Episode 162 - Steady Volume, Slower Pace: Canada’s Midmarket in Changing Times

Hello and welcome to Views from the Market, Mid-Market Private Equity and M&A in Canada. My name is Mario Negro, and I'm a partner in the Private Equity and M&A group at Steikman Alley. For today's podcast, I'd like to welcome our special guest, Tyler Lang. Tyler is the president of HDL Capital.

Tyler, thank you for joining us and welcome. Thank you for having me. Tyler, we always start our podcast by asking our guests to tell us a little bit about themselves, about their background, in your case, about HDL Capital. So why don't we start there?

Sure, we'll do. I was born in Sault Ste. Marie, and I lived there until I went to high school. I came from a fairly entrepreneurial family.

My father sold real estate and was a real estate developer. And my mother owned laundromats and convenience stores. They lost everything when the market crashed in the 80s, and we picked up and moved to Ottawa to start over. And I started high school the very next day after we moved there, which was very exciting.

After that, I went on to do university in Montreal and then later moved to Toronto where I did my MBA. I thought I would move to Toronto and be here for two years for the MBA. And that was 1997. And I'm still here, which Toronto tends to do, I find.

I joined HDL Capital back in 99 and I've been in the industry ever since. And I'll tell you a little bit about HDL. We're a boutique M&A advisor. We're here in downtown Toronto, and we primarily do sell-side and buy-side M&A advisory.

The firm's been around since 93. I took over in 2012. We're a smaller team, Lean and Mean, six individuals made up of CPAs, CBVs, and other finance professionals. We're looking to grow the firm and other few team members by year-end if we can find some good people.

Last year, I completed a buyout, and the firm is now 100% owned exclusively by me and the deal team members. In the sell-side M&A practice, we work mainly with Canadian clients and arrange sale transactions with buyers throughout North America and beyond. Our typical sell-side client is doing $5 to $50 million in revenue and probably $1 to $10 million if EBITDA. So it's kind of the true lower middle market, as you can get us, I suppose.

and we have pretty general focus, lots of transactions around manufacturing, services, technology, distribution. We also have a buy-side M&A practice where we work with a few larger corporations to source and close acquisitions for them across Canada and beyond. And we have two of those that we've had multi-year relationships with. So that's been pretty rewarding to be able to contribute to their longer term growth over a number of years.

So that's us in a nutshell. I've been in the business for over 25 years now, and we've done a few hundred transactions over that time. I've always considered myself more of an entrepreneur than a banker, frankly. Apart from HDL, I also operate an importing and distribution business with my wife, and it's been running consistently for over 15 years.

And surprisingly, she hasn't divorced me yet. So that's another tidbit most people don't know. And finally, I live in mid-Toronto with my wife and three teenagers, which I believe are all identical in age to your kids, if I remember Mario. Well, Tyler, you've obviously been working in the middle market for a long time.

You've been representing sellers as they try to sell their businesses. and I know it's been a bit of a monster ride for all of us in the middle market with all these macro forces and changes to the marketplace over the last few years, whether it's COVID interest rates, AI, Middle East tension and wars. I wanted to ask you a little bit about what you're seeing in the marketplace when it comes to M&A deals. And in particular, I know you've been seeing deals kind of have a new characteristics that we're not used to coming out of COVID where deals were going fast and a lot of stuff that we used to remember taking more time and more effort has changed.

And I want to talk a little bit about what you're seeing on the ground when you're working on M&A deals, particularly in terms of what it's taking to get them done. I know, obviously, one of the things that's changed is taking more time to get a deal done. Just want to get your perspective on what you're seeing on the ground, and particularly with the deals you're working on in the middle market. Yeah that all very good questions And I think that the market these days it changes almost every six months Well obviously look six months ago we didn have this situation with Trump in Iran You know, it's 12 months before that.

You're barely learning about the tariffs and tariff wars and all that. So it's really moving fast these days. And I think what we're finding is that a lot of that turbulence causes a lot of concern among lenders. And most of the deals in the M&A market and mid-market were lower middle market where we all play.

Kind of that $50 million in value and below is kind of what we consider the middle market. Most of those deals need to have lenders involved. No one has the cash sitting around to do a deal. And banks have become more and more and more diligent on looking at how things like tariffs or AI or these kind of things can affect the companies that they're lending against.

So that has come full circle. And we found in the last kind of five or 10 years, particularly in the last five years, they're really relying on something they call a quality of earnings report. And I've heard a couple of times in previous segments of your show, or guests have talked about quality of earnings reports. I mean, the problem is with quality of earnings reports is that we used to have a deal process where once you sign an LOI, you'd probably close in two, three, four months.

But now, if you haven't done that quality of earnings report and you didn't know you needed one, all of a sudden you sign an LOI, a bank tells the buyer they need a quality of earnings, bang, you've added two months to the length of your deal. So you've now taken a deal that takes maybe three or four months, and now it's four to six months. And then if there's any kind of issues whatsoever with what happens in the quality of earnings, maybe the EBITDA is lower than you thought or whatever, then you could blow another number of weeks renegotiating the deal.

So all of that uncertainty in the market causes indigestion for lenders and drags deals out and causes more cost for quality of earnings and so on and so forth. So that is one of the biggest things I see out there is banks getting more conservative and tightening up and looking for more and more due diligence lately. When you look back at a few years ago and you talked to an owner operator and you're obviously guiding them on the sale of the business, what would you have been saying to them then when it comes to timing to do a deal versus now?

What we have to do is we have to socialize to obviously clients who don't know how to do this, don't do this every day. What are you advising a client now in terms of the time to get a deal done? Yeah, that's changed a lot lately as well. you're always going to have a few kind of months to get the deal ready and get an investment memorandum ready and a financial model and data packet, data room and all that kind of stuff.

You're probably going to spend a couple of months out there marketing and finding a buyer. So when you look at it from when you sign that LOI, we would have said traditionally anywhere from as little as two months, done it many times. If everyone's organized, probably up to three or four months. And then usually there's other things that could come into play, like change your control or landlord issues or whatever you never think about.

But an average deal would have been from LOI kind of probably three to four months. Now I'd say it's four to six. And if people are inefficient, you're looking six to 12. And I think I heard that just on a few podcasts ago with Jim Friesen from Distinct.

And he was saying that they're starting to tell their clients, look, count on nine to 12. Right. So I don't know if that lines up with what you're seeing out there, Mario, but it's certainly something to take into account when you're causing your clients. I agree.

We're definitely seeing deals take a longer time. We're seeing buyers be more cautious and want to kind of see visibility into the next quarter before making a decision. Let me ask you, what do you find? I mean, obviously, the impact of longer deals is more costs, more uncertainty, as you said.

Any other impacts you see because things are taking longer? Any other factors that are affecting deals because of the longer timelines? Well, I think you'll know this one. The most common saying in the deal business is time kills all deals.

And every single day or week that you take to close a deal after you sign that LOI just creates this window for unexpected stuff to happen. You better believe some deals are taking longer because of the situation you're at. Like it going to affect every deal indirectly in some manner So the longer you wait the more a COVID could come in or a Trump tariff or anything unexpected And either the buyer has an issue and oh we have to put all our deals on hold or the seller has an issue.

Oh, our revenue's down and the bank may all of a sudden sour on the space. So I remember a deal we had. This is crazy. We had a deal I worked on when I was starting out in the business and the deal got canceled just one week before closing.

one week. And the buyer, who was a public company, they had a back quarter, their stock dropped 10% or something like that. I can't remember. And the board said, all deals are on hold till further notice.

So they missed it by a week. And you know what our client did? He decided the month before that, contrary to our advice, to go and take two weeks off and go to the Bahamas. And while he was away, everything ground to a halt.

Nothing happened on the deal. And if he had just stayed focused and kept his eye on the prize, he wouldn't be able to just go to Bahamas for two weeks, he would have been able to retire there. And again, after that, I saw him a little later, his business took a nosedive, but he never ended up selling as far as I know. So you know what I mean?

Like, it's just crazy how people, when you're in the deal process, they tell them, we've got to hurry up, we've got to hurry up, we're going to apply, and they don't take you seriously. And then something like that happens. So every day is valuable. I wanted to build on that, some of the uncertainty that we're seeing and all these factors and how they're affecting getting deals done.

How are you dealing with, we always have had this, the classic disconnect between a buyer and a seller when it comes to valuations. And in this environment, how is that playing out? What are you seeing on the ground when it comes to valuations these days in terms of misconceptions on valuations or disconnects on valuations between buyers and sellers? Yeah, it's becoming a problem.

And And we're seeing companies coming in to talk to us with these completely misguided notions of what their companies are worth. And frankly, it's not their fault because there's this amount of noise and information overload out there. It's at an all-time high. We'll speak to some company that straightforward vanilla services company.

They're doing a couple million dollars at EBITDA. Pretty straightforward. I mean, this is what we do all day. They'll come in like guns a blazing with a Deloitte or RBC or whatever industry report from three years ago.

And they'll say that they should be trading in an eight to 10 times EBITDA, you know, like double or triple what it's worth. Or the other thing they'll do is they'll come in with a 60 page valuation report that they paid their accountant to 20,000 bucks to do. And it's based on some sort of discount cash flow analysis that projects the company's EBITDA 20 years and brings it back. I mean, just completely irrelevant, right?

And to talk more to where you're getting at is our current favorite is I just went to chat GPT and told it what our revenue and our EBITDA and our industry is. And it said that we're worth at least a 10 times EBITDA multiple. Like it's, well, chat GPT told me, right? I mean, it's tough.

And so we spent a greater amount of time working with these clients to show them all the kind of top 10 or 20 checkpoints that a buyer is looking at and how they're valuing your business and kind of bringing them down to earth so that they can prepare to go out in the market and not be let down. So I think the information and AI and all this is really not helping things, but that's our job to go out and bring some kind of sensibility to the whole thing. I know we've talked about trends that you've been seeing in the market in terms of potential buyers or sales processes in the middle market.

I know you've indicated to me that you've been seeing a lot more of MBOs. And I wanted to talk more about that and what you're seeing on the ground. I mean, we haven't heard the word MBO in a while, or at least it hasn't been as popular as it used to be. Tell us a little bit about what you're seeing on the MBO side and I guess why it's interesting.

So. Yeah, I guess it's one of those, as they say, what's old is new again, right? I think I worked on an MBO in the late 90s, 99 or 2000 when I started in the business. And they were still hot back in the 80s and 90s, and they just kind of fizzled away.

And I can't really say why, but I think the MBOs were popular because that whole private equity market hadn't emerged yet. And there wasn't all this billions or trillions of dollars of private equity sitting around and who are you going to sell the business to? Well, either I sell it to my competitor or one of my kids takes it over maybe right And I think the other option was to have one of your employees take it over So I think the problem with the MBO is that in the old days you could just go to the bank and with the owner and you the employee or manager and they would just give you most of the money lend you most of the money to do that deal And I think over the last 20 years, what's happened is they want you all in.

You've got to put a bunch of cash down. You've got to personally guarantee it. You've got to put your house on the line. You've got to pledge all your stock.

I mean, it's really become difficult for someone to do that and very risky. So the ability for a manager to buy a business became very risky and difficult. So the MBO is something that seems to be coming out again. We're doing a very large one right now, probably just under $10 million EBITDA.

And I find that there is a great deal of interest from people that would otherwise be majority private equity buyers. We'll only buy a majority. We want to control. They're starting to lighten up and be like, you know what?

There's already a good manager in place, which you would expect. There's no transition issues. They're willing to take a shot on those. So we're doing one right now.

We've got some great interest. We're going to see how it goes. But I think it's starting to kind of be an area of focus for private equity people, private equity investors who don't want to be involved in heavy, heavy, heavy competition for always doing a control deal. So that's our sense of it right now.

It's still an emerging market. We'll have to see how it goes. I guess the idea there is if you have a good management team, it's getting easier to find capital to do deals from private equity firms who are looking for alternative ways to get deals done. Yeah, exactly.

I think that transition risk is something that a lot of private equity firms really struggle with. And I think that just kind of checks one of those boxes. One less thing to worry about. And also, I've noticed that in talking to senior lenders and their transactional working on, that checks the box for them as well.

Yeah. Can I ask, what are the trends that you see, Tyler? When working lifelong in the middle market, when you look at where we're going, where we're at, Anything else that you're seeing or that you think is kind of coming down the pipeline in terms of deal trends or anything else during the M&A market you're seeing as a deal trend? Well, I see a lot of trend towards doom and gloom right now, and I just don't think it's warranted.

Frankly, I don't know where it's coming from. I mean, if you just focus on geopolitical items or tariffs or things like that, sure. But I see there's a lot of good businesses that don't rely on importing raw goods or aren't heavily impacted by AI at this time. And they're just going about their business and they're great targets.

And they're getting older and they don't have kids to take over and they need to sell. And we're meeting them all the time. And on the other side, there's tons of PE money. I mean, it's endless and it's growing every day.

And I think the emergence, like I really am surprised at how strong the search funds are coming on. A few years ago, right? It's just like five years ago, wouldn't even consider it. But we're really looking at surge funds as a really viable option now.

They've become very sophisticated. They've now been cycles of surge funds have been fully out and made their investors money. And they've gotten in another one. They've already gone in and out.

So I think the market is good. This whole succession tsunami, it's overused the word. But I remember when I was back in 99, when I started, they were talking about the baby boomers. They're going to retire.

There's going to be this flood of deals. It didn't happen 10 years later. It didn't happen 10 years after that. It only happened a few years ago.

And we're really at the start of it. So I don't know. I guess I'm saying the trend out there is to hear about doom and gloom and all, but I think that it's a lot of talk. I think there's a lot on the go and it's holding in strong despite everything that's happen globally.

I'm excited by what you're saying because it means I'll have work to do. Well, thank you for joining us. Greatly appreciate learning more about you and more about HDL Capital and the work that you do. And greatly appreciate your insights in terms of where the market's at, particularly for the middle market.

Thank you again for joining us. Thank you for having me. Thank you for tuning in to Views from the Market. Stay updated with the latest episodes by subscribing wherever you find your podcasts or visiting steichman.

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