INITIATING THE M&A DEAL. PREPARING FOR THE DEAL, FINDING A BUYER, CONDUCTING DUE DILIGENCE & FINANCING THE DEAL By James L. Rench, Esq. DealSupportServices.com. CURRENT MARKET CONDITIONS. • Challenges of last recession have caused many to take very strategic look at their industry
PREPARING FOR THE DEAL,
FINDING A BUYER,
CONDUCTING DUE DILIGENCE
& FINANCING THE DEAL
James L. Rench, Esq.
• Challenges of last recession have caused many to take very strategic look at their industry
o What are growth prospects of industry?
o What will it take to become or remain competitive in industry?
o How will profits be affected by changing landscape?
• Many are making decision of whether they should be, or could be, a consolidator
• Others are assessing strategic alternatives
• Deal activity will continue to be fueled by
o Ongoing access to capital & financing
o Strengthened balance sheets of strategic buyers
o Increasing private equity activity
• S&P 500 companies have $2 trillion in cash on balance sheets & are increasing acquisition activity
• Private equity firms have $348 billion in capital to invest
• Relatively healthy debt markets with lenders active & competitive in M&A lending
• Current M&A market presents both
opportunities & challenges
o Companies that maintained or improved earnings over last 24 to 36 months can be highly valued in today’s M&A environment
o Strong competition for quality assets as both businesses & private equity continue to seek deals to fuel growth & deploy capital
o General worldwide macro events & general trends in U.S. economy, reflected in volatility of U.S. debt & equity markets, have a direct impact on M&A market activity
o Assuming a relatively stable economy, 2013 & 2014 anticipated to be an active M&A market with attractive valuation multiples
On March 5, 2013, John Slater of FOCUS, a nation-wide investment bank, blogged the following (in part):
“Business owners time their exits for many reasons: health, retirement planning, availability or lack of family successors, competition, technology change and many more. Yet overwhelmingly the question we are most often asked as a financial advisor to entrepreneurial companies is “What’s my business worth?” All things being equal, a rational business owner will presumably choose to sell at a point of optimal value for his or her interest in the firm. For the reasons outlined below, we believe that the next eighteen months may see the highest pricing for good middle market companies in the thirty years I have been in the M&A advisory business.
While the M&A market could be derailed by a major decline in the equity markets or further chaos in Washington, we believe that the odds favor a strong market for sales of middle market companies through sometime in 2014. By then a correction will be overdue and the likelihood of a cyclical bear market in equities may become increasingly high. Generally a serious decline in the stock markets leads to a precipitous fall in M&A activity.
The next 12-18 months will almost certainly be a highly favorable period for business exits. If this proves to be a cyclical market top, the next favorable period for businesses owners wishing to sell may not come around before the 2020s. In 2020 today’s sixty-six year old Baby Boomer will be seventy-three and today’s fifty-eight year old will be sixty-five and studying Medicare options.”
• Fear of unknown future
• Fear of losing meaning & purpose
• Fear of being taken advantage of
• Ignorance about “the process”
• Concern for employees
• Will I receive enough proceeds to accomplish my goals? My family’s goals?
How to Professionalize a Business
• Build upon your core strengths (“secret sauce”)
• Define market strategy
• Size box (physical element)
• Tame complexity (process element)
o Ability to manage complexity & scale
o Managing by group theory (product lines, property, values)
• Manage processes, not people (people element)
o Create culture of change
o Process defines organization, not function
o Create standard work
• Successfully apply information technology (IT element)
• Cause owner to “think like a buyer”
o Exhibit track record
o Attract “quality buyers”
• Use runway to improve EBITDA margins
• Enhance operations – infrastructure
• Demonstrate sustainability
• Highlight transferability
• Situational – each company
• Success of company should depend on entire
organization, not a few people
• Loss of one or two key personnel should not
negatively affect company
• Need strong second-in-command & junior-level management
• Develop business plan–reasonable & attainable assumptions
• Clearly define internal & external growth opportunities
• Identify & explain operation or margin improvements
(investment in technology, improved supplier terms)
• Identify capital expenditures
• Identify capital requirements (internal CF, outside capital)
• Hit your numbers
• Effective financial controls
o Audited or reviewed financial statements
o GAAP internal financial statements
o Dependable accounting department
• Gives sense of security, credibility
• Lowers due diligence costs
• Lowers holdbacks
• Putting off needed expenses may not add value
• Review & address operational processes
• Ensure systems & controls are in place
• Invest in technology or equipment
• Give best appearance possible
• Also applies to investment in human capital
o Other personnel
• Eliminate unprofitable products &/or customers
• Examine expenses (excessive, personal/family-related, nonrecurring expenses)
• Review & improve supplier contracts
• Sell divisions or locations if they significantly lower earnings & are not strategic
• Manage working capital
• Too much revenue with too few customers can
give appearance that business may be risky
• Improve quality (profitability) & diversification of customers
• Attempt to get sales contracts or agreements
• Be prepared for holdbacks in transaction
• Clean up
o Working capital
o Obsolete inventory
o Loans to shareholders
• Will clarify assets & liabilities in transaction
• Different owners = different objectives
• Beneficial to buy out minority shareholders
• Can ensure smoother transaction & may
• Corporate records
• Financial records
• Allow time to fix what might impact value
• If selling your company is your exit plan, timing can be single most important factor to consider
• “Buy low, sell high” applies to business sales as well
• Sell on your own terms
• In difficult market, deal structure & partner going
• Don’t be a lone ranger
TYPICAL MARKET TO CLOSING TIMELINE:
Prepare for Market 1-3 Mos.
Identify Buyers 1 Mo.
Project Launch 1 Mo.
Manage Inquiries 1 Mo.
Select Buyer 1 Mo.
Due Diligence 1-3 Mos.
Negotiation & Closing 1-2 Mos.
TOTAL INCLUDING PRE-MARKET PLANNING: 9
MONTHS TO ONE YEAR
Key members of the deal team:
Investment Banker/Financial Advisor
What business is the seller in?
Why is the seller in that business?
Who are the seller’s customers?
What are the seller’s immediate and long-term objectives?
How will the seller achieve those objectives?
Who is responsible and accountable for what?
Are those roles and responsibilities understood?
How does the seller compare to its competitors?
Through answers to these questions (and many, many more)
Benefits of using Financial Advisor:
Benefits of Valuation Expert:
Contacts with potential Buyers
Scope of services
Term and Termination
Disclaimer of ownership of work product
Confidentiality/Non-Disclosure Agreement (NDA) to be provided to Recipients of Confidential Information (CI)
Sample NDA with VDR provisions attached as Annex B to these materials
Advisor’s Engagement Agreement
Advisor’s Engagement Agreement (cont’d.)
Sample Engagement Letter with Drafting Tips attached as Annex C to these materials
Often competitors, suppliers or customers
Companies looking to diversify revenue streams
Companies seeking to build upon their business model &/or competencies to enhance earnings or reduce risks
Selling majority stake ‒ Advantages
Generallyspeaking, privateequity is the useof capitalto invest in privateor non-public companies.
PEG’s are intermediaries between investorsand private
Whoinvests in private equity?
Limited Partnership Interests (No active Management)
General Partner/Manager Compensation
Limited Partners subject to capital commitments
Investment Period for new investments (5-6 years)
Term of Existence (10 years; Additional 1-year extensions;
Subject to early termination in event of “key person(s)” ceasing
to manage the fund)
Use leverage to generate greater returns
Assume: Enterprise Value = $100MM
Leverage also allows for use of free cash flow to pay management fees to the fund and make distributions to the investors
- Many players = maximum sale price
- Creative and flexible transaction financing
- Access to capital
- Financial, strategic and operational expertise
- Relationships with bankers, advisors
- May not be familiar with your industry
- Unlike strategic buyer, lack of synergies
- Due diligence may be more involved
- Management continuity is necessary
- Firm exit strategy (5-7 years)
EBITDA (Cash is king, particularly in PE, and purchase price most typically is calculated based upon EBITDA)
Strong growth prospects
Strong management team
Externally prepared financial statements
- Current account receivables and payables
- Clear understanding of non-business expenses
- Support for travel, meals and entertainment
- Rational executive “perks”
Comfort with known liabilities and pending claims
Supportable forecasts and business plans
- Include information on competitors
- Differentiation, advantages over competitors
• BETA is market rate returns based on risk
• ALPHA is ability to create above-market rate returns (think beating stock market)
• PEGs are looking for underdeveloped companies in niche markets that are fragmented
• For this they will aggressively pay top dollar.
• Revenue cycle
o Market share
o Defensible niche
o Customer stickiness
• Management team
• Management systems
o Information technology
o Reasonable value
o Fair price – future cash flow
• Market position
• Why should seller consider sell-side diligence?
Answer: Sell-side diligence is about helping deal close at appropriate value
vulnerabilities to remediate or put on best case explanation
Sample Due Diligence Request attached as Annex D to these materials
• When should I complete sell-side diligence?
• Answer: Pure financial diligence is typically completed concurrently with deal book & distributed to qualified buyers. Work is often done in conjunction with investment bankers
• Advanced planning may be completed for sellers looking to improve their business prior to taking it to market
Advantages of VDR:
Risks to Seller:
Structuring Buyer’s Due Diligence Request:
Management presentations and site visitations:
Buyer’s use of due diligence results:
Letter of Intent
- Form (Asset, stock or combination)
- Purchase Price
- If Seller Financing, Terms of Subordination
- Equity ownership (including pre-emptive rights)
- Board composition
- Rights, preferences, privileges and restrictions
- Liquidity rights (including registration rights)
Agreements regarding continuing operations
Exclusivity, Confidentiality and publicity
- Equity participation (incentive plans, options)
Sample Letter of Intent attached as Annex E to these materials.
- Equity contributions
- Working capital adjustments
- Allocation of purchase price
Representations and warranties
- Investment purpose
- Employee retention
- Scope, thresholds and caps, joint/several liability
- Contribution agreement among former owners
Other agreements and considerations:
Seller Note & Subordination Agreement
- Fees paid to the fund
- Good quit/bad quit provisions
- Restrictive covenants, severance
Incentive and option plans
- Benchmarks for performance plans
- Conversion rights, vesting (death, disability, sale)
- Payment terms, use of shares
- Registration rights (demand, piggyback, follow-on)
-- Expenses of registration
- Rights of transfer
- Differ among agreements
Key man & D&O insurance
Investor Rights/Shareholder Agreement
- Dividend or distribution policy
- Preferences, anti-dilution
Board Representation (golden rule in effect)
- Reflect percentage ownership
- Appointment and removal procedures
- Process for notice, written consents, veto rights
- Committee selection, scope and responsibility
- Board fees
Defaults and “swamping” rights (Enables changes in control upon certain events; e.g.
breaches in financial covenants, failure to pay management)
- Permitted transfers to family trusts, affiliates
- Right of first refusal, Drag-along/Tag-along
Alternative sources of financing
Pittsburgh-based Mylan, Inc. agreed Feb. 27, to buy Strides ArcolabLtd.'sinjectables unit, Agila Specialties Pte. Ltd. for as much as $1.85 billion. Mylan will pay $1.6 billion in cash at closing and potentially up to $250 million in additional cash subject to certain
unspecified conditions that Strides must satisfy. Mylan isn't assuming any debt or acquiring
any of Agila's cash through the deal. It has obtained a commitment letter from Morgan
Stanley for a new $1 billion senior unsecured bridge term loan to help finance the
transaction. Mylan will also use its existing credit lines and cash on hand to fund the buyout.
Issues in Seller financing:
Asset Based Lending (ABL’s)
Disadvantages of ABL’s
ABL’s in M&A
Crowdfunding – JOBS Act of 2012
Provides securities registration exemption for online sales of up to $1M every 12 months to unlimited number of investors irrespective of accredited investor status
Issues with Crowdfunding:
The JOBS Act crowdfunding provisions have generated substantial criticism. Below is excerpt from New York Times opinion piece by Steven Rattner, dated March 3, 2013, entitled “A Sneaky Way to Deregulate”:
“Slapping a catchy acronym like the JOBS Act on a piece of legislation makes it more
difficult for politicians to oppose it — and indeed that’s what happened with the Jumpstart
Our Business Startups Act.
Unveiled a year ago by House Republican leaders, the proposal was rushed into law with
large majorities just two months later; its provisions are gradually taking effect.
Its enticing acronym notwithstanding, the JOBS Act has little to do with employment; it’s a
hodgepodge of provisions that together constitute the greatest loosening of securities
regulation in modern history.
No wonder that the Securities and Exchange Commission, whose former chairwoman Mary Schapiro opposed the legislation, has been taking its time writing the regulations to implement these provisions.”