing them underground. Wind storms knock out power from Oklahoma to Ohio. Stronger hurricane seasons threaten the Gulf Coast and Atlantic Coast in new and more frequent ways. Rising temperatures means more demand for air conditioning.
The nature of electricity is changing, and change creates opportunities and the need for more hardware and services. The old model was one-to-many; one source feeding all the need in a 100-mile radius. The new model is many-to-many; wind farms, residential roof solar panels feeding the grid. Even if demand was not increasing, the flow patterns and machinery is being revolutionized right under our noses.
There are also security issues -- terrorist plots and people taking pot shots at substations with sniper rifles. The system is not only vulnerable to natural causes but also deliberate man-made ones. If we didn’t know that before the war in Ukraine, we certainly do now.
Do you do much work in the distribution space?
Distribution generally, across all industries, has been a very popular and highly valued part of the chain of commerce for over a decade. Forty years ago, mergers and acquisitions were originally focused heavily on manufacturing. But that can move overseas, and has. Distribution cannot. Retail is under threat from online commerce and is subject to the ups and downs of narrow geographies. Distribution is not. The service industry has done well, too. But services are heavier on labor than distribution, and labor is getting expensive and hard to find. So it falls to second place in the manufacturing, distribution, retail and services segmentation.
Something that can’t be moved offshore or driven out of business by offshore providers, is not labor-intensive, has a strong moat and has customer that are extremely low risk is kind of the Holy Grail for business acquirers.
From a macroeconomic perspective, is it a good time to start thinking about exiting or growing your business?
Everyone should always be in a position to sell. The economics of any industry can turn quickly. So the real question is: Is it a good time to see what the market has to offer?
If you are in the electrical, natural gas, or water space but especially electrical, I can’t imagine things being better. There was a time when gravel pits were hot, auto parts stores, anything you can think of gets its moment in the sun. Given the larger forces at play, there is probably not a rush on here. But if the economy comes to some sort of landing, whatever it is, the laser focus on low-risk investments will dissipate and some money will move back to online pet food stores or whatever. There is definitely a surplus of buyside interest in the market at this time.
What kind of demographic trends are fueling M&As right now? (Baby Boomer retirement, etc.)?
A lot of people say a lot of different things on this. I worked in India from 2004 to 2008 doing M&A and I specialized in selling businesses that were founded exactly in 1947. That is the year of the Partition and the end of British rule. All those founders hit retirement age at the same time. That was a demographic push.
I don’t see that in the US. middle-market sellers don’t sell when they hit 65 or 70 or whatever. Our clients are in their 50s. They aren’t looking to retire. They are looking to step back and spend more time with their children or in some cases, their grandchildren. We are even seeing a growing trend of sellers in their 40s.
What drives the seller equation is not the age of the founder but rather the fact that the business has grown to a point where they either (a) feel overwhelmed by the work, or (b) have allowed the work to gradually eat int their family time to a point that is unacceptable.
I can only think of one deal in my last 20, which is as far back as I can recall, in which the founder actually left the business as part of the sale. I do like to stay in touch with former clients and see how the partners we helped them find has treated them. Nine times out of ten, they are still at the businesses five years later and surprised at how much fun it has become once they are not signing the paychecks, guaranteeing the loans and leases, and feeling a bit of imposter syndrome with all their family eggs in one basket.
On our first meeting with a potential clients, the most common reason we hear when we ask why they took the meeting is, “I want my time back.” To many, they think that means a 100% sale and walking away. But they quickly learn that the highest value will come from selling three-to-five years before you want to walk away. Then throughout the process, they fall in love with their business again. They remember they love sales or tinkering or whatever they did when the business was in their garage or basement. When we show them that with the right buyer they can go back to doing that thing they love – and take chips off the table – they get very excited. That is one of the most rewarding things we do in this business.
I think also it has become better known that the time to sell is not when you are ready to retire, but rather five years before then, and that has brought the age down. This not only allows our clients to spread their wealth and lower their risk by selling say 80% of the business, but also gives them a “second bite at the apple,” in which they often make as much on the last 20% as they made on the first 80%, and have a whole new experience with a sophisticated partner exposing them to new ideas, and a fresh chapter in their life.
How much do you think the potential rate cuts may affect the M&A market? Would the cuts loosen up capital?
Absolutely. We saw the higher end of the market, say deals of $100 million to $500 million tighten up significant in Q2 2023. Meanwhile, professional buyers such as private-equity funds kept raising capital but not deploying it. When they did not know what debt would cost in 90 days, it was hard for them to submit offers that would take 90 days to close. So even just the talk of rates going down, instead of up, helped loosen this up a bit.
More importantly though, we say was a fundamental shift in the market for deals of this size when the three banks failed and the government changed capital requirements on banks. As Jamie Dimon, chairman and CEO of JPMorgan Chase, said, “The government is telling us not to make loans to make business.”
As banks created a vacuum, non-bank lenders stepped in. Letting no good crisis go to waste, they charged exorbitant fees for their loans – against traditional standards at least. But banks realized they have to loan to small businesses and have come back into the market. The non-bank lenders have to compete with the banks now. We expect to see lending rates, and more importantly fees, come back down to earth.
I know it’s tough to say there’s an average “incubation period” for the sale of a company. But are there any “rules of the road” for how long can distributors expect the sale of a company to take?
Some will say you need to groom the business. My view is that this is like redoing the kitchen and bathroom before you sell the house. You may not get your money out of it.
First off, your business might not sell. Secondly, you may put in a CFO that is 60% better, but the buyer wants one 80% better. Or you move from Quickbooks to Sage for your accounting system, but the buyer has their own third system they want to use. You made the investment that the buyer thinks has zero value.
We’ve also seen businesses try to do this and then something bad happens that offsets it. They lose their top salesperson, a regulation changes, interest rates spike, or there are supply chain shortages.
It should take two months to go to market -- three months if the owner is very busy -- no more. The blemishes that you wanted to wash away will be seen as “low-hanging fruit” for buyers, and they will increase their multiple because they see them as easy fixes. That’s how you get your credit for the things left undone.
So, two months to go to market, three months on the market, one month to negotiate a letter of intent and sign it taking you into exclusivity and due diligence, and then buyers demand 90 days to close. Deals can often take 120 days to close. This is the ideal scenario, and it takes almost a year. We can truncate it to eight months when necessary, but requires tremendous focus from the seller, and the seller also needs to keep hitting numbers during that time so this type of focus is rare. Nobody shows up to sell because they have extra time on their hands to pull data, meet buyers and work with M&A attorneys. At some point speed cuts into value.
If you had an opportunity to talk for a few minutes with a room full of distributors considering the sale of their business, what would you tell them about how to prepare their business for a sale?
Data is key. The more data you have to share the better. But if you never collected it, you can’t create it now.
Keep hitting your numbers throughout the process. Nothing will drive down value more. If you think you have a solid six months ahead of you, don’t use it up and then go to market. It will worth more to you if it unfolds during the process.
Run the business like you will own it forever. Buyers can smell anything to the contrary. It’s uncanny. And they run when they see it. The biggest bluff (or truth) you have is that you do not need to sell and will only sell if you get top dollar. If you lose that, you’ve lost a ton of value.
Competitive tension is key to deriving maximum value. You need to run a process so that the buyer knows (a) as I just said, there is a very realistic "no sale option" that you are perfectly happy with, and (b) they have to beat not only that option but also every other player in the process.
So, to sum it up, don’t wait to sell until you have to. Do it when you think you might want to.
On the flip side, if you had a room full of potential acquirers, what would you tell them about the best way for them to approach a potential purchase?
Stay focused on the important stuff. Buyers have become too detail-orients on non-material issues.
Don’t make the seller fight for every penny as the closing approaches. Focus on your relationship with them, and make your money by driving value post-closing, not squeezing the life’s work out of someone’s hands pre-closing.
Prove early on that you have the capability to fund any offer you put forth. This has been a terrible problem in the markets as of late and sellers deserve to know the facts on this issue before they dedicate all this time to you and the process.