The well-known pop song “Blurred Lines” is about the conflict between societies’ desire for more and the desire to respect boundaries. The song could be describing the current state of affairs between and among investment banks, on the one hand, and, on the other, turnaround firms and accounting firms, which both now provide investment banking, turnaround, and quality of earnings (QoE) services. The lines have blurred between the roles these firms played years ago versus what they each do now.
Turnaround firms/financial advisors have gotten into debt capital raising and distressed M&A, encroaching on the turf of investment bankers. Accounting firms that provide QoE and other transactional services have also gotten into turnaround advisory as well as investment banking. To further complicate matters, turnaround firms have also encroached on the turf of accounting firms by offering transaction diligence and QoEs. All the while, investment banks have gotten into, well, investment banking. The traditional lines between and among investment banking, turnaround management, and transactional support have been blurred and aren’t going back anytime soon.
The irony is that there are no client conflicts of interest with blurred lines, but there are stresses in traditional referral paradigms. Said differently, it’s completely okay to be both turnaround advisor and distressed M&A advisor, as one assignment might quickly turn into another. Pre-COVID, the normal sequence of events would be for either turnaround firms to get called into an opportunity and refer in investment banks focused on debt capital or vice versa. This great symbiotic relationship worked well for years prior to a confluence of events that changed this dynamic.
To start, the most obvious and glaring issue of the past few years would be simply that there has not been enough turnaround work to go around due to trillions of dollars in federal stimulus programs. Bad businesses remained bad, but they had great liquidity thanks to those programs, thus delaying their need to restructure. Some companies also capitalized on a hot M&A window and sold at high market valuations rather than restructure. Taken together, there was simply less demand for turnaround services. There are also plenty of engagements that are at the smaller end of what a professional investment banker will take on. COVID was not the instigator of the blurring lines, but it was an accelerant.
A long-in-the-tooth economic cycle exacerbated by Payroll Protection Program (PPP) funds and other stimulus programs created a void of work for turnaround firms, which smartly expanded their services in response. At the same time, accounting firms in the middle of a consolidation run realized the need to expand beyond QoE and other transactional services. The result has been that investment bankers that have a singular focus on providing M&A and capital raise services clearly see their market share and relationships at risk.
To be clear, this phenomenon is more prevalent in the lower middle market. There the lines can be more easily blurred, and there is less scrutiny by the Financial Industry Regulation Authority (FINRA) for non-FINRA-registered groups to worry about with regard to smaller deals typically conducted by sophisticated investors.
In contrast, the further upmarket one goes the less the lines can be blurred due to the need for absolute specialization. The result of the blurred lines is that larger, platform-oriented turnaround firms and accounting firms can now provide transactional support, QoEs, and investment banking, among other things. This does not apply to all, but the larger the group, the larger the need is to do more than just one thing except traditional investment banking. Recent consolidation supports this notion.
Multiproduct Platforms
Consolidation by accounting and other transaction-focused firms to create multiproduct platforms has clearly played a seminal role. The platform approach makes sense when a firm can offer a QoE, transaction support, interim management, and debt capital advisory. It’s not hard to see why smaller, single-focus firms were merged or an emerging national or big regional accounting firm wanted to offer a platform of services. The constituency most at risk from this chain of events is investment banks, which often, at least as it pertains to M&A, start the chain of events in terms of bringing many of these services into the fold. Clear Thinking’s recent acquisition by an accounting firm speaks to this trend, as does Riveron’s acquisition of Conway Mackenzie and Hilco’s acquisition of Getzler Henrich. There are plenty more examples that speak to consolidation among service providers or turnaround firms expanding into investment banking.
This consolidation and resulting creation of platforms should actually bring more opportunities and options to distressed lenders as well as other lenders dealing with distressed portfolios. One difference that turnaround firms bring to the table in the lower middle is the ability to run a lightning-fast distressed process. These are typically situations where a traditional process simply might not work from a timing or dollar value return for a traditional investment banker. Some of the trends mentioned now better enable turnaround firms to come in and provide a good game plan to give optionality to do a debt refinancing or distressed sale, all while conducting normal turnaround services. Where the lines get blurred is when the regular turnaround work has been done and the turnaround folks then push for a healthy sale that a traditional investment bank would normally be the front-runner to pitch.
In general, from a lender’s perspective when dealing with a stressed situation it’s not always an easy choice whether to separate the turnaround and debt capital roles. What is clear is that they now have more options among more firms that are blurring the lines of traditional roles. It does not always benefit the bank to refer in a group that does both turnaround and distressed M&A for fear of upsetting a client that has hopes of returning to a healthy position with ownership intact.
On the flip side, an investment bank might have the special assets relationship and recommend a turnaround group while preparing a confidential information memorandum (CIM) to go to market. More firms providing more options is not necessarily a bad thing, but it complicates the traditional chain of relationships between and among investment bankers, transaction services providers, and turnaround firms.
Conflicts Ahead?
The key question remains: What will happen if some of these firms start losing significant referrals due to conflicts with referral sources? Historically, conflicting relationships that originally blurred lines tended to unwind. It has happened before and might happen again. That said, the blurred lines appear to be here to stay, at least for the time being.
This article first appeared in TMA's JCR: https://www.tmajcr.org/journalofcorporaterenewal/june_2022/MobilePagedReplica.action?pm=1&folio=25#pg27
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