2011

Managing Portfolio Investments Survey

Maximizing value in an evolving market
Experience the power of being understood.
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Table of contents
Foreword Executive summary Survey findings
Focus is power Costly surprises to consider before striking a deal Holding and growing Optimizing your exit

3 5 7
7 10 13 16

Contributors

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Foreword
In the spring of 2011 McGladrey teamed with mergermarket to conduct an independent, third-party survey of private equity group senior executives. This survey reflects our desire to provide our clients and friends in the private equity community with valuable information on how your peers are responding to an improving economy, and offer insight into the trends impacting your business in the coming year.
This report summarizes telephone interviews with 75 managing directors, principals and vice presidents who lead private equity groups investing in the middle-market. As the domestic market continues to emerge from the recession, many of the responses reflect past-year deals made in a less-than-optimal environmentone in which high-quality companies open to private equity acquisition continued to sit on the sidelines, waiting for the economic tide to turn in order to be rewarded with a better price. Now in an improving economy, prospective buyers are swarming quality sellers. Private equity groups have capital that is ready for deployment and are exploring exit strategies for their portfolio companies. For many, the investment horizon for generating favorable returns is narrowing. For owners of niche-leading companies, whether private equity-owned or first-time sellers, there is now a window of opportunity for a liquidity event at attractive valuations. McGladrey professionals expect to see more activity and major deals in the coming year. This report was issued in June 2011, in an environment where middle-market deal activity began to stabilize. While deal volumes last quarter were down, dollar volumes were up, even in a mixed environment as some sectors continued to improve their health. It is a highly competitive environment for private equity firms, as quality sellers with a good business model, high sustainable margins and a strong backlog are commanding interest from many suitors. In this environment, it is essential for those looking to proceed cautiously out of the recession to have strong relationships when it comes to the deal-making process and sourcing channels. Along with commentary from our private equity specialists, the report that follows explores trends in private equity specialization, costly surprises to weigh pre-deal, the rise of due diligence, evolving hold-and-grow strategies, and factors to consider in optimizing an exit. We hope these findings will help you evaluate your business practices and provide useful information for future decision making. Please contact us should you have any questions, and as always, we welcome your input.

Donald A. Lipari National Executive Director, Private Equity Services RSM McGladrey don.lipari@mcgladrey.com 212.372.1235

Hector J. Cuellar President McGladrey Capital Markets hector.cuellar@mcgladrey.com 714.327.8636

Executive summary
After a few quiet seasons, financial buyers returned to the market amidst improving valuations, better access to capital and pressure to deploy dry powder. Current deal activity resembles 2006 rather than 2008 with less consolidation and more actual deal closing, but some processes have changed for private equity groups as they hope to avoid the errors that caused widespread losses just a few years ago. Focus is power
Last years McGladrey report on portfolio management showed the tail-end of a narrow add-on acquisition strategy that populated the post-crash downturn. Private equity groups are turning the corner and opening their checkbooks, as acquisition operations will be largely centered on platform rather than add-on acquisitions. Sixty percent of respondents reported that they would be spending more than half their acquisition time in 2011-12 focusing on platform acquisitions. Amid a more competitive bid environment, buyers appear to be considering industry specialization as a way to set themselves apart from other would-be buyers, with nearly a third of respondents describing their private equity groups as generalists, but saying they intend to narrow their focus on specific sectors.

Holding and growing

When private equity groups are able to put their stamp on a portfolio company, they tend to be hands-on. Fund managers most frequently make changes to financial reporting, management and human resources, while simultaneously focusing on expansion, acquiring bolt-ons and introducing new products and services. In measuring their own impact, respondents feel they frequently increase top-line growth when theyre highly involved in increasing operational efficiency, and optimizing pricing strategy and organizational structure.

Optimizing your exit

Third-party specialists are receiving increasing attention from private equity groups. Outsourced due diligence expertise is approaching standard practice after post-closing surprises took their toll on portfolio revenues. A likely tie-in to a third of respondents hiring third parties to perform sell-side due diligence more frequently than five years ago. With the increasing popularity of IPOs as an exit strategy, the majority of respondents agree the time required to make a company IPO-ready is long, with 55 percent reporting that they begin preparing within 18-24 months before the intended IPO. Private equity strategies and the dealmaking process are in a redefining phase as many firms make adjustments based on the lessons theyve learned since the financial crisis. A small few have barely adjusted their approach, but the overall market is clearly changing.

Costly surprises to consider before striking a deal

Advisors are also being hired to work in a once-viewed unnecessary areapre-letter of intent (LOI) due diligence. With increased competition on the buy-side, exclusivity time has been cut short, if not eliminated, and private equity practitioners are beginning to see the benefit in adding the help of third-party expertise even before signing an LOI. An indication that IT may be underestimated in the dealmaking process, respondents stated that management reporting limitations incurred the greatest surprise costs post-investment (47 percent), followed closely by unforeseen capital expenditures (44 percent)both areas ultimately tie back to information systems.

Focus is power
Asked to describe their investment strategy, nearly a third of respondents described their private equity groups as generalists, but said they intend to narrow their focus on specific sectors. And more than half of respondents plan to spend 25 percent or less of their time on add-on acquisitions, a shift from McGladreys 2010 report, in which respondents split their focus between platform and add-on acquisitions. Moreover, buyers who have spent time pinpointing key sectors and subsectors often come out ahead when sellers investment bankers create a buyers list for an auction process. Current and prior investment history plays a key role in determining which groups have experience in a sector and will be able to quickly understand the target companies business. Trend data generated by mergermarket supports the findings of this research. During the last 12 months in the United States, the industrials and chemicals sector was most active in buyout volume. These companies will continue to be attractive acquisition targets for private equity groups in the coming year. That industry was surveyed as part of our Spring 2011 Manufacturing & Distribution Monitor, which indicated that 90 percent of manufacturing respondents are very or somewhat optimistic about their companys prospects for overall growth over the next 12 months. Steve Menaker, East Region Manufacturing Practice Leader, RSM McGladrey
US Private Equity Buyout Volume (Last 12 months)
1% 1% 4% 6% 8% 18% 3% 2% <1% 19% Industrials and Chemicals Business Services TMT Consumer 10% Healthcare Financial Services Energy/Mining/ Utilities 15% Leisure Construction Transport Real Estate Agriculture source: mergermarket.com as of 5/23/2011 Defense

Investment strategy
McGladrey believes the desire for industry specialization makes sense, as that specialization can be used to create operational efficiencies. Those efficiencies are the hardest to come by, but are the most valuable ways to improve growth. And when a private equity group targets a company, that specialization can help them stand out from the crowd of buyers and be a true differentiator. When a firm decides to specialize, it leads to much easier alignment between the private equity management team and a portfolio companys operating partnersboth groups are more likely to have an easier time understanding one another, and one anothers operations.

Which of the following best reflects your investment strategy?

4% 14% We are generalists and invest in many different sectors 49% We are generalists, but intend to narrow our focus on specific sectors We are sector specific and will remain that way We are sector specific, but will expand into other sectors

33%

13%

Healthcare and technology, media and telecommunications (TMT) trailed closely with 15 percent and 10 percent of all buyouts, respectively. The healthcare and manufacturing sectors also continue to sustain high levels of activity, which the 2010 McGladrey survey anticipated.

Platform vs. add-on

In specific interview commentary, many respondents said they intend to expand and indicated the majority of their platform acquisitions will target the manufacturing, industrials and healthcare sectors. In contrast, add-on focused firms will target technology companies. Business services (18 percent) and consumer (13 percent) are also popular sectors with private equity investors. Indeed, the largest buyout of 2010 was the $5.2 billion acquisition of Del Monte Foods Co. by a consortium of private equity investors led by KKR. A number of consumer products companies, in particular nondurables, are more recession-proof. Investors have been drawn to the sector for this stability, as well as for good values and the potential upside these companies offer in a recovering economy. Cristin Singer, Food & Beverage Practice Leader, RSM McGladrey Sixty percent of respondents reported that they would be spending more than half their acquisition time in 2011-12 focusing on platform acquisitions, compared with 18 percent of respondents who said the majority of their acquisition focus would be on add-ons. The divide is unsurprising. Coming out of a recession, now is the time to buy better-performing companies, compared to the heavy recession period, when add-ons were likely seen as a better fit or a safer strategy.

In the improved economy, capital is readily available, and private equity groups can deploy more of that cash through platforms acquisitions. From the activity we are seeing with our private equity clients, this redeployment of capital has begun and we consider it a positive sign for future economic conditions. Performing companies in the middle market continue to be a stabilizing force in our economy. Bob Jensen, Great Lakes Region Private Equity Services Practice Leader, RSM McGladrey

What percentage of your acquisition time will be focused on platform acquisitions or add-ons to existing platforms in 2011-12?
Platform acquisitions
4% 23%

6% 9%

None Under 10% Between 10% and 25% Between 25% and 50% Between 50% and 75% Between 75% and 100%

21%

37%

Add-ons
5% 1% 13% 18% None Under 10% Between 10% and 25% Between 25% and 50% 22% Between 50% and 75% 41% Between 75% and 100%

Firms in the survey also viewed fewer consolidation-focused buyouts, where cost cutting and synergies were at the forefront of the acquisition plan, as a sign of a more expansive market. One respondent commented, Platform acquisitions have been giving us consistent growth potential with stable incomes. Private equity seems to be moving away from the abundant consolidation of recent years. A poor economic environment leads to consolidation through add-ons, said another respondent, relating increased portfolio expansion to a positive economic climate. These results are consistent with what our professionals are seeing. Private equity groups are feeling pressure to deploy capital. Financing is readily available for higher multiples. The perfect storm may be gathering, leading many private equity groups to believe now is a better time to do a bigger acquisition.

Costly surprises to consider before striking a deal

The middle-market is the largest area of investment for private equity groups, and 48 percent of middle-market companies are private equity-owned according to U.S. Census data. As activity continues to heat up, the unique challenges and opportunities that accompany those potential portfolio companies cannot be overlooked. Now that a quality sellers market has arrived and the overall M&A marketplace has shifted toward a competitive bid environment, the trend toward conducting more intensive due diligence prior to executing a letter of intent (LOI) will likely continue in the coming year. Accompanying the continued rise of due diligence in U.S. private equity deals, respondents said a record 22 percent of the due diligence they perform before signing an LOI is now external. Third-party due diligence expertise is an increasingly important part in the standard private equity buyout process. While some firms prefer to keep their due diligence activities in-house (one survey respondent said conducting the work affords the private equity group the opportunity to get to know management better), a growing number are seeing benefits in seeking external expertise, particularly since the 2008 crash when pre-LOI due diligence was rare. It remains a potential battleground for quality platform companies and private equity firms are in a frenzy to gain position with sellers, making it a potentially dangerous time to be a buyer. Strategic buyers have cash and are back in the game aggressively pursuing synergistic acquisitions. Hector J. Cuellar, President, McGladrey Capital Markets And the simple fact is that while some larger private equity firms may have the resources to conduct due diligence, many smaller groups lack such internal resources. One fund manager respondent said, Using a third party for legal and technical diligence is essential. The importance of seeking outside expertise has been spotlighted by many firms after the financial crisis.

What percentage of the due diligence that you perform before you sign an LOI is internal or external?
22% External Internal

78%

The shift in the market to favor sellers, and the increased competition from strategic and private equity buyers, has had several profound effects on the deal process and due diligence. Exclusivity time is shorter and sometimes not granted, which makes it essential to understand due diligence best practices. Joe Kinslow, Transaction Advisory Services Director, RSM McGladrey

What was the most costly surprise youve experienced after investment? (select top three)
Management reporting limitations Unforeseen capital expenditure needs Unforeseen working capital requirements Customer retention and concentration Improper accounting methods Management capability limitations State and local tax noncompliance liability Inadequate IT systems 0%

47.2% 44.4% 41.7% 40.3% 36.1% 33.3% 13.9% 8.3%

10% 20% 30% 40% 50%

Percentage of respondents

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In examining the deal-making process, respondents reported that management reporting limitations incurred the greatest surprise costs post-investment. Especially in cases in which external advisors were not brought in earlier, or when a company is first-time sold, it is common for reporting fixes to be one of the fundamental things tackled after a new acquisition. There is a direct correlation between high caliber management and good information. Private equity groups want good information, and usually make getting good information a priority, as that is a core part of their management approach. Typically, sponsor-owned companies that have already been sold once and have moved away from their founder will have better systems and information, and thus less costly surprises on average. For a first-time sold company, there is a lack of transaction accounting experience, and the early days as a portfolio company are often characterized by the need for care and feeding by private equity groups. This is necessary not only in terms of reporting, but to ensure the platforms have consistent reporting across portfolio companies and for associated implications, be it regular and routine issuance of K1s, or gaining an understanding of business issues, such as inventory turn, in a timely fashion. A lot of these costly surprise factors ultimately tie back to information systems. I equate categories like management reporting limitations and unexpected capital expenditure needs back to IT. Our experience has seen a marked increase in the number of firms including IT in their diligence process; these responses underline the reasons more firms need to do so as soon in the process as possible. Jane Shaffer, Technology Consultant, RSM McGladrey Eighty-five percent of survey respondents said they have adjusted the purchase price in at least one transaction. And of those respondents, nearly half reported one in every four deals required an adjustment. If anything, in the context of a market in which the importance of due diligence is rising, it was surprising to see that 15 percent

of survey respondents said they had not encountered the need to adjust purchase price. Usually, adjustment mechanisms are built into acquisition contracts. One possible explanation is that some respondents may make concessions outside of purchase price.

Over the past year, what percentage of deals required an adjustment to the purchase price?
11% 9% 8% 15%

None Under 10% Between 10% and 25% Between 25% and 50%

25% 32%

Between 50% and 75% Between 75% and 100%

Fair or unfair, the view occasionally taken by investment banks is that when there is a purchase price adjustment, something has gone wrong. The end result is an occasional concession on other terms. Whatever the vehicle, the key is identifying a problem and getting value for identifying that problem. Half the surveyed population had 25 percent or more retraded, a significant adjustment to the purchase price. The expectation is the months ahead will see more retrading than what occurred during the look-back period surveyed. The companies that have come to market to sell over the past year were generally not as clean, not as high quality, and were accompanied by more issues. Its not surprising that once private equity groups got in there, they found issues and started the retrading exercise. Milton Marcotte, National Managing Director-Transaction Advisory Services, RSM McGladrey

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How often do each of the following issues play a role in purchase price adjustment?
Inaccurate EBITDA Working capital needs Pro-forma adjustments Non-recurring revenue Revenue recognition not in conformance with GAAP State and local tax noncompliance issues IT Systems requiring signi cant investment

In your experience, how valuable are each of the following advisory areas during the typical transaction process? (where 1=limited/no value and 5=immense value)
Legal Financial Operational Tax Environmental IT

73.4% 71.4% 70.0% 60.8% 58.6% 55.8% 52.8%

10% 20% 30% 40% 50% 60% 70% 80%

4.14 4.05 3.9 3.7 3.16 2.96 2.88

1 1.5 2 2.5 3 3.5 4 4.5

0%

HR

Percentage of time

Degree of value

Respondents said the primary issue for purchase price adjustment is inaccurate EBITDA calculations, with working capital needs and pro-forma adjustments similarly significant. Many respondents admit that an adjustment, albeit not always significant, is made for each of their transactions. Considering EBITDA multiples, adjustments have a significant impact on returns. The value is in identifying the adjustment, lowering the purchase price, and receiving a better return in the end. Also, the number of surprises post-closing will be reduced. Bill Spizman, Managing Director-Transaction Advisory Services, RSM McGladrey Private equity groups should be sure to take caution; a targets failure to comply with state and local tax filing requirements can often lead to significant tax exposure requiring escrows, indemnifications and purchase price adjustments.

Legal advisory is seen as the most valuable advisory position in the typical transaction process, with financial, operational and tax advisory closely behind. Environmental due diligence is important for sector-specific situations, according to respondents, especially in the manufacturing sector, where environmental regulatory issues are more prominent. Whether dealing with regulatory and contract issues, or when providing a tax-efficient structure, obtaining the correct legal and tax advice is critical to any transaction. Nick Gruidl, Managing Director - Mergers & Acquisitions Tax Practice, RSM McGladrey Bearing in mind the costly surprises encountered post-deal many of which tie back to IT expenditures the low ranking awarded to IT suggests a possible disconnect in deemed value. Private equity groups should consider whether they are performing enough diligence in the area, and ensure they scope accordingly to ensure they allow IT to add value and insight to the process.

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Holding and growing

Delving deeper into the relationship of private equity firms in the hold-and-grow stage with their portfolio companies, respondents were asked to identify the areas in which their involvement had the greatest impact on creating top-line growth. The responses found that general partners most frequently believe that taking a hands-on approach adds the greatest value, especially when they get involved in increasing operational efficiency and optimizing pricing strategies. As a previous question found, nearly half of all private equity groups said they were either sector specific (14 percent), or were generalists planning to narrow their sector focus (33 percent). Asked about the particular areas most likely to be affected by change throughout the investment lifecycle of a portfolio company, financial reporting and controls is rated the most frequently targeted area, followed closely by management effectiveness and compensation structure and design. These days, it is rare for a firm to simply buy a company and not make numerous changes to enhance the organization.

How often does direct involvement by a fund executive in each of the following areas lead to top-line growth?
Increasing operational e ciency Optimizing pricing strategy Optimizing organizational structure Guiding go-to-market strategies Increasing sales force e ectiveness Providing industry sector expertise

How frequently do you make changes to the following areas of your portfolio company?
Financial reporting and controls Management e ectiveness Compensation structure and design Cost e ciencies Resource utilization Business model innovation

76.8% 73.2% 71.6% 71.0% 71.0% 70.6%

69% 71% 73% 75% 77%

78.4% 76.8% 76.4% 74.2% 67.6% 65.2% 60.8% 60.6%

10% 20% 30% 40% 50% 60% 70% 80%

67%

IT systems New product design/ service process 0%

Percentage of time

That increasing operational efficiency tops the list is no surprise, as that is a primary driver behind maximizing value. The rise of the operating function is a distinctive trend in private equity. Whether bringing on board operating partners or working with external advisors who have the appropriate operational and industry experience, private equity firms with these expert resources can dramatically improve their portfolio companies performance. While comparatively ranking as a lower area of focus, increasing sales force effectiveness and providing industry sector expertise, should not be discounted. Industry expertise in particular is noteworthy, since some of the most valuable ways to create operational efficiencies often begin with a deep understanding of the business and the market. The same is true of optimizing pricing strategy.

Percentage of time

Respondents noted that although specific changes vary from company to company, consistency is maintained with respect to certain areas. One respondent said system tweaks can often be implemented at portfolio companies that otherwise need to make few changes to improve performance. Another segment of respondents revealed a tendency to frequently change compensation structure while rarely changing IT systems or product designs/service processes; frequency in other areas differed from respondent to respondent. That compensation structures are often modified is another key takeaway.

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In particular, first-time sold, owner-managed companies often do not have a compensation structure in place that is truly aligned with value creation. Private equity groups put that alignment in, which is why respondents cite changes around compensation structure as happening so frequently. That can be correlated to how often a portfolio companys personnel is changedprivate equity groups may not make a ton of people changes, but the end result is enhanced management effectiveness. Milton Marcotte, National Managing Director-Transaction Advisory Services, RSM McGladrey When asked about strategies for optimizing performance and reducing costs, only implementing consistent, automated reporting and insurance coverage and brokerage are reported to be used over 60 percent of the time. The relatively lower scores in other areas suggest a lesser sense of urgency in regard to cost-cutting strategy. This marks a contrast to the 2010 report, where consolidating costs among portfolio companies in a wide variety of areas was a key focus. Reflecting back on the costly surprises that accompany new acquisitions, it is apparent that private equity groups are making a fair number of changes in a variety of areas, and perhaps are surprised about how many of those changes they have to make.

Improved financial performance of portfolio companies can come either from cutting costs or increasing revenues. While there appears to be less emphasis on cost cutting, engaging in growth initiatives such as geographic expansion, the acquisition of add-ons to grow the business, and development of new products and services are in the cards for 2011 and beyond, according to respondents. Engaging in growth changesactivities such as expanding into foreign markets and/or increasing research and development investmenteven half or more of the time, as cited in the respondent answers, can have a very meaningful impact when it comes to a portfolio companys future outlook. The end result of those activities gets to the heart of the private equity model. Many acquired companies are somewhat or significantly undermanaged. To an owner managing a company, growth may be fairly important, but within the context of the private equity group environment, growth becomes extremely important. The difference between an owner satisfied to manage and maintain as opposed to a private equity group that is adding an emphasis on growth is a major shift. The business model is built around professional managers who understand how smart resource investments can transform a portfolio company.

How often do you implement the following strategies to optimize performance and reduce costs across all your portfolio companies?
Implementing consistent, automated reporting Insurance coverage and brokerage Consolidation of service providers Strategic sourcing/ procurement Network/carrier selection and consolidation Outsourcing network management IT server consolidation

How often do you implement the following changes to your portfolio companies?
70% 69.4% 67.6% 56.6% 55.6% 53.0%
10% 20% 30% 40% 50% 60% 70% 80%

71.6% 67.8% 59.0% 58.6% 58.4% 51.4% 49.4%

10% 20% 30% 40% 50% 60% 70% 80%

Expand into new domestic markets Acquire add-on acquisitions Introduce new products/ services Divest non-core assets Expand into foreign markets Increase R&D expenditures

0%

0%

Percentage of time

Percentage of time

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The careful management of private equity investments, coupled with the industry expertise and business acumen of senior executives, allows private equity firms to add value to portfolio companies. Respondents revealed a clear tendency among middle-market private equity firms to retain their key management, particularly the CEO. We always try to retain the key management and work with the existing team, commented one respondent. Many respondents echoed that sentiment. Explaining his firms thorough target identification, one fund manager did add he will consider the probability/necessity of changing management when it is needed to improve the business. The overall results for likely retention of top executives trended higher than anticipated, particularly in the case of the CEO. The assumption might be that the chief executive is the roadblock to implementing change in an efficient manner, and the person most responsible for having sub-optimized the company making it ripe for acquisition by a private equity group. Thus, such a high proclivity to retain the chief executive is very surprising. One explanation may be that deals wherein the CEO is retained for an agreed-upon amount of transition time is not reflected in the responses.

How often do you retain key management executives after an acquisition?

84.2% 78.2% 74.2% 74.0% 72.6% 71.8%

CEO VP Sales CFO VP Operations VP Human Rescources Controller

66% 68% 70% 72% 74% 76% 78% 80% 82% 84% 86%

Percentage of time

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Optimizing your exit

As management teams prepare to exit, and weigh sales to a strategic buyer or an IPO exit, the team can expect to spend long days facing difficult decisions, many for the first time. Companies need to have a credible financial team in place to weigh all the organizations options. The first step of the process begins with determining whether a company is actually ready to go public, and taking a hard look at the financial numbers. As the economy has turned in the past year, market conditions have followed suit, witnessing a significant increase in the volume of deals in 2010 and through the first half of 2011. Sell-side due diligence is also becoming more prevalent, both for buyers seeking reassurance, and for sellers who want to do everything possible to optimize their exit price. Whether private equity will gain time to plan and execute exits in a revitalized economy, or be hastened by new tax policy, respondents highlighted several issues to consider in optimizing value. According to one fund manager, Unreported accrual awareness is the main issue.

When exiting an investment, how important are each of the following issues? (where 1 = unimportant and 5 = extremely important)
4.42 3.77 3.75 3.66 3.42 3.09
1 2 3 4 5

Quality of earnings levels Revenue recognition accuracy Tax liability accuracy Identi cation and treatment of non-recurring items

U.S. Private Equity Exits

Volume
2006 2007 2008 2009 2010 H1 2011* 703 737 441 324 560 184

Value USD (m)

128,617 152,032 81,097 37,969 110,862 22,982

Unreported accrual awareness Valuing intangibles

Degree of importance

source: mergermarket.com * H1 2011 as of 5/23/2011

There is a large inventory of portfolio companies ready to be sold. Private equity exits have increased significantly over the last few months and we expect this trend to continue. Gina Hintz, Co-Head of Private Equity Coverage Team, McGladrey Capital Markets The volume of private equity exits declined in response to deteriorating economic conditions from 2007 to 2009, but witnessed a comeback in 2010. Many private equity groups held onto investments for longer than usual in anticipation of improved market conditions, financing and valuations. Another factor in the uptick of exits: proposed changes to carried interest tax policy, which threaten to change the way the private equity industry is taxed on income.
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Much of the work in the planning stages of a transaction is focused on the quality of earnings. Companies need to get to a point where they have produced three years of quality financials that are comparative when looked at year to year. While the equation to get there may be simple, it comes down to having the right team in placethe experience and credibility of a companys financial management team is what will most directly impact the quality of earnings. Unquestionably, private equity groups need to develop the right exit process to optimize value. The downturn in the domestic market continues to dictate the necessity for sell-side due diligence, which has long been a more prevalent practice in Europe.

With the depressed economy, the number of exits has been suppressed in recent years. Because the market is coming back, sellers want to make sure they receive optimal value. Third-party experts can help eliminate anything the market may attempt to use to discount the price. One nuance is that right now, some of the companies that are selling have gone through difficulties. Those companies have a story they need to bring credibility to through a sell-side diligence exercise. Because of non-normal activity in the marketplace that typically accompanies a major recession, many companies have weathered a number of issues, be it downsizing, restructuring, loss of accounts, big A/R write-offs. They need to credibly show that their business is sound in order to maximize value. Scott Vanlandingham, East Region Financial Advisory Services Leader, RSM McGladrey

that arise during the course of investment, thus helping in understanding the right value for the deal and eventual success of the deal. The upswing in sell-side due diligence is not surprising and corresponds to the other major shift in the market: more buy-side scrutiny on the deals. The uptick of sell-side due diligence can be largely attributed to the intensification of buyer due diligence, which is a direct outgrowth of economic conditions. Buyers typically have to put more of their own capital into deals nowadays, so they not only are facing potentially lower returns, but greater risk that an overlooked problem at an acquisition candidate could blow up in their faces. Bill Spizman, Managing Director-Transaction Advisory Services, RSM McGladrey

Do you perform outside (third-party) sell-side diligence more frequently now than five years ago?
1%1% 14% Yes, much more frequently Yes, somewhat more frequently No change No, less frequently 65% No, much less frequently

IPOs
On the IPO front, while the market is a key driver of IPO decisions, it is not alone. Structure and timing in going public are key, and become complicated in liquidating after the IPO is raised, one fund manager said. Respondents also pointed to poor current market conditions and stronger competition from strategic buyers. Market conditions are a relatively safe place to lay the blame for dismissing an IPO, but cost was a surprisingly prominent reason to dismiss an IPO as an exit strategy. Presumably, the value of an IPO will dwarf the cost. The reality is that if a company is struggling to remain SOX compliant, or lacks good internal controls, chances are it will never be in a position to seriously consider an IPO. Giving up control may be part of the perceived cost in pursuing an IPO, and that a strategic buyer may sometimes present a better option. Alternatively, a company may decide the IPO is not large enough when weighed against the surrender of control. There may also be a need to upgrade the talent of a companys team. Prior to reaching the IPO, a company should

19%

One-third of respondents perform sell-side due diligence more frequently now than five years ago. Bringing in outside experts to help prepare a company for an exit can allow management to focus more time on running the business, while helping optimize EBITDA and exit price, according to respondents commentary. One managing director summarized the trend by stating that: Third-party sell-side due diligence greatly helps in addressing and clearing up issues with technical, HR, finance and others

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have both a CEO and CFO in place with experience leading an IPO, as well as an SEC reporting person and a solid legal team, whether internal or a third-party provider.

At what point when considering an IPO as a potential exit strategy do you begin investing the time and resources to get the company IPO-ready?
6% 4% Greater than 24 months Within 18-24 months

For companies where an IPO was seriously considered but dismissed as an exit strategy, which of the following were the primary reasons why?
63.4% 59.2% 38.0% 38.0% 35.2% 4.2%
10% 20% 30% 40% 50% 60% 70%

Market conditions/valuation Cost Strategic buyer was a better option Length of time required to complete the o ering Lack of corporate preparation to meet regulatory requirements Other

35%

Within 12-18 months Within 6 months 55%

0%

Percentage of respondents

While the length of time to prepare for an IPO doesnt vary widely from company to company, the reality is that there are many companies we work with who believe they are much closer to IPO than they truly are. Some clients estimate they are months away from an IPO but then require years to file their registration statement. To me, the IPO is going to get you a large enough value that its worth the pain. Scott Vanlandingham, East Region Financial Advisory Services Leader, RSM McGladrey

For those who choose to go ahead with an IPO, the key issues do not change. Respondents are most concerned with market conditions, valuations and cost. The majority of respondents (55 percent) expect to get a company IPO ready within 18-24 months, with an additional 35 percent focusing on the exit 12-18 months ahead. Several respondents echoed the comment that with the current requirements, the time required to make a company IPO-ready is long. Ninety percent of companies begin investing time and resources toward IPO readiness between 12 and 24 months before the intended IPO. Our experience has been that this may leave them short on time, since systems are such a critical component of the process and often the necessary modifications of the systems and the related business processestake more time to effectively introduce and become operational with. Stan Mork, Managing Director-Technology Services, RSM McGladrey

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About mergermarket
mergermarket is an unparalleled, independent mergers & acquisitions (M&A) proprietary intelligence tool. Unlike any other service of its kind, mergermarket provides a complete overview of the M&A market by offering both a forwardlooking intelligence database and a historical deals database, achieving real revenues for mergermarket clients.

About Remark
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For more information please contact: Matt Leibman Publisher, Remark The Mergermarket Group Tel: +1 212 686 6305 Email: Matt.Leibman@mergermarket.com

Contributors
The following individuals contributed to the design and development of this study. Ben Brandes Director, RSM McGladrey ben.brandes@mcgladrey.com | 617.241.1379 Hector J. Cuellar President, McGladrey Capital Markets hector.cuellar@mcgladrey.com | 714.327.8636 Nick Gruidl Managing Director - Mergers & Acquisitions Tax practice, RSM McGladrey nick.gruidl@mcladrey.com | 612.629.9686 Gina Hintz Co-Head of Private Equity Coverage Team, McGladrey Capital Markets gina.hintz@mcgladrey.com | 714.327.8209 Bob Jensen Great Lakes Region Private Equity Services Practice Leader, RSM McGladrey bob.jensen@mcgladrey.com | 847.413.6221 Joe Kinslow Transaction Advisory Services Director, RSM McGladrey joe.kinslow@mcgladrey.com | 410.246.9190 Don Lipari National Executive Director of Private Equity Services, RSM McGladrey don.lipari@mcgladrey.com | 212.372.1235 Milton Marcotte National Managing Director-Transaction Advisory Services, RSM McGladrey milton.marcotte@mcgladrey.com | 312.634.3143 Steve Menaker East Region Manufacturing Practice Leader, RSM McGladrey steve.menaker@mcgladrey.com | 704.442.3851 Stan Mork Managing Director-Technology Services, RSM McGladrey stan.mork@mcgladrey.com | 612.376.9233 Jane Shaffer Technology Consultant, RSM McGladrey jane.shaffer@mcgladrey.com | 319.896.5423 Cristin Singer National Food & Beverage Practice Leader, RSM McGladrey cristin.singer@mcgladrey.com | 212.372.1184 Bill Spizman Managing Director-Transaction Advisory Services, RSM McGladrey william.spizman@mcgladrey.com | 312.634.4422 Scott Vanlandingham East Region Financial Advisory Services Leader, RSM McGladrey scott.vanlandingham@mcgladrey.com | 703.336.6548

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2011 RSM McGladrey, Inc. and McGladrey & Pullen, LLP. All Rights Reserved.