Pava focuses on midmarket M&A, which means transactions between 30 and 500 Mio. EUR. How was this segment affected in 2023?

It wasn’t an easy year. The number of transactions was low, and the transactions that still took place have taken longer to close. Rising interest rates have made refinancing transactions with debt more expensive. This has affected private equity companies, which are an important buyer group. Their model has become more difficult. They were also more reluctant to sell their portfolio companies, as valuations declined.

Are there marked differences in the decline of valuations depending on industries?

On average, we’re back to pre-Covid valuations, but there are huge differences. Take a look at the public markets. Valuations in public markets serve as comparables for transitions in private markets. The Nasdaq performed well in 2023, but the gains mostly came from the 7 big tech companies. Valuations in the broader market aren’t very exciting. In private markets, we have seen some industries that are doing very badly, for example, technology linked to combustion engines. Other industries experiencing tailwinds, for example, renewable energies and batteries and AI, have achieved high valuations in transactions.

You mentioned that higher interest rates have slowed transactions. What are the different mechanisms that are at play here?

First of all, a higher risk-free rate makes it more difficult for private equity firms to raise new funds. Or let’s say, only the good ones can still raise funds. Second, higher rates impact the offering of debt financing. Banks have become much less active in the field due to stricter regulations. Private debt funds are now the main source of transaction financing. They are not only charging more interest due to higher interest rates but are also decreasing the amount of capital they provide. As an example, a private equity firm that wanted to buy a company in the past could, say, pay up to 8 times the target’s earnings as price. The private equity firm would bring 3 times the earnings from its fund and borrow 5 times earnings from a private debt fund. Today the private debt fund will only finance 3 times earnings, so the private equity firm can pay only 6 times earnings in total for a target.

When private equity buyers need to calculate more carefully, does that mean that strategic buyers, meaning companies in the same industry that buy companies for synergies, have the advantage now?

To a certain extent, yes. Strategic buyers always had the disadvantage of being very slow. A potential transaction needs to be seen and approved by more people in a big company. But the large companies that do a lot of M&A have become faster and better at this game. And they have good reasons to buy since the speed with which new technologies have been developed has gone up. In topics ranging from energy to AI, strategic buyers, including European ones, are very active right now. It is cheaper and faster for them to buy new technologies than trying to develop them internally. The AI boom isn’t just about software, as the example of Nvidia shows. There is a lot of appetite for suppliers to the semiconductor industry among buyers who need to keep up with new developments.

What about private equity firms selling their portfolios to other private equity firms, in so-called secondary transactions?

In general, private equity firms are reluctant to sell right now because of the valuations, but those that come to the end of their fund lifetime have to sell. What we see is an increased number of continuation funds. These are funds run by the same private equity firm, with the same or additional investors, that buy strong companies out of funds that reach their lifetime. This additional option has decreased the need to sell portfolios to specialized secondary funds.

Taking a company public as an alternative to selling it isn’t a viable option right now, and contrary to the US, SPACs are a marginal phenomenon in Europe.

The IPO market is more or less dead. There were a few successful SPAC transactions in Germany such as Toniebox and HomeToGo, but this type of transaction has an inherent problem. If VC firms use it, as they do in the US, as a tool to get rid of their stakes in companies by taking them public even though they aren’t ready to be public yet, and sell all of their shares after the lockup period, it isn’t surprising that stock prices drop off a cliff.

Why aren’t there more interesting tech IPOs in Europe?

The small size of European VCs is to blame, not the stock exchanges. Building a big tech company that is ready to go public needs investors with big pockets and a tremendous risk appetite, both of which are lacking in Europe. If you need to raise really big sums, you can only do that in Silicon Valley. A success story like Slack, which after a pivot still raised 1.4 billion of funding is simply not imaginable in Europe. All the big household names like Amazon, Tesla, and Facebook made horrible losses over a very long time. You need to be able to stomach such losses if you want to see big tech players emerging in Europe.

The reason why Europe lacks big VC funds is that pension funds in the US allocate much more capital to venture than in Europe…

… and the tragedy is that early investors often lose out to late big investors from the US because of liquidation preferences. But the other deciding factor holding Europe back is the mindset. Whenever a new technology arises, Americans see opportunities and Europeans discuss how to regulate the technology to death. Take the Foreign Trade and Payments Act, which stipulates that the Ministry of Economic Affairs needs to approve transactions with foreign buyers of specific technologies. We had such cases twice; we waited two years for an answer. Instead of crafting new laws, we should find other ways to keep jobs here in Europe.

One industry has surely created a lot of new jobs: the number of private equity firms globally has increased dramatically in the past decade and is estimated to be above 10’000. Is that good news for people who want to sell their family firm in Germany?

There are indeed many new private equity players and teams that have established a presence in the German market, and the increased competition is palpable. However, this is more pronounced in bigger deals than in smaller ones.

A company sale as part of succession planning can always be postponed for a few years if the valuations aren’t attractive enough.

This is true in most cases and is also what we hear from owners in personal discussions. But then again, there might be issues, such as health, that make it a pressing matter.

Let’s talk about a very specific set of transactions, namely those that ultimately led to the creation of Pava. In 2019, the US investment bank Cowen took over the M&A boutique you co-founded with Jules Grüniger for USD 115 million. Since 2023, Pava has been an independent entity again. What is the reason behind these transactions?

When Cowen started talking to us in 2018, we were convinced that joining forces would make sense on a strategic level. Cowen wasn’t present in Europe yet, and we got along well because we shared the same entrepreneurial spirit. Selling an M&A boutique is a very tricky proposition, because you sell walking assets – partners can just walk away if they’re unhappy. But we managed this quite well: except for one partner, who preferred to join a portfolio company, all of us remained on board for that journey. It was a very good time to build an international platform. Cowen is very active in the healthcare space, which was marked by very high activity during and after the pandemic. In 2022, Cowen itself was taken over by Toronto-Dominion Bank, the largest bank in Canada. TD improved its position in the US with the acquisition of Cowen. But it also brought upon us the compliance procedures a global systemically important bank needs to follow. We deal with German Mittelstand companies and PE funds that have been in business for years. All of a sudden, we had to apply know-your-customer rules to every investor in every fund we dealt with, and onboarding a new client took 6 weeks. So we saw the chance to become independent again if the conditions were right, and every partner and employee of Pava supported that move. We’ve also seized the opportunity to promote young people to partners and secure the succession of dealmakers in the firm. The trust that we’ve established with our peers at Cowen we can still leverage for international transactions.

You have more than 2 decades of experience in M&A. How has technology changed your job?

The biggest shift was when I started working and it became possible to online search databases such as Pitchbook and Mergermarket for potential buyers. Before that, the process depended on your personal network. For us, technology was always a part of our business. Two of the three founders of Blue developed and sold software before, and we hired a software engineer to help us develop our own software that helped us automate reporting tasks, for example. We wouldn’t shy away from buying a tech company ourselves if there is a strategic fit with our work. And if you ask me about the future, I think that the impact of AI on our business and that of other service providers will be immense. Just recently a world premiere was announced when two AIs negotiated a contract between themselves without involving a lawyer. When I think about our business, the opportunities are there as well. An AI bot could easily assemble a longlist of buyers and ascertain the strategic fit as well as find comparable deals. There are also new actors emerging such as dealcircle which position themselves between M&A advisors and potential buyers – they generate lists of buyers and take a fee when a transaction happens. For the moment, we still hire humans who develop business plans in PowerPoint and elaborate a convincing equity story. But that they will use AI-based tools to help them do their work is pretty likely.