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Interview with an Investment Banker: Steven M. Rathbone of Stout

Interview with an Investment Banker: Steven M. Rathbone of Stout
February 3, 2021 by Chase A. Stuart, Partner | Brendan T. Gibson, Associate
The "Interview with an Investment Banker" blog series features Chase Stuart, who interviews various investment bankers representing a variety of industries, geographies and markets. This is the first in that series and summarizes Chase's interview with Steven M. Rathbone of Stout.

Steven is a Managing Director in Stout’s Investment Banking Group. He has more than 17 years of experience providing investment banking, strategic advisory and corporate financial services, with a primary focus on sell-side mergers and acquisitions. He primarily serves privately held middle-market clients. Steven's expertise spans a wide range of industries but is primarily concentrated in Diversified Industrials (services and supply) and Automotive (tire/wheel distribution, manufacturing and service; parts distribution; automotive service; e-commerce).

Chase: What are the biggest challenges that family- or founder-owned businesses experience when they go to sell their companies? What surprises a first-time seller, and as their advisor, how do you manage their expectations?

Steve: When families, founders or entrepreneurs engage us to sell their business, it is often the first and only time they may undergo the process. It is a very big and important life decision. Challenges come in many shapes and forms, but typically involve: (1) getting the business financially ready to go through the sale process and (2) emotionally preparing the sellers for transitioning either to new ownership or completely out of the company.

The financial preparation requires planning to maximize value, whether that be estate planning, getting the company’s finances in order or optimizing the corporate structure to maximize after-tax proceeds, and generally tidying up the business for presentation to potential buyers.

There are also emotional aspects. My clients have run their companies for years, sometimes decades. We recommend sellers do as much planning in advance as possible, contemplating lifestyle changes to their day-to-day life as they transition out of the business. You can never fully prepare for the outcome, but that is why we are there: to help them through both parts of the process.

Chase: You have particular expertise in the industrials distribution and services sector. Can you let us know what makes that industry unique and some of the reasons you enjoy working with these owners?

Steve: Generally speaking, I got involved in industrials because my family worked in construction and engineering. I relate to people in the industrial world very well. As I focused on mergers and acquisitions as a profession, I wanted to specialize in an area I knew well and help owners maximize value. The more I dug into businesses in the industry and related to the founders and operators, the more I could see how my expertise of financial markets, the M&A environment and climate and finance really carried value. I certainly have a passion for these types of businesses.

Chase: How do buyers in the industrials space treat sellers compared to businesses in other industries?

Steve: Industrials is so broad that each company really is examined individually and on its own merits. We are talking about a massive segment of the economy when we look at industrials. If we look back at 2020 when COVID-19 initially impacted these companies, many of these businesses were deemed essential or were serving essential businesses. This was a segment of the economy that needed to continue and really earned its essential status.

Chase: What did you see occur during COVID-19 in terms of valuation and timing? What has been your experience guiding companies through an exit during this time?

Steve: First and foremost, I tried to figure out each company’s place on the spectrum of businesses that COVID-19 created, which ranged from healthy market leaders to troubled companies with core performance issues.
 
  1. The first bucket consists of healthy market leaders that were impacted temporarily. We expected these companies to remain leaders in their industry despite the environment, but we did see some performance and business disruption that would be temporary. The question was for how long.

    To determine that we had to truly understand what was happening during the COVID-19 period. It was imperative to track their performance in detail.We did so on a daily and weekly basis to measure how deep performance dipped and why they came out of it so quickly.

    As we contemplated bringing these companies back up in 2020, we worked hard to develop the post-COVID narrative and reposition the company for optimal results, based on whether there was now a pick-up in demand, potential gains in market share, stimulus tailwinds or new trends developing of which they could take advantage. This led to strong interest in both strategic and private equity groups and a shift in mindset from crisis management to growth.
  1. The second bucket was the outperformers. There’s the saying, “sometimes it’s better to be lucky than good.” If you’re a good company and get lucky, it’s even better.  Some companies had performance enhanced by the conditions that COVID-19 brought upon us, driving business to their company with increases in trailing 12-month revenue and EBITDA.

    We emphasized these companies’ enhanced performance, recession-resistance and essential nature, which is very important to investors. We marketed them through a process driven sale with a shortened timeline or a proprietary deal with one-on-one negotiations, where suitable. We made sure they captured value created by the market conditions and cleared the market. Usually we saw a condensed timeframe to capture their outsized performance and minimize risks. We saw favorable sell terms and oftentimes valuations that were not achievable prior to COVID-19.
  1. The third bucket included corporate carve-outs and strategic divestitures and typically involved subsidiaries of large private and public companies. They needed strategic realignment and reallocation of internal assets, management refocus and/or tidying up of the core business. Oftentimes this led to a liquidity event at the parent level and valuation wasn’t necessarily the highest priority. It was more about streamlining the parent entity and achieving their goals.

    For these clients, the success is in the preparation. We advised on operational, legal, financial and personnel considerations to conduct a carve-out efficiently, cleanly and without protracted negotiation.
  1. The fourth bucket involved troubled deals and companies that were impacted more severely and saw significant disruption. There was a real lack of clarity on how they and their markets would perform in the following months, which led to a very difficult environment of forecasting revenue and earnings.

    This required sellers to adjust their expectations and alter their deal structure to reflect the current environment. Timing was very important. We would delay a launch until we had better visibility in the forecasting of the business. We saw some busted processes initially, but many were revived and we accomplished their objectives.

    Read more from Stout about M&A in the time of COVID-19 here.
Chase: How did buyers react to your proposed COVID-19 adjustments? How did you get everyone on board with your narrative?

Steve: We consider ourselves realists who want to capture the pieces of business that may have been temporarily lost. The actual, COVID-specific costs incurred that were one-time costs were treated as such. Generally, we have had very good reception with how we have cast COVID-19 adjustments, which we do on a case-by-case basis.

For certain companies that received PPP Loans, it was received predicated on the company maintaining payroll and cost structure throughout that period. The companies did just that to meet the criteria, but it was not representative of the appropriate cost structure for such a tumultuous time without the PPP funds being made available. Therefore, normalization is required.

We and the clients’ accounting advisors would look back through these previous months to determine either excess or potential cost savings, especially in labor. This, when combined with the requisite support, saw almost uniform acceptance from the market. Given the methodology employed, we haven’t hit many hiccups in regard to convincing buyers that our COVID-adjustments are appropriate.

Chase: For the founder, family or entrepreneur considering selling their business, what factors make 2021 a good year to effectuate such a transaction?

Steve: If the business was performing all along or is now performing and has “righted the ship” post-COVID, the start of 2021 appears to be a tremendous time to explore a transaction. There are multiple factors that have aligned for a robust M&A environment. We have an abundance of equity in the markets that ensures a highly competitive environment for quality assets. Interest rates have come down, reducing debt financing costs. We’re back to an environment where multiples are at or around record highs, and I don’t see that changing barring any material events in the coming months. It’s a tremendous time to take advantage of the market provided your goals align with this timing.

Chase: How do you advise your clients on whether they are a better fit for a financial buyer, such as a private equity fund, compared to a strategic buyer?

Steve: I start with figuring out the client’s goals, which drive our advice. Is it to retain a stake in the company and see it through with a partner but de-risk? Or to retire in 12 months and cash out with all or the majority of cash off the table? Do you see eyes on the market that can enhance your business through a strategic angle or bring capital to the table?

Then I provide counsel on the differences between a strategic versus a private equity buyer, and what that means for the diligence process, proceeds, seller obligations and role going forward, etc. With almost every process we run, both strategic and private equity buyers are typically part of the process.

Chase: That was a fantastic synopsis of where the market is going. I appreciate the time, Steve. 

Steve: It was a pleasure.

Chase Stuart is a partner in Ice Miller’s Business Group. He represents a variety of private equity funds, family offices, independent sponsors, mezzanine funds, and privately held businesses. He provides strategic and legal advice in their investment and general corporate strategies, including leveraged buyouts, mezzanine financings, growth capital transactions, early and late stage private equity investments, and secondary transactions. He represents family, founder, and entrepreneur-owned businesses as general corporate counsel and as a sell-side advisor. He has represented a variety of companies in sectors such as technology, manufacturing, health care, aerospace and defense, gaming, and business services.

Brendan T. Gibson is an associate in Ice Miller’s Business Group. Brendan earned his juris doctor from St. John’s University School of Law and his bachelor’s degree in American Studies from Yale University.

This publication is intended for general informational purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstance.
 


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