John Carvalho is the president of Stone Oak Capital Inc., an M&A advisory firm based in western Canada, and co-founder of Divestopedia, one of the leading online educational resources for selling a mid-sized business. Carvalho has worked in the M&A space for 20 years, beginning with a large investment banking firm, and transitioning to his own practice a decade ago.
In part 1 of our conversation with Carvalho, he shared his advice on sell-side strategy, for business owners and advisors alike. In part 2 of the chat, we switched the focus over to the buy-side of M&A. Alongside Carvalho’s advisory career, he has also positioned himself as an M&A educator. “I get a lot of excitement and satisfaction out of teaching people about mergers and acquisitions,” Carvalho said. Divestopedia became the hub of that education, but Carvalho saw the need for the same level of guidance for entrepreneurs looking to acquire.
“Before I knew it, we had purchased 17 businesses and took that initial $5 million acquisition to $240 million over a seven year period.”John Carvalho, President of Stone Oak Capital and Divestopedia
“I’ve been exposed to a lot of people on the buy and sell side, really amazing entrepreneurs that want to grow their business,” Carvalho said, and it was one such client of Carvalho’s who ended up partnering with him to acquire new businesses. “Before I knew it, we had purchased 17 businesses and took that initial $5 million acquisition to $240 million over a seven year period,” Carvalho told us. They then did a reverse takeover in 2019 and took the business public. “Through that experience, I saw the opportunity to really exponentially grow a business that a lot of middle market entrepreneurs weren’t taking advantage of,” Carvalho said. So he thought, “Why can’t I take this experience that we had over the seven years and help other entrepreneurs execute on this?” That’s exactly what Acquisition Playbook does. Carvalho added that even if business owners aren’t growing as exponentially as he and his partner did, a smaller rate of growth, something like $5 to $50 million, “is manageable, and with the right process and the right playbook, so to speak, a lot of entrepreneurs can take advantage of that.”
When asked about what entrepreneurs are often missing from their acquisition strategy, Carvalho noted that business owners’ gaps are always different, but that there are four pillars that makeup a good framework for understanding acquisition strategy. Those pillars are: deal sourcing, offers, overcoming challenges, and integrations. Each of these stages of the deal requires its own unique gameplan. “I think there’s a misunderstanding around how many deals you have to look at to land on one,” Carvalho said, sharing an anecdote about the 700 deals a private equity firm might look at before narrowing those opportunities down to a portfolio of six or seven investments for the year. Not understanding the normalcy of these high failure rates means that first-time acquirers can get deterred if the deal they are focussing on doesn’t pan out. Even in cases where an owner gets to the stage where a letter of intent is in place and signed, business owners still might abandon the deal because they “don’t know how to mitigate the risk, either operationally, through due diligence, or within the terms and agreements that they are signing,” Carvalho added. Understanding and anticipating potential challenges equips acquirers with the knowledge and resiliency to push a deal through to completion.
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Of course, sometimes the right thing to do is to walk away from the deal instead of working to mitigate the risk you see. When asked about how to know when this is the case, Carvalho recommended establishing what your “deal breakers” are in advance. Whether these are ethical considerations or litigation or liability that you just can’t overcome, knowing what your criteria is before you’re in the thick of the deal process makes it easier to decide when it’s time to walk away. Carvalho also suggested setting up a matrix to help accurately identify and analyze the level of risk. Sometimes things look scarier than they actually are, and mapping out the realistic probability of that risk and the avenues available to mitigate it, provides a methodical means for making decisions.
So much energy can go into tackling these deal hurdles, that the last phase of the deal, integration, can be neglected. Carvalho’s advice on this stage followed the same line of wisdom he’d shared thus far: the importance of planning. “At the onset, establishing that strategy for the type of acquirer you’re going to be gives you a roadmap for how integration will follow through,” he said. This will determine which factors you focus goes to post-transaction, whether that’s changes to management, brand, or IT systems. He also highlights how helpful integration experts can be to the process, advising acquirers to “bring in the expertise you need to bring these businesses together.”
Bringing the buy-side conversation into context, we asked Carvalho how a buyer should approach finding value in the current market, defined by the record success of the past year. “I think people have to be leery of the valuation that they pay,” Carvalho offered. The ability to be able to service any debt that you might be taking on in these kinds of transactions is an important consideration, he noted. In the lower middle market space, what Carvalho defined as sub $10 million, he sees value “where the buyer landscape is a little less crowded.” But he still cautions acquirers, emphasizing that “diligence, conservatism, really scrubbing your future forecast” are important.
“As long as access to capital doesn’t shut off, valuation multiples are still going to be heated.”John Carvalho, President of Stone Oak Capital and Divestopedia
With a market impacted by factors like inflation, labor shortages, and record access to capital, where does Carvalho see valuations headed in 2022? “As long as access to capital doesn’t shut off, valuation multiples are still going to be heated,” he said. He sees continued appetite, especially in response to some of those factors mentioned, for example, he noted the trend of acquisition as a strategy for access to needed talent and labor. Carvalho sees a lot of interest from entrepreneurs in acquisition. “I’ve found that people want to dip their toe into this area, and my philosophy is, if you’re going to do it, you gotta do it right.”