2011 Year-End Summary

I started this blog in August and it feels like we have already addressed some meaty topics.  Here is what I have covered so far.

M&A Acronyms

Terms like LTM, NDA, EOI, CIM, PSA and VTB explained.

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.

Constructing a Buyer List

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.

What Makes a Good Buyer?

To state the obvious… companies with ability to pay and an interest in paying a premium.

Finding a Buyer: It is Rarely the One You Expect

Once you have started the process you can’t wait for the company that you thought would be your buyer to be ready. 

Attracting Foreign Buyers: The Benefits of M&A International

Canada has many leading specialised mid-sized technology companies that have emerged here and for them to realise full value in a strategic auction process they must access international buyers.

What Will a Strategic Buyer Pay?

A strategic buyer will pay somewhere between the notional value and the value to the buyer.  Creating a competitive bidding environment can persuade the winning buyer to pay more than the notional value and share some of the value to the buyer with the seller.

What Will a Financial Buyer Pay?

Private equity will act like strategic buyer when it comes to portfolio add-on opportunities.

Normalization Adjustments for Private Companies

Normalization adjustments are a delicate matter; too many and it raises a red flag, too few and you leave money on the table.

The Basic Math of Valuations – Why Mid-Market Companies Are Valued Lower Than Their Public Company Peers?

The risk-return curve is the most fundamental principle of corporate finance. 

How Do I Attract a High Multiple for My Business: The Business Factors

The biggest driver in attaining a higher multiple is a company’s profitable growth prospects, and, this should already be evidenced by a historical growth record.

How Do I Attract a High Multiple for My Business: The Sale Process

The ideal time to sell is when there are positive trends in revenue and earnings with the expectation of more to come.

Why is a Tech Company Worth Three Times Revenue?

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.

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

Veracap's Value Enhancement Framework^TM follows well defined planning and execution strategies in undertaking the sale of a company.

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

An M&A advisor allows the principals and management to stay focused on the business and can wear the black hat as well as eat humble pie.

When is an MBO a Good Idea?

An MBO can be a good option if the buying management team is strong and interested in partnering with an institutional backer that can bring cash to the transaction.

Specialised Funds for Unique Needs

The Shotgun Fund^® will purchase common shares from departing shareholders when a shotgun clause or buy-sell agreement has been executed and the Succession Fund™ purchases shares from shareholders that are looking for liquidity and want to take "Chips off the Table".

Happy Holidays and if you have any thoughts for a topic in 2012, please let me know.

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.

Specialized Funds for Unique Needs

I have noted before that there are over 40,000 private equity funds in North America ranging from individuals to multi-billion dollar funds such as Kleiner Perkins Caufield & Byers, Draper Fisher Jurvetson, General Catalyst Partners, and Sequoia Capital. 

If you have a business that is generating about $1 million in EBITDA or greater, then there is a good chance there is a fund out there that may have an interest, and probably investments, in your space, resulting in the possibility of a good transaction.  Even companies at break-even or in a loss position can find interest from the private equity sector, however, in these cases they are likely to be opportunistic or vulture funds which sometimes results in the sector being painted with a broad brush.  In general, private equity is smart money that can bring more than dollars to the table and, as such, can be a good partner for the right company.

The most ad-hoc type of fund is a special purpose acquisition fund, where accomplished individuals are able to secure backing, typically from high net worth individuals, in the $5 million to $20 million range to acquire a single company.  This is a financial buyer in the purest sense as there are no synergies to be realised, however, usually a board of directors is formed by well heeled and well connected partners who can then help with business strategy, customer leads and further acquisition financing.

Beyond this one-off type of fund there are established venture capital and private equity funds.  In my experience venture capital investors typically take a substantial minority equity position and look for investments that can return 5x to 10x (i.e. if they invest $1 million, they target a realization of $5M to $10M in a sale or IPO exit).  VCs don’t look to achieve their goals by acquiring additional companies in the space but rather by betting on, and working with, the expected winner in the space.  Private equity on the other hand, quite often seeks 100% ownership and will then continue to look for add-on or tuck-in acquisitions to grow and increase the market power of its investments.  Private equity comes in many varieties including Leveraged Buy-Out (LBO), Growth Capital, Distressed and Mezzanine Funds.  It is not unusual, given that these funds often have a finite period within which to raise money, invest it, and return it to investors, that one fund’s exit is another’s entry. 

An example of a unique equity group is Argosy Partners.  Argosy Partners manages the Shotgun Fund^® and the Succession Fund^TM.  The Shotgun Fund^® will purchase common shares from departing shareholders when a shotgun clause or buy-sell agreement has been executed (i.e. your business partner offers you $5 million for your half of the business and you have 30 days to decide whether to sell to him or to buy him out).  Because of the time constraints in such circumstances, The Shotgun Fund asserts it can close a transaction in less than 5 days of first making contact.

The Succession Fund™ purchases shares from shareholders that are looking for liquidity and want to take "Chips off the Table".  The Succession Fund typically partners with continuing owner-managers who do not want to put their business up for sale prematurely, and who are reluctant to use significant leverage to accomplish their shareholder realignment objectives. 

If your view of private equity is that they will only buy companies at a discount, it may be time to take another look.  Private equity can be a good option for entrepreneurs looking for a variety of value enhancement or exit options.

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.

When is an MBO a Good Idea?

MBO stands for Management Buy-Out and describes one alternative for an owner-entrepreneur to exit his or her business.  Management can range from an experienced arm’s length team to family members who are active in the business.

The advantages of an MBO include:

• Low Transition Risk

The buying managers know how to run the business.  Management continuity is usually a big issue in the sale of a business and keeping management in place adds tremendously to the finance-ability of the transaction.

• Minimum Disruption

Putting a business up for sale creates a period of uncertainty that direct competitors can capitalize on.  While this threat is often overestimated, this rational will influence certain entrepreneurs to choose this path.

The drawbacks of an MBO include:

• Suboptimal Price

An auction process among strategic buyers that have the most to gain from the acquisition will most often realize the highest price.  One cannot predict what price a strategic buyer might pay. See: “What Will a Strategic Buyer Pay?”. 

In some cases management and the seller negotiate a fair and do-able price and in other cases an independent valuation is performed but in either case it is not likely to be equal to what a strategic buyer might pay.

• Suboptimal Structure

Unless there has been a plan in place for years, buying managers typically don’t have sufficient cash on hand to buy the business.  As a result, in most MBOs you will see vendor notes where the seller finances part of the purchase price for the buyer.

However, there is one big exception to the drawbacks and that is if the management team can attract the attention of a financial buyer.  I noted in “What Will a Financial Buyer Pay?”, that a financial buyer will pay like a strategic buyer when it is considering portfolio add-ons.  A strong management team that aligns itself with private equity that has other investments in the space can be a very strong buyer.  Now the question becomes: does the management team want to partner with an institutional investor and pay that much?

The decision to sell to management is one that should be addressed early and definitively.  Management should not be included in the auction process.  This creates a conflict of interest where management is incented to act in its self interest.  There are also expectations to manage.  If management is keen to buy the business but cannot come to terms with the seller, or cannot secure the financing, then they may be seriously demotivated and not work in the best interest of the auction process.

An MBO can be a good option if the buying management team is strong and is interested in partnering with an institutional backer that can bring cash to the transaction.  If the MBO is pursued simply because other options are not of interest then the seller must be satisfied with potentially accepting a lower value proposition.

 

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.