I can’t tell you how many times in my investment banking careers – the first doing Wall Street deals in the 1990s and my current with Newport LLC serving the lower middle market with sell-side advisory services – I have seen companies try to get everything perfect in their own house before accessing the capital markets or pulling the trigger on a sale process, only to have the whole plan backfire when the markets correct and every potential investor runs for the exits like in a theatre on fire. The timeless capital markets maxim is that an ideal situation for a company seeking an exit or capital is when the company is perfectly positioned and there is a tailwind in the capital markets. But those times are relatively rare. The more common situations are that (1) the company is not in tip-top shape but the market tailwind is strong, and (2) the company is ideally positioned but the market is blowing a headwind. In the first situation, deals are still very doable and often at very good valuations. In the second, they aren’t, at least at anything above a fire sale price. Every good investment banker is constantly advising companies to always work on improving the situation they can control, but don’t let the lack of improvements keep them away from selling or financing – if that is what they need or want – when a market tailwind exists.
We have intimate knowledge of a situation that is a perfect example. A fast-growing company in highly fragmented but rapidly consolidating industry – one that was fueled by exciting, disruptive technology that in turn drove the major disruption of a number of huge, well established industry players – entertained the idea of selling. Given the pace of consolidation and the high valuations accorded those companies with the best, most disruptive technology and market strategies, we advised them to immediately initiate a sale process that we estimated, based on market comparables, could produce a sales price of approximately $60MM, and possibly as high as $90MM. We advised that market frenzies in which it was immersed are infrequent and the company should hurriedly capitalize on the favorable conditions.
The company and its investors, some of whom are name brand VCs and should have known better, decided to focus instead on polishing the company’s business model and execution, hoping that the company’s improved performance and an even frothier market would produce an even higher valuation. Well, you know how this story goes.
Fourteen months later, the company finally initiated a sale process. But market conditions had changed dramatically. A full-blown industry shakeout was happening, public company comparables had plummeted, and no one wanted or was able to go out on a limb and pay anywhere near what the company was worth just over a year before. Granted, the company had become much stronger from both earnings trend and technical risk standpoints, but it was irrelevant to the market. The market headwind was strong and a sale above $20MM became unlikely. In fact, sale could have been impossible. If it had been, the company would have needed cash to stay independent, but raising cash would have been very difficult given market conditions. The company ended up selling for just under $20MM…all because of its decision to wait and try for a nine-figure (or about a 10X multiple of investment) outcome when it easily had a $50MM (or about a 5X MOI) exit in its reach.
Those of us at Newport can guide you to your finest “transactional judgment” and away from costly mistakes.
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David Traversi, Partner, Newport (firstname.lastname@example.org)