While 2020 private equity fundraising may fall below 2019 totals, according to a prediction by PitchBook, deal volume remains extremely high in the Pittsburgh market.
“Our pipeline is as robust as it’s ever been,” says Stephen Gurgovits Jr., managing partner at Tecum Capital, which has more than $850 million in committed capital and about 40 active portfolio companies.
He suspects activity levels are high because people want to do a transaction before the November election in a strong economy.
“Whether that will continue into the second half is pure speculation,” Gurgovits says. “There’s nothing right now that I see that says it won’t — other than the typical uncertainty surrounding any election cycle.”
S&T Bank’s Brian Dobis also sees the election, the economy and good results in 2019 as drivers for heavy activity now.
“As we enter 2020, I think they want to be able to capitalize on that, if at all possible, with a little bit of an uncertain outlook about where the economy goes from here,” says the executive vice president and managing director of Commercial and Industrial Banking.
Smart Business Dealmakers spoke with Gurgovits, Dobis and Rich Lunak, president and CEO of Innovation Works, about what they anticipate for the 2020 dealmaking climate.
How do you see the deal activity trends, and what could alter that?
Lunak: The climate has been so good for M&A activity, there’s only direction it can go. I don’t know that we necessarily see any softening. Debt is still really low, and strategic buyers continue to be involved in a lot of transactions. I remain surprised at the multiples financial buyers pay — and I think part of that is the amount of capital in the private equity markets and their ability to pay strong multiples.
If the economy starts to show signs of moving into a recession, some of that will change. And certainly, the election is a bit of a wild card. I, for example, wouldn’t be surprised if in certain sectors like health care, the IPO window closes in the later part of the year with a lack of clarity on policy positions.
Dobis: There’s definitely some substantive fear out there about trade. We’ve seen the presence of lower valuations on trade-affected deals, with bigger earn outs should the trade market turn around.
I expect valuations and multiples to hold reasonably strong, quite simply because any time there’s even the potential for change (an election year), people try to execute in the old environment. They prefer the known over the unknown.
Gurgovits: It seemed like we were on the cusp of talking ourselves into a recession in late summer — that hasn’t played out yet. There are still headwinds, whether it’s ongoing trade negotiations to mini-cycles in certain industries, but with a lot of capital and high demand, particularly for good transactions, the better the deal, the higher the multiple. That’s just the life we live right now.
What deal structures and terms are being utilized?
Gurgovits: Things are frothy in terms of valuation. With increased multiples, some structures are too loose on the lending side, whether it be covenant rights or overaggressive leverage levels. We’re seeing that creeping up over time, and that continues to be the trend.
When you’re paying more from an overall valuation perspective, a lot of times for equity investors, in particular, to make their necessary returns, you’re going to end up stretching on leverage to cover the gap that’s created when you pay a higher multiple.
Dobis: Banks are a little wiser from the last downturn and looking for better capital structures. Often, they’re asking for more capital to be put in by the new owner.
I’m seeing lower leverage on deals, but I’m also seeing lower pricing. People would rather do a deal at two times senior leverage and price it out at L plus 200, than do it at three times leverage and price it at L plus 400.
Banks are being very prudent about making sure deals have ample amortization, and banks are being responsible with variability to covenants, where there’s a lot of early warning signs or triggers.
Lunak: Through the lens of tech and disruptive deals, I’ve seen, in recent years, more competition over deals than ever before. That drives very favorable terms for the seller. For example, we’re involved in a transaction right now where there’s no escrow.
On the life sciences side, there continues to be a lot of milestone-driven transactions with earn outs.
Do you think the availability of capital will remain high?
Dobis: It’s horribly liquid on all levels of the capital stack. In the senior debt market, banks are being pushed by analysts and others to create asset growth. In the junior debt and mezzanine world, those folks have raised some pretty big funds and it’s a rat race to see who can get that capital out the door, so they can start to prove out returns. And then, of course, you’ve got equity, which has so much money on hand that they can’t find opportunities.
Gurgovits: Now is a good time to be fundraising. A lot of institutions and individuals, for that matter, want exposure to alternative investments. Private equity, as a broader class, is receiving its fair share of those asset allocations, and the more money that’s allocated to the class, that drives up the demand for good deals and, in turn, drives up price.
We try to be prudent and disciplined in how we approach deals, but clearly there is a lot of market pressure as it relates to valuation and leverage levels. I don’t know what changes that, other than some type of slowdown or downturn — whether it’s an outright recession or something that feels recessionary.
We’ve seen mini-recessions in different industries, whether it be manufacturing, which is in a little bit of recession now, or agriculture, which has struggled. But I think it takes a broader slowdown at a macro-economic level to drive down valuations and leverage levels. People have to feel some pain. Otherwise, they’re going to keep stretching in terms of what they pay and how they structure.