Episode 159 - Valuation and Due Diligence in an Age of Uncertainty

(upbeat music) - Hello and welcome to Views from the Market, Mid-Market Private Equity in M&A in Canada. My name is Mario Negro and I'm a partner in the Private Equity in M&A group at Stack Manally. For today's podcast, I'd like to welcome our special guest, Mackenzie Regent, Mackenzie's the Managing Partner at Chaos. Mackenzie, thank you for joining us and welcome. I'd like to start by asking a little bit about you and Kaelos and learning more about Chaos. - Great, well, hi everyone. And thank you so much, Mario, for having me. I'm excited to be here. My name is Mackenzie Regent. I'm one of the co-founders and Managing Partner here at Kaelos. We're a boutique transactions advisory firm focused on financial due diligence and valuation throughout North America and middle market transactions on both the buy and sell side. For myself personally, I grew up in one of the big four counting firms on their financial due diligence team as well as spend a handful of years in global investment banking with one of the big six banks. And kind of just reached a point in my career where I'm sure Mario would see this all the time. I got ironically sometimes it's actually the smaller deals that are harder to get done and really necessitate and advisors willing to roll up their sleeves and help get that transaction across the line. And with some of the larger firms, the economic model didn't always go around to serve as types of transactions. And so it sparked the idea to try and create that best of both worlds, big four Ben strength packaged into boutique that was the name of this required to really serve in cater to the middle market space. And so I hung the shingle seven years ago and last year was named the top financial due diligence firm in North America for 2025 and did about 140 transactions across Canada and the US. Kids, you obviously have been seeing the kind of turmoil that we're going through these days with M&A with tariffs and with the Macroll. I'm curious to a little bit about what you're seeing on the ground. I mean, you kind of see these diligence processes. - Perfect. - And you see the front end of the questions that people ask you what they're looking for in companies. It's been years ago when I used to talk to people in your shoes, it was all about the effects of COVID. Now that's kind of past. And you just asked you what are you being asked to see in this environment? Because we know deals are taking longer and people are spending more time on diligence. And so wanted to talk a bit about what you're seeing on the ground. - Yeah, absolutely. So as you alluded to, I think the scrutiny has gotten higher. And really it feels like since COVID, as you mentioned, uncertainty is the new certainty. We don't necessarily know what is going to be topical as a headwind in that given moments. But really since COVID and then you've got into inflation and supply chain disruptions and geopolitical uncertainty. And now with kind of the rise of tariffs or maybe not with the most recent subpoincorque decision, it's all been a little bit of noise to unpack for everybody. I think really what we've seen in my opinion on the matter is that there's almost too much dry powder on the sidelines for folks to kind of pause their de-activity for too long. And so we've kind of seen any given systemic shot to the system about a six to eight week pause where people go, is the sky falling, is the sky not falling, what are we trying to do? And then really we've seen a rise of structuring as a risk mitigation to no one really has crystal balls. So we don't know what this is going to be in the future. Let's not try and guess at it. Let's try and insert an evaluation bridge that both the buyer and seller can get comfortable about what this is going to look like and solve for it in the future. Where I think that requires a higher level of diligence is I think those days of high percentages of cash on clothes are behind us. And so when you look at kind of traditional quality earnings engagements, it's historically you would do kind of your three year to fully year trailing 12 month type look back. It kind of just assumed past equals future. We're going to normalize the last couple of years, use that as a proxy for the future and drive on. But we've really seen an un coupleing from the idea that past equals future. And so you have to kind of take a force for the trees view of understanding the idea that just normalizing the last 12 months and using that as a proxy for your enterprise values probably not going to work anymore. So how do you bridge into that future into that unknown? And that's where being a charter business value reader and bringing that history is interesting, but not always relevant lens. And how do you unpack and bridge that into the future? And so one of the biggest ways we've seen diligence evolve and how that is manifested is, yeah, that's great to normalize the past. But how do you perform that into the future and really get comfortable with those anticipated future cash flows? Because at the end of the day, that's what the buyers we represent are going to get out of the transaction is the future and not the past. And being able to apply on that with that broader valuation lines, that's been really important. I think the other thing that you would have seen in your practices where that creates complications in the definitive agreement. And so you have to be really cognizant about the accounting principles, how you're defining earn out to networking capital mechanisms. And what this looks like to the future, I mean, this past year we saw the Ontario Superior Court decision on project freeway. And you don't often get public case precedent on earn out disputes. It actually start to see these things come into the fold because valuation bridges have been on the rise now for so many years that we're actually starting to see the back end dispute where those earn outs were maybe unclear or not enforceable or getting into dispute territory and how that's unfolding. So can you reverse engineer, maybe where that definitive agreement fell short? So when you're protecting your clients on their life transactions that they're not repeating the same mistakes? Because when you look at the worker being asked to do now, versus a few years ago, when I think about things like tariffs, we find as clients, like you mentioned, are kind of trying to almost look into the future while they're in the middle of a transaction. How do you do with like additional processes, additional things are looking at? I always wonder how accountants manage your questions about things that they really can't control themselves in some way. Yeah, I think it's just trying to provide a basis from which to understand the future. Because to your point, there's no way to definitively opine on this is absolutely what's going to occur next year. I think it's when you hear the phrase quality learnings. I think it's so often simplified to just doing a retrospective adjustment of EBITDA and really just getting into the stereotypical personal expenses going through business or non-fair market value type transactions or accounting type corrections without truly getting to the underlying recurrence of those items. And so when you can elevate, call it base level compliance of what needs to be fixed in these financials, to truly understanding the nature of the underlying transactions of what is the level of confidence we have that this will or won't be able to repeat into the future? You saw that a lot, even with like margin profiles between supply chain disruptions and inflation. Sometimes people were able to react quickly and adjust their pricing. Sometimes they weren't able to pass that on a long quick enough. You see that kind of right sizing with tariffs now as well. And unpacking just because this was the margin profile for a few months for better or worse, doesn't necessarily mean that's going to be the margin profile in the future. So you have to kind of bench test the likelihood of that being able to replicate itself. But you can also start to understand historically in law of averages and new contracts to the extent they have any. The more you can kind of build out that forward capital profile, but then you bench test it. So we're going to end sensitivities on some of these key assumptions. And in more of a worst case bearer situation you over here. And if everything, you shoot out the lights and this goes extremely well you over here and the right answer is probably in the middle. So to the more you can at least provide goal posts and ranges of comfort that your client can kind of get your head around and the banks can underwrite at least this still cash flows for debt service on the low case, then you're probably in a good spot. When you look at mandates you're given now, do you notice new heads or people want-- because we notice you're taking longer. And so you're being asked to do more. Are you noticing in terms of what people want from you versus years ago in terms of just a scope of work? Is a scope of work? Or is it just deeper into what you already do in or you're also being asked to do newer things in this environment? Yeah. And I think just a back a moment, I would say that there's still very much a use case for-- I just want a standard quality of earnings. I'm comfortable with the business. I'm familiar with that we've done our own commercial. We just really need to unpack the financial element of this versus a full on financial due diligence of-- there's potentially a lot of hair on this or disruption or headwinds, and I really need you to dig into it. And so one of the things we're trying to solve or as a boutique is we don't go to our clients with here's our fixed list of products. And you're getting a QV or you're getting a vow, you're getting a model and you need to put together your own situation. I had the chief investment officer of Harvard Equity firm that we do a lot of work with last year called me and say, I don't know what I need, but I know I need help. And this is the situation. And so I think part of the benefit of the agility of a boutique is just listening to our client situation, understanding the unique elements of that deal, and then putting together a scope of work that's going to solve for the risks that are inherent to that specific transaction? Because your point on the deal fatigue is real. And so we really, all we want to be mindful of not making a mountain out of a mole hill. Yes, we have a job to do. And yes, we have risk to cover. And it has to be robust enough to get through adjudication to facilitate the acquisition financing. But at the end of the day, approach it with the ones that your client would like to see this deal get done. And how do you come with solutions, not just problems, and therefore being a more senior, we're intentionally a senior. or let team because it allows us to exercise the professional judgment of one you need to apply to 100,000 feet versus 50 versus 10. Is this something we really need to dig into and put a lot of hours or is this a better place for a rep and warranty and drive and move on? So we are trying to balance the realities of additional levels of scrutiny from all peas and lenders and others in the community with the idea that our clients are of capital deploy and deals to get done and vendors often too. I mean, he has some empathy for often the owner operator is going through this process. Like the right public company was 20 people in the financial department who can pull this data. So how do you become practical about sometimes where you would like the quality financial information to be versus where it is and you are seeing it's a little frothy out there right now for high quality inventory. So then what we have seen some of the financial sponsors do is look more for proprietary deal flow to get out at the bid process or they're not getting into too high of a multiple, but particularly in proprietary situations where that vendor doesn't have an advisor helping them compile all that information. Then it's up to us to be mindful and have the right bet sign manner of like, do we really need that or is that nice to have and what's the risk there and making sure we're kind of custom designing for the deal and make sure that makes sense. So on the valuation side have you seen changes in valuation in terms of again what people are looking for or how you look at these companies given all that's going on on the macro side. Is there any of that coming on in your valuation work as well? It is. It's surprisingly hasn't moved the middle that much and I think for reason for that is when people are willing to compromise on structure and find ways to share risk, then the top line valuation can kind of stay in place. And so I think as a headline, what we kind of saw get implemented through COVID is the preeminence of evaluation produced in a different way where I think there's been a bit of a professionalization with vendors on not being as afraid as VTVs as they used to be not being afraid as our nuts as they used to be like the days of 100% cash on clothes pretty much don't exist anymore. And so we've seen a willingness to compromise and get creative on structure. But the counter that to that is I still want to be made whole on valuation. And so I think it's a little bit vendor dependent and making sure they have that North star of what's important to you. So I want the most cash on clothes. Okay, well then you're probably are going to see a discount to your valuation because you haven't allowed for that risk mitigation. We're at or and or I don't really want a transition period like that kind of want to close and walk away. Probably still going to see a discount to the valuation yet again. Whereas if you have a vendors who've got a little bit more runway, they're willing to roll equity or have an earn out or otherwise participate in that future with you, then you're probably willing to make the more whole or potentially even play a premium to win the bid process. So we haven't really seen downward pressure on value of anything. There's kind of almost been a K shaped implication to this where if you're a high quality asset in a backdrop of trillions of dollars of dry powder out there that needs to get deployed and you found a good intermediary and they're driving competitive deal tension for you. You might actually get a bit of a premium and with archie back from a lot of the private equities we work with right now is there is some fraud thingness out there. So if anything, it's actually maybe gone the other direction. We always ask our guests that call up the crystal ball questions. Your sense of where things are going. Trends you see stuff to look before curious regarding your work what you're seeing or stuff to look out for or stuff that you think is coming down the pipeline. Yeah, I think from a macro perspective, regardless of all of the tariff uncertainty that it came apparent in 2025, we actually saw a year over year increase of over 36% of them in a activity over 2024 and I think the sentiment remains cautiously optimistic that 2026 is only going to see further activity. And so I think that just supports the idea that people are finding ways to structure around the uncertainty and still get deals done and the mandate is still to get capital deployed. And so from the berries market participants I've spoken to they're trying to originate they're trying to get deals done. We also work on the vendor due diligence side and we are working on one recently that in theory was the trifect of all the things you didn't want to be in terms of tariff impact and pretty large sales into the US and other things and they were still able to find their buyer and get that deer clothes. So I think it's more an issue of identification of what the headwinds are and then therefore how to run the best process. But I don't really foresee a slowdown and I think deals will continue to accelerate or at least the market seems to be cautiously optimistic that that will be the case. I'm very happy to hear it you say that that gets me excited so thank you. Well the kids I want to thank you for joining us. Thank you for being a guest. It's been a pleasure to learn about you and KALOS and congratulations on you know what you've built at KALOS and I sure appear to time KALOS has become a very active middle market participant and actor and we see you on a lot of deals together and congratulations and thank you for joining us today. Well thank you very much for having my Alex. A pleasure working with you and your team and I was happy to be here. Thank you for tuning into views from the market. Stay updated with the latest episodes by subscribing wherever you find your podcasts or visiting Steakman.com/views from the market. [BLANK_AUDIO]