Mergers and Acquisitions For Dummies (13 page)
Read Mergers and Acquisitions For Dummies Online
Authors: Bill Snow
Control investment:
A
control investment
simply means the investor has control of the company. This situation occurs when an investor, often a venture capital or private equity fund, invests money in exchange for stock in the company. (Well, maybe stock, maybe something else. See the nearby sidebar “Structuring equity investments.”) In most cases, this investment is in the form of a majority equity investment â that is, the new investor owns more than 50 percent of the equity in the company, or the bylaws of the entity are amended to grant effective control to the investor.
Non-control investment:
A
non-control investment,
often called a
minority equity investment,
is similar to a control investment, except the investor doesn't have control of the company.
Structuring equity investments
In the minds of most people, especially M&A novices, an investment comes in the form of
equity
â an investor buying stock in the company. This kind of investment makes the most sense when the company has publicly traded stock and the stock has a large-enough average daily volume to make the investment liquid.
But investments in private companies are highly illiquid because the shares don't trade on a public stock exchange, so investors are wise to structure the deal in the form of
convertible debt,
debt that they can convert to equity, usually at the time of their choosing. This way, if the company goes under, the investor gets repaid before equity holders, but she also has the option to covert her debt into to stock in the event the company goes public.
Why structure the deal this way? In the world of accounting, debt holders are higher up on the food chain that stock owners. Say a company has two investors: One person loaned $1 million to the company, and the other person owns 100 percent of the stock. If the company fails and selling the assets recoups $500,000, that money reverts to the debt holder, and the stockholder is wiped out. On the other hand, if the company is wildly successful, turning the debt into stock can be quite lucrative. Say that same company sells for $25 million. As a debt holder, the investor gets her $1 million (plus any outstanding interest) back, but as a stockholder, she'd receive the remaining $24 million.
As you may guess, Sellers tend to prefer the non-control investments, while Buyers prefer control investments. The control investor has greater recourse to change management and affect the direction of the company. The non-control investor simply goes along for the ride, with little or no recourse to exit the investment.
Diversifying assets: Take some chips off the table
Many business owners have nearly all their wealth tied up in their companies, so their finances are in serious jeopardy if the company fails. Selling a piece of the company to an investor allows an owner to create liquidity in an otherwise illiquid holding. This maneuver is called a
recap
(short for
recapitalization
).
With the right investor, an owner who has recapped her business also has a capital source for further investment in the business and/or for acquisitions. In other words, the investor may also be willing to pony up more money to invest in the business or pay for acquisitions. One of the many challenges for most business owners is the age-old question, “Do I pay myself a big fat dividend or reinvest that dough back in the company?” By selling off a piece of the company, the owner is essentially able to pay herself that big fat dividend and have a source of capital for growth.
Lastly, a recap sets up the owner to get a “second bite of the apple,” that is to say, to generate a second
liquidity event
(realizing a gain from an investment by selling shares for cash) when the company is sold to another acquirer. For an owner who's looking to retire in five to ten years, the recap can be a great way to lock in a certain amount of wealth and allow herself some additional time to continue to run and grow the company, setting up a potential second payday when she sells off her remaining shares and retires or goes off to another venture.
Bringing in an outside investor to buy out a partner
Partners are a great way to build a business: One person deals with one area, such as sales, and the other handles another (say, the back-office administration and accounting). That's a good coupling. The downside to having partners is that they sometimes stop seeing eye to eye, and one of them needs to leave the business.
For a closely held business, this situation can be a problem; the partner who wants to stay may not have the money to buy out the partner who wants to leave. Bringing in an outside investor is a way to solve this problem.
Planning Ahead to Ensure a Smooth Sale
If you're thinking about selling your company, a division, or a product line, you can take a few steps to make your asset more attractive to potential Buyers. This section tips you off to some areas to look at before you sell (or even decide to sell) so that you can avoid common pitfalls.
If Seller is unable to institute operational improvements prior to a sale process, she should inform Buyer where he can make additional improvements. Getting Buyer to pay for the improvements he's bringing to the table is often a difficult proposition, but it's usually worth a try. At a minimum, Buyer will view the suggested list of improvements as a sign of goodwill, thus increasing the odds of a successful closing.
Clean up the balance sheet
One of the biggest obstacles to getting a deal done is a messy balance sheet. Now, don't freak out about the accounting. Repeat after me: Accounting is your friend.
One of the key figures on a balance sheet is the
current ratio,
or the difference between current assets and current liabilities. Anything labeled
current
on the balance sheet is essentially the same thing as cash. So what are these cash or almost-cash items?
Assets:
Cash, accounts receivable, inventory, deposits, and prepaid expenses
Liabilities:
Accounts payable, accrued expenses (those not yet paid), and the current portion of any loans (interest, and perhaps some principal)
The current ratio measurement is important because if the current liabilities exceed current assets, the company is considered
illiquid,
which means that if all the current creditors demand immediate payment, the company doesn't have enough current assets to pay those demands. And if you're trying to sell a company, that's not going to endear you to most Buyers.
To fix up your balance sheet in preparation for a sale, follow these steps:
1. Collect your receivables.
Buyers check to see whether Sellers are diligent about this collection (at least, they should). If the terms are
net 30
(that is, money is due within 30 days), as a Seller you should be collecting those receivables within that time frame. If customers are taking longer to pay, that's effectively a use of cash.
Slow collections on receivables may mean Buyer has to obtain a
revolver loan
, a loan designed to help companies with fluctuations in cash flow. Loans aren't free; therefore Buyer may demand to reduce the purchase price to help defray the cost of that loan.
Buyer will likely assume your working capital, namely receivables and payables, as part of a transaction. Buyer will probably want all the receivables but may make you grant a discount on overdue accounts. Buyer will also only assume payables if they're current or
within terms.
For example, if a vendor gives you net 30 days terms but you've been paying net 45 days for years without complaint from the vendor, you can make a case that the actual (or
de facto
) terms are 45 days.
