Mergers and Acquisitions For Dummies (16 page)

Understanding why PE firms sell

Because PE firms are in the game to make money (and who isn't?), a PE firm will eventually be looking to exit its investment (which may now include some add-on acquisitions).

PE firms also hear the constant ticking of the
internal rate of return
(IRR), one of the key metrics they like to flaunt when raising capital. In a nutshell, the longer a PE firm holds an investment, the greater the chance the IRR will be lower than the PE firm prefers.

Evaluating a PE firm's portfolio company

I provide plenty of factors to consider in acquisitions throughout this book, but here are a few specific suggestions to look at for a PE firm's portfolio companies.

Does the company fit with your goals?
This question is pretty basic, of course, but as Buyer, take care when evaluating the fit of a portfolio company with your company. Despite the great case the PE firm may make for the portfolio company, a company that doesn't fit your goals isn't that great a deal.

How will the company's earnings affect your earnings?
If the acquired company's earnings increase your earnings, they're
accretive;
if they decrease your company's earnings, they're
dilutive.
Decide whether a potential earnings hit matters to your company. Consider also whether the acquired company will eventually be able to generate higher earnings for the entire firm if earnings take an initial hit.

Is the company actually an integrated set of other companies?
PE firms often cobble together multiple companies into one integrated firm. This setup is perfectly fine, and PE firms often do a wonderful job of integrating, but you need to be wary of just how well organized formerly disparate companies have been integrated.

How long has an integrated company been operating (since the last acquisition)?
If the acquired company is actually a group of formerly independent companies, don't make an acquisition too quickly. Waiting awhile (at least a year) to make sure these formerly independent companies are operating as a cohesive unit is a good idea.

Chapter 3

Previewing the Generally Accepted M&A Process

In This Chapter

Walking through a typical M&A deal

Discovering the difference between an auction and a negotiated transaction

Looking at both Buyer's and Seller's position

Keeping tabs on who has power

A
lthough the truism “always be prepared” applies to just about everything in life, it's especially true in mergers and acquisitions. To the uninitiated, the world of M&A may seem to be a Wild West of sorts: chaotic, bizarre, and full of strange nomenclature and acronyms. But believe it or not, the buying and selling of companies has a clearly defined process. To be a successful Buyer or Seller, you need to understand how that process works so that you can think many steps ahead and plan accordingly — just like a chess game, but without the checkered board.

In this chapter, I break down the phases involved in a typical M&A deal as well as define the two methods of selling a business: auction and negotiation. I also look at the constantly changing power balance between Buyer and Seller in a deal and provide suggestions on preserving as much power as possible in less-than-ideal circumstances.

Take Note! The M&A Process in a Nutshell

You don't wake up one morning and suddenly decide you want to buy or sell a business. A good deal of planning occurs before Buyer or Seller can undertake the process of buying or selling a business, let alone successfully close a deal.

The number of steps in the M&A process may vary depending on the type of deal you're negotiating (a quick auction versus a drawn-out negotiated sale, for example), but overall the process more or less remains the same. That's why being well versed in the generally accepted steps in the following sections is so important. M&A professionals have honed these steps over the years, and each step has a specific purpose.

The process to buy or sell a company isn't as linear as you may think, and it often takes longer and costs more than you expect. These steps aren't carved in stone, nor are they the be-all and end-all. Don't become rigid in your approach to doing deals; feel free to riff on these steps and write your own variations on a theme. The key points are to disseminate information in a timely, orderly, and appropriate manner and to close mutually beneficial deals.

To keep the process moving along, Seller needs to create a line in the sand by instilling due dates. The first due date will be for indications of interest. Buyers will almost always be late in submitting their indications, so Sellers are wise to allow for a little padding of time.

Step 1: Compile a target list

If ownership decides to sell or make acquisitions following discussions with advisors, family, friends, and management, the process begins by identifying prospective Buyers or Sellers. The key word here is
prospective;
these businesses may or may not be interested in doing a deal. You begin to make that determination in the following steps. Chapter 6 provides a much deeper dive into the process of researching, compiling, and culling a list of targets.

For a successful acquisition or sale campaign, I strongly recommend having at least 75 prospects, and preferably more than 100. Having a small universe of prospects simply lowers the odds of finding the right deal, but a list of many more than 150 targets gets untenable.

Step 2: Make contact with the targets

If the target list seems viable enough to warrant going through an M&A process (see the preceding section), Seller or Buyer begins to reach out to the targets. Some people prefer a passive approach (e-mails or letters), while others prefer a more assertive approach (phone calls). I prefer making calls when contacting Buyers (believe me, most of them are literally sitting by the phone waiting for a Seller to call). Contacting Sellers is far trickier. Check out Chapter 6 for more on contacting Buyers and Sellers.

Avoid hyperbole at all costs. Although I'm a big fan of creating a sense of urgency and having a call to action in my correspondence, telling prospective Buyers they need to act quickly or else they'll lose out on the greatest thing since sliced bread makes you sound like a snake oil salesman.

Step 3: Send or receive a teaser or executive summary

If Buyer wants to learn more about the company for sale, Seller will forward a teaser to Buyer. The
teaser
(sometimes called the
blind teaser
) is an anonymous document that provides just enough nonconfidential information to pique the interest of Buyer. As the name implies, the teaser is designed to tease Buyer into a frenzied state of wanting to know more.

An
executive summary
is similar to a teaser but isn't anonymous. These documents are the doorway that leads to the other steps in the process. Chapter 8 provides a lot more information on these documents.

Step 4: Execute a confidentiality agreement

If, after reading the teaser (discussed in the preceding section), Buyer is interested in learning more about Seller, the two parties often execute a
confidentiality agreement
(CA). (On planet Let's Use More Words, this document is called a
nondisclosure agreement
[NDA]). Essentially, Buyer promises to not share any of Seller's confidential and nonpublic information with anyone other than Buyer's advisors. Chapter 7 offers a detailed look at all the ins and outs of confidentiality.

The confidentiality agreement doesn't just extend to confidential information. As part of the agreement, Buyer usually agrees to not even mention that M&A discussions are ongoing.