Mergers and acquisitions or "M&A" is a time-tested growth strategy for buyers and an exit strategy for sellers. But, did you know that many prospective deals never close? Moreover, various studies report that between 70% and 90% of deals that do close are considered "failures," or at least fail to deliver the expected value.
In collaboration with our partners at The CEO's Right Hand (TCRH), we will explore the M&A life cycle in a 3-part blog series offering practical legal and business insights to help guide you when contemplating an M&A transaction of your own.
Part 1 – M&A as a Strategic Choice For My Business
Deciding to buy or sell a business or its assets may be one of the biggest decisions you will make as an executive. It is a major commitment of time and resources. Approaching a potential transaction requires clear goals, proper planning, and an objective, dispassionate mindset. If you are thinking about engaging in an M&A transaction, either as a buyer or a seller, what follows are some key questions you should consider and plan around before committing to a transaction.
Key Consideration #1: What is your motivation?
If you don't know the "why," you're not ready. Buyers and sellers will have different motivations for engaging in an M&A transaction. These motivations will affect how each party approaches the deal, as well as the structure of the deal itself. Therefore, it is critical that you bring clear strategic objectives, as well as a solid understanding of the counterparty's goals, to the table.
Whatever your specific motivation may be, it is always advisable to consider alternatives to M&A before moving forward. A potential seller might still have room to take another round of preferred stock. Other possibilities to consider include a leveraged recapitalization (take on debt and cash out stockholders), an IPO, or, on the other end of the scale, a liquidation. Meanwhile, a prospective buyer may wish to consider organic growth through research and development, market expansion through third party partnerships, or reducing cost and waste through internal management and manufacturing restructuring.
Sell-side Motivation
As seller, you may receive pressure from early investors for a
liquidity event (cashout), in which case your goal may be to
maximize cash at closing. Alternatively, you may be driven by the
opportunity to sell your business to a strategic competitor in
exchange for rollover equity in the buyer, and a chance to continue
to participate in growth within your industry sector. Perhaps the
deal is an "acqui-hire" situation where the buyer is
offering employment agreements to you (and your co-founders, if
any) but very little for the assets of the business itself.
Frankly, you may just be done, ready to move on and hand over your
life's work to a worthy successor.
Regardless of your specific motivation, how you grow your business in the years before a potential transaction will affect the ultimate sale process. For example, as you bring in outside investors to the business, it is important that you pay attention to your cap table and how it takes shape as this can influence the timing of a liquidity event, as well as the ease with which you obtain approval from your investors when it comes time to complete a deal.
If your primary issue is cash flow (e.g., your product or service isn't gaining traction and you are out of runaway), the state of your cap table can end up dictating how readily or smoothly you can wind it all down.
Of no less importance, a seller must fully understand the company's core strengths and weaknesses, as well as the source of its primary value, which may be its intellectual property portfolio, customer base, reputation, or a few key employees. How these assets are valued and allocated will have a direct impact on the purchase price and the transaction structure.
Buy-side Motivation
A strategic buyer may be driven by any number of reasons for
pursuing M&A. Are you looking for a bolt-on acquisition of a
discrete product line? An opportunity to build a new platform or
acquire discrete assets, technology, or a management team (but not
necessarily the product offerings that the team has been building)?
Do you wish to reduce costs and capture synergies or grow/ expand
your sales rapidly into particular market segments? Will you keep
the acquired business as a going concern or absorb its operations
into your brand identity?
All of these considerations will help drive the deal structure and the acquisition process. For example, in terms of structure, an acquisition of new technology or new product lines is more likely to be structured as an asset deal, whereas acquisitions that are intended to expand market reach and brand recognition may favor a merger or equity structure, depending on the relative size and position of the parties involved. And in terms of the deal process, a buyer's motivation will drive how they model out the expected value to be derived from the transaction (and hence the price that they should be willing to pay), and also, where to focus their due diligence efforts to ensure that the expected benefits are being rigorously evaluated and tested.
These different options, too, will drive the nature of the consideration paid (cash vs. equity vs. debt), type and amount of documents required to complete the transaction, and finally, the tax implications of the deal.
Key Consideration #2: Who do you want on your team and why?
Once you've identified your reason(s) for exploring a transaction, you will need to assemble a solid advisory team, which may include an investment banker, financial adviser, or business broker, to help sellers shape and shop the deal, or buyers evaluate and negotiate the deal. Deciding whether to use brokers or investment bankers is a major consideration, balancing the expertise to be provided with the cost (usually, a percentage of the purchase price plus expenses) of their respective services. Whoever you choose should have transaction and industry experience, and particularly for sellers, they should also have an extensive network of target opportunities and the ability to shop the deal and manage a transaction.
Your accountant and tax advisors should also be involved, and if they do not have experience in M&A, then you will want to supplement that part of the deal team.
Finally, selecting experienced legal counsel to run your deal is essential and as important, if not more so, than the name or reputation of the firm at which they work. A deal lawyer with an extensive M&A track record adds significant value by distilling key legal and business issues in order to keep the transaction from veering off course. Consider how many deals he or she has done, and how many in your specific industry. Will the lead attorney actively manage the deal, personally drafting and negotiating the documents, or will they delegate to junior lawyers? Do they have the experience and the judgment to focus on the key issues that will help you best achieve your business objectives for the deal? Beyond legal prowess, do they have a strong network of industry contacts that you can leverage?
Key Consideration #3: How do you shop the deal?
Another important consideration (for sellers only) is knowing how to shop the proposed transaction. Sellers will need to invest both time and effort into creating a marketing document, sometimes called a confidential information memorandum ("CIM"), targeting either potential strategic buyers (larger operating companies) or financial buyers (private equity funds, for instance). The target audience typically influences the asking price, the structure of the deal, and what will happen to your business post-acquisition.
Before releasing a CIM to the market, a seller should consider what measures are required to put its house in order. Conducting due diligence on your own business will allow you to anticipate potential issues of importance or concern and clean them up before a buyer enters the picture. For example, you might ask employees to sign intellectual property assignments, review customer and supplier contracts to ensure they are up to date and fully executed, or perform financial and compliance self-audits based on the nature of your business and the regulations that apply.
Other preparatory steps include drafting a confidentiality or non-disclosure agreement ("NDA") to present to potential buyers, and creating a secure, virtual data room to store information so that prospective buyers can conduct their due diligence and, hopefully, prepare a letter of intent. Finally, the seller might host management presentations and site visits for credible buyers who have expressed continuing and serious interest. This is a good opportunity to showcase the management team.
Key Consideration #4: What are your expectations?
Once a buyer and seller are serious about moving forward with a transaction, they will negotiate a letter of intent ("LOI"). This document typically is non-binding, except for a few sections governing confidentially and, critically, the provision granting a standstill period, which allows the buyer to conduct further detailed due diligence while the seller agrees to put any sale efforts on hold. Depending on the complexity of the business or the deal and the relative strengths of the parties, a standstill period can last anywhere from a month to several months.
Negotiating the LOI will provide a good indication of the major interests and positions of both buyers and sellers, all of which will affect deal structure, price and other key purchase agreement considerations. This is an important stage of the process, during which neither party has yet committed significant time or money. Now is the perfect time to level-set your own expectations by asking what – if anything- will make me walk away, change direction, or start over? It is also a good time to objectively reevaluate what key considerations need to be addressed to avoid a failed deal. Once the parties get further into the process, the harder it will be to change course or walk away.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.