Tuesday 29 November 2011

How Does an M&A Advisor Add Value to the Divesture Process: the Intangibles

My last post was about whether an M&A advisor is worth the cost of managing the divestiture process and how he or she goes about realizing the highest value for his/her clients.  In this post I want to comment on the non-price issues that could arise and how an M&A advisor can keep the process running smoothly and ensure the post sale relationships are started on the right foot.
The following are three areas where an advisor improves the chances of a successful transaction:

·         Allows the business owner to concentrate on running the business

I noted in “How Do I Attract a High Multiple for My Business: The Sale Process” that the selling process is one that takes seven to ten months to complete and that performing below expectations during this time could lead to serious delays and potential difficult renegotiation.  Creating the offering materials and contacting/informing suitable buyers alone is a full time job for the first several months.  Working with an advisor allows the principals and management to stay focused on the business and its performance throughout the process – the process can be long and distracting but the business should remain priority one.

·         Shows serious intent to complete a reasonable transaction

Retaining an advisor demonstrates serious intent of the vendor, ensures objective expectations have been set during the planning phase and makes buyers aware that they will be participating in a competitive and professional process; something which can be leveraged during negotiations.   The sale process is often an emotional one and having an objective advisor can provide independent advise and direction which otherwise might not be possible.

·         Creates a buffer during negotiations to ensure positive post-transaction relationships

Another role advisors play is wearing the ‘black hat’ during the process.  Not only during potentially heated negotiations, but any time the process looks to be stalling, the advisor can shoulder the blame in order to put the process back on track.  Keeping the principals one step removed during difficult negotiations allows them to maintain a positive business relationship as they work through a transition with the new owners.

The experience of having closed many transactions also provides the benefit of a portfolio of workable alternatives available during negotiations and deep knowledge of structural pitfalls (for example, tying an earn-out to the lower end of an income statement) and last but not least, a network of strong deal-friendly lawyers and accountants.

The Veracap Value Enhancement FrameworkTM illustrates that opportunities for value enhancement are created through timing the sale, preparing for the sale, valuation and pricing initiatives and how to realize on the value that has been created through building deal momentum in the search for buyers, preliminary due diligence, deal structuring, negotiations and closing BUT if you don’t manage the soft factors you may not close at all.

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.

Friday 18 November 2011

How Does an M&A Advisor Add Value to the Divesture Process?


M&A advisors typically charge between 3% and 7% as a success fee for managing the sale process for a company.  The contingent structure of a success fee means the advisor gets paid a nominal percentage if the deal is satisfactory to all parties.  Sounds reasonable.  The percentage, while small, can amount to hundreds of thousands of dollars and, when viewed in this light, vendors begin to question the value for money.  So the question is, is an M&A advisor worth, say 5% of the realized amount or, in other words, will engaging an M&A advisor improve your expected value by at least 5%?
The alternatives to working with a trusted advisor typically fall in three buckets: (i) respond to an unsolicited offer; (ii) approach other members of the existing management team or, (iii) approach a competitor.  Veracap's Value Enhancement FrameworkTM enables business owners to realize their personal and financial objectives by introducing appropriate planning and execution strategies in undertaking the sale of their company.   The chart below illustrates that opportunities for value enhancement are created through timing the sale, preparing for the sale and valuation and pricing initiatives. It demonstrates how to realize on the value that has been created through building deal momentum in the search for buyers, preliminary due diligence, deal structuring, negotiations and closing.

So will engaging an M&A advisor improve your expected value by at least 5%?  While I do not have empirical evidence to present, I can say that most of the time we see at least a 5% improvement between the average acceptable expression of interest and the signed LOI.  I have also seen this difference be as high as 100%.  The price improvement during the managed auction process will be the greatest when you have at least two interested parties at the table who both have plenty of room above the intrinsic value of the business to the value to the buyer (see What Will a Strategic Buyer Pay?).  
The main difference between the Veracap framework and do-it-yourself alternatives is that the latter are typically reactive as opposed to proactive.  An M&A advisor will: (i) position the selling company as a strategic fit for target buyers; (ii) present the opportunity to numerous logical and capable buyers; and (iii) manage the process along a defined and orderly timeline, in order to generate the highest premium possible.

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.

Wednesday 9 November 2011

Why is a Tech Company Worth Three Times Revenue?

First off, let me clarify that the number, three times revenue, is the actual average revenue multiple of over 85 private company digital media M&A transactions that we have tracked in the years 2009 and 2010.  If you would like a copy of this report please email me at dvanderplaat@veracap.com.
Now, of course you can’t generalize when it comes to assessing the value of a business, but there are two items of note in the title: (i) the valuation metric; a multiple of revenues and (ii), the notion that technology companies as a group are different from other companies.
So why do people speak of a multiple of revenues when they are referring to the value of a technology company?  First of all, if there is no EBITDA to speak of (i.e. the company is in a loss position/operating with a burn rate), then a multiple of EBITDA is meaningless; and, second, what if the EBITDA margin is at a very low level, much lower than the long term expected average?  What we are really describing here are two early stage phases that many technology companies go through.  The first stage is the start-up phase where companies incur a burn rate and the second stage is the initial growth phase, where it enjoys rapid growth but has not yet achieved the economies of scale to cover its relatively large product development (R&D) and marketing (product/service launch) costs.  In cases like this, while it doesn’t account for many possible differences in business models, the multiple applied to revenues is used as a proxy of future normalized EBITDA.
Many established software companies generate very healthy EBITDA margins.  Margins of 40% - 50% are not unusual (both Microsoft and Google EBITDA margins exceeded 40% during the last two fiscal years).  Equally revenue growth can be very strong, particularly in the early stages.  So what does a growth multiple combined with strong margins translate to, in terms of a revenue multiple? It could be 3, 4, 5 times, and we have seen strategic acquisitions as high as 10 times revenue.  Three times revenues with 50% EBITDA margins equates to six times EBITDA, not that different from traditional metrics.
At this point manufacturing, service, retail and distribution income statement ratios are all in well established ranges but technology companies can typically achieve stronger margins, quicker growth and, in some cases, generate sticky recurring revenues which reduce the risk associated with these revenues.  There are consumer product innovations from time to time that are low-tech and achieve tremendous growth (think of infomercial products like Sham-wow or Spanks) but in general the growth sectors in the North American economy are technology sectors like Software as a Service (SaaS) and Platform as a Service (PaaS) as well as search/comparison engines, e-commerce, social media and mobile applications (also clean tech and bio tech which I personally don’t see that much of).  Companies in these sectors can leverage digital distribution (where the cost of manufacturing and delivering an incremental copy is negligible) and the reach of 80% broadband and 90% mobile penetration to generate very robust growth.
So are technology companies different from other companies?  In a word, yes.  Many are venture funded and achieve substantial market penetration, creating tremendous value while still unprofitable and therefore, while nowhere near perfect, a multiple of revenues can be used as a common metric for technology companies in various stages of growth.

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.