The post-pandemic economic recovery and great opportunities arising from digital transformation, combined with the availability of capital, led to record-level M&A activity in 2021. In the first half of the year alone, global deal values amounted to 1.5 trillion U.S. dollars, a sharp increase in the numbers seen in the second half of 2020.
Many companies are looking to invest the dry powder accumulated during the pandemic to propel their business growth, strengthen their position on the market, and accelerate the adoption of the latest technology.
Through mergers and acquisitions, buyers can tap into new customer segments, broaden their product offerings, expand their geographical footprint and get access to new distribution channels. In addition to that, purchasing a smaller company allows them to eliminate competition and increase their market share, becoming a dominant player in the specific business domain.
With such a wide spectrum of benefits it’s no wonder that even before the pandemic, the number of companies willing to pursue acquisitions was far greater than the number of those ready to sell. In 2018, 41% of business owners said they expect to exit within the next five years. At the same time, 60% of top corporate executives claimed their company is keen on acquisition.
Often it doesn’t even occur to the founder that they can exit the business until someone else puts that idea forward. The decision to sell the company is not an easy one for a business owner. However, hefty compensation can tip the scales.
But apart from money what’s in it for the seller? In many cases the decision to step away is prompted by one of the following reasons:
- Owners may be divesting a division or a product line they no longer want to develop, retaining the proceeds of the sale to fund the growth of other business areas.
- New opportunities. M&A allows owners to free up cash for future investments and pursuing new ventures.
- Older founders or board members may seek M&A as a way out of the industry. Therefore, selling the company allows them to reap a solid return from their investment as they retire.
The exit strategy heavily depends on the state of the business. If it is struggling to grow, generate revenue and profit, you will be thinking about limiting your loss and giving your enterprise a chance to survive with a new owner. If the company is doing well, you can realize maximum financial gain from the deal, either when you are selling a certain share of your business or getting rid of it completely.
In this article, we will focus on the second scenario assuming you want to exit the business altogether. Here you would find some tips and tricks on how to prepare your company for a successful M&A transaction.
Please, keep in mind each case is different and the groundwork will depend on the type of the company, its size, equity structure, products and services it offers, financial performance, location and jurisdiction.
What follows is a step-by-step outline of the M&A process as it happens for most companies.
The transaction’s life cycle begins the moment you make a decision to pursue a sale. You should clearly define your motivation, set the objectives and draft your exit plan.
Think of your business as a product. This vision will help you create a winning purchasing funnel for your company and help drive your strategy. If you are not sure where to start, ask yourself the following questions:
- Why do you want to sell your business?
- What qualities are you looking for in your potential buyer?
- How do you plan to attract investors?
- What are your unique selling points?
- What sets your company apart from your competitors: client pool, human assets, technology, business expertise or something else?
This questionnaire can act as your guideline when you move to the pitching phase. It will help you to determine where your company’s strengths lie, and what resources you can bring to the table.
Before you start meeting with your potential investors, there are a few more steps to consider:
Bridge the gaps
A thorough self-assessment will help you ‘thatch your roof before the rain begins’. You should look for any gaps in your business structure, processes, tools, documentation and financial operations, way before engaging in M&A transactions.
Ideally, you should perform annual audits of your business activity several years prior to entering a potential sale. Independent legal and financial audits from one of the Big Four companies or a trusted second-tier firm will be a good start.
Hire outside counselors
Once you are not a 5-men startup anymore it’s worth involving an advisory firm or investment banker. Though you will have to shell out up to 5-7% of the total deal size for their services, this investment will pay off in the long run.
A professional advisor can bring significant value to your M&A activity by identifying potential buyers, designing the overall sale process, assisting with the preparation of an executive summary and management presentation materials. They can also help with challenging legal issues, communication with bidders, negotiations on price and other key deal terms.
Develop an offering memorandum
At the initial stage, for investors it all comes down to one thing: “Why do I need to buy this company?”. To answer that question you need to create a comprehensive sales deck that formally presents your company to potential buyers.
This document should include a short sales pitch about the history of your company, its market positioning, services or products and cover the following aspects:
- business domains;
- geographical areas of operation;
- market share;
- client portfolio;
- lead generation channels;
- key team members;
- high-level organizational structure;
- SWOT analysis;
- certifications, awards, ratings and other specific things you are proud of;
- culture and values;
- growth strategy.
Conduct business valuation
There are different techniques for calculating the right price for your enterprise. The most common approach is to use a multiple of annual revenue or profit.
This number largely depends on the market comparables, the company’s historical financial performance, expertise of the management team, and type of business. For example, in the case of an IT service company, you can expect to see 3x-8x EBITDA or 0.8x-1.5x annual revenue on average.
The following indicators can help to narrow down the market baseline to more a specific number:
- The capital structure along with business assets, including, but not limited to, the company’s physical assets, intellectual property, goodwill.
- Maturity of the organizational structure and business processes.
- Profitability or ability of the company to generate cash.
- Client base and risk diversification.
- The growth rate of revenue, profit, customer base, headcount, etc. in the past 3-5 years.
- Company’s strategic vision for the next 1-5 years.
Once you compile all the presentation materials, it’s time to let the world know you are putting your company up for sale. You have to go to the market and identify the potential buyers. Depending on your strategic rationale behind the deal, you may want to reach out to either of these buyer types:
- Strategic buyer aims to create corporate synergy by combining operations of two business entities. They usually share a client base, talent pool, sales and marketing pipelines, domain expertise and financial assets. This allows for cost savings and revenue increases, as both organizations gain access to a broader range of resources. The performance of the joined companies is, therefore, greater than the sum of its constituent parts.
- Financial buyer is primarily seeking economic benefits from the purchase. They can facilitate the target company’s growth, to reap the maximum return from the initial investment, but other than that the acquired firm operates as an independent entity. Once the business achieves the desired revenue or performance goals the buyer is likely to exit the organization, either by taking it public or reselling it.
When it comes to originating deals and nurturing clients, partnering with the investment banker is the easiest way to build your sales pipeline. You can leverage their network of professional contacts to get in touch with interested buyers. If you decide to handle lead prospecting and targeting on your own, you should first ask for references from your connections or check dedicated industry communities.
Once you’ve made initial contact and the prospects have reviewed your materials, you’ll start receiving bids. You can run a competitive bidding process to arrive at the most favorable deal, both in terms of price and transaction conditions.
If you’ve managed to generate interest from multiple buyers, you’ll need to sift through their offerings. To make the right choice you’ll have to delve deeper into the company’s profile, M&A history and business values.
Conducting management meetings with potential buyers will give you a chance to learn more about their needs, intents, and points of interest. You can also discuss how your entities might fit together and what synergies could be realized by merger and acquisition.
However, beware that some of the bidders might turn out to be your competitors, fishing for information on your business. Therefore when talking to potential buyers it’s better to disclose high-level details only. To ensure the other party won’t use your confidential data for their private gain, sign a non-disclosure agreement with every company you are sharing your investment memo with.
If the company is genuinely interested in pursuing the deal, they will send you a letter of intent. This is a non-binding document that provides a summary of the proposed offering. It covers such key aspects as the price, estimated duration of due diligence, management arrangements, and the structure of the deal.
Receiving the offer may feel as if the deal is already in the bag. While there might be strong working chemistry between the parties, this alone won’t be enough for a successful M&A transaction.
Before moving ahead with the deal you will have to anticipate an intensive and thorough examination of your business, known as due diligence. This practice helps to earn the trust of potential buyers. Moreover, a thorough audit may reveal that the fair market value of your business is more than you initially estimated.
From the buyer’s perspective, due diligence helps to make sure the purchase fits their M&A strategy to the full extent. This practice also offers a great opportunity for all questions to be answered and issues to be resolved. At this point, buyers can verify the statements they were provided with earlier on.
Knowing what lies ahead in a typical due diligence process allows your team to begin preparing in advance. Here are some points to consider:
Scope of investigation
The due diligence investigation usually focuses on three crucial aspects ‒ financial, legal, and technical. This includes an examination of assets, financial records, human resources, customers, intellectual property, and cultural matters.
The potential buyer will draw up a checklist of hundreds items you’ll have to respond to. All the answers you provide should be substantiated by documented evidence. The buyer may require corporate documents, contracts, intellectual property information, a capitalization table, and much more.
To preserve confidentiality and improve the workflow it’s advisable to keep valuable information in a virtual data room. This is an electronic warehouse that allows for all the company documentation to be safely stored and shared between M&A teams. You can try platforms like iDeals Virtual Data Rooms, Ansarada, or Datasite to manage your company’s records.
Due-diligence investigation can be a significant distraction factor for everyone involved. Therefore, it’s important to keep your internal deal team down to a minimum. Bring together your lead experts in critical operating areas, e. g. head of departments, who will take care of their respective parts of the due diligence process.
It’s also a good practice to assign a project coordinator. His role is to track the due diligence progress, make sure the estimated time frame is being maintained, and control the scope of the investigation.
Final Negotiation and Signing the Deal
To strike the deal both parties need to be confident they are armed with all the relevant information to make a proper decision. The negotiation process, therefore, requires mutual trust, communication and the managing of expectations.
The due diligence process can lead to some tweaks in the initial agreement between the parties. The issues can range from additional clauses, like defining the target company’s contingent liabilities, to transitional provisions such as earnout conditions. The latter applies when dealmakers want to strike the right balance between a sale price and a swift and timely close.
Once every box has been ticked and there are no last-minute hiccups, the deal can close when all relevant parties have signed the definitive merger agreement. It spells out the finalized deal terms, including transaction structure, purchase price, restrictive covenants, warranties and indemnities, earnout terms, allocation of risk, along completion and post-completion process.
Signing the final contracts and finalizing the transaction usually makes people feel like they have reached the pinnacles of success. But there is still a great deal of work to be done.
For a transaction to be worthwhile, the process of bringing two companies together should create maximum synergy. However, 46% of business leaders say that over the past two years less than half of their M&A has generated the expected value. In most cases that happens because buyers don’t have an effective post-merger integration strategy in place.
They also tend to overlook the internal factors which are among the top reasons why M&A transactions eventually fail. Some of the most often cited causes are integration gaps (28%), talent issues at the target company (28%), and lack of cultural fit (20%).
The human aspect is a key to successful integration since it’s the people that make companies great. They are a vital part of delivering synergies, so it’s important to keep them updated on what’s coming. Your primary task will be to debunk common concerns employees have in such situations, including, but not limited to, job security, losing the company’s identity, alteration of leadership style, and rapid changes in the processes and operation mode.
There’s no industry best practice on how to bring news about the acquisition to the public, but you can use some of these tips:
- Limit the circle of people with knowledge of the case. Have a comprehensive NDA with every person engaged in the due diligence activities. This way you can avoid any misunderstandings and destructive rumors within and beyond the company.
- Operate with stealth. Until the deal closes all information about the potential buyers and due diligence contents are strictly confidential.
- Get out of the transactional mindset. Upon signing the contract, prepare a clear and comprehensive statement, explaining all the transition details to your staff.
- Don’t forget about the clients. If you operate in the B2B segment your customers are likely to be wary of the purchase, so you need to assure them it won’t make any major difference in your partnership.
While working through the stages of mergers and acquisitions, you should always bear in mind the ultimate goal ‒ a beneficial agreement that not only looks good on paper but can also yield superb results in the long run. Therefore, aim not only at achieving cost and revenue synergies but also at cultural alignment, business lifecycle management and support, as well as employee satisfaction.