Financing a Transaction: What the Higher Cost of Capital Means for Getting a Deal Done in 2024
Ryan Palmer: Good afternoon. It's the last one of the day. Welcome to this panel on financing A transaction with the higher cost of capital means for getting a deal done in 2024.
My name's Ryan Palmer, I'm a partner at the law firm at GPM, and I run franchise and restaurant deals for the firm. And it is my pleasure to lead this group of gentlemen through what I think will be a very spirited conversation about what deals will look like in the month to come and kind of what we've come through here.
So we've got Brett Bishov, the Managing Partner at Capital Insight.
Brett Bishov: There I started a lending business that was acquired by Wells Fargo in a one Wells Fargo restaurant finance today and then shortly thereafter started Capital Insight. I've done about 15 billion of M&A and corporate finance as an advisor and principal in the multi-unit retail space much of which in the restaurant industry and onward to Glenn here.
Ryan Palmer: Brett, with just an overview of what we've come through in 2023, like we've heard slow start to the year, some possible momentum going into year-end into the first quarter. What are you seeing? What kind of deals are getting done right now just generally?
Brett Bishov: The multiples and valuations are still semi-embedded in expectations with interest rates and credit tightening M&AS down materially. Probably You know the restaurant space, you know you've seen a ton of statistics but 80% of deals that are getting done are some off-the-run independent chains, franchise deals where you know expectations are in alignment of multiples and operators that are more well-capitalized that are less dependent on leverage or less dependent on a lot of leverage. So deals are still getting done. We have three closing between now and year-end three M and three sell-side M&A and their you know valuations were reasonable but the the buyers and the sponsors are committing a little bit more incremental capital because they you know they find it strategic and desirous. So I think it's just moderation of expectations and and things will improve next year still be relatively slow, but it it's definitely going to improve in my opinion.
Ryan Palmer: Brett, I imagine you have views on on this topic on valuations there.
Brett Bishov: So they haven't come down yet on deals that are getting done, but in the sort of the paradigm of negotiating and talking and discussing from an expectation perspective, there is dialogue about some compression it it certainly isn't tracking.
You know the relative increase in interest rate is not you know directly linear to multiples, right.
Interest rates are effectively doubled.
Multiples are going to come down 50%, but there is some compression and you know the reality is if somebody doesn't have to sell, they don't have to sell.
But if if you want to be realistic in getting into the market, you have to start to calibrate for the leverage lines because it's not just interest rates.
There's more conservative underwriting unless you're a very modestly or low leverage large operator with a national brand, you're not going to get, you're going to, you're going to get less favorable covenants and and less liquidity and and lower leverage.
So there's it's going to calibrate like I know with Glenn and non real estate cap rates, you know cap rates always lagged interest rate increases and invariably they come up here there is a credit tightening and that credit tightening is going to result in some multiple compression may not be dramatic but it exists.
Ryan Palmer: Got it. Brett, what do you tell your, your clients they want to get something done.
They're used to doing deals from 2019, very different environment and they come to you now and what do you tell them about structure, what they have to bring to the table, you know, kind of those areas where you see the resilience too.
Brett Bishov: First of all, the strategic well capitalized buyer has a huge advantage in this market, right, because your alignment of interests on valuation when there's synergies from a larger consolidating is is beneficial.
But what I what I'm guiding people towards is you know have realistic expectations and expect if all things being equal, if you're not going to be flexible on valuation, you're going to have to be flexible on proceeds or carrying paper or you know deferred purchase price.
We have a, you know like you said we have 3 deals closing between now and year end and there's some earn out structures and other things that are are structured into the deal.
Try not to over engineer, any time you over engineer a deal it becomes a headache for everybody or wait right.
I mean the power of no is pretty interesting.
I mean if if you want to have certainty or at least more visibility give it a few quarters and then let the market settle and stabilize.
You know to to to create false deadlines in a disrupted market is is counterproductive.
Ryan Palmer: I'm not asking you to spell any secrets about the deals that you have closing, but just in in a general sense, what do you see in terms of earn outs and seller notes and in terms of percentage of purchase prices that, I mean, how much higher are we than what kind of your old deal norms?
Brett Bishov: 5 or 10% more, OK, 5 or 10% more, I mean the and and actually what I've also been doing is on with buyers is managing expectations upfront telling buyers that look we're not going to take capital markets risk.
So if you're not equipped you know to contribute a minimum of X amount of the deal whether it's 50% sixty for whatever it is.
We're always reverse engineering the the motives and the risks of a deal by by looking at the incentives of a buyer.
We always underwrite what we believe a buyer's return profile looks like because it's a litmus test.
You know you got to have a sanity check and somebody puts in an LOI and you know says their leverage is X and their equity is Y.
And you you know you run an equity return model and it and and their IR Rs are 13.
You got to ask yourself are they really going to close and if they are what do they know that we don't.
So we look at both sides because if you don't understand the motives and the rest of the either side, you're not really qualified to to provide advice to either side either.
You got to know both.
Brett Bishov: Well, when you think about it, right, you also have so much leverage being put out in 2122, you're going to start seeing refinance risk.
I mean the amount of of swaps and hedge positions in place today that are in the money in two years or starting at 12 months to 3648 months, there's a ton of refinance risks out of the the leveraged even some semi modest leverage operators when they go out to recap or refinance are going to have some pretty meaningful struggles.
And I I've been telling clients of mine that, you know, you've got to wait for that that window because those, those sellers that didn't sell or didn't want to sell when they're facing sale or refinancing, it's there's going to be some decisions to be made and there'll be a fallout.
Ryan Palmer: Let's talk about that in terms of M and A2.
In terms of if you're on the sell side and you're looking at a buyer, what are you doing to verify the buyer is real?
What are you doing to make sure this is actually a deal and they can get done what they think they can get done?
Brett Bishov: Well, we you know again as I said earlier we reverse engineer the, you know the economics for buyer for representing A seller and a seller for representing the buyer.
Because if the economics don't make sense, then there's, you know, statistically you have to size what the capital structures you know would rationally look like to gauge probability and underlying motivations and qualifying and we're not telling buyers to provide proof of funds per SE if they have credibility.
But you know we do say that you know if your expectations are to you know borrow X amount of money, forget it.
We're not even going to waste our time.
And so if their capital structure makes sense and if the returns make sense and they have you know the right incentives to execute as the few deals we're working on to close this year, those they've met those hurdles and just a little more due diligence before you sign a purchase agreement.
Ryan Palmer: Brett, where you fall on what 24 looks like?
Brett Bishov: I think you know what just said, deal with what you know.
And one of the challenges I've always had is take a motion out and don't come in with a preconceived idea, right.
The market's efficient.
If you hire someone that's competent and they know what they're doing and you go to market, have met, you know, modest expectations, guardedly optimistic the market.
If if you again, if you know what you're doing, you present it the right way, you'll figure out where a business can trade, you know, God bless the entrepreneur, right?
Everyone's optimistic and especially in the restaurant space.
Be realistic and present the best possible case and take a motion out if you can right you want to.
If you want to execute, be prepared, as Patty said, without a doubt, and then put your best foot forward and and let the market dictate.
I think there'll be opportunity.
Ryan Palmer: But we can wrap it up there. Thanks very much everybody and my thanks to you guys. You've spent a lot of time. Really appreciate it.