When I hear the expression, “what’s old is new again,” I’m apt to reflect fondly on the days of yore, how something from the past – vinyl records, bell-bottoms, (hell, actually using a phone for talking) – has re-established itself in the contemporary ethos, having undergone a transformation, evolution, or innovation of some kind, and having done so, become a better version of its prior self. Alternatively, when that same expression evokes feelings of disappointment because that which is new again hasn’t changed at all, or worse, has morphed into a lesser or deficient version of itself, or in the case of the titular business practice, a straight-up plague, I feel compelled to ask myself why has it come back at all? Such is the case with private equity’s dusting off of the re-trade which has come roaring back in 2018. I can’t help but ask why Private Equity firms have reanimated this anachronistic, tactical, M&A punch-bowl turd, especially in a market where demand for quality payments and payments technology properties is extraordinarily high? It makes no sense – at least not at first glance.
Perhaps my reaction is a bit excessive. Well, that’s for good reason. The re-trade’s resurgence contravenes common sense. Just look at this excerpt from KPMG’s, “Pulse of Fintech Report”:
PE Activity rising dramatically in the US
A strong US economy helped to boost interest and investment in the fintech space during Q4’17. The growing maturity of key sub-sectors within fintech, such as payments and lending, has also led to larger deals, and increased interest by private equity (PE) firms and corporates interested in making strategic acquisitions. PE investment skyrocketed during Q4’17, accounting for $3.4 billion in deals activity – the second-highest quarter of PE investment in fintech on record.
With the amount of private equity money chasing opportunities in payments and payments technology (fintech), one may figure that market dynamics would be such that high demand would necessarily make a stratagem like the re-trade a net-negative outcome proposition – especially over the long term. Competing PE firms consistently trading down on deals would be toxic to the marketplace, creating cynical sellers and a potential long-term aversion to dealing with PE firms altogether. One may intuit (and rightly so) that to not employ the re-trade would have a better payoff. But this is not the case. So, what’s really going on here?
If one were to view individual deals in isolation – as one-off occurrences – the re-trade makes sense. The tactical value of the re-trade is obvious: why not try to capture a property at a lower valuation by leveraging the promise of a quick funding event against an alleged deficiency in the property being acquired? In a pure business sense, it’s hard to fault a private equity buyer for (a) utilizing this tactic to capture a property at a better price, and (b) putting forth the argument for doing the same. However, as posited above, if we look at the sum of PE deals being consummated over a more durative time frame, the practice of repeatedly employing the re-trade as a tactical ploy to subvert paying higher valuations increases the probability that there will be lasting negative consequences for the PE community. I would argue this is all but a certain outcome.
So, it appears that what we’re witnessing in today’s marketplace is Private Equity’s calculus that the short-term benefit of utilizing the re-trade to acquire properties at lower valuations outweighs the long-term, arguably self-defeating, value of its continued usage. Now, I’m no logician, but does that make sense? Private equity groups generally average between four and eight year holds on their portfolio companies, so why mortgage their own future, and the good-will needed to continue to transact? There must be something else at work here – the resurgence of the re-trade can’t only be about trying to transact at lower valuations.
Counterintuitively, the high demand and low inventory market dynamic for quality payments and fintech opportunities is driving the re-trade resurgence because it’s the by-product of private equity groups floating super-premium valuations (which they don’t expect to pay) in an effort to lock up and secure exclusive negotiations with quality acquisition opportunities – keeping the target away from competing firms. It’s not about valuations – it’s about eliminating competitors in an active market.
It is this defensive tactic that’s driving the high occurrence of re-trades. How about that chain of causation! High demand and low inventory aren’t causing PE groups to compete on better terms and act in good faith; conversely, these factors are compelling them to proffer unrealistic and/or disingenuous terms without any intention of transacting on the same, all towards the end of pulling quality targets off the market quickly, thereby fending off competition. To the extent that PE groups transact at a lower valuation is just a bonus.
Want some proof? Here’s a metric for you: >90%. Yes, in representing sellers in traditional, sell-side processes, greater than nine out of ten PE groups will try to pitch a seller on the dangers of competing PE groups because the other private equity groups will most certainly attempt to re-trade them. In other words, the PE groups themselves are acknowledging the pervasive usage of the re-trade among their own community.
Now, for a BIG disclaimer…
Obviously, the practice of re-trading is not being employed by the entire private equity community – that’s hardly the case. Based on my own dealings I would project that it applies to less than 30% of the firms that are active in payments and payments technology. It must also be acknowledged that there are legitimate, very real and valid reasons for re-trading. If a buyer discovers a material liability, or some damaging event happens prior to closing which has a substantial negative impact on the property being acquired, it’s entirely reasonable for the terms of the deal to change last minute. That being said, the roughly 30% I projected herein is still a big number. So much so that it poisons the waters for all, and unfairly sullies the reputation of those PE groups acting in good faith and participating in fair, competitive processes for quality acquisition targets. And this toxicity isn’t limited to buyers; it also infects the psyches of owners/sellers, turning them (rightfully) into first order cynics and compelling them to be extremely guarded when dealing with any PE firm.
So, what can owners/sellers do to protect themselves against the bad actors out there? The “re-traders” as it were?
There are many strategies sellers may employ to defend themselves against the re-trade, and any reputable and experienced advisor/broker/banker will know which ones to use, how to use them effectively, and when to employ them. But there’s one strategy in particular that all owners /sellers ought to embrace in their dealings with private equity groups: the strategy of securing options.
When negotiating with any buyer, private equity or other, make sure that it is not the only entity you’re speaking with. You must always position yourself in a manner where you have actionable options with other buyers. By doing this, you’re leveraging your own position in the marketplace and lessening the leverage that a PE group may have to re-trade you. Remember, historically, the re-trade was employed as a last-minute tactic by private equity groups towards the end of chipping down valuation. It was injected late in the deal process (close to closing) when sellers, having survived the grueling due diligence process and being so close to a pay-day, were likely to concede – just to get the deal over with.
When an owner/seller has actionable options (multiple buyers), he or she is empowered with the single, most exceedingly effective posture one can have in any negotiation, M&A or otherwise: the choice to say “no”, and the minimal downside risk to mean it!
Adam T. Hark is Managing Director of Wellesley Hills Financial. With 15+ years of consulting in payments technology, SaaS, and fintech, Adam advises clients on growth, exits, and market positioning strategies. Adam can be reached at firstname.lastname@example.org.