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8/6/2019 2011 Managing Portfolio Investments Survey
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Managing PortolioInvestments Survey
Maximizing value inan evolving market
Experience the power o being understood.
SM
2011
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Foreword 3
Executive summary 5
Survey ndings 7
Focus is power 7
Costly surprises to consider beore striking a deal 10
Holding and growing 13
Optimizing your exit 16
Contributors 21
Table o contents
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This report summarizes telephone interviews with 75 managing
directors, principals and vice presidents who lead private equity
groups investing in the middle-market.
As the domestic market continues to emerge rom the recession,
many o the responses reect past-year deals made in a
less-than-optimal environmentone in which high-quality
companies open to private equity acquisition continued to sit on
the sidelines, waiting or the economic tide to turn in order to be
rewarded with a better price.
Now in an improving economy, prospective buyers are swarming
quality sellers. Private equity groups have capital that is ready ordeployment and are exploring exit strategies or their portolio
companies. For many, the investment horizon or generating
avorable returns is narrowing. For owners o niche-leading
companies, whether private equity-owned or rst-time sellers,
there is now a window o opportunity or a liquidity event at
attractive valuations. McGladrey proessionals expect to see
more activity and major deals in the coming year.
This report was issued in June 2011, in an environment where
middle-market deal activity began to stabilize. While deal
volumes last quarter were down, dollar volumes were up, even
in a mixed environment as some sectors continued to improve
their health.
It is a highly competitive environment or private equity rms,
as quality sellers with a good business model, high sustainable
margins and a strong backlog are commanding interest rom
many suitors. In this environment, it is essential or those
looking to proceed cautiously out o the recession to have strong
relationships when it comes to the deal-making process and
sourcing channels.
Along with commentary rom our private equity specialists,the report that ollows explores trends in private equity
specialization, costly surprises to weigh pre-deal, the rise o due
diligence, evolving hold-and-grow strategies, and actors to
consider in optimizing an exit.
We hope these ndings will help you evaluate your business
practices and provide useul inormation or uture decision
making. Please contact us should you have any questions,
and as always, we welcome your input.
Foreword
In the spring o 2011 McGladrey teamed with mergermarket to conduct an
independent, third-party survey o private equity group senior executives.
This survey reects our desire to provide our clients and riends in the private
equity community with valuable inormation on how your peers are responding
to an improving economy, and ofer insight into the trends impacting your business
in the coming year.
Donald A. Lipari
National Executive Director, Private Equity Services
RSM McGladrey
don.lipari@mcgladrey.com
212.372.1235
Hector J. Cuellar
President
McGladrey Capital Markets
hector.cuellar@mcgladrey.com
714.327.8636
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Executive summary
Focus is power
Last years McGladrey report on portolio management
showed the tail-end o a narrow add-on acquisition strategythat populated the post-crash downturn. Private equity
groups are turning the corner and opening their checkbooks,
as acquisition operations will be largely centered on platorm
rather than add-on acquisitions. Sixty percent o respondents
reported that they would be spending more than hal their
acquisition time in 2011-12 ocusing on platorm acquisitions.
Amid a more competitive bid environment, buyers appear
to be considering industry specialization as a way to set
themselves apart rom other would-be buyers, with nearly
a third o respondents describing their private equity groupsas generalists, but saying they intend to narrow their ocus
on specic sectors.
Costly surprises to consider beore striking a deal
Advisors are also being hired to work in a once-viewed
unnecessary areapre-letter o intent (LOI) due diligence.
With increased competition on the buy-side, exclusivity time
has been cut short, i not eliminated, and private equity
practitioners are beginning to see the benet in adding the
help o third-party expertise even beore signing an LOI.
An indication that IT may be underestimated in the deal-
making process, respondents stated that management
reporting limitations incurred the greatest surprise costs
post-investment (47 percent), ollowed closely by unoreseen
capital expenditures (44 percent)both areas ultimately tie
back to inormation systems.
Holding and growing
When private equity groups are able to put their stamp on
a portolio company, they tend to be hands-on. Fund managersmost requently make changes to nancial reporting,
management and human resources, while simultaneously
ocusing on expansion, acquiring bolt-ons and introducing
new products and services.
In measuring their own impact, respondents eel they
requently increase top-line growth when theyre highly
involved in increasing operational eciency, and optimizing
pricing strategy and organizational structure.
Optimizing your exitThird-party specialists are receiving increasing attention rom
private equity groups. Outsourced due diligence expertise is
approaching standard practice ater post-closing surprises
took their toll on portolio revenues. A likely tie-in to a third
o respondents hiring third parties to perorm sell-side due
diligence more requently than ve years ago.
With the increasing popularity o IPOs as an exit strategy,
the majority o respondents agree the time required to make a
company IPO-ready is long, with 55 percent reporting that they
begin preparing within 18-24 months beore the intended IPO.
Private equity strategies and the dealmaking process are in
a redening phase as many rms make adjustments based on
the lessons theyve learned since the nancial crisis. A small
ew have barely adjusted their approach, but the overall
market is clearly changing.
Ater a ew quiet seasons, nancial buyers returned to the market amidst improving
valuations, better access to capital and pressure to deploy dry powder. Current deal
activity resembles 2006 rather than 2008 with less consolidation and more actual deal
closing, but some processes have changed or private equity groups as they hope to
avoid the errors that caused widespread losses just a ew years ago.
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Asked to describe their investment strategy, nearly a third
o respondents described their private equity groups as
generalists, but said they intend to narrow their ocus on
specic sectors. And more than hal o respondents plan to
spend 25 percent or less o their time on add-on acquisitions,
a shit rom McGladreys 2010 report, in which respondents
split their ocus between platorm and add-on acquisitions.
Investment strategy
McGladrey believes the desire or industry specialization makes
sense, as that specialization can be used to create operational
eciencies. Those eciencies are the hardest to come by, but
are the most valuable ways to improve growth. And when a
private equity group targets a company, that specialization can
help them stand out rom the crowd o buyers and be a true
diferentiator. When a rm decides to specialize, it leads to much
easier alignment between the private equity management team
and a portolio companys operating partnersboth groups are
more likely to have an easier time understanding one another,
and one anothers operations.
Which o the ollowing best reects your
investment strategy?
Moreover, buyers who have spent time pinpointing key sectors
and subsectors oten come out ahead when sellers investmen
bankers create a buyers list or an auction process. Current and
prior investment history plays a key role in determining which
groups have experience in a sector and will be able to quickly
understand the target companies business.
Trend data generated by mergermarket supports the ndings
o this research. During the last 12 months in the United States
the industrials and chemicals sector was most active in buyout
volume.
These companies will continue to be attractive acquisition targets
or private equity groups in the coming year. That industry was
surveyed as part o our Spring 2011 Manuacturing & Distribution
Monitor, which indicated that 90 percent o manuacturing
respondents are very or somewhat optimistic about their
companys prospects or overall growth over the next 12 months.
Steve Menaker, East Region Manuacturing Practice Leader,
RSM McGladrey
US Private Equity Buyout Volume
(Last 12 months)
We are generalistsand invest in manydiferent sectors
We are generalists,but intend tonarrow our ocuson specic sectors
We are sectorspecic and will
remain that wayWe are sectorspecic, but willexpand into othersectors
49%
33%
14%
4%
Industrials andChemicals
Business Services
TMT
Consumer
Healthcare
Financial Services
Energy/Mining/Utilities
Leisure
Construction
Transport
Real Estate
Agriculture
Deense
10%
8%
6%
4%3%2%
1% 1%
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Healthcare and technology, media and telecommunications
(TMT) trailed closely with 15 percent and 10 percent o all
buyouts, respectively. The healthcare and manuacturing sectors
also continue to sustain high levels o activity, which the 2010
McGladrey survey anticipated.
Platorm vs. add-on
In specic interview commentary, many respondents said they
intend to expand and indicated the majority o their platorm
acquisitions will target the manuacturing, industrials and
healthcare sectors. In contrast, add-on ocused rms will target
technology companies.
Business services (18 percent) and consumer (13 percent) are
also popular sectors with private equity investors. Indeed, the
largest buyout o 2010 was the $5.2 billion acquisition o Del
Monte Foods Co. by a consortium o private equity investors
led by KKR.
A number o consumer products companies, in particular non-
durables, are more recession-proo. Investors have been drawn
to the sector or this stability, as well as or good values and thepotential upside these companies oer in a recovering economy.
Cristin Singer, Food & Beverage Practice Leader, RSM McGladrey
Sixty percent o respondents reported that they would be
spending more than hal their acquisition time in 2011-12
ocusing on platorm acquisitions, compared with 18 percent
o respondents who said the majority o their acquisition ocus
would be on add-ons.
The divide is unsurprising. Coming out o a recession, now is
the time to buy better-perorming companies, compared tothe heavy recession period, when add-ons were likely seen
as a better t or a saer strategy.
In the improved economy, capital is readily available, and
private equity groups can deploy more o that cash through
platorms acquisitions. From the activity we are seeing with our
private equity clients, this redeployment o capital has begun
and we consider it a positive sign or uture economic conditions.
Perorming companies in the middle market continue to be
a stabilizing orce in our economy.
Bob Jensen, Great Lakes Region Private Equity Services Practice
Leader, RSM McGladrey
What percentage o your acquisition time will be ocused
on platorm acquisitions or add-ons to existing platorms
in 2011-12?
Platform acquisitions
Add-ons
None
Under 10%
Between 10%and 25%
Between 25%and 50%
Between 50%and 75%
Between 75%and 100%
21%
37%
23%
4%6%
9%
None
Under 10%
Between 10%and 25%
Between 25%and 50%
Between 50%and 75%
Between 75%and 100%
41%
22%
13%
5% 1%
18%
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Firms in the survey also viewed ewer consolidation-ocused
buyouts, where cost cutting and synergies were at the
oreront o the acquisition plan, as a sign o a more expansive
market. One respondent commented, Platorm acquisitions
have been giving us consistent growth potential with stable
incomes. Private equity seems to be moving away rom the
abundant consolidation o recent years. A poor economic
environment leads to consolidation through add-ons, said
another respondent, relating increased portolio expansion
to a positive economic climate.
These results are consistent with what our proessionals are
seeing. Private equity groups are eeling pressure to deploy
capital. Financing is readily available or higher multiples.
The perect storm may be gathering, leading many private
equity groups to believe now is a better time to do a bigger
acquisition.
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The middle-market is the largest area o investment or private
equity groups, and 48 percent o middle-market companies
are private equity-owned according to U.S. Census data. As
activity continues to heat up, the unique challenges and
opportunities that accompany those potential portolio
companies cannot be overlooked.
Now that a quality sellers market has arrived and the overall
M&A marketplace has shited toward a competitive bid
environment, the trend toward conducting more intensive due
diligence prior to executing a letter o intent (LOI) will likelycontinue in the coming year. Accompanying the continued rise
o due diligence in U.S. private equity deals, respondents said
a record 22 percent o the due diligence they perorm beore
signing an LOI is now external.
Third-party due diligence expertise is an increasingly
important part in the standard private equity buyout process.
While some rms preer to keep their due diligence activities
in-house (one survey respondent said conducting the work
afords the private equity group the opportunity to get to
know management better), a growing number are seeing
benets in seeking external expertise, particularly since the
2008 crash when pre-LOI due diligence was rare.
It remains a potential battleground or quality platorm
companies and private equity rms are in a renzy to gain
position with sellers, making it a potentially dangerous time to
be a buyer. Strategic buyers have cash and are back in the game
aggressively pursuing synergistic acquisitions.
Hector J. Cuellar, President, McGladrey Capital Markets
And the simple act is that while some larger private equityrms may have the resources to conduct due diligence,
many smaller groups lack such internal resources. One und
manager respondent said, Using a third party or legal and
technical diligence is essential. The importance o seeking
outside expertise has been spotlighted by many rms ater
the nancial crisis.
What percentage o the due diligence that you perorm
beore you sign an LOI is internal or external?
The shit in the market to avor sellers, and the increased
competition rom strategic and private equity buyers, has had
several proound eects on the deal process and due diligence.
Exclusivity time is shorter and sometimes not granted, which
makes it essential to understand due diligence best practices.
Joe Kinslow, Transaction Advisory Services Director,
RSM McGladrey
What was the most costly surprise youve experienced
ater investment?
(select top three)
External
Internal
78%
22%
Percentage o respondents
47.2%
44.4%
41.7%
40.3%
36.1%
33.3%
13.9%
8.3%
0% 10% 20% 30% 40% 50%
Inadequate IT systems
State and local taxnoncompliance liability
Management capabilitylimitations
Improper accountingmethods
Customer retentionand concentration
Unforeseen workingcapital requirements
Unforeseen capitalexpenditure needs
Management reportinglimitations
Costly surprises to consider beore striking a deal
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In examining the deal-making process, respondents reported
that management reporting limitations incurred the greatest
surprise costs post-investment. Especially in cases in which
external advisors were not brought in earlier, or when a
company is rst-time sold, it is common or reporting xes to be
one o the undamental things tackled ater a new acquisition.
There is a direct correlation between high caliber management
and good inormation. Private equity groups want good
inormation, and usually make getting good inormation a
priority, as that is a core part o their management approach.
Typically, sponsor-owned companies that have already been
sold once and have moved away rom their ounder will have
better systems and inormation, and thus less costly surprises
on average. For a rst-time sold company, there is a lack o
transaction accounting experience, and the early days as a
portolio company are oten characterized by the need or
care and eeding by private equity groups. This is necessary
not only in terms o reporting, but to ensure the platorms
have consistent reporting across portolio companies and or
associated implications, be it regular and routine issuance o
K1s, or gaining an understanding o business issues, such as
inventory turn, in a timely ashion.
A lot o these costly surprise actors ultimately tie back to
inormation systems. I equate categories like management
reporting limitations and unexpected capital expenditure needs
back to IT. Our experience has seen a marked increase in the
number o rms including IT in their diligence process; these
responses underline the reasons more rms need to do so as soon
in the process as possible.
Jane Shaer, Technology Consultant, RSM McGladrey
Eighty-ve percent o survey respondents said they have
adjusted the purchase price in at least one transaction. And o
those respondents, nearly hal reported one in every our deals
required an adjustment.
I anything, in the context o a market in which the importance
o due diligence is rising, it was surprising to see that 15 percent
o survey respondents said they had not encountered
the need to adjust purchase price. Usually, adjustment
mechanisms are built into acquisition contracts. One possible
explanation is that some respondents may make concessions
outside o purchase price.
Over the past year, what percentage o deals required
an adjustment to the purchase price?
Fair or unair, the view occasionally taken by investment banks
is that when there is a purchase price adjustment, somethinghas gone wrong. The end result is an occasional concession
on other terms. Whatever the vehicle, the key is identiying
a problem and getting value or identiying that problem.
Hal the surveyed population had 25 percent or more retraded
a signicant adjustment to the purchase price. The expectation
is the months ahead will see more retrading than what occurred
during the look-back period surveyed.
The companies that have come to market to sell over the past
year were generally not as clean, not as high quality, and were
accompanied by more issues. Its not surprising that once privateequity groups got in there, they ound issues and started the
retrading exercise.
Milton Marcotte, National Managing Director-Transaction
Advisory Services, RSM McGladrey
None
Under 10%
Between 10%and 25%
Between 25%and 50%
Between 50%and 75%
Between 75%and 100%
32%
25%
9%
11% 15%
8%
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How oten do each o the ollowing issues play a role
in purchase price adjustment?
Respondents said the primary issue or purchase price
adjustment is inaccurate EBITDA calculations, with working
capital needs and pro-orma adjustments similarly signicant.
Many respondents admit that an adjustment, albeit not always
signicant, is made or each o their transactions.
Considering EBITDA multiples, adjustments have a signicant
impact on returns. The value is in identiying the adjustment,
lowering the purchase price, and receiving a better return in the
end. Also, the number o surprises post-closing will be reduced.
Bill Spizman, Managing Director-Transaction Advisory Services,
RSM McGladrey
Private equity groups should be sure to take caution; a targets
ailure to comply with state and local tax ling requirements
can oten lead to signicant tax exposure requiring escrows,
indemnications and purchase price adjustments.
In your experience, how valuable are each o the ollowing
advisory areas during the typical transaction process?
(where 1=limited/no value and 5=immense value)
Legal advisory is seen as the most valuable advisory position
in the typical transaction process, with nancial, operational
and tax advisory closely behind. Environmental due diligence
is important or sector-specic situations, according to
respondents, especially in the manuacturing sector, where
environmental regulatory issues are more prominent.
Whether dealing with regulatory and contract issues, or when
providing a tax-efcient structure, obtaining the correct legal
and tax advice is critical to any transaction.
Nick Gruidl, Managing Director - Mergers & Acquisitions
Tax Practice, RSM McGladrey
Bearing in mind the costly surprises encountered post-deal
many o which tie back to IT expenditures the low ranking
awarded to IT suggests a possible disconnect in deemed
value. Private equity groups should consider whether they areperorming enough diligence in the area, and ensure they scope
accordingly to ensure they allow IT to add value and insight to
the process.
Percentage o time
0% 10% 20% 30% 40% 50% 60% 70% 80%
IT Systems requiringsignicant investment
State and local taxnoncompliance issues
Revenue recognition not inconformance with GAAP
Non-recurring revenue
Pro-forma adjustments
Working capital needs
Inaccurate EBITDA 73.4%
71.4%
70.0%
60.8%
58.6%
55.8%
52.8%
Degree o value
1 1.5 2 2.5 3 3.5 4 4.5
HR
IT
Environmental
Tax
Operational
Financial
Legal 4.14
4.05
3.9
3.7
3.16
2.96
2.88
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Delving deeper into the relationship o private equity rms
in the hold-and-grow stage with their portolio companies,
respondents were asked to identiy the areas in which their
involvement had the greatest impact on creating top-line
growth.
The responses ound that general partners most requently
believe that taking a hands-on approach adds the greatest
value, especially when they get involved in increasing
operational eciency and optimizing pricing strategies.
How oten does direct involvement by a und executive in
each o the ollowing areas lead to top-line growth?
That increasing operational eciency tops the list is no
surprise, as that is a primary driver behind maximizing value.
The rise o the operating unction is a distinctive trend in
private equity. Whether bringing on board operating partners
or working with external advisors who have the appropriate
operational and industry experience, private equity rms with
these expert resources can dramatically improve their portolio
companies perormance.
While comparatively ranking as a lower area o ocus,
increasing sales orce efectiveness and providing industry
sector expertise, should not be discounted. Industry expertise
in particular is noteworthy, since some o the most valuable
ways to create operational eciencies oten begin with a deep
understanding o the business and the market. The same
is true o optimizing pricing strategy.
As a previous question ound, nearly hal o all private equity
groups said they were either sector specic (14 percent), or were
generalists planning to narrow their sector ocus (33 percent).
Asked about the particular areas most likely to be afected
by change throughout the investment liecycle o a portolio
company, nancial reporting and controls is rated the most
requently targeted area, ollowed closely by management
efectiveness and compensation structure and design.
These days, it is rare or a rm to simply buy a company and
not make numerous changes to enhance the organization.
How requently do you make changes to the ollowing
areas o your portolio company?
Respondents noted that although specic changes vary rom
company to company, consistency is maintained with respect
to certain areas. One respondent said system tweaks can
oten be implemented at portolio companies that otherwise
need to make ew changes to improve perormance. Another
segment o respondents revealed a tendency to requently
change compensation structure while rarely changing IT
systems or product designs/service processes; requency in
other areas difered rom respondent to respondent.
That compensation structures are oten modied is another
key takeaway.
Percentage o time
67% 69% 71% 73% 75% 77%
Providing industry
sector expertise
Increasing sales forceeectiveness
Guiding go-to-marketstrategies
Optimizing organizationalstructure
Optimizing pricing strategy
Increasing operationaleciency
76.8%
73.2%
71.6%
71.0%
71.0%
70.6%
Percentage o time
0% 10% 20% 30% 40% 50% 60% 70% 80%
New product design/service process
IT systems
Business model innovation
Resource utilization
Cost eciencies
Compensation structureand design
Management eectiveness
Financial reportingand controls
76.4%
76.8%
78.4%
74.2%
67.6%
65.2%
60.8%
60.6%
Holding and growing
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In particular, rst-time sold, owner-managed companies oten
do not have a compensation structure in place that is truly aligned
with value creation. Private equity groups put that alignment in,
which is why respondents cite changes around compensation
structure as happening so requently. That can be correlated to how
oten a portolio companys personnel is changedprivate equity
groups may not make a ton o people changes, but the end result is
enhanced management eectiveness.
Milton Marcotte, National Managing Director-Transaction
Advisory Services, RSM McGladrey
When asked about strategies or optimizing perormance
and reducing costs, only implementing consistent, automated
reporting and insurance coverage and brokerage are
reported to be used over 60 percent o the time. The relatively
lower scores in other areas suggest a lesser sense o urgency
in regard to cost-cutting strategy. This marks a contrast to
the 2010 report, where consolidating costs among portolio
companies in a wide variety o areas was a key ocus.
Reecting back on the costly surprises that accompany new
acquisitions, it is apparent that private equity groups aremaking a air number o changes in a variety o areas, and
perhaps are surprised about how many o those changes they
have to make.
How oten do you implement the ollowing strategies
to optimize perormance and reduce costs across all
your portolio companies?
Improved nancial perormance o portolio companies can
come either rom cutting costs or increasing revenues. While
there appears to be less emphasis on cost cutting, engaging
in growth initiatives such as geographic expansion, the
acquisition o add-ons to grow the business, and development
o new products and services are in the cards or 2011 and
beyond, according to respondents.
Engaging in growth changesactivities such as expanding
into oreign markets and/or increasing research and
development investmenteven hal or more o the time, ascited in the respondent answers, can have a very meaningul
impact when it comes to a portolio companys uture outlook
The end result o those activities gets to the heart o the
private equity model.
Many acquired companies are somewhat or signicantly
undermanaged. To an owner managing a company, growth
may be airly important, but within the context o the private
equity group environment, growth becomes extremely
important. The diference between an owner satised to
manage and maintain as opposed to a private equity group
that is adding an emphasis on growth is a major shit. The
business model is built around proessional managers who
understand how smart resource investments can transorm
a portolio company.
How oten do you implement the ollowing changes
to your portolio companies?
Percentage o time
0% 10% 20% 30% 40% 50% 60% 70% 80%
IT server consolidation
Outsourcing networkmanagement
Network/carrier selectionand consolidation
Strategic sourcing/procurement
Consolidation ofservice providers
Insurance coverage
and brokerage
Implementing consistent,automated reporting
59.0%
67.8%
71.6%
58.6%
58.4%
51.4%
49.4% 0% 10% 20% 30% 40% 50% 60% 70% 80%
Increase R&D expenditures
Expand into foreign markets
Divest non-core assets
Introduce new products/services
Acquire add-on acquisitions
Expand into new domesticmarkets
67.6%
69.4%
70%
56.6%
55.6%
53.0%
Percentage o time
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The careul management o private equity investments,
coupled with the industry expertise and business acumen o
senior executives, allows private equity rms to add value to
portolio companies. Respondents revealed a clear tendency
among middle-market private equity rms to retain their key
management, particularly the CEO.
We always try to retain the key management and work
with the existing team, commented one respondent.
Many respondents echoed that sentiment. Explaining his
rms thorough target identication, one und manager didadd he will consider the probability/necessity o changing
management when it is needed to improve the business.
The overall results or likely retention o top executives
trended higher than anticipated, particularly in the case o the
CEO. The assumption might be that the chie executive is the
roadblock to implementing change in an ecient manner,
and the person most responsible or having sub-optimized
the company making it ripe or acquisition by a private equity
group. Thus, such a high proclivity to retain the chie executive
is very surprising. One explanation may be that deals wherein
the CEO is retained or an agreed-upon amount o transition
time is not reected in the responses.
How oten do you retain key management executives
ater an acquisition?
Percentage o time
66% 68% 70% 72% 74% 76% 78% 80% 82% 84% 86%
Controller
VP Human Rescources
VP Operations
CFO
VP Sales
CEO 84.2%
78.2%
74.2%
74.0%
72.6%
71.8%
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Optimizing your exit
As management teams prepare to exit, and weigh sales to a
strategic buyer or an IPO exit, the team can expect to spend
long days acing dicult decisions, many or the rst time.
Companies need to have a credible nancial team in place to
weigh all the organizations options. The rst step o the process
begins with determining whether a company is actually ready
to go public, and taking a hard look at the nancial numbers.
As the economy has turned in the past year, market conditions
have ollowed suit, witnessing a signicant increase in the
volume o deals in 2010 and through the rst hal o 2011.
Sell-side due diligence is also becoming more prevalent, both
or buyers seeking reassurance, and or sellers who want to do
everything possible to optimize their exit price.
U.S. Private Equity Exits
Volume Value USD (m)
2006 703 128,617
2007 737 152,032
2008 441 81,097
2009 324 37,969
2010 560 110,862
H1 2011* 184 22,982
source: mergermarket.com * H1 2011 as o 5/23/2011
There is a large inventory o portolio companies ready to be
sold. Private equity exits have increased signicantly over the
last ew months and we expect this trend to continue.
Gina Hintz, Co-Head o Private Equity Coverage Team,
McGladrey Capital Markets
The volume o private equity exits declined in response to
deteriorating economic conditions rom 2007 to 2009, but
witnessed a comeback in 2010. Many private equity groups
held onto investments or longer than usual in anticipation
o improved market conditions, nancing and valuations.
Another actor in the uptick o exits: proposed changes to
carried interest tax policy, which threaten to change the way
the private equity industry is taxed on income.
Whether private equity will gain time to plan and execute
exits in a revitalized economy, or be hastened by new tax
policy, respondents highlighted several issues to consider
in optimizing value. According to one und manager,
Unreported accrual awareness is the main issue.
When exiting an investment, how important are each
o the ollowing issues?
(where 1 = unimportant and 5 = extremely
important)
Much o the work in the planning stages o a transaction is
ocused on the quality o earnings. Companies need to get
to a point where they have produced three years o quality
nancials that are comparative when looked at year to year.
While the equation to get there may be simple, it comes
down to having the right team in placethe experience and
credibility o a companys nancial management team is what
will most directly impact the quality o earnings.
Unquestionably, private equity groups need to develop the
right exit process to optimize value. The downturn in thedomestic market continues to dictate the necessity or sell-side
due diligence, which has long been a more prevalent practice
in Europe.
Degree o importance
1 2 3 4 5
Valuing intangibles
Unreported accrual awareness
Identication and treatmentof non-recurring items
Tax liability accuracy
Revenue recognition accuracy
Quality of earnings levels
3.75
3.77
4.42
3.66
3.42
3.09
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With the depressed economy, the number o exits has been
suppressed in recent years. Because the market is coming
back, sellers want to make sure they receive optimal value.
Third-party experts can help eliminate anything the market
may attempt to use to discount the price.
One nuance is that right now, some o the companies that are
selling have gone through difculties. Those companies have a
story they need to bring credibility to through a sell-side diligence
exercise. Because o non-normal activity in the marketplace that
typically accompanies a major recession, many companies haveweathered a number o issues, be it downsizing, restructuring,
loss o accounts, big A/R write-os. They need to credibly show
that their business is sound in order to maximize value.
Scott Vanlandingham, East Region Financial Advisory Services
Leader, RSM McGladrey
Do you perorm outside (third-party) sell-side
diligence more requently now than ve years ago?
One-third o respondents perorm sell-side due diligence more
requently now than ve years ago. Bringing in outside expertsto help prepare a company or an exit can allow management
to ocus more time on running the business, while helping
optimize EBITDA and exit price, according to respondents
commentary.
One managing director summarized the trend by stating that:
Third-party sell-side due diligence greatly helps in addressing
and clearing up issues with technical, HR, nance and others
that arise during the course o investment, thus helping
in understanding the right value or the deal and eventual
success o the deal.
The upswing in sell-side due diligence is not surprising and
corresponds to the other major shit in the market: more
buy-side scrutiny on the deals.
The uptick o sell-side due diligence can be largely attributed
to the intensication o buyer due diligence, which is a direct
outgrowth o economic conditions. Buyers typically have to put
more o their own capital into deals nowadays, so they not only
are acing potentially lower returns, but greater risk that an
overlooked problem at an acquisition candidate could blow up in
their aces.
Bill Spizman, Managing Director-Transaction Advisory Services,
RSM McGladrey
IPOs
On the IPO ront, while the market is a key driver o IPO
decisions, it is not alone. Structure and timing in going publicare key, and become complicated in liquidating ater the IPO
is raised, one und manager said. Respondents also pointed
to poor current market conditions and stronger competition
rom strategic buyers.
Market conditions are a relatively sae place to lay the blame
or dismissing an IPO, but cost was a surprisingly prominent
reason to dismiss an IPO as an exit strategy. Presumably,
the value o an IPO will dwar the cost. The reality is that i a
company is struggling to remain SOX compliant, or lacks good
internal controls, chances are it will never be in a position to
seriously consider an IPO.
Giving up control may be part o the perceived cost in pursuing
an IPO, and that a strategic buyer may sometimes present a
better option. Alternatively, a company may decide the IPO
is not large enough when weighed against the surrender o
control. There may also be a need to upgrade the talent o a
companys team. Prior to reaching the IPO, a company should
Yes, much morerequently
Yes, somewhatmore requently
No change
No, less requently
No, much lessrequently
65%
1%1% 14%
19%
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have both a CEO and CFO in place with experience leading an
IPO, as well as an SEC reporting person and a solid legal team,
whether internal or a third-party provider.
For companies where an IPO was seriously considered but
dismissed as an exit strategy, which o the ollowing were
the primary reasons why?
For those who choose to go ahead with an IPO, the key issues
do not change. Respondents are most concerned with market
conditions, valuations and cost.
The majority o respondents (55 percent) expect to get a
company IPO ready within 18-24 months, with an additional
35 percent ocusing on the exit 12-18 months ahead. Several
respondents echoed the comment that with the current
requirements, the time required to make a company IPO-ready
is long.
Ninety percent o companies begin investing time and resources
toward IPO readiness between 12 and 24 months beore the
intended IPO. Our experience has been that this may leave them
short on time, since systems are such a critical component o the
process and oten the necessary modications o the systems
and the related business processestake more time to eectively
introduce and become operational with.
Stan Mork, Managing Director-Technology Services,
RSM McGladrey
At what point when considering an IPO as a potential exit
strategy do you begin investing the time and resources to
get the company IPO-ready?
While the length o time to prepare or an IPO doesnt vary
widely rom company to company, the reality is that there are
many companies we work with who believe they are much
closer to IPO than they truly are.
Some clients estimate they are months away rom an IPO but then
require years to le their registration statement. To me, the IPO isgoing to get you a large enough value that its worth the pain.
Scott Vanlandingham, East Region Financial Advisory Services
Leader, RSM McGladrey
Percentage o respondents
0% 10% 20% 30% 40% 50% 60% 70%
Other
Lack of corporate preparation tomeet regulatory requirements
Length of time required tocomplete the oering
Strategic buyer wasa better option
Cost
Market conditions/valuation
38.0%
59.2%
63.4%
38.0%
35.2%
4.2%
Greater than 24months
Within 18-24months
Within 12-18months
Within 6 months
35%
6% 4%
55%
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About mergermarket
mergermarket is an unparalleled, independent mergers &
acquisitions (M&A) proprietary intelligence tool. Unlike any
other service o its kind, mergermarket provides a complete
overview o the M&A market by ofering both a orward-
looking intelligence database and a historical deals database,
achieving real revenues or mergermarket clients.
For more inormation please contact:
Matt Leibman
Publisher, Remark
The Mergermarket Group
Tel: +1 212 686 6305
Email: Matt.Leibman@mergermarket.com
About Remark
Remark, the events and publications arm o The Mergermarket
Group, ofers a range o publishing, research and events services
that enable clients to enhance their own prole, and to develop
new business opportunities with their target audience.
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Contributors
The ollowing individuals contributed to the design
and development o this study.
Ben Brandes
Director, RSM McGladrey
ben.brandes@mcgladrey.com | 617.241.1379
Hector J. Cuellar
President, McGladrey Capital Markets
hector.cuellar@mcgladrey.com | 714.327.8636
Nick Gruidl
Managing Director - Mergers & Acquisitions Tax practice,
RSM McGladrey
nick.gruidl@mcladrey.com | 612.629.9686
Gina Hintz
Co-Head o Private Equity Coverage Team,
McGladrey Capital Markets
gina.hintz@mcgladrey.com | 714.327.8209
Bob Jensen
Great Lakes Region Private Equity Services Practice Leader,RSM McGladrey
bob.jensen@mcgladrey.com | 847.413.6221
Joe Kinslow
Transaction Advisory Services Director, RSM McGladrey
joe.kinslow@mcgladrey.com | 410.246.9190
Don Lipari
National Executive Director o Private Equity Services,
RSM McGladrey
don.lipari@mcgladrey.com | 212.372.1235
Milton Marcotte
National Managing Director-Transaction Advisory Services,
RSM McGladrey
milton.marcotte@mcgladrey.com | 312.634.3143
Steve Menaker
East Region Manuacturing Practice Leader, RSM McGladrey
steve.menaker@mcgladrey.com | 704.442.3851
Stan Mork
Managing Director-Technology Services,
RSM McGladrey
stan.mork@mcgladrey.com | 612.376.9233
Jane Shafer
Technology Consultant, RSM McGladreyjane.shafer@mcgladrey.com | 319.896.5423
Cristin Singer
National Food & Beverage Practice Leader,
RSM McGladrey
cristin.singer@mcgladrey.com | 212.372.1184
Bill Spizman
Managing Director-Transaction Advisory Services,
RSM McGladrey
william.spizman@mcgladrey.com | 312.634.4422
Scott Vanlandingham
East Region Financial Advisory Services Leader,
RSM McGladrey
scott.vanlandingham@mcgladrey.com | 703.336.6548
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Power comes rom being understood.SM
When you trust the advice youre getting, you know your next move
is the right move. Thats what you can expect rom McGladrey.
Thats the power o being understood.
www.mcgladrey.com
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