Listen: The Pipeline: M&A and IPO Insights | Ep. 3 - Launching an i-bank in a low deal environment

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Joe Manton

The deal-making environment has been slowed by a number of headwinds, including higher interest rates, lower equity prices and geopolitical uncertainty. Despite the challenges, Matt Edgar decided to go ahead and launch a brand-new investment bank. Why is now a good time to start an i-bank? We talk about that with the founder of Edgar Matthews & Company on the next episode of The Pipeline, an S&P Global Market Intelligence podcast.

Welcome to The Pipeline, a podcast that's dedicated to all things deal-making. I'm your host, Joe Manton, and I recently spoke with Matt Edgar. Matt was previously an i-banker with Goldman Sachs and Sandler O'Neill and Partners before that. But now, he's decided to branch out on his own and launch his own firm.

While it may seem counterintuitive to start an investment bank when M&A and capital raising has been slow, Matt sees the current environment offering some benefits. For instance, other i-banks are cutting back, and that could lead to some hiring opportunities for firms like Edgar Matthews.

Matt expanded on that topic and also spoke about the current deal-making landscape during our conversation. And here it is. Well, first of all, Matt, thanks a lot for joining us today. And congratulations on launching your new firm.

Matt Edgar

Thank you. Appreciate you having me.

Joe Manton

Sure. So the deal-making environment has been pretty challenging of late. So I was kind of just curious on why you think now is a good time to start an investment banking firm.

Matt Edgar

Yes. I mean it's a fair question. And look, there's certainly a pretty significant dislocation going on in the current market. But we think during these dislocations, there's a massive opportunity being created. So in founding Edgar Matthews, we seek to be a true solutions provider and to be very flexible and very creative when working with our client. And we think the middle market is the place to play right now.

The M&A front there, I think, continues to be busy. And when you hear the anecdotes of there being a slowdown in deal-making, the environment being challenged, I think that's more so speaking to the large cap part of the market, which is more dependent on the health of the debt and equity markets, quite frankly, not to mention the sort of re-rating that we're seeing to a more normalized state following a record-breaking year of M&A that we're coming off of.

And in the middle market, sure, deals are taking longer to close, earn-outs and other structured deals are becoming the norm, but activity remains healthy versus historical levels. That being said, when we think about the other side of deal volume on the financing side, that's where we're really spending a bulk of our time right now, particularly in sectors that we're most active in that need capital.

And I think folks are kind of approaching it from both a defensive lens, where, given some uncertainty in the economy, they're looking to shore up their balance sheets. But also from an offensive perspective, being able to bolster their capital resources today, take advantage of mispriced assets or market share opportunities is something that's keeping us quite busy and really playing into the thesis in starting the shop.

Joe Manton

So we say financing, so equity financing? Or is it debt -- access to the debt markets? Is that what you mean?

Matt Edgar

I mean, we're -- we've been looking at situations sort of across the capital structure. I think, right now, what we're focusing on is more on the debt financing side, just given sort of the dynamics playing out there. But also more on what I describe as structured credit side, where it kind of looks like a blend of debt and equity or mezzanine type of solution, which is something that a lot of clients have been sort of dusting off the pages on that, so to speak.

Joe Manton

And so the terms are favorable enough for issuers out there?

Matt Edgar

I think there's enough capital out there chasing deals that there is a meeting in the middle. I think some folks are sort of anchoring on the 2020 and 2021 price, but realizing quickly that given the rate environment massively resetting, this is sort of the current state of affairs.

Joe Manton

And then you mentioned that you're focusing on the middle market. How do you define the middle market?

Matt Edgar

Yes. I mean, look, everyone has a different definition of the middle market, right? So we like to think about things on a deal size basis. So less than $500 million is sort of how we're branding it, which is intentionally a wide range. But you can really break that down. Especially at the beginning, when I look at the deals we retained on now, it's going to be closer to $50 million to $200 million in terms of deal size.

And right now, I mean, we're getting our name out there. We want to develop an excellent product and service offering, and most importantly, sort of build the infrastructure around that. Once you get north of the $200 million to $250 million type of range in deal size, those tend to be more competitive processes in a lot of situations, which obviously takes time and infrastructure to sort of get there. But I think over time is where we'll sort of seek to play.

Joe Manton

Right. And that's M&A size deals you're referring to there, right?

Matt Edgar

I'd say, it's a fair assessment for both. I think when thinking about where we want to play on the M&A side, we might be a bit more selective. But I think for both financing and M&A, that's a good range.

Joe Manton

Okay, interesting. All right. And then the sector focus, is there a specific area where your firm will be focused on?

Matt Edgar

Yes, so I'll answer that in two parts. So my career has largely been focused in the financial service sector, mostly spending time covering asset managers and specialty finance companies. So right now, of the 5 to 7 sort of situations that we're actively working on, that makes up the large portion of deal flow. But I will say it's not a function of where we want to play over time.

It's just by virtue of where my experience and relationship sort of lie. Our goal over time is really to build capabilities in all sectors, which is more characteristic of what you see in the big banks. We think being able to cannabis all sectors and really build out expert teams in each sector and subsector not only creates great synergies across the firm longer term, but also sort of keeps an eye on providing better service to our clients at the end of the day.

So as I think about sort of our biggest strategic focus right now, it's building out those capabilities in sectors outside of financial services. And 12 to 18 months from now, we sort of tend to have at least 3 to 4 teams starting to be built out and really leverage it from there.

Joe Manton

So you're hiring. You're actively hiring.

Matt Edgar

Correct, correct.

Joe Manton

Okay. Yes, in the asset manager space, that's a good space to play because it always seems like there's a high volume of deals there.

Matt Edgar

Yes. And the interesting thing about -- especially in the alternative asset management space, which is where when I think about the past 4 to 5 years, where I've spent time, that's probably been the most active from my perspective. And there's just so much new technology and structures being introduced to that part of the market.

And we can talk about what the secondary market coming in folks sort of means for those types of players. But also when you think about sort of the GP side of the equation, working with private credit and private equity sponsors, those folks really have a whole new toolkit available to them. And what I mean by that is, I mean, that market sort of started out many years ago as a GP minority stake market, where some of the managers might have opportunities to cash out and get some liquidity against businesses that they build.

But now you have things like a very built out GP financing market, things like NAV facilities and hybrid facilities and the like. But also more creative options on the preferred or strip sale side as well. So I think there's a lot to do in that space and something that's been keeping us very busy.

Joe Manton

Okay. Yes. And then in the private equity world, I mean, I know private equity firms have a lot of dry powder. I know you're saying the middle market space, the activity hasn't slowed as down as much as the larger cap space. But I mean the deal-making environment, given the headwinds, do you -- is it difficult to be putting that dry powder to work right now?

Matt Edgar

I think on the platform side, it has been difficult, especially in sort of what I'll call the upper middle market. You've seen a lot of activity more on the add-on side of the equation rather than new platform. And I think that's just a function of, quite frankly, where the financing markets have been trending.

It's a lot more difficult to clear an IRR hurdle or a MOIC hurdle, borrowing at financing costs that's, in some cases, 500 to 600 basis points wider than you were previously sort of borrowing at 2010 to 2020. So I think folks are beginning to re-rate that.

Joe Manton

And we say add-on, you've just been bolting on to a portfolio company.

Matt Edgar

Correct. Correct. Because that sort of plays into the thesis I was mentioning earlier, right? I mean, they're lower in mid-market. It's just a less efficient part of the environment, and that's been more resilient from our view.

Joe Manton

So even if you're a bigger company, you can make a smaller acquisition.

Matt Edgar

Correct. Yes, and I think that's a theme that we've been seeing play out from our sponsor clients.

Joe Manton

Right, right. I mean, do you think we're at the point though where we might see some private equity firms having to return capital to investors if they can't get some of that money to work?

Matt Edgar

I think a lot of sponsors will do whatever they can to not do that. But look, I mean, it's a fair question in the sense you've had this mounting trend of fundraising and dry powder over the past 10-plus years in the asset class, right? And as I mentioned, platform deals have been challenged in the last 12 months. Add-ons continue to be healthy for smaller check sizes.

I think the take-private type of trade is coming back, at least anecdotally from my conversations and folks are looking to deploy capital in sort of different ways, especially just given the depression and sort of equity prices currently, some of the oversupply of public companies post ease back to happen in sort of 2020 and 2021.

So that being said, there seems to be new opportunities presented where you can put capital to work in an accretive manner. So I don't envision a significant rebalancing act going on, particularly when you keep in mind the actual structures of these funds at the end of the day.

Typically, there's some leniency or ability to extend the fund, pass the fund life, and up to a certain point, sort of get LP concept in order to do that. So I think that's one lever that focusing sort of pull that's going to become a more popular area to visit over time.

Joe Manton

Okay. And your firm, I know the press release that announced the launch of your firm also noted that you're going to be an investment in merchant bank as well. So could you just explain a little bit about what the strategy is there?

Matt Edgar

Yes, happy to. And look, in writing the business plan for Edgar Matthews, a big focus of mine was to really enhance the alignment between us, as the adviser, and the end client. And we think that's critical, and there are a few ways to do that. So our principal investing efforts are largely done in conjunction with the broader transaction that we're involved with.

So whether that's investing in a financing we're placing for a company or taking a portion of our fee in equity or warrants, we think it's a competitive advantage, quite frankly. And we don't want to be in the private equity business directly today. Building sort of a world-class investment banking offering is the core focus.

So we're less interested in doing the sort of independent sponsor model, where we're bidding on a platform and managing it as a private equity firm. Otherwise, would. But I think that's certainly something we would entertain in Phase 2 or 3 of the development.

Joe Manton

And then you mentioned the hiring. I mean, so I guess, any more color there? I mean, are there any certain sectors of focus that you're kind of thinking about early on?

Matt Edgar

Yes. I mean, as we think about building talent, we're taking a pretty opportunistic approach. I think there's some interesting movements in the market just with some of the larger banks sort of shutting down or merging with counterparts. A lot of the larger banks don't have as much of spend appetite for hiring right now just given the over-extension sort of in 2020 and 2021.

So it's an imbalanced market which creates an interesting opportunity for a shop like ours. In terms of sector expertise, I mean, we would love to get experienced folks in technology or health care, just because when you look at the relative fee pool by sector each year, those tend to be near the top. And we just think there's a significant opportunity to bank clients in that space.

But we're also coupling that desire with the fact that there's a lot of good free agents out there right now. So we're interested in speaking to anyone that has experienced really executing deals across the product set between M&A and financing, and has real relationships and real domain expertise that we can deliver to our clients under the Edgar Matthews brand.

Joe Manton

So is that what you were referring to at the beginning when you mentioned there was some dislocation in the marketplace?

Matt Edgar

Well, I was addressing it more in this response in terms of the hiring environment right now. I think a lot of institutions over-hired in sort of the boom years. And now that it is a bit more of an uncertain lower deal-making backdrop, a lot of talent is finding that they're no longer needed at those institutions.

Joe Manton

Got you. Okay. And then just thinking about the private equity opportunities now. I mean, are there any sort of new structures or different approaches that you see some of your clients trying to take just to get deals -- again, to put some of their capital to work.

Matt Edgar

Yes. I mean a couple of things. Like I kind of alluded to earlier, I think more structured type of deals are becoming more than the norm, quite frankly. And what I mean by that, things like earn-outs, things like milestone-based contingent consideration are becoming much more popular, which is quite obvious, right? I mean, acquirers are just trying to sort of derisk any transaction for themselves.

So that's been the majority of what we're seeing. That's always sort of been at play just much more sort of top of mind right now. And on the private equity side of the equation, I was kind of getting into it earlier, but just the amount of liquidity options sort of available in the current market has, I think, changed the calculus of what sponsors are doing strategically and in managing their portfolio.

So things like NAV-level financing, things like continuation funds, things like portfolio strip sales, I think, are gaining some traction in the GP-led side of the market, which is offering some interesting liquidity options and ways to get capital in the door and managed through the sort of uncertainty.

Joe Manton

All right. Okay. Interesting. And how about distressed deals, do you see that picking up at all in the current environment?

Matt Edgar

Yes. I mean, 100%, that's something that we're interested in investing in heavily from a talent perspective. Because, look, I think regardless of your view on the economy, the hard landing, the soft landing, companies levered up materially in 2020 and 2021. And I think the influx of private credit really magnified that amount of leverage in the system.

And I think there's going to be both opportunities for creditor side advice and debtor side as well. From the creditor side or the albacore side is probably a better way of describing it. A lot of these middle-market businesses that materially levered up, likely don't have the sort of know-how to navigate a restructuring or bankruptcy process. God forbid, something goes bust on one of their financing lines.

So being able to provide advice in those types of situations, I think, is a huge need and will be a trend sort of playing out over the next 12 to 18 months. And I think on the lender side, again, some of these smaller nonbank private credit type of providers, even folks with $100 million to $200 million in assets under management have been committing capital to the space.

And in a lot of cases, they don't have in-house sort of workout experience. So I think being able to provide advice to shops like that as well is a huge sort of white space from an investment banker's perspective. So like I said, it's a core focus of ours, and we're definitely bullish on that sort of picking up.

Joe Manton

Okay. So that kind of falls under the restructuring realm would you say.

Matt Edgar

Correct. Correct.

Joe Manton

Yes. And then it kind of seems like you've been seeing carve-outs and some spinouts. I mean, I don't know if it's just more anecdotal than anything else, but are you seeing more of those types of deals picking up?

Matt Edgar

Not in particular. I mean, I think in any time of uncertainty, folks are sort of re-underwriting all of their business lines and seeing what makes sense, where financial and operational success has been found. So I think folks are just being tested a bit.

I think it's less of a need for liquidity. So let's divest business line or institution. But I think folks are just kind of going under, like I said, a re-underwriting and focusing on what's sort of core versus noncore type of businesses.

Joe Manton

Well, that will do it for this episode of The Pipeline podcast. We thank Matt for joining us, and we thank you for listening.