What Makes a Good Buyer?

Now that we have constructed the buyer list, what really went into the thinking of who to include?  What are the buyer list criteria?  I have outlined several considerations in my previous post but another way to look at it is as follows: identify companies with an ability to pay and an interest in paying a premium.

Assessing the ability to pay in the private market space is difficult.  While for public companies you can peruse their financial fillings, private company information is usually based on voluntary disclosure and may be out of date.  The other area where ability to pay is difficult to assess is if the company has a relationship with a private equity group.  The company may appear small and unable to acquire but the private equity group may have access to hundreds of millions of dollars.

With respect to paying a premium, the rationale for doing so may be:

• Economies of scale
  The combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
• Economy of scope and cross-selling opportunities
  Economies of scope are attained when, for example, efficiencies are gained by increasing the scope of marketing and distribution to additional products (sometimes creating product bundles as seen in the Telecom sector).
• Unlocking underutilized assets
  In some cases proprietary resources such as R&D, patents, proprietary processes and technologies and even personnel are underutilized because of limited access to capital or other constraints.  Acquisition by a more well resourced company can unlock these assets.
• Access to proprietary technology
  In some cases start-up or R&D focused companies have developed technologies that can have an immediate and broad impact on the operations of leading incumbents and substantially improve their competitiveness.
• Increased market power
  Acquiring a close competitor can increase market power (by capturing increased market share) to set prices.
• Shoring up weaknesses in key business areas
  When talent is hard to attract, acquiring businesses that perform functions that are under performing can be an efficient way to fill gaps.
• Synergy
  An example of synergy includes increased purchasing power as a result of bulk-buying discounts.
• Geographical or other diversification
  Acquisitions can achieve immediate access to new geographic or product markets.  In some cases this can also serve to reduce earnings volatility.
• Providing an opportunistic work environment for key talent
  Growth through acquisitions provides managers for new opportunities for career growth and advancement.
• To reach critical mass for an IPO or achieve post IPO full value
  Larger companies typically have more financing options thereby reducing capital risk.  Once public, companies need sufficient trading in their shares to realize full value.
• Vertical integration
  Vertical integration occurs when a company acquires its supplier and can result in significant savings if the supplier has substantial market power.

Determining beforehand whether a private company has these goals or can potentially achieve these results is nearly impossible.  The best way to find the company that will pay the most is to approach all possible buyers, talk to them and discuss the possible fit.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

Constructing a Buyer List

The first step in constructing a buyer list is having a conversation with the divesture principal.  He/she will know the immediate competitors they face every day and why or why they will not be “good” buyers.  They will also know the reputation of these companies in the marketplace and may not want their legacy in such a company’s hands. 

It is important to understand all of the objectives/considerations of the seller.  Realizing the most money possible is the obvious goal but is it also to leave a legacy? ....to provide continuation and opportunity to the staff? ....to retain the brand? ...the local employment base? 

Acceptable acquisition structure and transaction timeframe are also important considerations in constructing a buyer list.  Does the seller want to exit as soon as practical (usually a minimum of six months post close) or does he/she want to continue to lead the company as a division of a larger, perhaps public entity, and in this circumstance, he/she may be more comfortable with an earn-out or accepting shares of the purchaser as consideration (more on all of the potential structures later).

M&A advisors will use many resources to prepare a buyer list including proprietary in-house databases, existing relationships in industry and the private equity and fund sectors, business networks, associations, and commercial company databases, some containing as many as 15 million companies world-wide.  These databases allow for searching by revenue/profit size, geography, key words, business description, NAICS codes (a government approach to classifying industries) and also by number of funding transaction and M&A transactions.

The buyer list is an evolving document.  While an advisor has tremendous resources and many relationships at his/her disposal, they will never identify all potential buyers before engaging in the process.  Once the teaser is in play, recipients (particularly private equity groups) will sometimes suggest other interested parties.  Sometimes, private equity groups will have investments in companies (or relationships with companies) that are not obvious.  These days companies can evolve from an idea to a funded and well strategically aligned early stage company in a matter of six months.  Databases and M&A personnel have a hard time keeping up with this level of activity.

Entrepreneurs often exclude direct competitors from a buyer list for the obvious concern that the competitor will use the information that the seller is for sale a sales tool against them OR they may wish to feign purchase interest only for reasons of gaining competitive intelligence.  Excluding direct competitors may or may not be an issue from the perspective of realizing full value in the sale process.  I have found that rarely does the obvious buyer turn out to be the actual buyer.  Direct competitors may be undercapitalised or they may have very similar products where very little synergies are realised in the acquisition.  For example, they may just want the customer base and then lay off staff and replace the solution.  This may not be a desired outcome.  For more on what makes a good buyer, see my next post.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

How Much Information (and when) Do I Share With Potential Buyers?

There are four phases of progressive information release to smaller and smaller audiences in the acquisition/divestiture process. 

The first document is called a teaser and is typically only one to three pages in length.  The teaser is a "blind" (i.e. no information from which the company identity can be deduced) overview of the acquisition opportunity and is sent to pre-approved qualified buyers (more on identifying buyers later) whereupon interested parties must sign an NDA to receive a CIM.  As the teaser is constructed so as not to be able to identify the company specifically it can go to as many as hundreds of potential acquirers (particularly as there are thousands of private equity funds out there).

The second document is the CIM where the number sent maybe several to as many as fifty or more.  CIMs are only sent to qualified buyers who have signed an NDA.  CIMs vary in level of detail but typically range from 40 to 100 pages.  A CIM describes the nature of the business (i.e. product/service range, revenue model etc), suppliers, customers, competitors, a management profile, high level financial information such as historical revenues and EBITDA and a balance sheet.  In many cases it will also describe the market the company competes in and the competitive dynamics and growth opportunities the company faces. 

One must appreciate that a CIM is a selling document and therefore opportunities tend to get more time than threats.  However, it is important to provide all relevant information in a CIM because potential buyers will be asked to issue an expression of interest based on the CIM and they will then be afforded due diligence to verify for themselves that all that is represented in the CIM is accurate and complete.  Customers, key suppliers or key management are not necessarily mentioned by name in the CIM.  The CIM undoubtedly raises questions which are typically answered by the agent or in concert with management.  It is important to protect competitive intelligence at this point as there will be only one successful buyer and this company should not be put in a position where its competitors now know sensitive information about the company.

The third stage is one where, based on an acceptable expression of interest, seriously interested parties are afforded a management presentation.  Only the top three to six (depending on the price range, the quality or potential threat of the bidders) are typically selected for this phase.  At this point more detailed information is shared with the goal of securing a LOI that will contain as few conditions as possible.  The dance here is one between protecting sensitive information and disclosing enough information to ensure that the final LOI is one that will be quickly translated into a purchase and sale agreement.

The final stage is exclusive due diligence and closing.  At this point the seller is an open book, so it is of utmost importance to have a high level of confidence in the selected party.  Private companies are typically not ready for due diligence.  Such a detailed level of record keeping is not required and generally not a priority for private companies.  The agent will usually issue a due diligence request list early in the process and it often takes some time for the company to prepare the information.  Each request is different but some items to expect include: monthly financial statements, a receivables aging list, revenue analysis by customer/by product/service, customer/supplier/strategic agreements, details on patents/IP/software architecture, employment policies and contracts, details on any environmental/legal claims and more.

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

M&A Acronyms

The field of M&A is full of acronyms, appropriate I suppose as the descriptor of the field is one.  In actual fact mergers are very rare (in order for a transaction to be recognized as a merger under GAAP it has to meet numerous accounting criteria) and the activity really consists of acquisitions and divestitures or A&D.  In any case, I thought I would start by clarifying some acronyms used throughout the process.  At this point, I will define the acronyms without getting into detailed explanations.  I will provide explanations in later posts.

One of the first documents used in the M&A process is a no-names summary description of the opportunity typically called a teaser.  If the teaser is of interest then parties will sign an NDA or CA (Non-Disclosure Agreement or Confidentiality Agreement) to receive more detailed information about the company.  The comprehensive information document is called a CIM or just IM (Confidential Information Memorandum or Information Memorandum).

In order to assess whether parties reviewing the CIM are worthy of moving forward they are typically be asked to issue a non-binding EOI or IOI (Expression of Interest or Indication of Interest) which will identify a valuation range, rationale and transaction structure parameters.

If the EOI is acceptable, potential purchasers are furnished with still more information typically in the form of monthly income statements, revenue and customer analyses and whatever else is important to the potential purchaser under the circumstances.  At this stage the potential purchaser and seller will meet in person and a Data Room is set up that will contain the actual contracts to allow the purchaser to verify that everything that has been represented to date is actually true (these days more and more data rooms are virtual data rooms in cyberspace). 

Subsequent to this an LOI (Letter of Intent) is sought and upon signing the LOI, a period of exclusive due diligence is awarded to the single final successful party.  Once the potential purchaser is sufficiently comfortable, work will begin on the PSA (Purchase and Sale Agreement) and signature on this document and its many companions will consist of the closing.  The PSA will define the deal structure which may contain a hold-back and/or a VTB (Vendor Take Back).  A hold-back is typically for a period of less than one year and contingent on receivables being paid, customers being retained or any indemnity claims the purchaser may have a right to as defined in the PSA.  A VTB or vendor note is a purchase loan from the seller to the buyer.  This is typically subordinated to a senior lender (i.e. a bank) and is usually of a term longer than one year.

On the financial/valuation side there are acronyms such as EBT, EBIT and EBITDA (Earnings Before Tax, Earnings Before Interest and Tax, Earnings Before Interest, Taxes and Depreciation and Amortization (non-cash items), EV and TEV (Enterprise Value and Total Enterprise Value), FYE (Fiscal Year End), LTM (Last Twelve Months), and YOY (Year Over Year).

Derek van der Plaat, CFA has worked in private market M&A for more than 20 years and is a Managing Director with Veracap Corporate Finance in Toronto.

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