Interview transcript:
Terry Gerton This is a pretty uncertain time still for federal budgets and acquisition priorities are certainly shifting under the Trump administration. With all of the changes going on, how would you characterize the mood among strategic buyers in the government contract space?
Adam August It is an interesting time. There is a lot of interest in buying companies and finding out what properties are available to be acquired, what capabilities can a buyer expand its offerings to its customer, the federal government, with. There’s a lot of sizzle and there’s not a lot of steak.
Terry Gerton That’s an interesting characterization. Tell me more about that.
Adam August Over the last four to five years, there’s been a flurry of activity in the government contracting mergers and acquisitions community. And a lot of the really premium properties have been sold, been acquired. And now we have this new layer of company that is providing unique capabilities. And if it fits within a buyer’s, either a strategic buyer or financial buyer’s interests, then they command premium valuations. But if there’s any issue with the customers of that target or its capabilities, then buyers are very wary about moving forward, and it creates a very difficult environment to get a deal done.
Terry Gerton The Trump administration has really been, I don’t know, shifting the seating assignments at the contracting table, if you will. Folks who used to be the big contractors are kind of on the outs and lots of new firms are getting looks. Is that changing how the market is viewing these companies?
Adam August Yes, absolutely. There are the winners that align with the administration’s priorities and the future of how the government wants to acquire its goods and services. And there are those primarily in civilian agencies like USAID, for example, that are not aligned with the administration’s priorities and therefore, there’s less interest, and there’s an opportunity for them to retrench and to focus their business on what are the administration’s priorities.
Terry Gerton It really does feel like there’s a lot of shuffle in the market. The Trump administration certainly is prioritizing the procurement of commercial goods and services, but they’re also putting less focus on disadvantaged firms and small businesses. What makes a good acquisition target in this market?
Adam August Essentially, a company needs to have durability with a customer, whether it’s a socioeconomic set aside or other set aside contract or a full and open contractor, they need to have that customer intimacy and that durability and the customer, of course, needs to have long term abilities to procure services and goods from that. And so it’s important that the company maintain its relationships and really be that trusted and capable provider to the federal customer.
Terry Gerton Really talking about a market, suppliers, people who want to sell and buyers literally who want to buy, with all of this uncertainty, are you seeing more folks who want to get out of the market altogether and therefore are offering their firms up for sale?
Adam August In a word, yes, but there are, it’s also a very difficult time to sell. And I think some sellers come to the realization that their company is not ready for sale, they need to get their corporate housekeeping in order, their contracts a little bit better situated for a buyer to be acquired because they understand that buyers are being finicky and are being particular and they need to be able to match the buyer’s needs.
Terry Gerton I’m speaking with Adam August. He’s practice group leader in Holland and Knight’s Corporate M&A and securities Practice Group. Well, speaking about those buyers, it seems like there’s more of a role these days for venture capital and private equity. Are you seeing that and how is it playing out?
Adam August Yes, we’re seeing a ton of what we call minority investments where investors will acquire 20% to 40%, usually, of a concern. And there are tremendous advantages for the investors and for the issuers accepting that money.
Terry Gerton How does that play out? What does the government know about those minority stakes? And are there any kind of risks in that process?
Adam August We’re closing a transaction next week where the company accepting the money has significant classified contracts with the government customer. And the customer needs to know the identity of the investors in order for the company to maintain its facility clearances and contracts.
Terry Gerton And are there other sort of regulatory hurdles or uncertainty right now even in the government payment space that makes an acquisition challenging for a buyer?
Adam August Yes, there are no shortage of compliance hurdles that buyers are looking at and sellers need to be aware of. These include things like compliance with the False Claims Act, various accounting standards, organizational conflicts of interest, cybersecurity compliance. The government has a whole layer of compliance that most companies, frankly, can’t be fully compliant with. And so buyers need to get comfortable with any little issue that could expose it to liability after the closing.
Terry Gerton Is the disruption of the federal workforce posing any challenges to you as you’re looking at corporate mergers and acquisitions?
Adam August It is, we have a transaction that was ready, certain to close, and the customer accepted a voluntary retirement, and the buyer got nervous that the program wouldn’t continue because that customer wasn’t there and wasn’t sure that the program would be durable. And so the transaction has been paused until that certainty becomes more relevant.
Terry Gerton So how do you help buyers manage these kinds of risks? Are you doing anything different today than you were, say, five years ago?
Adam August I think there’s a lot more structure in transactions in terms of rollover equity, where the seller acquires a portion of the equity in the buyer or earn outs, where amounts aren’t paid until certain metrics are hit. And that has been more prevalent in today’s transactions than they were several years ago.
Terry Gerton Interesting. Can you say a little bit more about how that works?
Adam August When a seller sells its business, it can acquire certain equity in the buyer entity so that its interests are aligned in the ultimate success of the buyer. Or in an earn-out situation, a seller doesn’t receive payment for the sale of its shares until those metrics are achieved. And that can be a contract is renewed or certain revenue or gross profit margin metrics are hit.
Terry Gerton And so if you’re a seller in this market, what advice do you have for them? What should they be doing to prepare their company to be an attractive target for an acquisition?
Adam August Get your house in order. Nothing will be overlooked. You have to fortify your story with backlog, prime contracts, and durable access to customers. But most importantly, be realistic. Put yourself in an acquirer’s shoes. Strategic multiples are reserved for strategic assets. Be the target that that buyer wants.
Terry Gerton And are you expecting, then, that the M&A market’s going to continue to grow and be healthy through this administration?
Adam August We think there’s going to be a lot of certainty, which is what the government M&A market in particular requires, and so yes, we think there is going to be significant M&A deal flow for the foreseeable future.
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