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Broadcasting from the Winvale Studio in Washington D.C. Welcome to Government Contracting A to Z about letting the latest insight, trends and newsmaker in the world of federal state and local government contracting. For more on Winvale, visit winvale.com. Now, here's your host Kevin Lancaster.
Hello and welcome. My name is Kevin Lancaster, managing partner of Winvale and the host of Government Contracting A to Z. Our goal is to provide you, the listener, the aspiring or seasoned government contractor with the latest insight, trends and the newsmakers in the world of government contracting. So thank you very much for taking time out of your busy schedule to listen with this episode on the world of government mergers and acquisitions. Before we get started, I would be remitted if I did not encourage all of our listeners to visit Winvale's website to find out how we can help accelerate your government sales marketing and contracting opportunities including the development of your GSA schedule contract. The site is www.winvale.com. Okay, enough of the shameless plugs. Today's episode, episode three is especially important if you are contemplating dipping your toe into the M and A marketplace where it cover a wide variety of topics, but we're really going focus on the current status of the M and A marketplace today, how to successfully understand and leverage the market, what drives value and how organizations are valued today and the different kind of deals and how they happen. Today, I am grateful to have David Charles joining me. He is an industry expert, I have known him for a handful of years now and I am just really thrilled him to have him participate. So a little bit about David, David is a shareholder at Rees Broome, PC and he is a member of the firms' business and tax group. He has been advising clients on a broad range of business and corporate matters for nearly 20 years now including entity formation, capital structures, mergers and acquisitions and aligning corporate strategies with business goals. David has substantial experience structuring business transactions, negotiating financial and legal deal terms and drafting related documents. He has advised clients in more than 50 M and A transactions involving both public and private companies operating in a variety of industries including information technology, defense energy e-commerce and aviation services. Prior to joining Rees Broome, David was a partner with a leading international law firm and prior to that, he earned his BA and MA from Johns Hopkins University and J.D. magna cum laude no less from Georgetown University. So with that, welcome David.
Thank you Kevin. I really appreciate the kind remarks Kevin and I certainly appreciate what Winvale is doing trying to provide these educational opportunities on the space. As you mentioned, I am a shareholder with Rees Broome or a full service law firm located here in Tysons Corner for more than 35 years and I have been doing mergers and acquisition deals for almost 20 years now. I have worked on a wide range of transactions from sales of a few hundred thousand dollars of assets to multi-billion dollar mergers and stock sales and it really is always a pleasure to share my insights that I have gained from the art of mergers and acquisitions.
Now, we certainly appreciate and as I mentioned, you know, organization, working with companies out there and helping kind of figure out navigate the government marketplace and we see a lot of -- certainly there is a ton of firms out there, you know, large firms, small firms and it is very rare that you come across somebody that is still well regarded but treats their clients and customers and partners as equal. So with that, you know, I want to kind of jump right in to today's topic and kind of run through some of the questions that I know that we get in just given today's climate with government mergers and acquisitions, government contracting, federal spending in general, kind of jump in here and maybe run through your couple of questions that I think our audience might be interested in hearing about. So with that, you know, we are post-election, we are on the potential verge of sequestration and all that fun stuff that that brings. You know, what would you say is the current state of today's M and A's marketplace?
Right now, it is a very interesting time. We are post-election, we are pre-decision with respect to sequestration and the budget talks and right at this moment in time, there is actually a fair amount of M and A activity. You will see companies announcing transactions, acquisitions, right up until the end of the year and that is being driven a large part by the perceived risk of changes related to the tax rates and so you have a lot of owners of businesses who have been working on sale transactions for three months, six months now and their deals are ready to close and you are going to see those closing. So there is quite a bit of activity right now, but in thinking about where the market is for government contractors, it is really important to turn back the clock to understand where we are at this moment in time and when I started doing M and A transactions in the early to mid-90s, the market was really driven by the explosive growth in the equity markets and the buyers were public companies in a broad range of industries but with a lot of emphasis on commercial technology and roll ups and wireless and telecom, and that market was charging forward until the late 90s when the bloom came off the rose of telecom and wireless and there was a real slowdown in M and A activity and at that time, I was with the big firm and we started looking around at some of our clients who were in the government contract space and it was a relatively quiet area of business because before 2001, government contractors were kind of viewed as a very safe business relatively low margins and slow growth and kind of a nice business to be in but not a business where a lot of capital came in a very big way.
Some of them the afterthought I guess (crosstalk) for most companies at that time, yeah.
It did not capture the attention of Wall Street and the Private Equity groups the way it does today and then of course, September 11, 2001 happened and there was a huge growth of government spending on services, a lot of it related to battling the war on terror and the two wars were fighting overseas and just a reflection of how much growth there was in 2000 or so, the Pentagon spent approximately 100 billion dollars on services. Last year, that number was about 200 billion dollars so there has been huge growth over the last 10 years and there was a lot of M and A activity as a result of all of that business activity and that M and A activity was extremely strong from 2002 to 2007. That is when the credit crunch happened and it is hard to believe that was already five years ago. But then credit crunch really changed things and particularly with the markets cradling a year after the credit crunch that was 2008 as you know. And the M and A market after 2008 was really a very spotty market. You would see periods of time where M and A activity would peak up. You would see periods of time where it would slow down and everybody described the market really from a business standpoint and a merger and acquisition standpoint as characterized by a great deal of uncertainty and that uncertainty has continued over the last four years and has really impacted how people buy and sell companies.
So on that note, so you were a small medium size firm in this marketplace. You know, you were hearing kind of the news out there about government spending and you know you are kind of understanding some of the trends out there. What are the first steps, I mean where do people start and how do they start this process of looking in to selling their business or merging or acquiring businesses?
That is a really good question Kevin and I get that question a lot and when I tell my clients and even people I consult with who are my clients' business owners, I explain to them that the first thing you need to do is really educate yourself. You need to go other there and understand both the large macro level issues related to a merger and acquisition transaction as well as the micro or details and the great news is in this area, in the Washington D.C. area, if your company is here, there are plenty of seminars and programs that law firms and accounting firms put on to educate business owners about how to do M and A transactions and what the market is like. There are also plenty of journals and publications that I refer my contacts to look at things like Washington Technology and capital business and of course there is things like this podcast that you guys are doing. So there was a wealth of information out there and it is just a matter of tapping into it to really try to learn and understand the big picture as well as the details about how deals are done. Second thing I tell folks is that you really need to build relationships with a range of experts who can help you execute a merger or acquisition and those experts include the lawyers and the accountants and also the investment bankers or business brokers and if you find the right people to interact with, they will be very helpful in assisting you to understand again the big picture of mergers and acquisitions as well as the details. You really want to understand this process. The process is a very challenging process. It requires a great deal of focus, time and commitment and it really is the kind of process that you want to understand it as well as you can before you undertake it because it is such an important process. And then finally, what I do recommend people do before they undertake this process is to really figure out what their goals are for the process and as you are talking to your advisers, you want to make sure that your goals are realistic goals for the process given the state of the market.
Yeah, you know that actually may kind of segue into my next question here is that you I think everybody has different goals and expectations and certainly hear about technology companies when they are viewed, they have a certain valuation or multiplier placed on them versus a services company and depending on what your space herein. It could vary greatly so you know in your experience and again today's environment you know how are valuations placed on companies in this marketplace you know product organizations versus services company you know one of those drivers being behind the valuations.
Most companies when they are being acquired, buyers will have models or metrics for valuation and most of the buyers really across broad range of industries use as a primary metric for valuing the target company multiple of earnings and depending on what industry you are in that multiple of your earnings or EBITDA sometimes referred to as, that multiple of the earnings for valuation falls into a range so for information technology service providers to the federal government, the range and when I say range it is probably the standard deviation 66 and 2/3% of all deals in the IT services industry probably fall in a six times to eight times multiple of EBITDA. Now companies do fall above that, there are transactions that happen above that range and the drivers that really differentiate companies they get the higher multiples particularly for government contractors are things like are they operating in a niche. Do they have customers that are very hard to penetrate because maybe there are requirements for security clearances or the type of work is extremely technical and therefore it is high value work. If that is the case then those kinds of companies can definitely command a higher multiple. I also do see higher multiples for companies that are focused in what they are doing and the business they are in is much more sustainable and you even do sometimes see higher multiples for larger companies and the reason for that is that a buyer engaging in an M and A transaction has to dedicate substantial resources whether the target company is small or large and if they are going to dedicate essentially the same resources then they could actually pay a little bit higher multiple for a larger company because of the benefits they get.
Sure, sure. And I imagine, there is kind of that beauty is in the eye of the beholder I guess paradigm normally in this processes where somebody that is looking to acquire an organization has a very specific process and steps and guidelines and somebody that is probably going in the path of selling the organization has a different set of expectation and so can you kind of touch on that maybe anything in that totally that you can share about bringing organizations to the table and expectations not aligning or matching up.
Yes absolutely and one of the things you want to do as an owner of a business is you build your team for an M and A transaction. You probably want to ideally engage in what would be called a limited option and the investment bankers are very good at stimulating interest in their clients and creating a situation where there may be two or three very serious credible buyers who are capable of closing the transaction and who really want to make a deal with you, and what you find though in those situations is that quite often particularly more recently, the sellers expectations about what their company is worth is it does not quite match what the buyers are willing to pay and we have seen a lot of this mismatch recently because of the concerns over sequestration and where federal budgets are going. Sellers know their businesses really well, they are confident in their pipeline. The buyers are looking at sellers a little bit with skepticism because of what has happened over the last several years. So there is sometimes a mismatch between what sellers expect and what buyers are willing to pay and so what we do see a fair amount in transactions and what structure are contingent payments to bridge that gap. So that if the sellers' expectations about their pipeline and their business growth comes to path then the buyers will actually pay the higher price, but there are lots of challenges associated with structuring and earn outs so that it works well and most people who do this for a living can tell you many stories of earn outs that did not work out well. So you really do need experts who could advise you in a transaction who have a lot of experience with earn outs and know how to structure them so that it can work best for your particular situation.
Sure. I guess I kind of get into you know the acquisition exits and how deals are structured and you know what really makes those types of transactions happen. Are you seeing anything? Are there any norms other there? Are these organizations that are selling their business so they are staying on with the new entity for two years, five years or they are just outright selling the organizations and walking away, I mean, what are the different types of acquisitions that are out there or exits that these business owners are saying?
Well most of the time in the government contract space, the acquisitions are structured as equity or stock purchases where the buyers simply acquire all of the ownership interest in the target company from the seller. Sometimes, you do see acquisitions where buyers for tax purposes may structure as a merger but most of the time, it is a stock purchase and that has a lot of benefits. Buyers use stock purchases and sellers like stock purchases because they are very easy to affect and there is no novation of any government contracts that gets triggered by the stock purchase so it makes the transactions very easy to execute and you asked about whether sellers stay on with the buyer after the transaction closes and that really is a case-by-case situation. It depends on how involved the owners are with the business, how critical they are to generating the business for the company, how critical they are to the relationships with the companies' key customers, how critical they are to maintaining kind of the infrastructure of the company that the people that are really doing the work for the customer. I always explain to my clients that that best approach for them when they are going into an M and A transaction is to be flexible is to really try to understand what are the buyers' expectations about their position with the company post closing.
And to be willing to work with the buyer to find the appropriate arrangement post closing and if they have flexibility and they are willing to listen, that becomes really important because some buyers look at target companies as essentially units in their business that they are building out and they look to the owners who built those companies that are becoming units of the large business to continue running it and that sort of holding company strategy that some buyers use and if you are dealing with the buyer that has that strategy then you have to be prepared to make the commitment for a couple of years under an employment agreement to help the buyer continue to grow the larger business by growing your company as a unit. Other times, there are buyers -- strategic buyers that have a fully developed executive team and the owners of a target company that they acquire are not really necessary to their strategy. They have got all the capability to manage the business they are acquiring. So on those cases, they are probably looking for only a transition period out of the owner to help them understand the business, how to maximize the businesses performance and then once that transition period is over, they really do appreciate a very amicable separation.
Got it, got it. So, what is the best piece of advice? I mean it sounds like there are a lot of complexities to the process, there is a lot of things to think about prior to beginning the process, going through the process and then post an acquisition or what have you. You know, what is the best piece of advice that you could give to one of our listeners? A business owner who is determining how to approach selling their business or maybe in the foot side potentially buying the business?
Yes. I think there are couple of pieces of advice that owners who are thinking about selling or thinking about acquiring a business really need to confront. The first is as I mentioned easier you really have to look in that mirror and figure out who you are and understand your business as well as you can understand it and make sure that your business is run as well it can be run. It sounds simple but some owners I have worked with in the past had become a little bit distracted by the M and A process whether they are buying companies or they are engaging in a sale of their own company and it is really important to never lose sight of yourself and an understanding of yourself and never to lose focus on the business you are engaged in and the culture of the business you have built. Having said that, it is absolutely critical to understand that this emanate process whether you are buying or selling, it is a long process it is complicated process and it requires a whole-hearted commitment to do it right and if you make that commitment and you find the right advisers to work with as a team with you, you can absolutely be successful and really achieve fabulous results for your company if you are acquiring companies and growing it or fabulous results for yourself if you are looking at a liquidity transaction to sell your business.
Well, that is a great information, absolutely, great information. That actually kind of brings us to the end of our episode here today. I want to thank you so much for allowing us to pick your brain. It is really a valuable information you know timely and I know for a lot of the listeners out there, I think they are struggling with these questions and concept again given the current state of the government marketplace, government contracting marketplace and you know global macro economics all embedded on top of that. So I want to thank you for joining us here. To our listeners, be sure to head over to our website over at governmentcontract.com, get a full recap of David's interview and links to the show notes and as you link to David's firm website. We would love to have you guys join us for the next episode and we will discuss how to survive and thrive in the __23:54__ company. We got a great guest coming up. We will have Mike Peart of an organization called i4DM joining us here on the next episode. So with that, David anything to add here? Any last little bit tidbits that you can share with our audience?
Well, I think it sounds a little trite but I also do remind my clients that if you fail to plan, you plan to fail and that is something I live by when I am working with my clients on M and A transactions and I always share that with them. But I do appreciate you including me in this podcast today Kevin and really do appreciate it.
Absolutely. Thanks for joining us. Well, that about wraps things out for today. I want to once again thank our guest David Charles and I want to thank you for listening, tuning in and helping make this podcast possible. If you like what you heard, please hop over to iTunes and leave us some positive feedback on the show. If you would like, you can also follow me on Twitter, my Twitter handle is @FollowLancaster. You can also follow Winvale on Twitter and that handle as @Winvale, and if you like you can send emails to email@example.com, give questions. We will try to get to them. We will try to include these things in our next broadcast and until then, we wish you the best and hope your government contract initiatives are thriving.
This podcast was brought to you by Winvale. Winvale providing commercial organization, government contracts, and GSA schedule consulting, government business development and sales support services. To learn how Winvale can help accelerate your government opportunities, visit winvale.com. That is WINVALE.com or call 202-296-5505.
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It's good to talk.
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