The Perils of Optimism

The Perils of Optimism

As financial war chests have been built and coffers filled, the pressure on M&A professionals to make deals has increased, raising the risks that a deal will go poorly or end up unprofitable.

Photo Credit: SIphotography

Sequoia Capital recently announced their intentions to raise $8 billion for a new fund to invest in tech. The VC firm, most famous for its early backing of Google, is on the record as saying they need a “bigger war chest” with how valuations in the sector have shot up. Of course, while the technology sector has stolen more headlines than others as of late, it’s no secret that equity markets have been on a tear over the past 12 months, even with the recent market indigestion. However, these good times can go to people’s heads, both investor and corporate, and that can lead to bold decisions with overly optimistic assumptions, that can be anathema to good M&A activity.

As most M&A professionals who have been through multiple business cycles know, activity tends to heat up as economic growth picks up and 2017 saw synchronized GDP growth globally. Toss in record levels of corporate cash combined with the facts that borrowing costs are still remarkably low (but look poised to begin rising), investors and acquisitive corporations are itching to deploy their dry powder, driving M&A activity across all sectors and sizes.

A Rising Tide

However, the feelings of optimism, confidence or, less cheerfully, hubris that go hand-in-hand with “Goldilocks” scenarios make them not necessarily the best environment for relatively bold and large undertakings like a merger or an acquisition. Rosy outlooks can often cloud the judgment of decision makers in these matters. As the old adage goes, a rising tide lifts all boats; not only are your own company’s fortunes rising but so are those of the acquisition targets, making them more expensive for buyers. The fact that appetites for risk in the markets have been rising has exacerbated this. As all these financial war chests have been built and coffers filled, the pressure on M&A professionals to make deals has increased, even if it’s not the best decision at a given moment, raising the risks that a deal will go poorly or end up unprofitable.

Consider Warren Buffet, who is arguably one of the best M&A investors of all time. He follows his mantra and doesn’t buy companies purely for the sake of getting a deal done. In fact, Berkshire Hathaway has sat on large cash piles for years as the “right” deal hasn’t materialized, something lamented by the Oracle of Omaha at annual shareholder meetings for years. It can be undeniably painful to sit and wait, especially given the pressures to act for both corporate acquisition teams and professional investors such as Private Equity firms. This is certainly not to say that no deal today is a good one – the right terms may present themselves at any time, after all – but it a good idea not to get ahead of ourselves, and a better one to not get ahead of the market!

Riding the Wave

On the other hand, as times are very good presently, savvy investors and entrepreneurs who have been riding the wave of optimism may consider leveraging the current environment for an exit opportunity. The same overall factors apply, of course: the copious amounts of cash on the sidelines that investors and corporations are looking to deploy, and increased optimism is driving risk appetites, not to mention that sellers can achieve very favorable terms and valuations. However, it can also be difficult to sell in the good times, primarily due to the ever-present fear of missing out: why sell today if you’ll get a substantially better price tomorrow?

While there are any number of clichés to prattle off reminding investors to be prudent about realizing their gains, it all boils down to staying disciplined, regardless of what side of the deal you may be on. The good times won’t last forever, so prices won’t stay high indefinitely, an important thing to keep in mind for both buyers and sellers. For sellers looking to exit, it may be best to take your gains today and avoid a downturn tomorrow, while buyers need to ensure they get the right deal, even if that means it’s not the “right now” deal.