A well-run, solidly profitable Middle Market company will almost always be, and should be, represented by an Investment Banker and sold through what we call in the industry, “The Process”. So what is the M&A Process?
It begins with Documentation:
- Documentation is more than a blind teaser, confidentiality agreement and a memorandum (CIM) on the business. It is about understanding the strengths and weaknesses of the company, industry and the likely types of buyers that should be approached.
A. The teaser is a blind one or two page offering of the deal. It typically reflects a summary of the company, summary financial information and the goals of the owner.
B. The confidentiality agreement is more than a statement of keeping information private and confidential. It is also an opportunity to confirm the capabilities, background and qualifications of the potential buyer.
C. The confidential information memorandum (CIM) is the 90% answer percent answer to what a buyer needs to make an informed decision. There is usually a company history, a discussion about the business and its services, capabilities and products. There is typically an indication of the strengths and weaknesses of the company along with discussions on the management team. Financial information is often more detailed and there is usually a forecast of earnings for the future. Often there is a description of the assets of the company and some form of market value for assets.
Now you are ready to move to the next step of the “Process” The Auction:
- Auction Process: In the 3rd episode of the M&A minute I referenced why you should, if possible, conduct an auction. It typically creates tremendous benefit to the seller. It starts with a list of potential buyers and should include both strategic and financial buyers.
Strategic buyers are usually in your industry and they are typically looking for a company that expands their market share or capabilities. I have a number of searches right know that is looking to expand their locations into new markets that they currently don’t have a presence in.
Financial buyers are usually about the management team and what can be created in the future. While they are looking for a return on their investment they are usually willing to put in the systems to develop the company and accelerate growth. The best type of management team for a financial buyer is a team that has a plan for growth and they can articulate that vision.
It is during the auction process that offers are generated, negotiated and ranked on their strengths and weaknesses. There will typically have been high level discussions with the owner and their management team although occasionally the management team is not included until after a proposal has been accepted.
Typically, this phase of the process is the most important for the owner as their ability to influence the terms of the deal is at its highest.
Due diligence and legal documentation:
- In the due diligence phase the Buyer examines the owners books and records looking to confirm everything the owner has claimed. During the due diligence process buyers are not just looking for what is right but what is wrong.
In a blog written by Jim Zipursky posted on October 25, 2016 “What keeps M&A transactions from Closing” Jim wrote: “What is the number one reason for deal failures? Earnings fluctuations, which means the earnings are not as projected. This causes significant problems for buyers, making valuations and lending much more difficult.” Not surprising, the number two reason is Seller valuation issues, which means Sellers want more than their company is worth. Taken in the aggregate, across all five categories, valuation-related issues account for more than 52% of deal failures. Clearly, valuation/earnings issues are the number one cause of deal failures.
Seller Issues and Company Issues can be avoided with proper preparation of the seller and the company. A seller who has reasonable valuation expectations, clean financial statements with verifiable earnings and realistic financial projections help keep most deals out of the ditch.”
Concurrently, with the due diligence process the legal memorialization of the transaction of the deal is done and closing documents are created. This is often the most onerous and difficult part of the transaction. What benefits the owner does not necessarily benefit the buyer and deal points can become quite adversarial. There are often differences in working capital issues, hold back and basket & cap issues along with employment contract and lease negotiations.
- The closing and post-closing true-ups. Once the documents are signed and transaction has occurred there are still often settlement issues that need to be resolved especially in the areas of working capital and contingent earn outs.
Smart business owners retain Investment Bankers and M&A advisors for “The Process”. It sounds easy enough but once you get into the details of the transaction having a deal team to prepare, advocate and articulate your position is very important for its outcome. Keeping the process at an arm’s length places the seller in a better position for success.
Now that you know a little about the M&A process for a company going to market, next month we will begin a series of episodes designed to prepare a company in advance for sale.
Sponsored in part by:
George Walden is a Managing Director and Principal in Corporate Finance Associates’ Houston office with twenty-five years experience as a middle-market investment banker. George is a member of CFA’s equipment industry practice group and an expert in the precision machining industry with special emphasis on manual machining, CNC precision machining, and gun drilling services and has been responsible for several industry-leading transactions. You can learn more about George HERE.