How to Find the Upside of a Downturn

In a difficult economic climate, private equity firms are working overtime to gain leverage against their competition. From choosing the right deal partners to building relationships, all while minimizing transaction risks, some firms are staying aggressive and finding ways to gain the upper hand.

At ACG’s DealMAX panel, “Staying Aggressive in a Downturn: How Deal Teams Can Gain Leverage Over Competitors,” held in Las Vegas earlier this month, experts discussed how to uncover and utilize strategic advantages in a tough deal environment.

Finding—and Landing—the Right Deals

In shaky financial times, dealmakers need to ensure that the deals they pursue are high-quality. Savvy PE firms are being extremely selective in the targets they pursue and the partners they choose to work with.

“Given the (market) uncertainty, you’d better only make a big investment when you’re certain of the asset you’re buying into. Investing earlier in the process in commercial diligence, building a thesis around a sector, being prepared to execute and really having conviction [are] really important,” said panelist Mike Murray, the managing director of Peloton Capital.

Milwood Hobbs, Jr., managing director and head of sourcing and origination with Oaktree Capital, echoed this sentiment, noting that his team has been very choosy. “No one on my team is anxious to do a deal because our mantra is we want to avoid losers,” he said. “If we’re not sure, we’d rather just not do it. Out of a hundred deals, we’re making one or two.”

Out of a hundred deals, we’re making one or two.

Milwood Hobbs, Jr.

Oaktree Capital

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Francis Carr, co-founder and managing partner of Milton Street Capital, said that in his experience with family-owned businesses, the transaction process can be emotional and volatile—issues that are exacerbated by a tough economic climate. To cope with this, he said his firm emphasizes transparency and follow-through in their dealings.

“(We say) here’s our valuation, here’s what’s underlying our valuation, here are the milestones we see in diligence—just very black and white. (We tell them) we have a 100-point checklist for closing a transaction and we’re now 60 points into that,” Carr explained. “Hopefully when they see that, even if the valuation isn’t what they hoped for, they know exactly how we got there. They now know there’s a buyer out there that’s really straightforward.” 

The Importance of Relationships

Building robust relationships is a necessity even when M&A markets are buzzing, but when the chips are down, sellers seek out people they trust. The panelists noted that building a strong reputation in boom times will give you a leg up in bust cycles.

“When things get tough, sellers are not going to call everybody, they’re going to call three or four firms that they know they can count on,” said Murray. “It’s a good reminder that being known for doing what you said you were going to do, being consistent, and being transparent (is a strength), especially in times like this when (sellers) don’t want to be with someone who’s flighty.”

“We haven’t seen much of a downturn yet, but we’re of the belief that it’s coming,” Carr said. In response, his firm is building direct relationships in the investment banking community, their capital-raising arms, restructuring groups and especially regional banks—relationships that often open doors and facilitate early connections with sellers.

“At the end of the day, relationships matter…Whether you’re a buyer or a seller or a financer, you want to do deals with folks that you want to do deals with,” Hobbs noted. “Ultimately what you’re dealing with is trust and in this market it’s hard to figure out who to trust.”

Minimizing Risk in a Tough Economy

When things are rocky, it’s best to already have a portfolio that can withstand a few bumps and to seek out targets with a high level of resiliency. Shifting market conditions have changed deal. terms and influenced how buyers are looking at prospective investments.

Hobbs says that the market has shifted from one where it was relatively easy to turn a profit to one where private equity firms need to make sure they’re buying the right business with the right leadership at the right time. “I think the interesting transition that everyone’s having to make now is that you’re pricing risk and—at least for us—that means we want to make sure we’re investing in businesses that can manage through increased interest rates and supply obstruction,” he explained.

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Murray said that while his team went into the downturn with a strong, “all-weather” portfolio, they’re now focusing even more on businesses that can withstand downturns.

“Our thesis has always been that we want to buy businesses that have good recession resilience, so we’ve been fortunate in not having to deal with pain in our portfolio today,” he explained. “But when I think of where we’re focusing now, it’d be more on how this business is going to perform in a downturn, has it got that resilience, and (we’re) thinking more about leverage. We’re running a lot of scenarios and thinking about situations that even a couple years ago we just didn’t model.”

Hilary Collins is ACG’s Associate Editor.