The M&A Process
Mergers and Acquisitions (M&A) is one of the most powerful tools an organization can use to achieve massive growth and transformation in a short period of time. However, acquiring a company is not easy, and it requires hard work. Some acquisitions last for months, while others last for years. There are many things to consider before the buyer, and the seller, can formally close the deal.
If you are new to the world of M&A, here are some of the basic steps of the M&A process:
- Deal Sourcing
- Due Diligence
- Confirmatory Diligence
- Signing and Closing
Despite what most people think, M&A is a tool, not a strategy. We've seen it many times where a company's strategy is to buy other companies. This is probably the best way to turn your company upside down, in a negative way. Remember, in M&A, 1+1 should equal 3. You should have a definitive strategy as to why you want to acquire a company in the first place. It is crucial to understand why and how acquiring a company can create growth.
An example of this is when Disney purchased Lucasfilm back in 2012. Disney did not buy Lucasfilm just for fun. They wanted the rights to Star Wars so that they could sell its merchandise on their platform. With Disney's capabilities, they can do and earn more with the Star Wars franchise.
You need to develop your strategy first before you do anything else. The strategy should drive everything you do in your M&A process and every step that you make should be an actionable task towards accomplishing that strategy.
A seller's strategy should be pretty straightforward. Either they want to exit the business and get paid in the process, or grow the company, which they can't do alone.
Deal sourcing is when you pick a target company that you want to acquire. But before you can choose a target company, you must have a list of companies to consider. This is one of the major roles of corporate development; building a pipeline.
Creating a list of target companies will ultimately depend on your M&A strategy. What kinds of companies do you want to buy? How big or small? And not every company that you want to buy is willing to sell you the business. A huge part of having a list is keeping track of the companies you are considering. They may not be ready to sell today but might be two to three years. Constant communication with any potential companies is crucial to deal sourcing.
Also, it is essential to note that everyone can be a source of deals; your friends, family, or even the business next to your office. Opportunities can come from anywhere. One of the most popular deal sources is investment banks. You can utilize their services for a certain amount of money, and they will find a deal for you. This is very popular amongst sellers, as they want to involve as many buyers as possible.
After the acquirer has selected a target company they want to acquire, they can start approaching and communicating with them. Find out everything that they possibly can about the company. If the seller is willing to sell by any chance, they can both then proceed to the next step.
Before a buyer can decide to purchase a target company, they have to make sure that their assumptions are correct. Is the business making money? Does the seller own the product or patent that they want to acquire? Does the seller's business advance the buyer's strategy? All of these are deemed confidential, and the buyer will need a non-disclosure agreement to gain access to such information.
A non-disclosure agreement (NDA) is a legally binding document between two or more parties that promises confidentiality among them. Everyone who signs this agreement will be liable if any sensitive information they may obtain during the transaction is made available to outside parties. This is a very common document between businesses sharing confidential information, but we will stick within the context of M&A.
An acquisition will rarely happen without the use of an NDA. From a buyer's point of view, they wouldn't want to broadcast to the world that they are looking to buy a specific business, as competitors might find out and it could trigger an auction battle to acquire the target company. This would make the acquisition more expensive and complex.
But for the seller, it's probably more important to have an NDA than the buyer. First, the seller would have to release sensitive information about their company to the buyer, such as financial statements, intellectual property, or whatever secret ingredient makes their company unique. If the buyer decides to back out of the transaction and not pursue the acquisition, they would have already acquired the seller's confidential information. They can use it for personal gains, tell competitors about it, and other potentially harmful scenarios that could lead to the seller's demise.
The seller wouldn't want to announce to its employees that they are looking to sell the business before the sale is made. Employees can panic and start looking for another job in the middle of the diligence process, which can decrease productivity and eventually decrease the company's value.
The NDA is not limited to the buyer and the seller. In an M&A transaction, it is ubiquitous that both sides will hire outside parties to work on the deal. The external parties will also be included in the NDA as they will also gain access to sensitive information.
After signing the NDA, the buyer will access much-needed information to determine if the target company is the right organization to acquire. This is where due diligence starts.
Diligence is the process of truly understanding what it is you are trying to own. What will buying this company accomplish, and why can't you build it on your own? How will this company fit in inside your organization? Should you proceed with buying this company? These are just some of the most common questions you need to answer during due diligence. Even though your access to files is limited, as the buyer typically won't show you everything this early, you should have everything you need to answer some of these questions.
This process usually involves a small team that includes the head of corporate development, the chief financial officer, and the business sponsor. Some companies like bringing in HR, and the integration leads this early in the process. Looking at the company from all angles helps the buyer identify and mitigate some potential risks in acquiring the target company.
Nowadays, even sellers are advised to perform diligence on their company. It reduces surprises that the buyers may find in their process and allows the seller to understand how much their company is worth.
After assessing the company, you come up with a price that you are willing to pay in exchange for the company. Everyone has their way of coming up with their prices, but there are typically four primary business valuation methods often used in M&A.
Market Value Valuation Method
This valuation method determines the value of a particular company by comparing it to a similar company that has been sold recently. This approach only works if you can gather enough data from the competitors.
ROI-Based Valuation Method
This method evaluates the value of a company based on their profits and the ability of the investor to recover their initial investment. This valuation can be subjective as the ROI ultimately depends on how good the market is currently.
Discounted Cash Flow (DCF) Valuation Method
One of the most utilized valuation approaches in M&A, the DCF method values a business based on its projected cash flow but adjusted to its present value. The concept behind DCF is the assumption that a dollar today will be more than a dollar tomorrow because it can be invested.
Multiples of Earnings Valuation Method
As the name suggests, you determine the company's value by applying a multiple to the company's earnings. The multiplier will depend upon certain factors, such as predictability or recurring revenue.
Letter of Intent
After negotiations, you formalize your tender offer to acquire the company. Typically, this is a non-binding document that will include payment methods, escrow size, confirmatory diligence duration, and any other proposed terms by the buyer to the seller. Even though this does not conclude the deal, there are agreements or terms inside this document that can be binding. The most common of all is exclusivity.
When a letter of intent goes out, the deal is almost inevitable unless something massively changes in the target company. Because of this, the buyer will sometimes ask for exclusivity so that the seller will no longer entertain any other buyers. If the seller agrees to such terms, this agreement will be binding.
Others call this phase the formal diligence process. It's the buyer's last chance to walk away from the deal, and they will have access to pretty much everything about the target company at this point. The seller will open a data room and upload all the necessary information and documentation that the buyer might need to finalize the deal.
Confirmatory diligence is about understanding how the target business ran pre-acquisition. What is the organizational structure? How compliant are they? And probably the most important of all, what are the liabilities that the buyer will be absorbing post-close? The buyer's responsibility is to discover everything, as they will be held accountable for every violation, debt, or criminal act that the seller did post-close. They will also have to start planning how to operate the business after the deal is closed. The number one priority of the buyer should be business continuity.
In short, this is where all the heavy lifting comes in, so they will need a reasonably large team to finish the confirmatory due diligence. Diligence teams commonly include a legal, tax, finance, accounting, IT, insurance, and real estate team.
Signing and Closing
The deal ends when both parties sign the purchase agreement. This formally marks the end of the transaction and the transfer of ownership from the seller to the buyer. However, in some cases, signing and closing don't always happen simultaneously.
From the time of signing, the buyer will have the right to transfer the property to themself only after the closing conditions have been fulfilled. These closing conditions can take some time to accomplish on rare occasions, such as consent of key customers or waivers, registration to the local register, or the purchase price delivery. But the most common and relevant condition that could halt the deal for a long time is clearance from the antitrust authorities.
Antitrust authorities exist to prevent monopolies on specific markets. They encourage competition and will prevent any M&A deal that will result in monopolies. If you are buying a competitor, you will most likely trigger the antitrust authorities to review your transaction before you can officially close the deal.
After you pass the antitrust review and comply with the other closing conditions, both parties can formally close the deal and transfer the company's ownership to the buyer.
Integration is the last phase of the deal where the company has a new owner, and the seller is out of the picture. Integration is the process of absorbing the newly acquired business and making it a part of the parent company. The simplest and most common example of this is payroll. For the acquirer to track and compensate their new employees, they need to integrate the payroll into their central system. Also, the buyer might have some compensation or rule changes as part of their organization. Every acquisition has a different level of integration, and it will all depend on their strategy. Integration includes changing the name of the newly acquired company or leaving it alone while it operates under new management.
The most important and probably the most challenging part of this process is day one. Day one is the very first day of your ownership, and you will have to announce to the entire business that you are now the new owner.
Ideally, this is the very first time that employees find out about the deal. Frequently, employees' normal response id fear and uncertainty. It is your job to calm the storm, or they will start looking for another job.